Brexit’s Winners and Losers. An Empirical Analysis of Economic Effects of Deglobalisation on the Financial Services Industry

Bachelor Thesis, 2020

27 Pages, Grade: 1,0



Albeit the United Kingdom withdrew from the European Union on 31 January 2020, the parties' mutual relationship remains unsolved and subject to negotiations. This paper pursues the impact on the financial services industry in case that the trade talks do not bear fruit.

On that account, the status quo ante Brexit is examined in terms of the legal framework and the current mutual interconnectedness of both parties in financial services. Thereafter, the status quo post Brexit is approached with an emphasis on scrutinising the legal framework for providing financial services into the European Union as a third country.

It is identified that third-country equivalence is not a suitable substitute for passporting. Equivalence is mostly deficient in its scope of establishing market access and it constitutes as unstable and uncertain. Further, it is anticipated that an affirmative equivalence decision of the United Kingdom shall solely be expected for subindustries that pose an intra-EU comparative advantage. Sustainable access to the European single market may be approached through physical relocation into the European Union. Eventually, the status of the City of London is jeopardised as a hard Brexit weakens the City's core principles for its long-time strength. Holistically, the United Kingdom must define its place in the world; regarding the EU, it will be treated as any other third country.

1. Introduction

Over the last decades, a strong increase in global interconnection and worldwide integration has unleashed a free movement of capital, people and goods while diminishing the role of nation states. With the United Kingdom's (UK) withdrawal from the European Union (EU) on 31 January 2020, hereinafter referred to as Brexit, a rejection of globalisation can be observed and further, a so-called process ofdeglobalisation has been induced (Coyle, 2016).

Anti-globalisation movements are caused by various reasons; in the case of Brexit, it was encouraged, inter alia, by seeking to take back legislative control over the country. Causes aside, resulting from jointly occurring disentanglements of economic relations, deglobalisation comes along with a certain economic cost; viz. HM Government (2018) estimates the total impact of Brexit on the UK's Gross Domestic Product (GDP) to be negative under every possible scenario of future arrangements. Further, it is shown that the higher the intended degree of deglobalisation is, the smaller the overall long-run level of economic output will be. While certain overall losses must undoubtedly be put up with for "freeing oneself from the EU's clutches", the sectoral heterogeneity of global integration lets the severity of the effects of Brexit be sectorally depending.

Since the financial services industry is usually among the most globally entwined components within an economy (Armour, 2017) and in light of the present crises of globalisation (Witt, 2019) understanding the impact of deglobalising the financial services industry has become essential. According to Armour (2017), financial services "comprise all the activities undertaken in the financial system - the sector that channels savings from consumers toward firms and households that need finance for investment or current consumption. It includes banks, asset managers, financial markets and insurance" (p. 54).

While as of August 2020, the status of the future relationship between the UK and the EU, consequently, the degree ofdeglobalisation, remains subject of the ongoing negotiations, this paper approaches a no deal scenario. Besides the limited likelihood of reaching and ratifying a Free Trade Agreement (FTA) in less than a year1 and the negative impact of the pandemic SARS-CoV-2, the previously negotiated FTAs of the EU address financial services if at all, only slightly (Lang & Conyers, 2014; Magntorn & Winters, 2018). Apart from that, Lang (2018) points out that the terms of the World Trade Organization (WTO) continue to apply alongside and in addition to any other agreement reached and that any additional agreement will only render obsolete certain aspects of the WTO regulation. Therefore, the WTO option does not only represent a backstop when an agreement fails to be reached but the foundation of all future relationships between the UK and the EU.

Accordingly, this paper aims to analyse what the impact of a no-deal Brexit on the Financial Services Industry is. Given the significant global integration of the UK's financial services industry as the largest exporter and the host of the world's leading centre of financial services (House of Lords, 2016), the gained observations and experiences from the example of Brexit shed greater light on determining the consequences of deglobalisation on the financial services industry.

In order to determine the impact of a no deal Brexit on the financial services industry, it will be assumed that not only within the transition period but also in the long term, i.e. after an initial period of no relations, no further agreements will be reached between the UK and the EU. Further, the impact will be analysed solely for the industries of the two directly involved parties, thus the EU and the UK. In this course, given that the UK's exports in financial services strongly exceed their imports of financial services in trade with the EU (House of Commons, 2020), the UK will be considered as the exporting nation; and consequently, the EU will be treated as the importing nation of financial services. Based on this trade surplus indicating a greater reliance from UK-based financial services firms on the EU than from EU-based financial services firms on the UK, the focus will be laid on UK-based financial services firms, which as a whole represent the UK's financial services industry. The remainder of this paper is structured as follows: after an initial introduction to Brexit and the development of the relationship negotiation; in the third section, the status quo of the financial services industry ante Brexit will be depicted. In this regard, the legal framework will be emphasised, and the mutual reliance will be identified. In order to forecast the future situation of the financial services industry after the transition period, the legal relationship under WTO terms will be thematised in the fourth section. Within this section, a focus will be laid on the possible legal paths of the provision of financial services. Based on the derived legal aspects and considering the political influences in the absence of any relationship, in the fifth section, a post transition period outlook for the financial services industry will be given.

2. Development of Brexit and UK-EU Relationship Negotiations

Ever since the UK's accession to the EU, precisely, its predecessor, in 1973, Euroscepticism has been a strong cultural component in the UK that caused recurring political campaigns calling for revoking 2 the UK's membership in the EU (Spiering, 2015). Following Conservative Party's manifesto commitment for the UK's General Election in 2015, on 23 June 2016 the 'United Kingdom European Union membership referendum' took place resulting in 51.89% of the votes cast being in favour of leaving the EU. As the referendum was not legally binding the required Parliamentary approval was then given in March 2017 allowing Prime Minister May to formally initiate the withdrawal process by invoking Article 50 of the Treaty on European Union (Barnard, 2017). After triply extending the original only two years lasting negotiation period, a withdrawal agreement was reached and ratified by the UK and the EU, resulting into UK's official secession from the EU on 31 January 2020.

Given that any future relationship may only be negotiated once the UK has left the EU, i.e. became a third country, in withdrawal agreement's Article 126 a transition period is defined seeking to mitigate the impact of the secession by binding the UK by EU law while allowing them unfettered access to the EU's Customs Union and single market (Duff, 2016). Since prolonging this transition period must have taken place before 1 July 2020, the transition period will cease on 31 December 2020. Thus, the UK and the remaining EU have less than a year to negotiate, reach and ratify a, if any, post-Brexit relationship.

In light of the UK's redlines on topics such as the free movement of people, the European Court of Justice or the independent trade policy, as presented by the slide of Barnier (2017), feasible post- Brexit models like joining the European Economic Area (EEA), the European Free Trade Area or the Customs Union are ruled out. Therefore, there remain only two possible outcomes reachable within the transition period for its time after: either the UK and the EU approve on a FTA, or they do not. In the latter outcome, hence in the absence of any deal, the relation between the UK and the EU will fall back solely on the terms of the WTO. Especially after the UK successfully withdrew from the EU, this default option is commonly referred to as a no deal Brexit2.

3. Status quo ante Brexit

In order to be able to identify the changes caused by a no deal Brexit, this section analyses the initial situation of the financial services industry. For this purpose, the UK's financial services industry's provision of financial services into the EU will be examined and the legal framework for financial services will be illustrated. Further, the EU's areas of pronounced reliance on the UK's financial services industry will be approached and the ecosystem of financial services will be covered.3

3.1. The UK's Financial Services Industry's Reliance on the EU

Financial services is a crucial sector of the UK's economy; as beyond its vital role for the wider national economy, e.g. through the provision of capital, it also accounts for 7-12% of the UK'S GDP (House of Lords, 2016). Further, about 1.1 million people are employed in the UK's financial services industry, representing 3.1% of total employment in the UK (House of Commons, 2019). In addition to that, Oliver Wyman (2016) analysed that the financial services industry generates annual revenues of about 200 billion pounds resulting in 60 to 67 billion pounds in taxes making financial services a significant source of income for the UK Government.

Reported in Table 1, those revenues in financial services generated by UK-based firms in the year of 2015 are further itemised by their sectoral breakdown. It can be seen that the contribution to the overall 45 billion pounds of revenues generated in relation to the EU differs substantially by subsector. In fact, the subsector of 'Market Infrastructure' (10.5 billion pounds) generates more revenues related to the EU than the two subsectors 'Asset Management' (5.5 billion pounds) and 'Insurance' (4 billion pounds) combined. Nevertheless, by generating more than half of all EU- related revenues, the subsector of 'Banking' (25 billion pounds) is by far the most relevant element of the UK's revenues related to the EU. Hence, measured by the revenue generated, 'Banking' represents the UK's most substantial component offinancial services related to the EU.

In orderto evaluate the relevance of EU-related revenues and the thereby inferred dependence on the EU market, the fraction of EU-related revenues relative to the overall revenues is considered. Accordingly, Table 1 illustrates that the 45 billion pounds of revenue generated in international and wholesale business related to the EU account for approximately one-fourth of all revenues generated by the UK's financial services industry. However, it is important to remark that the relevance of revenues generated in relation with the EU is significantly different for each subsector. Therefore, specific subsectors are more reliant on the economic relationship with the EU.

Evidently, the subsector of 'Market Infrastructure' can be perceived as strongly dependent on its EU revenues (EU-fraction of 44%). Meanwhile, for the subsectors of 'Asset Management' (EU-fraction of 26%) and of 'Banking' (EU fraction of 22%), the EU market is less and only partially relevant. The subsector 'Insurance' possesses only minor reliance on EU revenues (EU-fraction of 10%).

Hence, while the subsector 'Banking' is the driving force of the UK's revenues in relation with the EU, the byfar most on the EU dependent subsector is 'Market Infrastructure'.

Table 1. The UK's financial services industry by subsectors (2015)

Abbildung in dieser Leseprobe nicht enthalten

Notes: Data obtained from a study conducted by Oliver Wyman (2016). (1) Values represent the middle ofthe estimated range and are expressed in billion pounds. (2) Contains 'Sales and Trading', 'Investment Banking', 'Retail and Business Banking' and 'Private Banking and Wealth Management'. (3) Comprises 'Domestic Retail and Commercial', 'Corporate and Speciality' and 'Reinsurance'. (4) Includes mainly a full range of 'Technology', 'Credit Rating Agency' and 'Payment and Data Services'. Further, it lists 'Securities Services and Exchanges', 'Clearing' and 'Inter-Dealer Broking'.

3.2. The EU's Legislative Framework

By virtue of the UK's former EU-membership, UK-based firms could enjoy the advantages of EU legislation. In the following, those essential benefits of EU legislation will be discussed.

3.2.1. Financial Services Passport

While international endeavours commonly require a firm's compliance with the relevant regulations separately in each of its operating countries, the mechanism of passporting relies on the idea of mutual recognition and harmonised prudential measures (European Parliament, 2017a). Essentially it means that any financial services firm, which is located in the EEA and authorised by its domestic regulator, may provide its services into, on a cross-border basis, or within, through an established branch, all other EEA Member States without any further authorisation. A financial services firm that wishes to operate based on passporting solely needs to notify its domestic authority about its intention (De Vries et al., 2017). Hence, by avoiding the elsewise requirement of establishing a separate subsidiary in a country before providing service there, no additional regulatory obligation nor any additional costs are faced (House of Lords, 2016). Consequently, given that there are no additional costs, nor any additional conditions posed, a country's membership in the EU de facto expands the possible scope of firms' national operating area by the area of all other EU Member States. At the same time, from a macro environment point of analysis in matters such as potential political tensions, passporting can be perceived as a suitable business model as it is reliable and generally permanent.

Passporting rights are split by the particular activities and services they grant; thus, the mechanism of passporting is embedded in various directives ofthe EU's financial services legislation. Therefore, firms eventually use more than one kind of passport to provide different services under different directives. Nevertheless, those separate passports operate in an additive way (House of Lords, 2016).

3.2.2. Free Movement of Labour

EU legislation defines all citizens of each and every EU Member State as citizens of the Union who possess four principal rights. Firstly, citizens of the Union may leave a Member State, enter into another Member State and reside there. Secondly, they are entitled to labour as a worker, selfemployed or as a provider of services. Thirdly, irrespective of the nationality of their family members, citizens of the Union may bring their family along. Further, those family members are entitled to work.4 Lastly, citizens of EU Member States and their family must be treated equally and may not be discriminated directly or disproportionally indirectly (Barnard, 2018).

Consequently, from the perspective of UK-based firms, the employment of citizens of other EU Member States de facto does not differ from the employment of UK citizens. Therefore, UK-based financial services firms benefit from recruiting their employees from an ampler variety as it results in a deep and more diverse pool of human capital (Armour, 2017).

3.3. The City and the Ecosystem

Key drivers for the development of the UK's financial system have been its pioneering in a market- based financial system (Rajan & Zinglas, 2003) and the UK's membership in the EU (International Monetary Fund, 2016). In fact, the framework of the European single market enables countries and regions within the EU to specialise in their strengths in goods and services. In the UK, especially in its capital, the city of London (City), this grouping occurs in financial services (Gros, 2016). As firms providing financial services concentrated their activities in the City, throughout the years, the City has evolved into the EU's principal wholesale financial center (Lannoo, 2016). As such, the City offers its financial services to firms, states and institutions and furthermore refinances other financial centres (Lannoo, 2017). The City's vital essentials for its attainments and its resistance to crisis are explained by The Economist (2019) as "stable politics and regulations, close ties to America and seamless ones to Europe".

This high concentration of financial activities in the City and its resulting vast scope of its mighty cluster led to high complexity and strong interconnectedness of financial services which should be viewed as a financial ecosystem (House of Lords, 2016). A settlement in a pronounced cluster, such as the City, causes financial services firms to grow faster than average (Pandit, Cook, & Swann, 2001) and increases the efficiency of the system (International Monetary Fund, 2018). Those agglomeration externalities are induced by spill-over benefits from accessing a diverse pool of human capital. Additionally, they let the City benefit from "rapid circulation of innovations and tacit knowledge" (Armour, 2017, p. 56).

3.4. The UK's Financial Services in the Eyes of the EU

Having had the City as a leading global financial centre and its prowess located within the EU's territory has been highly beneficial for the EU. Currently, about one-fourth of the EU's financial services are obtained from the worldwide largest international financial centre (The Economist, 2019). Generally, the City, as the financial hub of the EU, with its enormous pool of liquidity and capital markets provides essential sources for governmental and firm funding across the EU.5 Nevertheless, the relevance of UK-based financial services for the EU differs radically when considering the subsectors of the industry. For instance, UK-based banks are of minor importance for the EU in terms of direct lending, whereas the EU relies substantially on the UK in areas such as the clearing of derivatives (European Central Bank, 2020).

As is well known, a central counterparty clearing house (CCP) strives to introduce efficiency and stability into financial markets by interposing itself between contractual counterparties and thereby guaranteeing the compliance with the terms of trade in any case including such of one party's default. Access to a CCP for a party of a transaction is commonly given through a clearing member like a clearing firm. In 2019, on average6, about 80% of the EU's clearing members' over-the-counter derivatives' positions were cleared through the UK's CCPs (ECB, 2020).

Another aspect of the EU's reliance on the UK is given through global banks and investors whose preferential base of EU-operations is the City7 (TheCityUK, 2016). Those global banks, which are based outside the EU, access the European single market from a subsidiary in the UK through the in subsection 3.2.1. discussed framework of passporting. Global banks' importance for the EU market can be approximated by their anterior portion to finance public spending and firm activities. Over the last seven years, global banks issued, on average, 47% of the EU's debt and 48% of the EU's equity. Further, EU-based firms' mergers and acquisitions were to 43% financed by global banks; additionally, they lent 29% of the volume of syndicated loans (ECB, 2020).

Abbildung in dieser Leseprobe nicht enthalten

Figure 1: The UK's share of the EU's financial markets (2015). Data obtained from the TheCityUK, 2016.

According to Figure 1, in which the UK's share of the financial market of the EU is illustrated for various activities, it can be seen that particularly activities in wholesale markets such as trading of foreign exchanges are mainly concentrated in the UK. Further, there is pronounced reliance in asset management. Generally, around one-third of the EU's wholesale financial services occurs in the City (TheCityUK, 2016). In line with this, Armour (2017) identifies that "UK's greatest intra-EU comparative advantage lies in asset management and wholesale markets" (p. 56). With the EU being "overbanked", the significance of EU's dependence in wholesale markets gains further weight (European Systemic Risk Board, 2014).8


1 Commonly, the EU's FTAs required several years to be finalised (cf. e.g. the 7-years-lasting negotiations with Canada).

2 Development of Brexit and UK-EU Relationship Negotiations Ever since the UK's accession to the EU, precisely, its predecessor, in 1973, Euroscepticism has been a strong cultural component in the UK that caused recurring political campaigns calling for revoking

3 Effectively, a no-deal Brexit describes the UK's withdrawal from the EU without a withdrawal agreement.

4 Barnard (2018) points out that for UK-based firms the possibility of accessing talent through the granted rights to family members (e.g. spouses) to work has been essential.

5 TheCityUK (2014) estimates that about two-third of revenues in European Capital Markets and Investment Banking generated from non-UK EU clients are touched by the UK.

6 Based on data for March, June, September and December.

7 Half of all EU headquarters of non-EU firms as based in the UK (TheCityUK, 2016).

8 Status quo post Brexit Once the transition period ends on 31 December 2020, the de facto EEA Member State status of the UK will be terminated. Therefore, after the transition period, UK-based firms will no longer be able to rely on EU rights. As the UK and the EU are both members of the WTO, the trade in financial services between the EU and the UK will then be regulated by the General Agreement on Trade in Services (GATS). However, in the area of financial services, the GATS regime solely seeks to eliminate redundant barriers by governing the process of regulating cross-border provision. Hence, the GATS does not cover the content nor the scope of its members' domestic regulations (Alexander, 2018), and it does not open markets (Grant, 2018). Further, the Member States' autonomy in their

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Brexit’s Winners and Losers. An Empirical Analysis of Economic Effects of Deglobalisation on the Financial Services Industry
European University Viadrina Frankfurt (Oder)
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brexit’s, winners, losers, empirical, analysis, economic, effects, deglobalisation, financial, services, industry
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Lukas Kirchner (Author), 2020, Brexit’s Winners and Losers. An Empirical Analysis of Economic Effects of Deglobalisation on the Financial Services Industry, Munich, GRIN Verlag,


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