There seems to be universal a lack of understanding of the enormous task ahead of us from a legal perspective and a pervasive view that our politicians have little idea of the scale and complexity of the legal changes that are required. In this first of a two part article, we'll initially be assessing where UK Banks currently stand and the challenges they face prior to Brexit.
So, this is perhaps a good juncture to remind ourselves briefly of the scale of the UK financial sector:
A recent article in City AM reported that the financial and professional services industry contributed £179 billion (or more than 10%) to the UK economy in 2015 – employing some 2.2 million people about a fifth of that number in banking. According to HMRC, in 2015-16 the banking sector alone contributed £24.4 billion in taxes to the UK government.
Where are UK Banks now?
There are of course 3 different groups of banks in London – UK domestic banks; EU27-headquartered banks and non-EU banks – the US, Chinese and Japanese banks are amongst the most prominent – and they all now face a similar challenge.
They provide an enormously diverse range of services from simple current or operating accounts to much more complex treasury and advisory services. They provide these to client companies around the world but specifically, via the passporting arrangements within the EU, more or less on a unfettered basis.
The key point here is that a disproportionate amount of sophisticated product business is delivered out of the UK. The European Securities and Markets Authority noted recently that the French senate reported that: 5,476 UK firms hold 336,421 passports, to sell financial products or services in the EU. This access will have to be replicated in some way.
According to consultancy group Oliver Wyman; UK domestic banks generate around a quarter of their revenues from intra-EU activity, amounting to some £25 billion. It is within that context and the overall contribution banking (and financial services in general) makes to the UK economy - that banks are faced with maintaining access to EU customers.
Brexit Challenges for Banks
A recent EY survey suggested that a mere 4% of senior executives said they were well prepared for Brexit, while breathtakingly 1 in 10 organisations currently have no plans.
Apart from the legacy issues flowing from the financial crisis the banks, like many major businesses, are facing macroeconomic, geopolitical and in particular technological uncertainty and competition.
So, what are the Brexit challenges for banks – putting aside for a moment the rather important question that nobody knows where we are going to end up.
It is axiomatic that uncertainty and change are expensive for any company – given the complexity of banks’ structures. To paraphrase a recent Deloitte paper; US banks will need to reassess their commitments to individual markets and products segments - and pricing strategies will be redesigned as cost of capital and funding in the UK and EU diverge.
So, ten years on from the financial crisis, banks are still trying to adjust their internal structures and product arrays to raise return on capital to an attractive level for investors –having, of course, previously relied on leverage.
AFME, the Association for Financial Markets in Europe, estimates that restructuring costs emanating from a hard Brexit would be in the order of 15 billion euros, involving the shifting of 70 billion euros of regulatory capital.
Is London the Banking Capital still?
Recently, the commercial think tank, Z/Yen published its latest Global Financial Centres Index – and whilst London remained the No 1 global financial centre, its prominence fell several points whilst Frankfurt and Paris moved up, albeit from a low base. Nevertheless, and despite its attractions as a livable city, there is no doubt there are many cheaper places to establish a banking business – at least on a purely cost basis.
Following the Brexit result (and the Trump presidential win) volatility in markets generated large profits for many banks.
However, the subsequent uncertainty, generated by both events, has led to uncertainty and indecision by clients, leading to a reduction of trading and to some extent M&A activity.
Also, partly because of the uncertainty generated by Brexit, the G5 central banks have continued with their recession-era ultra-low interest rate strategy. As you know this involves a lot of conflicting issues around asset inflation and increasing wealth inequalities – but for banks it merely means another revenue challenge as deposit/loan differentials continue to be squeezed.
In the next article, I'll be taking a look at what life might be like for Banks after Brexit and the legal implications following it.