14 October 2019

Bruegel: Brexit and finance: Brace for no impact?

One of the structural shifts, or lack thereof, that may be associated with the UK’s possible departure from the European Union, and not the least, is the potential impact on the European and global financial system, writes Nicolas Véron.

London is currently the undisputed financial hub of Europe of the broader region encompassing the Middle East and Africa; together with New York, it is one of the two still-leading financial centres worldwide, despite the ongoing rise of Asia and especially China. How does an event as momentous as Brexit interfere with this critical regional and global role of the United Kingdom?

The answer so far is: not much, and looking forward, probably not much more. Massive as the political shock of Brexit is, the European and global financial systems are intriguingly resilient to it.

[...] Seen through the lens of the financial sector, the complex arborescence of possible UK futures boils down to two relatively simple observations.

First, the really decisive choice for the UK, from a financial-sector standpoint, is not whether or not to leave the European Union, but whether or not to leave its Internal (or single) market. The single market is closely associated with the EU construct and is defined by compliance by EU law, but its boundaries are broader than the Union’s. [...] So far, beyond responding to specific requests from supervisory authorities, most financial firms have appear to act on the baseline assumption that the UK is staying in the single market over their business planning horizon, and have correspondingly not made major changes to their operations even as they have sought new licenses to operate in the European Union outside of the UK.

Second, leaving the European single market would be severely detrimental to the UK as a regional and global financial hub. The loss of passporting rights would mean, to summarise a complex arrays of different situations, that the UK will no longer be the best place in its time zone to conduct financial business. In the benchmarking with the best competing locations within the post-Brexit European Union, the comparative advantages of the UK, significant as they are in matters such as language, culture, and the legal environment, would not be enough to offset the disadvantage of not being in the single market. As a consequence, new investment would be overwhelmingly directed elsewhere than to the UK, and there would most likely also be some direct transfers of activity from London to other European locations – in contrast to what has happened so far.

As a consequence, it appears highly likely that the UK will remain in the single market, even if it ends up leaving the European Union. The 2016 referendum was about leaving the EU, not the single market. Leaving the single market is too much pain for too little gain. And if the UK stays in the single market, its financial sector can and probably will keep its leading position regionally and globally.

If however, by an improbable twist of political dynamics, the UK does leave the European single market – a “hard Brexit” as the expression tends to be used – then the consequences may be dire for the UK, but will not be disruptive from a European let alone global perspective. Summarising again a lot, this is because the core of the City of London is a set of firms that are not structurally dependent on the UK: most are international arms of firms headquartered in the United States, or in Asia, or indeed in Continental Europe. For these firms, if London loses its edge, relocating elsewhere will be annoying and costly but by no means impossible. And one can be confident that European and other authorities will do what is needed to facilitate an orderly transition, because they have no interest in financial instability. [...]

Full analysis on Bruegel

A version of this opinion piece was also published on ispionline.it

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