Brexit: The Death of a Financial Center, or Much Ado About Nothing?
Is panic contagious?
Now that I’ve lived through multiple financial crises, I’d have to say, “Yes, easily.”
Looking at my Facebook and Twitter feeds last week, I couldn’t tell if a political event had taken place, or if terrorists had detonated a nuclear weapon in a major city.
Most people treated the U.K.’s decision to leave the EU as a sign of the impending apocalypse, only a hair removed from Sauron killing Frodo and taking his ring.
This made me realize that:
- I dislike ~75% of my “friends” on Facebook – time to cull the list!
- There has been a massive overreaction to this referendum.
As I browsed around, I realized that I disagreed with about 90% of the “Brexit” coverage.
So before you do anything drastic, please read this first:
Defining the Scope
You could write hundreds of pages about what Brexit means for immigration, the GBP/USD exchange rate, home prices, or wheat farmers in the east of England.
I’m going to focus on financial services, and more specifically on M&A and investment banking jobs.
While Brexit is unlikely to make a positive impact, it isn’t nearly as bad as the media and the markets have claimed.
Fear #1: Banks Will Relocate All Jobs to Paris/Frankfurt/Amsterdam/Dublin/Edinburgh
This idea is pure fantasy.
Sure, bank CEOs went around threatening to move banking jobs elsewhere, but only one of these cities (Paris) is even close to London’s size (see: European cities by population).
Then there are other issues, such as much better employee protection in France, Germany, and Italy, which banks hate, and a lack of housing and infrastructure in most of these cities.
For reference, there are approximately 350,000 financial services employees in London:
(Other sources put the figure in the 700,000 range, so that number may be on the low side.)
Do you honestly think that everyone will relocate to Frankfurt, which has a total population of ~700,000?
Even if the city could support that massive population increase, it isn’t possible to build enough infrastructure to do so anytime soon.
Amsterdam’s population is ~800,000, and Edinburgh and Dublin have ~500,000 each. Paris is about the same size as London if you count the entire urban area (but smaller if you count only the inner circle), but language, economic, and regulatory issues make it unlikely for banks to relocate there en masse.
Continental Europe also has a tradition of being unfriendly to Anglo-Saxon-style banking, which is why France and Germany pushed for a “financial transaction tax” a few years ago, while the U.K. and others opposed it.
Even if banks move some jobs to continental Europe, U.K. and Irish companies were involved in 36% of all European M&A deals by value, just in 2014 – 1H 2015:
Cross-border M&A deals happened before the EU ever existed, and they’ll continue after Brexit.
But the biggest problem with this fantasy scenario is what happens next: specifically, what if other countries now vote to leave the EU?
If this idea seems far-fetched, remember that almost everyone was wrong about Brexit as well.
Banks are not going to relocate entire teams when there’s uncertainty over the possible exits of other EU member states.
Fear #2: You Won’t Be Able to Work in the U.K. as a Foreigner Anymore
If you’re relatively young, and you earn a lot of money, the U.K. government wants you in the country for your tax money.
True, the Brexit vote was mostly about the refugee crisis and immigration, but immigration rules will become stricter primarily for lower-earning employees.
In all likelihood, the U.K. will adopt a points system similar to what it currently uses for non-EU workers, which heavily favors young, educated, and high-earning professionals.
Also, if you’ve been working in the country for more than five years, you can still apply for permanent residency if you want to stay.
Fear #3: Non-EU Banks Will No Longer Be Able to Operate in EU Countries
Under a practice known as “passporting,” a U.K.-authorized firm can do business in any other European Economic Area state by winning approval from British regulators.
This practice lets non-EU banks like CS and JPM operate in London and then access all the other EU markets.
If this goes away, these banks will have to open local subsidiaries and go through the regulatory approval process in each country separately.
But is that really such a big deal?
These are giant corporations with hundreds of thousands of employees, and banks like Credit Suisse already appear to have subsidiaries in various EU countries (Source: Capital IQ).
It might take some time to set up subsidiaries, but would it destroy JP Morgan if they had to set up new entities in the top 5-6 countries?
Also, keep in mind that “leaving the EU” is not an all-or-nothing scenario.
The U.K. might end up negotiating bilateral agreements, as Switzerland has done, or using the “Norway approach” and remaining in the EEA.
I’m skeptical of that approach since it would mean accepting “the free movement of people” – but the point is, no one knows what the new relationship will look like yet.
Fear #4: They’ll Rescind Your London-Based Job Offer
As mentioned above, banks are unlikely to shift around entire teams when other countries are at risk of leaving the EU and when the U.K.’s new relationship is a big unknown.
So I find it highly unlikely that banks will rescind offers for jobs set to begin in the next year.
They might shift some staff to other cities, but I don’t think anything major will happen within the next year.
Fear #5: Recruiting in London Will Change Completely
We’ve received questions to this effect, but I don’t see the logic: why would the recruiting process change?
Why would banks eliminate assessment centers or competency questions?
These features exist because they do a better job of evaluating candidates than traditional interviews do – not because the U.K. is a part of a political and economic union.
Hiring could become more localized, with London acting as less of a hub.
And there are recruiting differences between London, Frankfurt, and Milan (for example).
So in that sense, recruiting could change because fewer candidates would go through the entire London process.
But isn’t that a positive development?
If a team in London hired you because you’re Italian, and you have to work with Italian companies, isn’t it better to work in Italy?
You might get less exposure to different products and teams, but you could always transfer elsewhere if the bank is big enough.
The Bottom Line
With all that said, no, the hiring outlook for London is still not positive.
European deal activity is down by 20-30% this year, hiring has been sluggish everywhere, and the global economy is weak.
With this new uncertainty, banks are unlikely to expand hiring anytime soon.
Brexit may offer some potential benefits, but I’m skeptical of most of them.
Here are a few I’ve seen mentioned:
Benefit #1: The U.K. Gets Out of CRD IV… Maybe
A few months ago, I read through thousands of pages of U.S. and EU government documents on Dodd-Frank and CRD IV as I was working on our new Bank Modeling course.
It was so boring that I almost jumped out a window, but I learned a lot about banking regulation in the process.
CRD IV is the EU’s local implementation of Basel III, but it goes well beyond capital requirements for banks and also impacts banker compensation.
For example, it limits the bonus:salary ratio to 1:1, though it can be raised to 2:1 in certain scenarios.
It also imposes additional capital buffers on banks (beyond the Basel III requirements) and requires disclosures on executive compensation, risk management, and more.
I don’t think the U.K. can just “repeal” CRD IV, but it may be able to tone down parts of it.
In the U.S., Dodd-Frank applies only to banks with over $50 billion USD in assets.
A similar carve-out already exists in the U.K.: the bonus cap does not apply to banks and building societies with under 15 billion GBP in total assets.
That might stay in place, and possibly even expand.
But even if the U.K. somehow got out of CRD IV, it would still have to comply with Basel III, which automatically reduces profits and therefore bonus potential.
Benefit #2: Lighter Regulations on Private Equity Firms and Hedge Funds
The U.S. hedge fund industry, at ~$2.2 trillion, dwarfs the one in Europe (~$700 million).
Many factors explain that, but one recent one is the “Alternative Investment Fund Managers Directive” (AIFMD), which regulates everything from fund marketing to leverage to reporting and compensation.
There is some evidence that U.S.-based managers have stayed away from Europe because of the added burden of these regulations.
So regulators might reduce these requirements, which would encourage more funds to set up shop in the U.K.
But as with CRD IV, this one is heavily dependent on the U.K.’s new relationship with the EU. If they still want access to the single market, they’ll have to comply with the AIFMD.
Benefit #3: Increased M&A Activity and Foreign Investment
With a much lower GBP, many U.K. companies are far cheaper to foreign acquirers, especially ones in China and the U.S.
Plenty of U.K. companies will also spin off divisions, in some cases, and make acquisitions, in other cases, to retain access to the EU market.
M&A activity tends to increase when there are regulatory changes – we’ve seen that with Basel III and worldwide bank M&A, and with Obamacare and health-insurance deals in the U.S.
Then there are other EU rules that restrict investment and deal activity.
For example, ownership of European airlines by non-EU companies is currently limited to 49.9%, which explains why Delta owns exactly 49% of Virgin Atlantic.
With rules like these eliminated, minority-stake investments could turn into full acquisitions more easily.
So what will actually happen as a result of Brexit?
- Relocation of Jobs to Other Cities: I doubt anything major will happen in the near term. In the long term, the banking industry might become more evenly distributed across Europe, but the biggest teams will still be in London.
- M&A Activity: It’s down in Europe and down even more in the U.K. this year, and that won’t reverse anytime soon. But all these regulatory changes could result in higher deal volume down the road.
- Compensation: There’s an outside chance that compensation could increase because of more CRD IV carve-outs, but this one is unlikely to happen at the big banks. As in other regions, boutique banks still win on compensation.
- Your Job Offer: Yes, some banks rescinded offers after Lehman in 2008, but that move also led to a shortage of mid-level bankers a few years later. This time around, if anything happens at all, you’re more likely to be relocated (~60% of London bankers are from other EU countries).
The Death of a Financial Center?
So I lean more toward the “much ado about nothing” camp on this issue.
Beyond the factors above, there’s a host of other reasons why this move may make a smaller impact than what the media claims (just as one example: The U.K.’s EU membership fees are equivalent to a 7% tariff vs. the 3-4% tariff on non-EU countries).
So no, the world is not ending.
Sure, banks may shift around some jobs, but they’re not going to pack up and suddenly leave the world’s fifth-biggest economy.
And if people on social media claim that this, or any political event, represents the apocalypse, be skeptical.
They might just be confusing it with a wildfire explosion or a stray dragon in King’s Landing.
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