Brexit: What next for financial services?
Andrew Probert CA, a director in EY’s Financial Accounting Advisory Services team, and part of the Big Four firm’s response to Brexit, speaks about the challenges and opportunities for the financial services industry in the wake of the EU referendum vote.
My role is primarily to educate clients when there is change on the horizon, be there to support them through the transition and help them when they’ve got tricky questions. I’ve been pretty busy since the EU Referendum result was announced.
We are working with a number of clients to help them through this period of transition, however, for the financial services industry, I don’t think they have defined all of the questions yet let alone found answers for them. In particular, there is increasing concern about whether or not the industry participants will be able to continue to conduct their business in the same way, if the passporting rules, under which so many of them operate, are lost.
The buzzword on everyone’s lips at the moment is “uncertainty”. There is uncertainty about the timing of the UK’s departure from the EU and there is uncertainty about what the new relationship will look like.
The longer this period of uncertainty the worse the potential impact could be for the industry and the people who work in it. It is, therefore, critical that the government sets out their proposed timelines and objectives as soon as is practicable.
There is a lot of work to be done, but this should be their key focus in order to minimise the potential impact and allow financial institutions and individuals to start planning for the future.
The government and the input of CAs
During this period, the government should be encouraged to engage with industry forums and bodies, like ICAS, and asking them to put forward the interests, views and opinions of their members. The CA network is large and wide with many holding senior roles in government, financial institutions and practice. It’s a hugely talented pool of individuals and I think they’re going to have a huge role to play in the coming days, months and years in informing and shaping policy.
A lot of the planning will depend on what type of model the UK Government wants to have with the EU. This could include joining the European Economic Area, along the lines of Norway, or negotiating bilateral agreements with the EU along the lines of Switzerland. They could also decide to go it alone under the World Trade Organisation (WTO) rules, which the USA utilises, or they could decide to sign up to the EU Customs Union like Turkey has done. However, it is more likely that we will see a bespoke arrangement, unique to the UK.
The present situation which we find ourselves in provides a number of opportunities for those willing to take them"
This will, and should, take a significant amount of time and effort to develop. There are encouraging signs from within the EU with Germany’s European affairs minister, Michael Roth, proposing a “special status” for the UK reflecting its size, significance and the length of its membership of the EU.
The major concern for the UK financial services industry during these negotiations will be the loss of “passporting” and the knock-on effect of having to set up a fully authorised branch or subsidiary in the EU. Depending on the outcome these entities may need to be independently substantial and fully capitalised in order to access the European markets.
The pros and the cons
The lack of a clear timeline given by the Prime Minister is understandable and whilst it has some obvious disadvantages, there could be some advantages as well. The longer the time frame to invoke Article 50 and to conclude the subsequent negotiations for the UK’s exit from the EU, the greater the period of uncertainty and I think this will have a two-fold impact.
Firstly, many European financial institutions who are headquartered in the UK, or overseas financial institutions who use the UK to gain access to the European markets, will be rethinking their strategy and geographical footprint ahead of the outcome which could lead to a potential exodus.
I’m personally not convinced that there will be a mass exodus, but most financial institutions will be, wisely, considering their options. Similarly, UK financial institutions will want to retain the most talented individuals and will be concerned that other institutions and markets will be trying to attract them.
Secondly, the markets will remain volatile and there is a danger that the UK could fall into a recession as investment decisions are delayed and cost-cutting initiatives are instigated. We’ve already seen the Bank of England trying to boost the economy through quantitative easing (which was over-subscribed in the latest reverse auction) and cutting the base rate to 0.25%, however, a prolonged low-interest rate environment is going to make life very difficult for many, if not all, financial institutions.
On the plus side, the more time it takes to get these negotiations hammered out, the more time financial institutions will have to prepare for the “new normal”. The types of decisions they are going to have to make and the restructuring they are going to have to undertake are significant projects that take a huge amount of time and effort to effect. Therefore, having more time to prepare, if they have not done so already, might be a good thing. That’s not to say the transition will be without its challenges, we have already seen from the UK’s ring-fencing regime just how much effort is required to effect significant structural reform.
I was recently at a presentation where Hubertus Väth, representing Frankfurt Main Finance, said: “Never let a good crisis go to waste.” The present situation which we find ourselves in provides a number of opportunities for those willing to take them.
What the EU referendum result has done is highlight a number of issues that have been bubbling under the water for quite some time. Many commentators think that the European banking industry is fundamentally broken, and the regulatory environment is rigid, contradictory and does not create favourable conditions for banks to thrive, no matter which city they operate in.
The current situation will force institutions to invest time and effort into deciding what type of organisation they want to be in the future and rethinking what their business model should be. In my view, we are going to see fairly significant mergers and aquisitions activity to facilitate the realignment of business models with financial institutions focussing on their most profitable, core activities and carving out the less profitable or capital intensive non-core activities.
We have already seen this happening in recent years and the EU referendum result will accelerate these plans. This will present the opportunity for new businesses to enter that space or for others to consolidate their positions.
The current low-interest rate environment will also mean investors are looking for alternative investments for return. This presents a huge opportunity for the wealth and asset management industry to take the market share away from the traditional high street and investment banks where people have previously invested. We have already seen wealth and asset managers amongst those quickest to react with many launching new products and raising redemption fees in response to the revised economic outlook.
Business as usual?
I am a naturally optimistic person and I try to impart that outlook on the people I’m surrounded by. In situations like this, there is always opportunity. Many people thought that a vote to leave the EU would be a complete disaster for the UK economy and that the financial services sector would crumble, pushing us into a deep recession.
This hasn’t happened - yet. If there is a recession I don’t think it will be as bad as some of the economists have been forecasting. EY’s ITEM Club has recently has downgraded its growth forecast from 2.6% to 1.9% for this year and down to just 0.4% for 2017.
The revised forecast is unfortunate, but it’s not a slide into recession. Rather, it means a slowdown in growth.
Without wishing to underplay the macroeconomic impact of the vote, the nature of the change is still a long way from the type of shock suffered by financial services during the crisis of 2008. Factors such as the strength of the UK’s banking industry, higher levels of capital and liquidity and the rigorous levels of regulation that our financial services firms have to meet, are all good signs that the sector is well placed to ride out this immediate period of uncertainty.
Whilst there will be changes to the financial services industry at a macro level, I think we will see the biggest changes at a micro level. Most financial institutions are going to have to evolve their business model, and at the very least, their legal entity structure. This presents a huge opportunity for everyone involved in the financial services industry to help reshape the way the financial services industry operates and that can’t be a bad thing.