It’s difficult to determine the impact of a potential British exit, or Brexit, on the country’s financial industry and the foreign investors it serves. The terms of any exit would only become clear after a vote to leave.
But speculation abounds and investors, including Canada’s largest pension funds, are watching the debate closely.
According to a report in the Globe and Mail last month, a senior executive at a large Canadian pension fund said the risks posed by the vote were part of the reason it had passed on a recent deal for an office property in London.
Some economists insist a Brexit would be good for London because it would reduce the regulatory burden. But many London-based asset managers expect the regulations would remain in place even if Britain leaves and they worry about losing access to the European market.
“The key issue is whether the U.K.’s partners within the European Union would be vindictive or constructive,” says Andrew Hilton, director of the Centre for the Study of Financial Innovation in London. A Brexit could be liberating for Britain’s economy and its financial industry, he suggests. “But if we handle it badly, dreadful people like [European Commission President] Jean-Claude Juncker could decide, ‘I’m really going to nail the Brits.’”
If Britain does opt to depart, it will take at least two years to determine the specifics of the new relationship between London and Brussels. European Union law stipulates a two-year negotiation period if a country leaves.
The regulatory debate
No matter what an exit deal looks like, Patrick Minford, a professor of applied economics at Cardiff University’s business school, believes Britain’s financial sector would do better outside of the European Union.
“There’s a tidal wave of regulations sweeping in from the EU,” he says, referring to things like bankers’ bonus caps and efforts to ban short selling.
“Many continental people don’t have rigorous financial markets, so they don’t have much sympathy with finance,” he adds, suggesting it would be better for Britain’s financial sector to have a “market-friendly” British government regulating it rather than a “market-unfriendly” Brussels.
But financial industry representatives disagreed with that argument during submissions in January to the House of Commons on the financial costs and benefits of European membership.
“The tsunami of regulation post-crisis was a global phenomenon,” not just a European one, said Jiri Krol, deputy chief executive officer of the Alternative Investment Management Association.
Still, he admitted members of his industry are on both sides of the Brexit issue. “Most of the regulatory responses in the wake of the crisis were correct and went in the right direction,” said Krol. “Increasing the capital in the banking industry was a necessary thing. Moving towards central clearing of derivatives transactions was something we supported because it improves the safety of markets.
“There are equally things which we felt went too far. For example, on the short-selling regulations, we disagree with some of the outcomes. But some of them were actually supported by the U.K. government as well, so we do not feel that there would be a different outcome some time in the future.”
Guy Sears, interim chief executive officer of the Investment Association, agreed. “Some of the European legislation that came forward was derived from global commitments at the G20. De-risking derivative clearing and looking at banks’ leverage were both matters where the EU was following the global lead,” said Sears, speaking before the House of Commons as well.
“You mustn’t forget the United Kingdom… has gone its own way and introduced its own regulation in some areas, which goes beyond that of Europe, or is tougher. . . . I do not believe there would be a significant reduction in the costs of regulation.”
In Sears’ view, the benefits of European Union membership outweigh the regulatory burdens. A major one, he said, is Britain’s ability to sell financial services across the European Union. “We have had considerable success within the single market,” said Sears.
It’s true that a lot of entities set up shop in Britain to access the European market and they might relocate after a Brexit, Minford concedes. But if Britain loses access to that market, it would simply focus on other places, he suggests. “There’s something called the U.K. national interest. Our job is not to make it easy for everyone else in the world to enter the European market.”
Whether Britain loses access to the single market depends on the terms of any exit.
Under the optimistic scenario, Britain would join the European Economic Area as non-member countries like Norway and Switzerland have done, says Thomas Sampson, assistant professor of economics at the London School of Economics. Membership in that area provides full single-market access.
Under the pessimistic scenario, Britain wouldn’t join the European Economic Area. “Then there would be bilateral negotiations between Britain and the EU over what kind of access Britain has,” says Sampson.
If it doesn’t reach a deal, the default option would be to revert to relations governed by the World Trade Organization, he notes. “So Britain would be just like any other country that’s not a member of the EU but can trade with European countries under World Trade Organization rules but doesn’t have any privileged access that comes with being a member of the single market.”
Ambivalence fuelled by fear
Although many in London appreciate the benefits of a single market and oppose exiting the bloc, they don’t necessarily like Europe. A recent survey of employees in finance by the London-based Centre for the Study of Financial Innovation found 49 per cent said they’d definitely vote to stay in the European Union and 24 per cent said they’d probably do so. Only 12 per cent said they’d definitely vote to leave.
Among those who said they’d definitely or probably vote to stay, 31 per cent said the European Commission, the union’s executive arm, was “actively hostile” to London’s interests and 49 per cent thought it was “neutral at best.”
The reason for those conflicting views is a fear of the unknown, says Hilton. “It’s not like going to a Chinese restaurant and saying, ‘I have a choice between chop suey and chow mein.’ You’re already deeply in the chop suey. It’s a choice between something you know and something you don’t know. People in [financial services] say, ‘We know how to deal with the Europeans; we don’t like them, but at least it’s the devil we know.’”
Even if they dislike Brussels, some financial firms are going as far as financing the pro-European camp. In January, Sky News reported that Goldman Sachs had made a six-figure donation to Britain Stronger in Europe, a group campaigning to keep Britain in the European Union.
“City insiders told Sky News… that other firms had also agreed to commit money [to pro-EU campaigns] in recent weeks,” the outlet noted in the report.
New deal for Britain
Europe doesn’t want to lose Britain, either. In February, the European Union and Britain reached a deal that would give it special status within the bloc.
The deal addresses the treatment of the nine European Union countries that don’t use the euro. Britain wanted an explicit recognition that the euro isn’t the bloc’s only currency and that, as a result, those outside of the monetary union wouldn’t be at a disadvantage from decisions applying to the euro zone.
When it came to that issue, the deal addressed concerns about bailouts of euro zone countries in financial trouble. “Emergency and crisis measures designed to safeguard the financial stability of the euro area will not entail budgetary responsibility for Member States whose currency is not the euro, or, as the case may be, for those not participating in the banking union,” the deal states.
The agreement also mentions political integration. It seeks to reassure Britain that it doesn’t have to further integrate with the rest of the European Union and notes that “references to ever closer union do not apply to the United Kingdom.”
British Prime Minister David Cameron has said he’s happy with the deal and has pledged to campaign during the referendum with his “heart and soul” to remain in the bloc.
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