FS industry faces up to Brexit uncertainty

With the UK’s departure from the European Union now less than 12 months away, FStech assesses the impact a potential deal could have on the financial services sector.

The UK government and the EU recently reached an agreement regarding the implementation period of the UK’s withdrawal from the EU, which will operate from 29 March 2019 to the end of December 2020, during which time the UK will remain under jurisdiction of European Union law.

The government outlined a “desire for the freest possible trade in financial services between the UK and EU member states” in a Brexit white paper, with prime minister Theresa May envisaging financial services being covered by a comprehensive Free Trade Area (FTA).

Throughout the implementation period, financial services firms and funds will continue to benefit from ‘passporting’ – which enables institutions in the UK to sell their services across the EU without any regulatory barriers. However this is one of the benefits of the EU that is now under threat from a Brexit agreement.

Chief Brexit negotiator for the EU, Michel Barnier, recently expressed to the Centre for European Reform that the UK will lose passporting rights by withdrawing from the EU single market.

As a result, UK firms may no longer be able to offer services across the continent, and would potentially have to establish subsidiaries within the EU and apply for a local licence. This will have a direct impact on around 5,500 financial firms in the UK that currently take advantage of European passporting, who exported over £20 billion of services in 2014, according to the British Bankers Association.

The financial services industry plays an important role in the well-being of the UK economy, employing more than one million people and accounting for over seven per cent of the total value created by UK industry. In 2016, the City of London Corporation estimated that the sector generated more than £70 billion in tax revenues, making up 11.5 per cent of the national total.

A recent report from PwC estimated that the overall impact of leaving the Single Market would be negative for the UK’s financial services sector – with the gross value added of the sector predicted to dip by 5.7-9.5 per cent by 2020.

One potential outcome of Brexit could be the adoption of the Swiss banking model, by operating through subsidiaries without passporting rights. The UK government could also pursue new free trade agreements beyond the market access rights provided under the current EU regulations, following recent FinTech deals with China, Hong Kong and South Korea.

FStech spoke with Graham Olive, chief executive of digital-focused challenger bank OakNorth about how they are preparing for the Brexit outcome, with such uncertainty surrounding the negotiations. He sees the UK’s withdrawal from the EU as an opportunity for the government and the Bank of England to determine which aspects of legislation from the EU they wish to maintain and which they wish to reform, and introduce more proportionate regulation for new banks vs incumbents – particularly in respect to capital.

“Currently, the European Banking Authority mandates that national regulators in EU member states must impose the Basel standards in full on all banks, regardless of size or whether they pose a systemic risk or not,” Olive explained. “This means that new banks like us have to adhere to more onerous capital requirements and hold up to 10 times more capital than larger banks to write the same loan. We have to use a Standardised Approach to our risk weighting, compared to the Internal Risk-Based model that larger banks get to use.”

By moving away from the Standardised Approach, OakNorth would be able to apply its own model regarding risk weighting – which would provide the bank with more capital at its disposal, enabling more lending capacity.

To prepare for the UK’s withdrawal from the EU, OakNorth is proactively monitoring its borrowers, reviewing their monthly and operations data, factoring in any potential impact of Brexit into credit decisions. Olive noted how difficult it is to foresee what the impact Brexit will have on the bank, “but by working with established, profitable businesses with excellent management teams, and ensuring that we do robust credit analysis and proactive monitoring, we’re confident in our ability to continue growing our business and our loan book post-Brexit.”

Another issue is the potential talent drain that Brexit brings, as European workers wither have to leave or find it harder to get work visas in the UK.

Research from the Enterprise Investment Scheme Association (EISA) among its members found that 71 per cent from the UK and Ireland said the triggering of Article 50 was the one event that had the most impact on the European FinTech sector, reporting that it had impacted their companies in terms of hiring and fundraising.

Dan Jones, head of UK digital capability at management and technology consultancy firm Capco, said he has seen certain roles in banks going to Dublin and Paris, which is a general trend across the industry.

“If we talk about digital skills – people who can work in an agile way, like product designers, developers, people with a lot of digital experience – those skills are in high demand in the UK full stop, there’s a massive shortage,” he stated. “The challenge for both FinTechs and existing banks who are trying to compete in this space, is just getting the numbers of people, but also the quality, and Brexit will only exacerbate this situation.”

Meanwhile, a report from free market think-tank the Institute of Economic Affairs (IEA) argued that Brexit presents an opportunity to improve its own regulations and work with other international financial centres.

One of its authors and the IEA’s director of international trade, Shanker Singham, said that now is the time for the UK to promote more competitive regulation in global standard setting organisations and to challenge global rules with anticompetitive effects.

“Financial regulation is already based on international standards in many key areas,” he explained. “Outside the EU, the UK will have the advantage of greater agility in decision making, entering into regulatory recognition arrangements with third countries and implementing appropriate regulations. If these tracks are initiated, the future for UK financial services should be very bright.”

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