Daily Management Review

What banks will do if Brexit gets real


Results of the British referendum on membership in the EU fluster not only politicians, but also the world's largest banks, for which London is the second (in some cases even first) home.

Dave Kellam via flickr
Dave Kellam via flickr
Given a minimum profit, relentless pressure from regulators and impatient investors, the referendum is an additional headache for financial institutions. However, banks should prepare for the fact that the United Kingdom can vote for the exit from the EU on June 23. 

Should they in this case transfer their business from the financial capital of Europe? Banks have no answer to this question yet. Moreover, they are hoping that they will never have to answer it. Until now, banks have considered the referendum as a market event, which could possibly lead to volatility and lack of liquidity.

Exchange rate is the most likely source of problems, which is already showing certain turbulence. From the beginning of the year to the beginning of April, the pound has weakened against the euro by 9%. Today, it is only 3% lower, and stronger to the dollar and euro compared February, when the referendum date was announced.

If the British vote for Brexit, the current fluctuations will look like small movements. Economists expect that the results in favor of exit would instantly lower the pound by 4%. In the next 6-12 months, the fall would reach 15% or even 30%. The OECD, the IMF and the Treasury are forecasting extremely negative consequences for the British economy (Brexit supporters call it a "horror stories"); the Eurozone would suffer as well.

This scenario is extremely unfavorable for the London-based banks. To reduce tensions, Bank of England is planning three additional repo auction near the referendum’s date. In fact, it is going to offer money to any bank capable of providing common shares as collateral.

Major British banks have access to foreign currency through other central banks, and Bank of England has a swap line with colleagues from the G7 group and Switzerland.

In principle, volatility can be managed. However, there is another issue, namely, EU rules, according to which a financial institution of a European Union’s member can serve customers in the remaining 27 countries without opening a local branch. European representatives of banks from countries outside the EU have the same rights that allows American, Swiss and Japanese companies to work across Europe from London headquarters.

Goldman Sachs is a typical example. 6 th. of 6,5 thousand European employees of the American Bank are based in the British capital. TheCityUK notes that largely thanks to these rules, London has 70% of the market interest rate derivatives in euros, and 90% of the European market in the primary broker segment.

In case of Brexit, Goldman Sachs, as well as other UK-based financial institutions, may lose the opportunity to enjoy the privileges. In principle, they can conclude a new agreement, the more so EU laws allow third-party companies licensed by their own supervisory bodies to work on the internal market of.

However, reaching an agreement would not be easy. Former UK partners can show intractability: French and German politicians wouldn’t like to look too spineless in anticipation of their own elections.

There’s no point in expecting a quick resolution of all issues. Britain will remain a EU member for two following years (possibly more) once a discussion on the leave’s condition starts. Sooner or later, however, the time will come, and banks will have to plan for the future.

Financial institutions are reluctant to discuss (at least publicly) what they're going to do. No one wants to build specific plans until they have no urgent need. Nevertheless, in February, HSBC announced that it can transfer one thousand employees (approximately 25% of its London staff) in Paris, where the bank has a subsidiary - Crédit Commercial de France.

In April, Deutsche Bank’s co-director John Cryan said that "it would be strange" to trade European government bonds and the German currency in a bank branch in a country not included in the EU. Top managers of other companies have hinted that they could move business in Dublin (partly because of liberal labor legislation of Ireland), or Luxembourg.

Over the years, London has repeatedly overcome the direst predictions. It became the financial capital of the Eurozone, without being a EU member. The city is too attractive for big banks to completely leave the British capital.

In addition to banking services, there is an army of upper-crust accountants, lawyers and other professionals. People like to live in a huge pot full. This is why banks are looking forward to the referendum, hoping that the British could eliminate all potential problems.

source: economist.com