Whatever the outcome of June’s EU referendum, the consequences for financial services will be hugely significant.
Ranging from the threat of relocation, through to the rising cost of firms planning to do business on a Pan-European basis, the claims and counter-claims have come thick and fast from both sides in the debate. Following the recent launch of our Structured Products provider Hartmoor we take a look at Brexit’s potential impact on this market. So now that the starting pistol has been fired on the arguments for and against Brexit, now is the time to start demystifying what this all means for the financial services community and, in particular, the structured products market.
Liquidity and Funding Costs
In the first instance, the parties most affected by a Brexit are likely to be financial institutions who do business on a cross-Europe basis. UK banks for instance now make great use of cross border liquidity solutions in order to raise capital in different EU member states.
One thing that is a certain outcome of a Brexit is uncertainty. Capital markets hate uncertainty, and as a likely position of stability would not be achieved for some time, it is likely that capital raising would be more difficult and also it is likely that the cost of funding for banks would increase.
Currently UK banks make use of the European Central Bank for liquidity; this would not be as accessible post-Brexit, meaning that a range of institutions could potentially need to look elsewhere for liquidity. JP Morgan recently highlighted the risk of increased bank funding costs post-Brexit, as have UK banks such as Clydesdale. Higher costs for bank funding would have a knock on effect on asset creation, which in turn would feed through to higher cost lending activities.
On the flipside, some advantages could emerge from this outcome for customers purchasing structured products. If there is an increase in bank funding costs, as the supply decreases from alternative sources, structured product terms typically will increase as the bank is willing to pay more for the money. This is also likely to feed into alternative funding sources such as fixed rate bonds. As customers typically sit on both sides of the funding angle (i.e. they lend to the bank via savings and borrow in the form of credit cards/mortgages) the net effect to household income is likely still to be negative of increased funding costs.
Financial services re-location
London is seen as not only the financial centre of Europe, but also the world. Worldwide financial institutions have large European headquarters in the UK as they are able to easily serve the European market. This is largely achieved via passporting, which is where an authorised firm in a European Economic Area (EEA) country is able to perform permitted activities in another EEA state by exercising the right of establishment of a branch or providing cross-border services. Global US banks, including JP Morgan, have threatened to leave London in the event of a Brexit, even though the expectation is that passporting will remain. The extent of financial services relocation will depend on what trade arrangements the UK could agree with Europe post Brexit. CityUK published figures recently which highlighted that 37% of financial services companies are very likely or fairly likely to relocate staff if the UK left the EU. Whatever your view on the likelihood that this will happen, this is a concern which should provide a moment of pause for voters prior to 23 June.
Brexit could also force individuals to adopt a new approach towards regulation and client service. Keeping abreast of local (and potentially different) regulatory requirements in the UK may be much harder, with the potential impact of products being offered to the market and created without essential local knowledge. This is not to say that there won’t be any structured products providers left in the UK, but there may not be the current level of expertise across the spectrum of skills needed to service the market.
Regulation regulation regulation
The UK structured products market has been wrestling with regulation, guidance and thematic reviews for the past few years, all of which tends to be inextricably linked to what is happening in Brussels. Some pro Brexit camps have highlighted the benefit of not having to comply with consistent EU wide regulation if the UK were to leave the EU, as the UK would likely be able to decide on standards as it sees fit. However the huge downside is in order to continue to serve EU customers, British firms would likely need to comply with EU regulations as well. Exiting the EU may mean the UK can no longer influence or challenge regulations in Brussels, which could result in diverging regulatory environments and more implementation of standards for UK firms who have to follow both domestic and EU requirements. Ultimately even when it comes to a concept which could potentially benefit from change, on closer inspection the advantages of leaving the EU are less clear.
In the structured product market, the impact of EU wide legislation in the form of MiFID and PRIIPS certainly raises issues around relevance and application into the UK market of a standardised EU wide approach. Being part of the EU now, allows UK based firms and industry bodies (UK Structured Product Association or TISA for instance) to help shape and influence what comes into legislation via Europe. The FCA listens to the financial services industry, and are present at the table when policies are decided, with a view to representing UK interests when relevant legislation is passed. If Britain were to leave the EU, there would be a loss of the seat at the table, yet still most likely the requirement for domestic firms to comply with the legislation.
This loss of influence is likely to see structured product providers having to manage two legislative powers, potentially leading to increased compliance and legal support. This could lead to high cost income ratios, a less efficient service proposition to customers and potentially higher cost product offerings. This would create large headaches for domestic firms when trying to implement and meet best practice.
Overall if a Brexit were to happen, it could happen in a number of ways and hence the impact on the market is yet to be clear. One commonly touted likely model would be like the current one employed by Switzerland, where there are specific accords. This seems most logical but does also require constant renegotiation and has its flaws. We will wait and see what happens in the referendum in June, yet the true impact of a Brexit may not be known for many years after the event.