Uncertainty – this is usually the first word that springs to mind when you hear the word Brexit. While almost every sector across the UK is facing uncertainty, financial services industry is suffering more than most, with claims in the mass media that Brexit will have a severe impact, including the mass exodus of financial companies moving to Europe. But is this true and will London lose its crown?
Some UK banks and financial services companies are reportedly making plans to shift staff and operations from London to EU cities, such as Brussels and Frankfurt.
Failing to do this and maintaining large operations in London, and therefore outside of the EU, could render banks unable to properly service their European clients and in turn cause them a considerable loss of income.
If banks want to retain their competitive edge, they will need to adjust their operations to ensure they are able to function globally, whether that is opening offices within the EU to service EU clients or in the UK to service the UK market.
More recently, another trend is emerging, with some major banks considering taking advantage of the space being left by financial companies moving some of their operations to EU countries.
For example, UBS, Credit Suisse and private bank Julius Baer, are all believed to be keen to remain in the UK and are in fact reported to be looking to open regional offices or strengthen their London operations.
Defining branches and subsidiaries
The exact terms of a post-Brexit financial agreement remain to be seen. However, it is widely accepted that British-domiciled banks will be unable to utilise the EU passport – a system that allows financial services companies based and regulated in an EU country to conduct business in other EU-member countries.
Following Brexit, without passporting rights, banks will be unable to service customers in the EU from the UK and vice versa. As a result, they are expected to need operations on both sides of the Channel. For many, this will require the reversal of a key trend of the past decade, namely simplification of banking structures.
For a customer, a bank is a bank whether it's a physical building, an online system, or someone sitting in a call centre in another country. The same cannot be said for the institution itself. The exact form the bank takes, be it a subsidiary or a branch, matters in regulatory terms and defines how it may operate in a particular country. This is even more prevalent now that the UK is leaving the European Union.
A branch is an independent entity that conducts business in its own name, but is not legally separated from its foreign parent. It is subject to local laws governing its parent company, and while a branch can be useful for gaining an understanding of a local market and is more cost-efficient than setting up a subsidiary, it cannot operate as a standalone business.
By contrast, a subsidiary is an incorporated legal entity, which can operate in its own right. A subsidiary will maintain a fully-funded balance-sheet, take responsibility for its own capital and liquidity flows and is regulated in the country in which it is located.
Under the new financial requirements post the global financial crisis of 2008-09, banks have to ensure they have sufficient access to capital and adequate liquidity to operate in all markets. Looking towards Brexit, financial institutions which only have branches in either the UK or the EU will need to restructure these operations to run as subsidiaries.
This will involve significant transfers of capital, funding and liquidity and will ultimately require the bank to address the increased scrutiny of regulators and legislators that will inevitably accompany such fundamental changes to the operating models and organisational structures.
Retaining access to EU and UK financial markets
In the future, banks may be required by EU regulators to set up or upgrade EU-domiciled booking centres, replicating the current arrangements in London and effectively splitting their trade booking models. Additionally, banks would also be forced to choose between servicing their non-EU international business from either London or a location within the European Union.
In order to maintain adequate access to EU and UK markets post-Brexit, banks will need to ensure they have both sufficient balance sheet capacity and operational capabilities. EU-domiciled institutions typically have this within their primary commercial entity or in key subsidiaries operating within the EU, but for many non-EU-domiciled banks, subsidiaries operating in the EU will not have the required balance-sheet scale or operational capacity.
In some cases, banks will not have a subsidiary operating within the EU and will have to consider how best to set up such an entity, either from scratch or by converting a main bank branch in a specific country. Deutsche Bank recently said it may shift about €300bn (£265bn), equal to almost a fifth of its balance sheet, to Frankfurt from London in order to facilitate trading in the EU post-Brexit.
Looking towards a Brexit future
While there is no doubt that Brexit will have an impact on the banking sector in more ways than originally anticipated, one thing that is for sure is that the trend towards organisational simplification will be reversed, a move that will inevitably incur significant costs for the banks. Moreover, there will also be some migration of capital, liquidity and infrastructure out of the UK and into the EU.
This may however be mitigated by inflows from the EU for banks wishing to gain access to UK-domiciled clients, the UK's highly-liquid capital markets, favourable regulatory conditions or any free-trade benefits the UK is able to negotiate with non-EU countries.
That said, London has 200 years' experience as a leading financial centre, and continues to top the charts, outperforming Hong Kong, Singapore, and New York in the recent Z/Yen global financial centres index (GFCI), which ranks 92 financial centres. The city has survived numerous economic and political events, therefore it is unlikely that Brexit will take its crown as a leading financial hub.
Christopher Burke is the chief executive officer of Brickendon, a global management and technology consultancy, specialising in solutions for the financial services industry. He has over 18 years' experience advising and consulting global financial institutions, including banks, hedge funds and asset managers.