Brexit and the UK’s Financial Services industry – What is the size of the challenge?
The importance of the financial services industry and related professional services industry to the UK economy, is a reflection of the fact that the UK is the world’s leading exporter of these services, with London as the world’s leading global financial centre. As financial services (including banking, asset managers, financial markets, and insurance) operations have grown, so too have complimentary businesses such as legal, accountancy, and advisory services.
Some of this success can be attributed to the UK’s membership of the EU, and access to the EU’s Single Market of ~500 million people. This access has attracted significant foreign direct investment (~£581bn) from firms wanting to set-up subsidiaries or headquarters in the UK. In particular, the Single Market (and the associated ‘Passporting regime’) has meant firms can service their clients out of London, cross-border, into the EU, without having to set-up bases in individual EU member states (with the associated capital requirement and cost implications).
In addition, Eurozone firms with headquarters already inside the EU, have also been keen to set-up subsidiaries in the UK, in order to gain access to the broad and deep financial ecosystem, and carry out substantial amount of business from here. These dynamics are also the reason that the sector continued to dominate, even after the Euro was introduced, as firms could continue to service Euro denominated business, cross-border from the UK.
Looking at several measures of financial services, reveals how important it is to the UK, and to what extent the industry and the economy could be impacted by various potential Brexit outcome scenarios.
UK Exports and Imports
Over the last 10 years, since the 2007 financial crisis, Britain’s economy has gradually imported an increasing level of physical goods, from -£70bn in 2005, to -£126.3bn in 2015. Although the picture is quite different for services, where we are a net exporter in all service sectors categories except travel and transport. In the same time period, financial services net trade has roughly doubled, from £22.9bn in 2005, to £42.1bn in 2015.
Source: UK Office for National Statistics, The Pink Book 2016 (data 2015)
Financial Services – Net Trade
Focusing on financial services, the 2015 trade surplus was £42.1bn, of which £19.1bn (45%) was traded with the EU. Adding insurance and pensions, increases the net surplus from £42.1bn to £55bn, which is 62.5% of the total net trade (£87.8bn) in all UK services combined.
Source: UK Office for National Statistics, The Pink Book 2016 (data 2015)
Comparing the UK to other countries (instead using $ denominated WTO data), we can see that the UK is the world’s largest exporter of combined financial services at $77.1bn. Although the US has a higher level of exports of financial services ($40.9bn), this is off-set by large imports of insurance and pension services ($-30.7bn), meaning overall US net exports in combined financial services is lower than the UK at $40.9bn. Notably, the UK figure ($77.1bn), is roughly equivalent to the next three leading countries combined: US ($40.9bn); Switzerland ($22.3bn); and Luxembourg ($17.1bn).
The UK’s position is in stark contrast to some lesser developed economies, that are overall net importers of Financial Services.
Source: WTO Statistics – Trade in Commercial Services, 2016
Financial Centre Rankings
Looking at London specifically, it is ranked by the Global Financial Centres Index (GFCI) as the world’s leading financial services centre, just ahead of New York and significantly ahead of other EU cities:
Source: Long Finance, ‘Global Financial Centres Index 20’, Sep, 2016
Interestingly, financial centres that are being talked about as potential alternatives to London, to facilitate firm’s access to the Single Market (Frankfurt – 23rd, Paris – 29th, Dublin -33rd, and Amsterdam – 40th), are ranked significantly below the current leaders (London – 1st, New York – 2nd, Singapore – 3rd).
Contribution to UK economy – Tax
In terms of contribution to the UK economy from a tax perspective, in the 2015/16 tax year, financial services contributed £71.4bn, which was 11.5% of total tax receipts for the UK overall (Source: City of London / PWC – Total Tax Contribution of UK Financial Services, 9th Edition)
During the House of Lords, European Union Committee enquiry, Anthony Browne, Chief Executive of the British Bankers’Association said:
“Financial and related professional services pay over £60 billion a year in tax. Of that, banks pay about £31 billion. Of that £31 billion, slightly over half … is paid by foreign banks based here. It is worth noting that that is bigger than the entire UK net contribution to the EU budget”
Source: “Brexit: financial services, 15 December 2016”
Financial Services – Employment
In 2015, the financial services sector employed approximately 1 million people. When related professional services are added, the UK workforce in financial services number is nearly 2.1 million. This includes 452,000 in management consultancy, 263,000 in legal services and 354,000 in accounting services.
Source: ONS, Business Register and Employment Survey, 2015 data
Though large numbers work in London, approximately two-thirds of employment in financial services is spread throughout the UK. The health of the sector is therefore hugely significant for the UK economy.
Source: TheCityUK, UK-Based Financial & Related Professional Services: Enabling Growth across the UK
Financial Services – Revenue & Market Share
The UK financial services sector plays a vital role in providing services to the wider economy, both in the UK and internationally. The industry is highly diverse across a range of financial activities, where the UK has both significant revenues, and global market share.
Analysis by Oliver Wyman calculates the sector’s annual financial revenues at around £200 billion, £90–95 billion of which is domestic business, £40–50 billion relates to the EU, and £55–65 billion relates to the rest of the world.
These figures would suggest that around a quarter of revenues in banking and asset management, and nearly half of revenues in market infrastructure and others, are related to the EU. While insurance is less reliant on EU revenues.
Potential impact of Brexit on the Financial Services Industry
Despite the somewhat poor public perception of the sector since the financial crisis of 2007–2008, financial services are vital to the prosperity of the whole of the United Kingdom, and therefore should be an important element in the forthcoming negotiations on Brexit.
In order to assess what potential impact Brexit could have on the sector, much of the debate has focused on to what extent firms based in the UK could access the Single Market, in a post-Brexit scenario. This will largely depend on what type of deal the UK government can negotiate with Brussels. Some worst-case scenario analysis has estimated up to 20-30% of financial services trade and revenue could be lost, as UK-EU regulation diverges and passporting is no longer possible, which would mean large numbers of firms relocate to other centres (e.g. Frankfurt, Paris, Dublin and Amsterdam) inside the EU area.
Realistically, the likely outcome will become more clear now the 2017 General Election is finished, and the new Conservative-DUP government will finally begin the Brexit negotiations with Brussels.
Clearly the stakes are high – Look out for our next article on Single Market Access and Passporting, for more in-depth analysis…
For more detail on the above, feel free to download the following detailed data and analysis:
UK Financial Services – Data Analysis_Jun 2017
The Global Financial Centres Index_210317
CityofLondon Total Tax Report_2016
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