Financial services make up nearly 10% of the UK economy. With the debate over whether or not Britain should stay in the European Union in full swing ahead of the June 23 referendum, it is important to understand how a Brexit could affect this important part of the UK economy.
As a full member of the EU, the UK has unconditional access to the single market, which includes the market for financial services. This includes banking, selling securities, insurance, and related services such as accounting and auditing.
EU membership means that the UK is automatically subject to EU financial regulation. However, the UK has a say (meaning it has a vote) in the making of EU financial rules, like in other aspects of EU legislation. EU financial legislation is decided jointly by the European Parliament and the Council of Ministers, and the UK is represented in both these institutions.
Various UK institutions are members of the European supervisory authorities which, among other things, promote cooperation among national financial supervisors in banking, securities markets and insurance. The European Banking Authority, which is one of the three EU’s supervisory authorities, is based in London.
If Britain decides to leave the EU there is likely to be a regulatory impact and a corresponding impact on trade. The exact nature of which depends on what type of relationship Britain has with the EU and what deals are struck, should there be a Brexit.
In the EU, the UK has by far the largest financial sector and the British financial industry has strongly benefited from access to the single financial market. According to data from TheCityUK, a financial sector lobby group, the EU is the biggest market for UK exports of financial services, generating a trade surplus of £15 billion, a third of the UK’s total trade surplus in financial services, which totalled £46 billion in 2012. The UK’s financial services trade surplus with the EU has more than doubled over the past decade.
About 70% of the EU’s foreign-exchange trading and 40% of global trading in euros takes place in the UK. The UK hosts 85% of the EU’s hedge-fund assets, 42% of EU private-equity funds, half of EU investment bank activity, half of EU pension assets and international insurance premiums.
The UK attracts more foreign direct investment (FDI) than any other EU member state, and financial services are a big part of this – they attract FDI more than any other sector. More than £100 billion has been invested into the UK by foreign companies since 2007. While more than half of this came from outside the EU, access to the single market is a major motivation for it.
There are different scenarios of Brexit: “Full Brexit”, whereby UK-EU relations are regulated by the World Trade Organisation; the UK joins the European Economic Area and has to comply with EU rules to enjoy access to the single market (as Norway does); or UK-EU relations are regulated by a set of specific bilateral agreements in a variety of economic sectors, as in the case of Switzerland.
Although each Brexit option has specific implications for financial services, they all share three key features:
The UK would have the power to negotiate international trade agreements, albeit it would have less bargaining power than the EU as a whole, given the comparative size of the two economies. Excluding the UK, the EU economy is about seven times the size of the UK economy. About half of the UK’s total trade is with the EU, while only 8% of EU trade is with the UK. The EU, excluding the UK, has a market of 445m consumers, compared to the UK’s market of 63m.
The UK financial industry would have access to the EU market if the UK adopted the bulk of EU financial regulation – but it would not have a say in the making of those rules. Alternatively, the UK could appeal to the EU that its rules be considered as equivalent to EU rules. This would require some sort of agreement to be made, however, and that depends on the willingness of the other EU member states to negotiate this deal.
Theoretically, there is the possibility that if an ad hoc bilateral relationship were to be agreed by the UK and the EU, the UK would be able to maintain unrestricted access to the EU single market without having to comply with EU financial legislation. But this should not to be taken for granted. Currently, it is not the case for Switzerland, which does not enjoy unrestricted access to the single financial market, despite the importance of the financial services industry there.
So, although the exact impact of a Brexit on Britain’s financial services industry is unclear, it is safe to say that it will suffer as a result. Firms will have less influence over the market they are operating in and trade is likely to decrease. Given the industry’s size and importance, this is bad news for tax receipts and the UK economy as a whole.