Brexit and financial services: the only certainty is uncertainty

From Ovum, the financial services consultancy

By a slender majority of 51.9% to 48.1% the United Kingdom has voted to leave the European Union. The move will have ramifications for banking and financial services internationally as the country renegotiates its relationship with the EU and could topple London’s standing as a leading global financial center.
Nothing will change immediately, but in the short-term the industry and the IT vendors that serve it will be hit by the uncertainty that will follow the vote and through the period of renegotiation.
In the longer term, much depends on how those affect the ability of London-based Financial Institutions (FIs) to operate in the EU under ‘passporting’ arrangements. While underlying IT needs and activity will remain the same in aggregate, they may move elsewhere, as budget centers and decision-making shifts into EU countries.
In capital markets and investment banking this is a particular issue as international FIs face potential changes to their legal entity status and location of some roles. There are also questions over the future of trading and clearing infrastructures, particularly for euro-denominated securities.
Uncertainty will affect projects in-flight
While there are no immediate changes to the operating environment for FIs – all EU-inspired laws that have been transposed to UK law remain in place until amended or repealed by the UK Parliament. The vote simply triggers a sequence of actions: the decision has to be approved by the government and the UK then invokes Article 50 of the EU Treaty, which begins a period of negotiation on the terms of withdrawal that is expected to last at least two years.
During that period the fundamental drivers of IT investment for the industry and institutions across Europe will remain unchanged of course but uncertainty over the outcome of the exit negotiations will undoubtedly see imminent IT projects paused or de-scoped, while some large-scale projects may be shelved indefinitely.
The longer the period of uncertainty, the greater the risk and the impact.
From a banking perspective, some of the biggest immediate challenges will come from the loss of the UK’s ability to passport FIs into the EU. Institutions which have European or global HQs in the City will be forced to re-evaluate, with the consequences of that rippling through the supply chain.
Immediate questions will be raised over the compliance requirements around European-level initiatives and regulations such as the second Payment Services Directive (PSD II) and the pan-eurozone SEPA Inst immediate payments project. With the implementation timelines falling well within the period in which exit negotiations will take place, there will be uncertainty (and inconsistency) in the way banks will respond.
The threat to the City of London’s position as a leading trading venue is perhaps even more profound. As things stand it appears that the UK will diminish in importance as a hub for the financial services industry. At an aggregate level, total demand for software, hardware and services from financial institutions will continue to be buoyant, but vendors will need to adjust their go-to-market and implementation strategies accordingly.
Over the past 30 years London has vied with New York for the title of Financial Capital of the World, but it is worth bearing in mind that this status can be almost entirely traced to the deregulation of the City of London in the ‘Big Bang’ in October 1986 when the London Stock Exchange monopoly on securities trading was removed.
This created an influx of Wall Street trading houses and large Europeans banks to London, who brought a completely different, more aggressive, culture to the market, and who quickly snapped up local broking firms and banks.
The City of today has been built around this, creating an infrastructure of service firms such as lawyers, accountants and IT professionals that would be hard for any other European center to replace quickly, but the three decades between Big Bang and Brexit may one day be looked back on as a golden age.
Insurers face increased costs from compliance requirements
The biggest impact on the insurance industry would be regulatory. Currently insurers conduct cross border business within Europe through the provision of a single European insurance license. As a result of this ease of access to 500m customers, the UK insurance sector contributing a trade surplus of over £12Bn in 2014.
Brexit could at some point in the future require that UK insurers meet the insurance regulation of each EU member state with which they wish to conduct business – potentially meeting the varying regulatory rules of 28 countries to achieve what we currently have. The additional resources and costs to enact and maintain this would be enormous as well as make solvency and capital reserving hugely complex and inefficient reducing insurer’s capacity to write business.
Perhaps the most ironic outcome of the regulatory impact of Brexit on the insurance is seen in Solvency II. This piece of fundamental reform of the EU insurance industry, strongly championed by the UK insurance industry and having taken a decade to implement came into force at the start of 2016. The UK insurance industry which has implemented and meets these requirements, will at some point have to apply for so-called ‘Solvency II equivalence’ status as an ‘external third-party state’.
Despite the pro-leave camp view that the UK insurance industry would thrive further if it did not need to meet the costly burden of EU regulation (pointing at the Swiss insurance sector as an example), regulation is critical to ensure the robust operation of an insurance market capable of meeting all its liabilities. In Ovum’s opinion Brexit will mean a significant backwards step for the UK insurance industry incurring an overall increase in the cost of meeting compliance needs and making it more difficult to undertake international business.
Appendix
Author
Kieran Hines, Practice Leader, Financial Services Technology
kieran.hines@ovum.com
Daniel Mayo, Chief Analyst, Financial Services Technology
daniel.mayo@ovum.com
Charles Juniper, Principal Analyst, Financial Services Technology
charles.juniper@ovum.com
David Bannister, Principal Analyst, Financial Services Technology
david.bannister@ovum.com
Gilles Ubaghs, Senior Analyst, Financial Services Technology
gilles.ubaaghs@ovum.com
Noora Haapajärvi, Associate Analyst, Financial Services Technology
noora haapajärvi@ovum.com

Ovum Consulting
We hope that this analysis will help you make informed and imaginative business decisions. If you have further requirements, Ovum’s consulting team may be able to help you. For more information about Ovum’s consulting capabilities, please contact us directly at consulting@ovum.com.

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About Tom Groenfeldt

I write - mostly about finance and technology, sometimes about art, occasionally about politics and the intersection of politics and economics. My work appears on Forbes.com and International Finance Magazine. The Financial Brand ranked me 20 on a list of the top 25 global influencers in financial services and Jay Palter included me in his list of 250 fintech influencers to follow in 2016 http://bit.ly/1SSRXC6
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