The Brexit Conundrum: Implications and Repercussions on Corporate Banks
As Europe’s premier international financial center, the UK leads in most financial services areas. Around 35% of the EU wholesale financial services activity takes place in London and the country’s financial services industry attracts more FDI than any other sector (35%). Its share of the financial markets in the EU is as follows:
However, as a result of the landmark referendum in June, the dynamics of the UK financial services sector looks set to transform. In fact it seems clear that the effects will be widely felt – beyond financial services and beyond the UK. While politicians and companies are still trying to work out what the outcome will be, the uncertainty has driven Sterling to a 168 year low. And to make matters worse it may impact the location, liquidity and cost of financial services in Europe, undermining London’s global competitive position.
Industry experts have differing opinions about the effects. While a leading economist, Prof Patrick Minford has predicted that the UK’s financial sector will get a £20 billion boost from leaving the European Union, German thinktank Bertelsmann Stiftung has stated that leaving the EU could cost Britain £224 billion. Banks themselves are divided in their opinion. On one hand, both HSBC and Barclays have vowed to keep their headquarters in the UK and Deutsche Bank has said that London will keep its status as the premier financial center. On the other, heavyweights such as JP Morgan and Morgan Stanley have moved quickly to relocate some employees out of the UK, while others including Goldman Sachs Group and Citigroup are said to be planning to follow suit.
Why are they so worried?
One of the biggest areas of concerns of the UK banking industry comes from the fact that membership of the EU provides banks in the UK with the legal rights needed to serve customers cross-border. Brexit does not simply mean additional tariffs being imposed on trade – as is likely to be the case with other sectors – it is also about whether banks would retain their ‘passporting’ rights. Under this regime financial services firms based in the UK are allowed to operate throughout Europe without seeking separate authorization. Today, over 5,000 firms registered in the UK use passporting rights to gain access to and operate in other countries.
If they lose these rights, all major European banks with operations in London would incur significant costs and regulatory hurdles to continue doing business in other EU countries. Global banks could start to look elsewhere for their European bases because they would no longer be able to use the country as their passport to trade across the EU. To put things in perspective, the current free trade in financial services that crosses the Channel each year, helping customers and boosting the economies in the UK and Europe, is worth more than £20 billion.
There are currently 22 trade agreements between the EU and individual countries, and five multi-lateral agreements covering multiple countries. Once Brexit takes place if the UK wants to retain preferential access to the markets of the 52 countries covered by these agreements, it is argued that it will have to negotiate trade deals with all of them. This will take time and tremendous negotiation skill. Little wonder that some people argue that it simply isn’t possible. With such wide ranging possibilities, one must delve into the impact Brexit will bring in terms of SEPA payments, PSD2 and cash pooling:
- Will UK companies still be able to make and collect SEPA payments?
Given that we are in unchartered waters, uncertainty over business growth will prevail until the Brexit situation is clarified. It does seem certain that the UK will no longer be a member of the European Free Trade Association (EFTA). In the short-term, it is highly likely that UK based companies will be able to make and collect SEPA payments. If the UK doesn’t, however, either join EFTA or create its own trade agreement like other non EU states (Switzerland), then charges may be levied on SEPA payments. A ‘SEPA’ payment from the UK to France, for example, may be subject to a charge by the bank in France. SEPA collections too, centralized in the UK will possibly be subject to charges. Needless to say, the increased costs and increased friction will be deeply damaging.
- Will Cash Pooling still be optimal in London?
With a benign tax environment conducive for cross border business; access to markets and, a well-developed banking infrastructure with access to SEPA payments, London has been the preferred location by corporate treasures for their cash pool accounts.
However, many corporate treasurers will now be reassessing those cash pool structures and will reconsider their existing banking relationships. London’s loss could be Paris, Amsterdam or Frankfurt’s gain in the long term. While Paris has a stringent regulatory regime for setting up cash pooling structures, international cash management banks are well represented in Amsterdam and Frankfurt due to their liberal regulatory regime and sophisticated cash management culture and offerings.
Earlier this year HSBC CEO Stuart Gulliver indicated that the bank plans to move 1,000 of its investment bankers to Paris if the UK withdraws from the EU. This could be taken as a sign of what is to come should the UK vote to leave.
Not every bank will be impacted in this way though. The ones to be affected would be the UK regulated entities, such as HSBC, that use the UK to passport into Europe. A US headquartered bank for instance, could, in addition to relying on the EU passport, also have US branches operating in Europe that are negotiated locally in each particular country.
- Will PSD2 now be fully implemented in the UK?
Basically, Payment Services Directive 2 (PSD2) mandates that banks must provide account access to third party providers. While many large UK banks’ PSD2 plans are well developed, Brexit means PSD2 will no longer be applicable to payments in the UK. Will some banks now do what many FinTechs feared all along and attempt to avoid PSD2? Additionally, payment services providers who are not authorised (institutions exempted under PSD) within the EU, will need to establish a new legal entity within the EU, which in turn would have a significant cost impact on their businesses.
The way ahead
Corporate treasurers will need to understand what Brexit means for their banking partners and that some banks will be more affected than others. Those having relationships with some of the large UK banks might find that, operating from the UK, the banks can no longer offer the services they need to operate into the European market. Banks may need to move part of their business into Europe to keep servicing the markets locally.
The loss of passporting rights could be an equally significant issue for money market funds too. In the event of Brexit, asset managers could find that their ability to sell funds across Europe from the UK is hampered. As of today, the right to do this is guaranteed under the EU’s Undertaking for Collective Investments in Transferrable Securities (UCITS) Directive. But there is a very real possibility that the EU will seek to change these arrangements if the UK exits. If that were to happen some funds would have to either withdraw from marketing on the continent or re-domicile their assets. This too could become an issue for treasurers of European companies using UK domiciled sterling money market funds post-Brexit.
The process of Brexit will be initiated once Article 50 of Lisbon treaty has been triggered (which Theresa May has said she will trigger before the end of March 2017). Once triggered, negotiations are expected to complete with 2 years, however there is considerable concern about whether this timeline is even possible. In order to help insulate itself from volatility, the Bank of England reduced interest rates from 0.5% to 0.25% in August, the first reduction in the cost of borrowing since 2009 – taking UK rates to a new record low. Corporates and banks will have to work together to come up with the solutions needed to sustain their existing businesses without disturbing the original working model. And they will need to do this in the face of continuing uncertainty about what Brexit actually means – decisions which are being driven by politics that are outside of their control.