UK Financial Services Industry & Brexit 1

UK Financial Services Industry & Brexit

1 willistowerswatson.com

Update on the events and impact of the UK’s decision to leave the European Union

Recent Events and Implications for the UK Financial Services Industry

�� These strong growth figures caused Andrew Haldane – The Bank of England’s chief economist – to publicly state that his profession needed to adapt to regain the trust of the public having failed to foresee the 2008 financial crash and having misjudged the impact of the Brexit vote.6

�� In contrast to all this, in a speech given to the London School of Economics, Bank of England governor Mark Carney warned that up-to-now strong consumer spending would soon be tempered by rising prices from the weaker pound. He also sounded a cautionary note on the growth in household debt.

�� These observations have led the Bank of England to forecast that growth will slow in 2017 as higher inflation weighs on consumer spending.7

�� Amidst all this uncertainty, what was clear was the notion that until the EU and UK have agreed the exact nature of their post-Brexit relationship, it would be very difficult to assess with any certainty the complete impact on the financial services sector.

Despite relatively strong UK economic performance there has been much pessimism in the financial services sector as the prospects of a ‘hard Brexit’ have become clearer

�� Immediately after the vote to leave the CBI found that optimism amongst Britain’s financial services firms had become more pessimistic for the third consecutive quarter in the three months to September, marking the longest decline since the financial crisis in 2009.3

�� This was despite official government statistics suggesting that the economy had in fact grew by 0.6 per cent in the immediate three months following the 23 June Brexit vote.4

�� Similarly, The International Monetary Fund (IMF) has actually raised its forecast for the UK’s economic growth this year, following a better than expected economic performance since the Brexit vote.

�� The IMF says it now expects the UK to grow by 1.5% this year, compared with the 1.1% it was previously forecasting. Albeit, the 2018 forecast was downgraded, from 1.7% to 1.4%.5

It contributes a trade surplus of

approximately

£58bn to the UK’s balance of

payments

The sectorannually earns approximately

£190 – 205BN in revenues

UK’s biggestExporting

industry with a

£67bn contribution to the balance of trade

£40 – 50bn (~25%) of annual financial services

revenues is international and wholesale business

related to the EU

2 million+jobs in the UK,

of whichtwo thirds are

employedoutside London

The sector contributes

£120 – 125bn in Gross Value

Added

UK’s largest tax paying sector

paying

£66bn in 2015/16

UK financial services industry snapshot1,2

UK Financial Services Industry & Brexit 2

1 http://www.cbi.org.uk/insight-and-analysis/financial-services-and-the-eu/2 http://www.oliverwyman.com/content/dam/oliver-wyman/global/en/2016/oct/Brexit_POV.PDF3 http://www.pwc.co.uk/industries/financial-services/insights/cbi-pwc-financial-services-survey-sept-16.html4 http://www.independent.co.uk/news/business/news/bank-saved-250000-jobs-by-cutting-rates-after-brexit-vote-says-carney-a7530496.html5 http://www.bbc.co.uk/news/business-386372436 https://www.theguardian.com/business/2017/jan/05/chief-economist-of-bank-of-england-admits-errors7 http://www.bbc.co.uk/news/business-386449638 http://www.economist.com/blogs/bagehot/2017/01/countdown-2019?fsrc=permar|image19 http://www.telegraph.co.uk/news/2017/01/11/eu-has-lose-hard-brexit-uk-mark-carney-says/10 http://www.telegraph.co.uk/business/2017/01/17/city-figures-give-stoic-welcome-mays-plans-eu-single-market/11 http://www.ibtimes.co.uk/morgan-stanley-citigroup-shift-many-jobs-outside-uk-post-brexit-report-160229612 http://uk.reuters.com/article/uk-britain-eu-barnier-idUKKBN14Y0DM

Theresa May’s announcement that Britain will leave the single market and the customs union may start to make the picture clearer

�� On 17th January 2017, Theresa May announced her twelve point plan outlining her negotiating terms over how she wishes to see Britain leave the single market and the customs union, and will thus be able to negotiate its own trade deals with third-party economies.

�� She wants a comprehensive free-trade agreement (FTA) based on the one recently signed between the EU and Canada and wants to achieve this in no longer than the two years permitted by Article 50, indicating that there will be no formal transitional period.8

�� It seems that Theresa May is betting on non-cooperation being very bad for Europe, perhaps even worse, which echoes recent comments from Mark Carney that the risks to financial stability of a hard Brexit really lie with the countries remaining in the European Union, not with Britain which is leaving.9

�� Crucially, her announcement gives financial services firms some of the certainty they have craved since June 23rd – those fundamentally reliant on continental supply chains or the EU “passport” for financial services will now certainly have to make contingency plans given that the UK will not seek to remain part of the European Economic Area.

�� Two of the largest investment banks in the City of London and two American banks have therefore quickly stated that Theresa May’s speech means that some staff will definitely have to move abroad when the UK leaves the EU.10,11

�� Clearly, everything still rests on the sort of deal the UK eventually ends up with after debates within the UK and negotiations are over with the EU. For its part, the EU is already stressing that it will be no pushover. For instance, the European Union’s Brexit negotiator Michel Barnier recently stressed that the EU will demand “special vigilance” before letting British financial firms access the bloc because of the large risk London could pose to the EU’s financial stability.12

3 willistowerswatson.com

Factors that impact the Financial Services Industry

Passporting unlikely to remain an option for UK banks seeking access to the single market

�� London is seen as an entry point to the EU’s single market in financial services. A complete exit from the EU would mean that the UK would not be party to EU single market Directives and therefore lose the ability to passport under them. There could possibly be a period of significant confusion as overseas financial services firms which use a London subsidiary would need to decide how to restructure themselves and decide how much of their operation to transfer elsewhere in the EU.

�� Crucially, equivalence provisions already exist in the legislation that covers many financial services activities. It is an arrangement that should allow US and Swiss banks to keep operating from London bases.13

�� Yet, there is also an inherent tension between the need to keep UK regulation broadly consistent with EU rules, in order to preserve equivalence, and the fact that the City considers the main advantage of Brexit to be the opportunity to set its own rules. The UK would need to agree in advance how equivalence would be assessed, in order to keep a reasonable degree of flexibility and avoid a situation in which Brussels could constantly threaten to cancel the arrangement.14

‘Hard’ Brexit likely to mean some financial services jobs are moved to elsewhere in Europe

�� If passporting is unlikely to be maintained then many financial services firms will seek to move some staff from London.

�� Immediately after the Leave campaign prevailed in June several banks warned that Brexit would undermine the logic of basing so many staff in the UK.

�� Banks may not be able to delay moving of some of their operations to the remaining EU member states – even if the government were to announce a transition period beyond the two years after triggering article 50 – because of the time it takes to get authorisation from regulators and installing new management teams.

�� Bank of England officials have even warned there could be an impact on the wider EU. Sir Jon Cunliffe, deputy governor, has said economies across the EU could lose out and that operations may move to New York, rather than another financial centre in Europe.

On an administrative level, no passporting would mean much upheaval for financial services

�� If passporting into the EU from the UK is not allowed following Brexit, a UK or non-EU financial services operating in the UK may need to establish a fully authorized branch or subsidiary in the EU—if it does not already have one—in order to access European markets. This scenario could equally apply to a European bank with an operation in the UK, which may need to “upgrade” its UK operation with additional capital.15

A restriction on free movement of labour may affect attracting the best talent

�� Theresa May appears to have interpreted the referendum result as a wish from the British people to curb immigration – “Brexit must mean control of the number of people who come to Britain from Europe” – it should be expected that immigration rules will be significantly tightened when the UK eventually heads out of the EU.

�� This could mean that the financial services sector may no longer be in a position to attract talent from across  Europe.

�� Nearly 11 per cent of the City’s 360,000 workers come from elsewhere in the EU, according to the latest census.16

The following factors apply to all financial services firms, including investment banks. Later on, we look at specific factors affecting asset managers and insurance companies.

13 http://www.leaprate.com/2017/01/eu-uk-mifid-passport-to-be-replaced-by-equivalence-as-hard-brexit-unfolding/14 https://www.ft.com/content/6d07353e-d997-11e6-944b-e7eb37a6aa8e15 https://www.bcgperspectives.com/content/articles/financial-institutions-strategy-what-brexit-means-financial-institutions/?chapter=2#chapter216 https://www.ft.com/content/23d576b0-386a-11e6-a780-b48ed7b6126f

UK Financial Services Industry & Brexit 4

Foreign Exchange Trading

�� If there is one activity that the City of London dominates it is foreign exchange trading. Analysts are split over exactly how endangered London’s position is now that the country has opted for Brexit — the City had been dominant for decades before the creation of the EU.

�� But its mantle as the prime spot in which to trade the euro ($2tn a day market) looks under threat.

�� The European Central Bank has already attempted to bar clearing houses outside the eurozone from handling the euro but was overruled by the EU’s highest court. Without membership, the result may not be so favourable next time and other connected trading activity could well follow.17

Data-sharing

�� Data will also be a critical consideration. Depending on the terms of exit, it might be necessary to put in place a specific data-sharing agreement, akin to the EU-US Privacy Shield that was launched in 2016. If an agreement cannot be made regarding the UK, the EU may block data flows, which would create significant challenges for financial services.18

MiFID II and MiFIR regulation

�� The FCA has announced that MiFID II and MiFIR regulations which will apply from January 3, 2018 should not be ignored by financial services thinking that the legislation won’t apply outside of the EU.

�� Firstly, there is every chance that MiFID II/MiFIR will come into effect whilst the UK is still negotiating its exit arrangements and this is even more likely given Theresa May’s strict two year negotiation period timeline.

�� Second, many of the provisions in MiFID II and MiFIR were part of the international regulatory reform agenda that the G20 pursued following the 2008 financial crisis.

�� Thirdly, if the UK is not to be part of the single market and instead try and achieve ‘third country’ status, as for example enjoyed by the USA, then adherence to MiFID II and MiFIR will be crucial as it will be needed for ‘equivalence’ of the UK regulatory regime.19

�� More recently, the FCA reaffirmed its stance with chief executive Andrew Bailey declaring that Brexit should not be the ‘driver’ of UK financial regulation.20

Banking Capital

�� Whatever system of regulation the UK seeks to negotiate it is worth remembering that it will continue to be a member of a number of international standard setting bodies such as the G20, the Basel Committee on Banking Supervision and the Financial Stability Board (FSB).21

17 https://www.ft.com/content/23d576b0-386a-11e6-a780-b48ed7b6126f18 https://www.bcgperspectives.com/content/articles/financial-institutions-strategy-what-brexit-means-financial-institutions/?chapter=2#chapter219 https://www.law.ox.ac.uk/business-law-blog/blog/2016/07/brexit-and-financial-services-10-things-you-should-know20 http://www.internationalinvestment.net/regions/brexit-not-driver-uk-regulation-fca-ceo-andrew-bailey/21 https://www.law.ox.ac.uk/business-law-blog/blog/2016/07/brexit-and-financial-services-10-things-you-should-know

5 willistowerswatson.com

Specific Issues for Asset Managers

�� For the UK asset management industry the impact of a total exit would be significant on the basis that several fund vehicles such as UCITS and European Long Term Investment Funds must be domiciled in the EU and managed by an EU-based management company.22

�� What is certainly clear then is that the sector is likely to face lengthy European negotiations with the EU for the future distribution of UK funds across Europe. Law firm Dechert had stated that it believes the continued success of the sector may depend on the success of negotiations and the exact nature of the agreement that is reached over equivalence and access to the single market.23

Specific Issues for Insurance Companies

�� The impact that leaving the EU will have on the insurance industry will vary depending on the type of insurance business underwritten and, crucially, the method of distributing the product to market. General insurers, who have a large retail customer base, are likely to rely more heavily on the EU passport for cross-border transactions.

�� For other more specialist insurance businesses, the UK’s withdrawal from the EU will likely be less significant. Lloyd’s has released a statement stating that only 4% of its global gross written premium (“GWP”) is at risk with the UK outside the EU single market. The EEA only accounts for 11% of Lloyd’s total GWP and almost half of this is reinsurance. The loss of the EU passport will likely not significantly impact pure reinsurance business.24

�� Despite this, Lloyd’s of London became one of the first major City businesses to confirm that it will move a part of its operations to the continent in reaction to the UK’s vote to leave the EU.25

�� ‘In March, it confirmed this plan by announcing that it hoped to open a Brussels office by the middle of 2018, which would allow it to continue underwriting insurance policies from all 27 EU and three EEA states after the UK leaves the union.

�� Inga Beale, the Lloyd’s chief executive, explained that because it took time to set up a new company and many commercial insurance policies were renewed at the start of January, Lloyd’s had to act now to ensure its Brussels subsidiary was up and running by the middle of next year.’26

�� Insurers themselves will also be looking to set up bases in mainland Europe in a bid to combat the potential loss of passporting rights. For instance, AIG has declared its intentions to move some operations to Luxembourg. More will inevitably follow and some jobs will surely be shifted from the UK even if the bulk of insurers are playing down this possibility at the moment.27

�� Similarly, European insurance firms currently holding an inbound branch passport will have to apply to the PRA for authorisation in order to continue trading in the UK, if an agreement on passporting is not agreed prior to Brexit. European firms will therefore be looking to UK authorities to minimise disruption in the domestic and international insurance markets and provide a solution to this conundrum well in advance.28

22 https://www.law.ox.ac.uk/business-law-blog/blog/2016/07/brexit-and-financial-services-10-things-you-should-know23 http://www.investmentweek.co.uk/investment-week/news/3003402/uk-asset-managers-face-challenging-fight-for-bespoke-brexit-agreement24 https://m.mayerbrown.com/files/Publication/b837077b-aba0-4fa1-bbeb-6adfb712ad53/Presentation/PublicationAttachment/312b6793-d16d-4a3b-b6ae-76a7117e81d2/Brexit-

What-does-it-mean-for-the-insurance-industry_jul16.pdf25 http://uk.businessinsider.com/lloyds-of-london-part-of-business-will-leave-london-2016-1226 https://www.theguardian.com/business/2017/mar/30/lloyds-of-london-brussels-office-insurance-uk-eu27 http://www.insurancebusinessmag.com/uk/news/breaking-news/aig-reveals-european-destination-62264.aspx28 http://www.insurancebusinessmag.com/uk/news/breaking-news/what-does-article-50-actually-mean-for-the-insurance-industry-64064.aspx

UK Financial Services Industry & Brexit 6

Negotiating with the EU on Free Movement of Labour

�� With some bankers warning that London could gradually lose its position as the only financial capital of Europe and major banks announcing job relocations, Paris has launched a tongue-in-cheek advertising campaign aimed at poaching business from London.

�� “Tired of the fog? Try the Frogs! Choose Paris La Defense” adverts have been put up at Heathrow Airport and the London train station of the Eurostar, showcasing the French capital’s business district.

�� The French government has already introduced extra tax concessions for expatriates in the hope Paris could profit from Brexit, but experts say other centers with more flexible labor and tax rules are likely to be bigger beneficiaries.27

�� In political terms, Angel Merkel has previously hinted at a readiness to discuss the parameters of the free movement of people in the EU, suggesting there may be some room for manoeuvre on the issue in Brexit talks. These remarks were made at a meeting of the German employers’ association BDA.28

�� Following Theresa May’s announcement that the UK would follow a hard Brexit, Jean-Claude Juncker, the European Commission president, said that the EU was “not in a hostile mood” towards Britain, but predicted a “very, very, very difficult” negotiation with Britain as a third country outside Europe.

�� At the heart of the negotiation will be how far the EU will enable Theresa May to square her demand for a “bold and ambitious free-trade agreement” with her refusal to accept the free movement of EU workers and the jurisdiction of EU courts.29

�� On the other hand it seems Mrs. May might well have the bargaining chip of an enhanced trading and labour movement agreement with the US to rely on as her relationship with President Trump develops rapidly. It seems a part of her wider negotiations with Mr. Trump revolve round ways to explore ways in which it is easier for US citizens to work in the UK and vice-versa.30

Read more WillisTowersWatson insights on Brexit at our dedicated micro-site.

27 http://www.cnbc.com/2016/10/18/fog-or-frogs-paris-tries-to-woo-londons-financial-sector-shaken-by-brexit-vote.html28 http://www.telegraph.co.uk/news/2016/11/15/angela-merkel-suggests-she-is-willing-to-compromise-on-free-move/29 http://www.telegraph.co.uk/news/2017/01/18/may-praised-churchillian-vision-europe-talks-tough-brexit/30 http://www.telegraph.co.uk/news/2017/01/22/theresa-may-donald-trump-hold-talks-trade-deal-cuts-tariffs/

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Willis Towers Watson has a range of services to help you navigate Brexit - both the opportunity and the risk.

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ContactsJonathan Bush GB Regional Industry Leader, Financial Institutions Group

T: +44 20 3193 9495 E: jonathan.bush@willistowerswatson.com

Andre Van Hooren Western Europe Regional Industry Leader, Financial Institutions Group

T: +31 8854 33025 E: andre.van.hooren@willistowerswatson.com

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