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06/23/2016

BREXIT OR BREMAIN: A major difference for the powerhorse called European Union?

In 1991 Saskia Sassen defined “a global city” as cities with most important economic activity. Worldwide 3 cities were labeled as global cities according to the definition: New York, London and Tokyo. A couple of years later, the Globalization and World Cities Research Network (GaWC) ranked according to cultural, economic, political and financial global influence labeling them alpha, beta or gamma cities. Only 2 cities earned the Alpha ++ status because of their major influence on other cities worldwide: New York and London. Although reviews of the ranking are only marked by minor changes between the 2 cities, future review may be strongly impacted by the outcome of events on 23rd of June 2016 in both a negative or a positive way for either London, European cities and even cities worldwide. Will New York be the only “global city” in a couple of years, will London strengthen its position in the worldwide market or will other cities profit of the outcome of the British referendum? The British exit (Brexit) will impact both the United Kingdom as the European Union on economic, financial and political level. The future outcomes and side-effects are highly volatile as well as uncertain and will depend on long term decisions, negotiations and developments.

The European effects of the Brexit

 If the UK decides to leave the European Union, it is impossible to proceed as before the referendum. Different aspects of the European Union as budget, army power and trade will be affected but also less quantifiable sources like soft power and uncertainty in the European Union can be affected by a vote in favor of the Brexit. The question remains whether these effects will be positive or negative for the European Union. In the following paragraph we will point out major implications for the EU on political and economic level.

International influence through hard and soft power of the European Union

One of the most important aspects within the international forum are the aspects of both soft and hard power. Soft power is the ability to change other countries behaviors through the means of attraction and persuasion which is for example economic power but also cultural and political values. Hard power on the contrary is the ability to change the behavior of a country through military and economic means.

With members France, Germany and the UK, the EU is represented with 3 member states in the G8 and 2 member states in the UN Security Council. Through these countries the European Union as a whole has a strong representation in important political organs worldwide.  The EU would lose a strong voice within these institutions and even beyond these organization by losing the UK because of its important institutional position in the, G20, NATO, IMF, World Bank and the Commonwealth. The soft power 30 index rating ranking countries according to the ability to coax and persuade, ranked Britain as strongest soft power worldwide. It measured the country stronger than the United States or China.

Furthermore we see that EU probably contributes highly to the positive perception of Britain’s soft power as the EU is seen as most positive influence worldwide in international interactions according to the BBC. They divided influence of countries as positive and negative as perceived by other countries. It can be concluded that the EU needs the UK as power. But the other way around means that the UK needs the EU for its image and perception on the international forum.

Lastly, in global political crises like Iran, Irak, Islamic State or Syria, the EU did not show the strongest political power through a lack of delivery of promised rules. The UK has been acting as more strongly opinionated, within global political conflicts and showed strong military power as it is heavily investing in army power.  

The UK has an influence on both the soft power part as the hard power of the European Union which could be a major future outcome of the Brexit after the 23rd of June. The UK will tend to follow either EU or US policies in foreign international relations, it can have a strong impact on the EU’s worldwide credibility.

Foreign direct investment in the European Union

Compared to the rest of the European Union, the United Kingdom has a highly favorable business environment attracting more foreign direct investment than any other nation of the European Union. The country is also the home to most corporate headquarters within the EU leading to job creation and future attraction of foreign investments.

This strong position might be affected through the Brexit and the question rises whether the member states of the EU will respond to the loss of UK competitiveness. Over the long term, the UK is likely to recover but in the short term the EU member states can profit through creating an investment and business friendly environment in individual states leading to the attraction of companies to settle their European headquarters.

The major threat to the European Union is a strong liberalization and lower taxation executed by the UK, like the “Dublin model” which may draw investment away from the European Union that will have to react with a more liberal environment of investment.

Other implications on the European Union

Furthermore the Brexit can have major impact on other aspects of the European Union. As the United Kingdom is a major contributor to the budget of the European Union, the monetary implications of a Brexit need to be replaced by other member states which will be a major challenge. The Brexit will also impact the trade relations with the European Union. Many of the European member states like Germany or France run a trade surplus with the United Kingdom. While the amount of trade with the UK as total amount of trade within the EU is limited, this probably will have an impact of the trade of member states impacting them individually.

The Financial Services Industry in Europe

The impact for Europe on the financial services industry is highly unknown. It leaves the European Union without the major financial hub, London, affecting European customers. At the same time it creates a financial services gap that needs to be replaced.

The Impact on European customers

In case off a Brexit on Thursday 23rd of June, the European private and business customer will be impacted in the long term. The city has major operations of large European banks creating economies of scale. A loss of London out of the European Union will negatively impact households and companies that benefit from several liquidities. In case of new trade barriers with the UK, Europe would partly be affected through high charges and poorer products because of a lack of innovation and liquidity, aspects that cannot be picked up by financial centers elsewhere in the short term.

A shift in the financial centers in Europe and worldwide?

The global financial centers index which ranks Cities according to their importance for financial services, places London at the top spot acting as global financial hub together with New York. Different factors such as working skills available, regulatory environment, availability of business infrastructure rank London way higher than any mainland European counterparts. Other financial centers are affecting and connecting regions but not being globally integrated as the UK’s capital.

For European cities a Brexit could be the ideal opportunity to take over the role of London as financial center in Europe and put feet next to New York as global financial center. Because of the lack of infrastructure and the amount of skilled workers, the question remains whether these other financial centers will be able attract the enormous amount of services offered in the UK  and make their way up in the financial centers index.

Different EU-cities have developed expertise, knowledge and services in niches of the financial industry like Dublin for fund management, Amsterdam for legal compliance or Frankfurt profiling itself as the similar environment for major banks as London. If the UK decides to leave the EU, these cities will try to attract certain services offered in the UK supported by their access to European single market that Britain will partially or not possess. At the moment, 30-40% of euro-trading is happening in the city of London. In the event of a Brexit, this situation is simply not sustainable and the activities would move most probably to Frankfurt or Paris.

Both cities possess the infrastructure, skilled workforce, international outlook. Furthermore importance of both cities and their respective countries in the European Union are important as reasons for attraction. Both Paris and Frankfurt are metropoles providing a nice living environment and a strong connection with the rest of the world. Apart from these factors, these 2 cities are already home to 5 of top 10 major financial banks in Europe like BNP Paribas, Societé Générale, Deutsche Bank and 2 of the most important European stock markets. Both cities provide an attractive environment to provide the European market with financial services.

Ultimately the impact on other financial centers in Europe will only be measurable post-Brexit. A certainty is the fact that the financial services industry will be the first industry affected and impacted. Because of the passport rights and lack of bilateral trading agreements previously established by the EU, large banks headquartered in the UK, will reconsider other European cities to service the EU market. A catastrophic scenario for both the European Union and the UK is major banks reconsidering their services to other places outside the EU. This could be the case for mobile activities, which are of major importance in London nowadays. This will in the end not favor Britain or the EU but will imply a movement of important financial services to New York or Asian financial centers.

Brexit or Bremain, a different impact on exchange rates?

During the past days and weeks, financial markets have seen strong fluctuations in the exchange rate of the euro and pound sterling. A Brexit could in the short term result in a strong appreciation of the euro making UK’s products more attractive in the short term but having a negative effect for the UK in trade with the EU. A Bremain vote will most probably result in an appreciation of the pound sterling bringing the EUR/GBP rate back to the level of almost a year ago.

A certainty is that a Brexit will lead to major exchange rate fluctuations for which the economic implications are difficult to measure for both the EU and the UK.

The Reaction of the European Union.

But even if other financial centers take over the activities of the city, the UK will remain important to the EU as major future trade partner because of the importance of UK’s economy and their international influence. The EU will renegotiate their terms with the UK regarding regulation, trade, industrial policies,… This process will take a timespan, at least 2 years according to experts, in order to connect the UK market in a different way with the EU activities.

Different scenarios after the Brexit are possible to establish new relations:

  • European Economic Area agreement: The EU will approach the United Kingdom as a participant of the single market that needs to adopt the EU standards and regulations following EU political decisions.
  • Free trade agreements: The EU negotiates trade agreements with the UK. These are likely to avoid trade barriers for the UK, not allowing any deviation from these agreements. This agreement will most likely favor the British market.
  • Bilateral accords: This agreement would be similar to the agreement with Switzerland which only allows the Swiss only access to specific sectors of the single market. This access to the single market comes also with the adoption of regulation. This agreement enhances permanent amendment and tremendous effort to always align euro-sceptics within the country on the one hand and the European commission on the other hand. Since this agreement with Switzerland has been set up for an eventual entry to the European Union, it is not likely that the EU will allow an agreement like this with the UK.
  • Most favored nation based approach: The EU would lose its power over regulation but will be able to set external tariff barriers. These would not favor trade between the UK and the EU.

Ultimately a Brexit would force the European Union to send a sign. On a political level, the traditional 3 strong EU forces France, UK and Germany will be diminished to 2, expecting from Germany an even stronger role in extra-EU relations to fulfill the gap the United Kingdom will leave behind. The short-term post-Brexit period for the EU will consist of trying to find a good balance between sustaining the belief in the European Union and giving a clear message that “out of the EU” is not the same as “in the EU”.

The challenge for European political leaders will exist of finding a balance between “punishing” the UK by working out a deal which is less beneficial than EU-membership but still positive for both parties. At the same time, the EU does not want to create doubt about the membership towards other member states or anti- euro movements that favor an exit of their country, a situation that could create uncertainty in the short and long term within the European Union.

Over recent years, several member states like the Netherlands, Italy and even France have seen the rise of euro-sceptic parties communicating strong anti-EU messages to a growing amount of voters. These parties could grow even stronger in case of a weak sign from the EU towards the United Kingdom after a Brexit which eventually can lead to high uncertainty, affecting the base values of the European Union.

Conclusion

The ultimate effects on the European Union from a Brexit are highly unsure. On a political level, the European Union will lose a partner with a lot of leverage and a strong voice on the international forum. The economic strength and the positive soft power of the European Union is one of the assets to sustain the negative effects of the Brexit in the long term. Furthermore the volatility will be very clear for the financial services sector. It will impact financial centers worldwide, shifting certain services from the UK market to the European market and other worldwide markets in the short and eventually the long term. The main question will be how the EU and UK will approach the post Brexit period which will define the future financial services sector, the economic environment as well as political evolutions in the EU.

 

Sia Partners

Copyright © 2016 Sia Partners. Any use of this material without specific permission of Sia Partners is strictly prohibited.

 

1 comment
Pratik Agarwal le 06/24/2016 am30 11h20

A very interesting read and a thoughtfully written article. What might lead to global meltdown after this are 2 factors which needs to be pondered on very deeply: 1) the effect of the ripple which might trickle to other EU members 2) rating cuts due to slowing economic growth in the UK

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