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Policy 02 Nov 2016

The U.K. is exploring ways to mitigate the impact of Brexit on London

Fintech firms could be the saving grace for the U.K.’s financial sector, but greater complications to attract global talent could pose a serious problem. It all depends on the political negotiations.

The U.K. and the EU continue to prepare for Brexit, but as of this month, they are doing so with a clearer focus. The British Prime Minister Theresa May revealed her plans for a hard Brexit in a hard-hitting speech at the political conference of the Conservative Party, “ It is not, therefore, a negotiation to establish a relationship anything like the one we have had for the last 40 years or more. So it is not going to be a Norway model. It’s not going to be a Switzerland model,” she warned, referring directly to the two countries that have had to comply with the EU freedom of movement in order to access the single market.

The market did not at all appreciate this tone (the following day the pound fell 1.2% compared to the dollar and 0.9% compared to the euro). Neither did the British financial sector, which had already warned of the need to maintain a fluid relationship with the EU before May started to develop specific plans for the U.K. to leave the EU.

“The danger of hard talk now is that it increases uncertainty, reduces confidence and will result in businesses triggering their exit plans from the UK,”.”, Barclays Chairman John McFarlane, told the ‘Financial Times‘. He is also Chairman of the lobby, TheCityUK, which defends the interests of the British finance industry and related professional services (consulting, advising, legal services, etc.). “There has to be a balance between the rational and the political. It can’t just be politics.”

There is a lot at stake in the talks between London and Brussels. In a recently published article, BBVA Research’s Principal Economist, Pep Ruiz estimated that Brexit would cost Spain’s economy 0.4% in 2016-2017, with a greater impact in some areas like Murcia, where it will decline six tenths. The Eurozone Observatory from the same institution warned in August that Britain’s decision would affect consumer spending and investment, although it would have a “limited” overall impact on the economy.

The financial sector is one of the industries with the most at stake. Britain’s financial sector and related professional services represent 12% of the U.K.’s GDP. It also employs 2.2 million people, according to the U.K. National Statistics Office’s data from March.

The British Treasury receives £66 billion in taxes from all this economic activity. The British financial industry is probably the country’s sector with the closest ties to the EU. In the referendum campaign, former Prime Minister David Cameron stressed that Brexit would cost 100,000 jobs related to finance in a greater or lesser extent.

More recently, the consulting firm Oliver Wyman offered more modest figures. In a worst case scenario, meaning if the U.K. becomes just another country in its relationship to the EU with no special treaties, the financial industry would lose up to 35,000 jobs and would stop paying between £3 billion and £5 billion in taxes.

The sector has been preparing for what may occur. McFarlane says that “unlike the 2008 financial crisis,” the financial industry “made sure that everything would work properly after the decision to leave the EU was made.” TheCityUK Chairman maintains that the U.K.’s appeal to the finance  sector is based on “far-reaching pillars” that do not depend on whether or not the country belongs to the EU like “the time zone, legal framework, a favorable climate for investment and a society where talented and hard-working people can be successful.”

However, clouds have been appearing on that horizon and some are reflected in the report “UK financial and related professional services: meeting the challengers and delivering opportunities.” Automation is threatening jobs, especially outside of London. Profitability has fallen and many businesses have been declining since 2008. Some places in Asia and the U.S. are taking advantage of their strengths in business areas like cybersecurity. The decision to leave the EU exacerbates these problems, and even more so if it is a “hard” Brexit.

What is the British financial sector considering doing? One thing experts recommend is strengthening fintech firms, where the U.K. is already in a good position. British fintech firms have more employees than Singapore, Hong Kong and Australia combined (see graph) and six of the 31 fintech firms worth more than $1 billion are British. According to the report, the niche areas where they can grow are Regtech (regulation technology), InsurTech (insurance technology) and LegalTech, meaning adapting the professional services that have always been related to the financial sector to the tech world.

Research and investment in potentially disruptive areas like blockchain, the Internet of Things, cognitive analytics and big data, is another possible way for the financial industry to grow, which needs to maintain a good position in the fierce competition for the best global talent. So far, it has done well in this, but its position is in jeopardy.

Beyond the obvious limitations Brexit will pose for recruiting EU talent, which in principle, will enter into force in 2019, statements made by some politicians and some early measures indicate that the U.K. is moving toward a major shift in its labor market.

Home Secretary Amber Rudd said in Parliament that the U.K. has too many international students, while announcing new selection criteria for elite schools and universities.

And there are decisions that are already starting to affect companies’ day-to-day business. In April 2016, London decided that it would only grant indefinite visas to immigrants from outside of the EU if they have an annual salary of at least £35,000 (€38,000). There are exceptions, but the impact on companies is clear. Startups are affected the most, especially those outside of London, where salaries are significantly higher than the rest of the U.K.

TheCityUK believes that limiting skilled immigration will damage business. They also highlight that European immigrants have contributed more than £4 billion to the British government from 1995 and 2011. Strengthening the British educational system by putting more emphasis on digital skills and math is a possible remedy for this decreased access to global talent, says this organism that defends the interests of the finance sector.

This would be an option for the medium-term because in the short-term, everything depends on politics. Talks will be tough, as May’s tense trip to Brussels in mid-October demonstrated. But all options are on the table. Many who were concerned by May’s tough discourse saw a ray of hope on October 2nd when a few weeks later, Nissan’s President who had hinted at the possibility of relocating his factory in Sunderland (in northern England), left a meeting with the Prime Minister feeling satisfied. Downing Street may decide to be particularly careful with certain sectors in their negotiation with the EU, and given its economic importance, no sector deserves this more than the finance sector.

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