Blog Post

Brexit endangers London’s status as a financial hub

The UK’s competitive edge in financial services is substantial and would be difficult to dislodge. But Brexit could damage London’s attractiveness as the centre of European banking, as an entry point to the EU and as a global financial hub. FDI is also at risk.

By: and Date: March 10, 2016 Topic: Finance & Financial Regulation

London’s strength as a global financial centre is impressive. The British capital has a share of nearly 50% in certain segments of global financial markets. Table 1 shows that the UK hosts  48.9% of the world’s interest rate over-the-counter (OTC) derivatives turnover and 40.9% of foreign exchange (FX) turnover. The UK is also one of the main players in the US equities trades, with 20% of the global market. By contrast, other European countries play only a comparatively small role in global markets: France hosts 7.3% of interest rate OTC derivatives, and 2.8% of FX turnovers. In terms of European markets, the UK and Germany each have a share of more than 20% in the issuance of securitisation. The share of investment fund assets in Europe is 24% for the UK, compared to 22% in France and 17% in Germany.

In general, the UK has been accumulating  substantial surpluses in trade of financial services over the last 15 years. Looking at the geographical distribution of UK financial service export in 2013, we see that 30% was with the European Union, while 70% was with the rest of the world. .

Recent research has found that the synchronisation of business cycles between the UK and the euro area has increased since the end of the 1990s. Campos and Macchiarelli have recently argued that this probably increases the costs of a potential UK exit from the EU. In a recent paper, we found that the UK credit cycle – measured here as the filtered growth of real bank credit to the private sector – has also become significantly more aligned with the credit cycle of the euro area, particularly since the end of the 1990s (figure 2). This suggests that EU-UK financial linkages have become tighter, although it does not tell us who would suffer the most from the financial consequences of Brexit. We should therefore look more in depth at specific aspects of UK-EU financial integration.

International integration of the banking sector

Turning to cross-border banking, table 2 shows that the banking sector of the euro area consists of 83% domestic banks, 14% banks from other EU countries, and only 3% from third countries. The rate of cross-border integration in the entire EU banking sector is even higher. 16 % of total bank assets are owned by banks based in other EU countries, and 9 % by banks from the rest of the world. By contrast, the UK seems to be a special case.  It is the only EU country with more claims from banks in the rest of the world (32 %) than from banks headquartered in the rest of the EU (17 %).

This can be explained through the role of major US and Swiss (investment) banks, which use their London offices as a springboard to conduct business across the EU. Indeed, when asked about the importance of EU membership for financial service businesses located in the UK, 49% of high-level professionals from “The City” cited access to EU customers and 46% cited the single regulatory framework for financial services as very important for their own business (see Ipsos Mori poll, 2013). The former is guaranteed through the role of UK authorities in ‘passporting’ banking and other financial services. Currently any firm headquartered in the UK can apply for a passport from the UK regulators to do business in the whole of the European Economic Area. The latter is granted through the European Court of Justice, which is in charge of enforcing single market rules.  84% of respondents said that the best option for the overall competitiveness of the UK as a financial center would be to remain a member of the EU.

Foreign direct investment in the UK

Beyond financial services, many European firms invest in the UK in a variety of sectors. When looking at the inward stock of Foreign Direct Investment (FDI), the EU is the biggest FDI investor in the UK, with nearly 500 bn GBP invested in 2014, as opposed to 253 bn GBP invested by the US (figure 3). The FDI investment of European firms is spread across different sectors (figure 4), in 2014 most notably retail and wholesale trade (83.2 bn), mining (67.5 bn), IT (48.7 bn) and financial services (47.5 bn).

In this context, 415 members of the Confederation of British Industry (CBI) in  a survey conducted by YouGov in 2013 also valued the financial aspects of EU membership: 52% of respondents said that the ability to invest in other EU states without restrictions had a positive or very positive impact on their business; 42% said that the ability of their company to attract inward investment from companies based in the EU would be negatively affected by the UK leaving the EU and 32% said that their company’s ability to attract investment from companies based in non-EU countries would be reduced. A sizable 75% of respondents expected that Brexit would have a negative impact on the level of FDI.

Brexit uncertainty

If Brexit happens, the advantages of EU membership that businesses appear to consider the most significant could be at risk. The UK’s passporting capacity in financial service might have to be re-negotiated. The UK’s adherence to a single rulebook would also be called into question, as exiting the EU would mean exiting the jurisdiction of the  European Court of Justice. However, much would depend on the exact form of EU-UK relationship that was built after Brexit. The UK could opt for a Norwegian-style agreement, and join the European Economic Area (EEA) with full access to the single market. It would then fall under the jurisdiction of the EFTA Court of Justice, which enforces European laws in countries which are part of the EEA, but outside the EU.This would mean adopting regulations and standards without much influence on their development, an awkward situation for the EEA’s preeminent financial centre. Another alternative would be free trade agreements or bilateral agreements, which could guarantee access to the single market in selected sectors while preserving independence in others.

However, the outcome of any negotiations for single market access or shared regulation is uncertain. This uncertainty alone could prove destabilising. Even if a new deal were eventually reached, the confusion surrounding the negotiations would have negative consequences for European firms operating in the UK and might endanger FDI flows to the UK. The attractiveness of London as a global financial hub and springboard to Europe might also suffer.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article Download PDF More on this topic More by this author

External Publication

ref dirk

Les banques européennes se retirent-elles de la scène internationale?

Dirk Schoenmaker conducts a comparative analysis of global systemically important banks (G-SIBs) and examines their evolution (Note: this paper is available only in French).

By: Dirk Schoenmaker Topic: Finance & Financial Regulation Date: May 23, 2017
Read about event More on this topic

Upcoming Event

Jun
2
12:30

Substance requirements for financial firms moving out from the UK

In the run-up to Brexit, UK-based financial firms are considering how to organize their operations across the future divide between the UK and EU27. This event will discuss the regulatory requirements on how self-sustaining the operations in the EU should be, and implications for the single market and third countries.

Speakers: Gerry Cross, Simon Gleeson and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic

Blog Post

Uuriintuya Batsaikhan
DSC_0794

UK economic performance post-Brexit

What’s at stake: Almost a year after the UK voted to leave the European Union, its economic performance has showed mixed results. The risks of a Brexit-induced recession do not seem to be materialising. On the contrary, up until the end of 2016 the UK saw a continuation of strong consumer spending and strong output in consumer-focused activities. However, the UK economy is showing signs of slowing down in the first quarter of 2017, with weak growth in the services sector and business investments. In addition, strong consumption growth started to cool down as individuals’ purchasing power declines due to a weaker exchange rate. This leads to a question whether it is the beginning of the Brexit slowdown. We review the contributions made on this topic in the last year.

By: Uuriintuya Batsaikhan and Justine Feliu Topic: European Macroeconomics & Governance Date: May 15, 2017
Read article More on this topic More by this author

Blog Post

André Sapir

International arbitration is the way to settle the UK’s Brexit bill

The UK-EU financial settlement risks becoming a toxic stumbling block in Brexit negotiations. But there are actually much more important issues to discuss. To diffuse the issue, both sides should agree to independent international arbitration.

By: André Sapir Topic: European Macroeconomics & Governance Date: May 11, 2017
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

Brexit will change millions of lives. Our leaders must do more than posture

From the land border with Ireland to expats’ pension rights, there is much to negotiate.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: May 8, 2017
Read article More on this topic More by this author

Podcast

Podcast

How will Europe's banking system respond to future challenges?

After the financial crisis, the EU has taken measures to create conditions for a safer banking sector. One of the key measures to do that is the creation of the banking union. How successful has the implementation of the new framework been so far? How will issues in the Italian banking sector be addressed? And how will Brexit change the European banking sector?

By: The Sound of Economics Topic: Finance & Financial Regulation Date: May 5, 2017
Read article More on this topic More by this author

External Publication

palgrave handbook of european banking

The Banking Union: An Overview and Open Issues

Dirk Schoenmaker's chapter in 'The Palgrave Handbook of European Banking', a handbook that collates the expertise and research of leading academic and senior policy makers in the field of European banking

By: Dirk Schoenmaker Topic: Finance & Financial Regulation Date: May 2, 2017
Read article Download PDF More on this topic

Policy Contribution

PC 11 2017 2004test

Tackling Europe’s crisis legacy: a comprehensive strategy for bad loans and debt restructuring

Years after the start of the financial crisis, non-performing loans and private debt remain obstacles to the recovery of bank credit and investment.

By: Maria Demertzis and Alexander Lehmann Topic: Finance & Financial Regulation Date: April 21, 2017
Read article Download PDF More on this topic

Policy Contribution

PC 10 2017 cover

Europe’s role in North Africa: development, investment and migration

The authors of this Policy Contribution propose five ways in which EU policymakers can contribute to development in North Africa and build partnerships on trade, investment and migration.

By: Uri Dadush, Maria Demertzis and Guntram B. Wolff Topic: Global Economics & Governance Date: April 8, 2017
Read about event

Past Event

Past Event

Micro- and macro-based methods in assessing the impact of investment

This workshop will discuss methods for accurately evaluating the performance of public and private investment initiatives.

Speakers: Francesco Di Comite, Grégory Claeys, Zsolt Darvas, Helmut Kraemer- Eis, Áron Gereben, Robert P. Lieli, Simon Mizrahi, Amine Ouazad, Debora Revoltella, John K. Swales, Simone Signore, Natacha Valla, Marcin Wolski and Guntram B. Wolff Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 5, 2017
Read article More on this topic

External Publication

g20 insights cover

Key policy options for the G20 in 2017 to support an open and inclusive trade and investment system

In the face of exceptional challenges, the G20 should step up its efforts in 2017 to preserve the current global trade and investment system, including effective multilateral dispute settlement procedures, while not losing sight of medium-term reforms. The G20 should focus on (1) supporting the World Trade Organization, (2) being upfront about the mixed effects of trade and investment, (3) improving G20 measures to tackle protectionism and (4) promoting investment facilitation.

By: Sait Akman, Axel Berger, Uri Dadush, Simon Evenett, Lise Johnson, Maximiliano Mendez-Parra, Raul Ochoa and Claudia Schmucker Topic: Global Economics & Governance Date: April 3, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Italian banks: not quiet on the eastern front

Italian banks are back in the spotlight. After MPS failed to raise enough capital from private investors earlier this year, Banco Popolare di Vicenza (BPVI) and Veneto Banca take centre stage. The story of these two banks epitomises the strategy of delayed reform that has been so characteristic of the Italian banking crisis.

By: Silvia Merler Topic: Finance & Financial Regulation Date: March 31, 2017
Load more posts