Regulatory changes are not normally the concern of a strategic foresight consultancy, but the possible departure of the United Kingdom from the European Union is a once in a lifetime event. Brexit’s effect on global financial institutions is worth an examination to help inform strategic decisions that may need to be made about the future. As financial institutions (FIs) are mandated by current regulations to have contingency plans, it is helpful to think about how these institutions can survive and how they can even excel in this time of uncertainty.
Passporting has been a major driver of the growth of London as a FinTech hub. Henry Kravis, co-CEO of KKR, stated that he expects 20% of London’s financial sector to leave “because they need that passport to operate on the continent.” In the City of London 11% of workers hail from a different country in the EU. Post Brexit, the right of these employees to continue working in the City will be up in the air. What effect will the end of passporting have on financial services firms in Europe?
What is Passporting?
Passporting is the popular term used to describe the right of a firm operating in a European Economic Area (EEA) state to conduct permitted activities in any other EEA state by either exercising the right of establishment (of a branch and/or agents) or providing cross-border services. This right only exists for as long as the UK is a member of the EEA. UK-licensed banks (those with UK headquarters or foreign headquarters) would need to seek extra licenses from the EEA member state in which they want to do business in order to offer financial services in that member state.
This decision manifests itself through an FI’s decision to conduct operations in another country as either a branch or a subsidiary. A branch takes advantage of passporting, where a subsidiary must submit to local licensing rules and regulations. Many large foreign banks operate in the UK as branches. Deutsche Bank, for example, derives 19% of its net revenue from the UK and operates as a branch.
Passporting works both ways. Many European banks operate branches in London under passporting, and many UK-based banks utilize the regulatory framework to have branches throughout Europe.
For more than a century, the City of London has dominated other European capitals in terms of financial services. Brexit could be the opportunity that these cities have been waiting for. While it would be in the UK’s interest to negotiate an arrangement equivalent to passporting with the EEA, they are likely to encounter resistance from countries who see Brexit as a chance to substantially increase jobs and income tax bases.
While Brexit would allow the UK to relax capital rules that limit bankers’ bonuses, it may not be enough to compensate for increased regulatory costs. Ireland, an EAA member, is in the same time zone as the City of London and has a low (12.5%) corporate tax rate that has already made it the ideal place for European headquarters for many foreign companies.
End of Local FinTech
Many financially oriented startups call London home. They do so because of the quality of talent, availability of capital, and the local regulatory environment. By being based in the UK, these startups can access the entire EEA from one location. This has driven the dramatic growth of companies like Azimo, Ensygnia, Judo Payments, and others. The screencap of the Monese website below is illustrative of this:
These companies will be faced with a choice to either move or only serve the local market. As most startups are cash-strapped and facing financing headwinds driven by Brexit-driven uncertainty, they will be unable to relocate.
Who Wins in the Possible Future?
In the low-growth environment expected post Brexit, banks and insurance companies are likely to be especially hard hit. Following the June 23rd referendum, the banks and insurers on the FTSE suffered higher declines in their stock price than other non-financial corporations.
The end of passporting will create constraints, but constraints create innovation. International expansion and growth of local financial firms inspires competition based on price. A forced hard look at the local market will lead UK FIs to the opportunity at hand. Focusing on international growth fails to take advantage of the changes occurring at home.
Demographics will have a large impact on any future scenario. With the percentage of people over the age of 80 set to double in the next twenty years, how are customer experiences being simplified and adapted? There is a huge intergenerational wealth transfer expected to occur from boomers to millennials, but before that happens, there will be an intergender wealth transfer driven by the lower life expectancy of men compared to women. How can FIs be prepared to address those needs?
While Brexit-led uncertainty has driven declines in property value locally, ownership of this property is still beyond the reach of many. What kind of products and services will help to finance the life goals of digital natives, and will these new products and services replace the mortgage?
With an increased reliance on the local market to drive growth, market players will be forced to create compelling customer experiences that drive increased engagement. Market events like this reinforce the need to create signature customer experiences that drive brands and create customer loyalty.