The impact of the UK’s decision to split from the European Union (EU) sent shockwaves across the continent when the decision was announced on June 24 last year, swallowing political, social and economic issues whole. The enormity of Brexit and what it means for the future of the capital markets, both in the UK and the Eurozone, cannot be underestimated and financial firms have already begun making contingency plans for whatever outcome is reached when the two year period for negotiations under Article 50 expires on March 29, 2019.

As part of his keynote speech at the European Securities and Markets Authority’s (Esma’s) conference last month in Paris, Valdis Dombrovskis vice president for financial stability, financial services and the capital markets union at the European Commission, said that until further progress was made on initial negotiating factors, ambiguity could not be lifted from the industry.

“The fact that the largest financial center is leaving the union is a serious concern for many businesses,” he said. “Pending the outcome of negotiations, it creates legal uncertainty and requires businesses to reassess their strategies. My main priority during the process will be to reduce this uncertainty as much as possible, and preserve the stability and resilience of our financial markets.”

Pierre-Henri Conac, professor of commercial and company law at the University of Luxembourg, who was speaking as part of a dedicated Brexit panel during the one-day event, was far blunter in his assessment of the situation, describing Brexit as a “political disaster.”

“Now it is also turning into a technical disaster if it is not fixed,” he said, referencing the possibility that a “hard Brexit” scenario was becoming more likely.

Confusion Reigns

The ongoing lack of clarity as to how Brexit will unfold is severely hampering the ability of capital markets participants on both sides of the Street to adequately prepare for life both before and after the UK’s withdrawal from the EU, and crucially, the European single market.

While negotiations continue to stall between the UK government and European Union officials over how the divorce will play out, with details over trade deals and “passporting”—the ability to export services throughout the EU—yet to be hashed out, financial institutions may have to take the lead and execute their strategies, regardless of political outcomes to safeguard both their businesses and investor interests.

“You cannot, as an industry, keep all optionality open for very long, so that means if there is no decision or clarity at some point, we will have to make a decision,” said Sylvie Matherat, chief regulatory officer at Deutsche Bank, who was also part of the Brexit panel. “Maybe we will need to move before any political decision will be made, which is a pity from a political perspective because that means that the decision will be made by the industry.”

At what point financial institutions will decide that plans must be put into motion also remains unclear, but there seems to be little doubt that once one organization begins the process, others will follow. And, if Brexit naysayers need any convincing that capital markets firms are serious about their threats to up sticks and move to the Continent, Goldman Sachs’ CEO Lloyd Blankfein’s October 19 tweet would have make sobering reading: “Just left Frankfurt. Great meetings, great weather, really enjoyed it. Good, because I’ll be spending a lot more time there. #Brexit.” 

London’s position as Europe’s prime financial and technology hub is under serious threat, as other major banks, including JPMorgan, Citi and Morgan Stanley have outlined plans to move operations from the UK to Frankfurt, while others are assessing Dublin, Paris and Amsterdam as possible relocation sites post-Brexit.

Fintech Future

It is not just the banks that are seeking new homes in the wake of the split. As previously reported by Waters, technology vendors and service providers are also beginning to follow in the footsteps of the sell side and plan for life outside of London.

The UK capital has long been in pole position as the go-to center for European fintech startups, with the Continent’s largest financial players on the doorstep and huge investment poured into fintech accelerators and innovations hubs such as the Level 39 complex.

Despite the ongoing uncertainty caused by Brexit since June last year, investments in UK-based fintech topped the $1 billion mark in 2017, according to figures from research and data firm Pitchbook and published by London & Partners on behalf of the London Lord Mayor. Of that investment, London accounted for $980 million.

“Clearly, Brexit poses major challenges but London’s position as a global financial center and world-class technology hub is built on strong foundations, which cannot be replicated anywhere else: access to more software developers than Stockholm, Berlin and Dublin combined; Europe’s largest fintech accelerator Level 39; and the Continent’s only truly global financial market,” said Rajesh Agrawal, London’s deputy Mayor for business, in a statement accompanying the figures.

Whether that level of capital will continue to flow into London-based fintech firms in 2018 and beyond is, for now, a matter of speculation, but that hasn’t stopped those banking institutions that are rooted in the UK, such as Barclays, which launched its London Rise accelerator hub in May this year, from forging ahead with their own programs.

On the flip side, countries around the Eurozone will be looking to exploit the situation to attract new or existing fintech startups from the UK. Panelist Hans-Ole Jochumsen, vice-chair of Nasdaq, said European authorities need to focus on the formation and development of the capital markets union to ensure that Europe is able to compete on a global level when it comes to fostering financial technology.

“We have a big problem already today that we are not very good at creating jobs,” he said. “My concern, having lived in the UK, the US and Sweden, three countries where fintech is hot, is how to keep these new European companies in Europe.”

Transitions

Any transition to a new location will be a major undertaking for any institution that decides to do so and the technology problems associated with such a move will only be exacerbated for larger players, such as Deutsche Bank.

Matherat said the organization’s ultimate objective is to minimize disruption to clients, despite planned relocation, which will inevitably involve a number of unavoidable transition costs, including the implementation of new technology platforms and infrastructures, projects that once again touch on the eternal “build versus buy” debate.

“There needs to come a time either to accommodate an existing platform from a provider that is already present in Continental Europe or build a new one, and you need to take some time to deal with that,” Matherat said. “In the long-term, the more operations it takes the more difficult it will be. We will reach a point where, decision or no decision, we will need to make a choice, and if you create those platforms in order to move to a position in Continental Europe, we will not come back.”

While banks have historically struggled with problems associated with legacy technologies and infrastructures, hybrid models of legacy and cloud technologies presents a viable way to establish a new, or at least greater, presence in a new location without having to begin completely from scratch.

Both hybrid models and cloud can help preserve the embedded functionality that legacy technologies provide, while also improving agility and responsiveness required to adapt to new environments. As such, flexibility will be one of the most important facets for banking institutions around Europe post-Brexit. Whatever the short- and long-term ramifications, there will be costs to bear.

Allianz Global Investors, which is headquartered in Frankfurt but maintains a sizeable presence in London, has yet to make a formal announcement on its post-Brexit location plans, but Elizabeth Corley, vice chair of Allianz Global Investors, said any transition will inevitably be a “very expensive and complex process.”

“There will come a point where transition will start to happen anyway and the larger, more well-resourced organizations will be responsible, and will do it as well as they can,” she said. “But there are mid-tier organizations for whom this is a very significant investment with no payback, so they will naturally delay to the point at which they have to do that. For small and mid-tier organizations this is not a risk-free delay; execution risk, at the weakest link in the chain, will start to go up significantly, definitely beyond the end of this year.”

Nasdaq’s Jochumsen said he expects most financial firms to enact their Brexit plans next year following the introduction of the revised Markets in Financial Instruments Directive (Mifid II) on January 3, 2018. “What we hear is that people need to act soon and in reality they would like to have certainty within a few months, but my fear is that it is not going to happen,” he said. “What we will see next year when Mifid II is implemented is that people will start to implement their Plan B.”

However, Jochumsen did explain that around 70 percent of the exchange’s trading participants had divulged their post-Brexit organizational plans, a level that he is “pretty comfortable” with.

Investor Protection

In terms of investor protection, one of Mifid II’s central tenets, Allianz Global Investors’ Corley said that the high level of uncertainty over the future of UK and European relations meant that increased market fragmentation could lead to higher costs, reduced liquidity and more challenges toward sustaining a compliant market.

“The biggest impact in the near-term is to make sure that there is a sense of protecting customer rights, whether that is wholesale or individual, and that we do not sacrifice that at the altar of political ambitions,” she said. “Our concerns are all about the fact that come April 2019 we want to be able to look after our clients’ money in a seamless way.”

Any impact on financial institutions’ ability to protect investor interests as a result of Brexit would directly contradict much of the work the industry and regulators have done to implement new operations and technologies since the global financial crisis a decade ago.

A prime example of this would be the incoming revisions on the back of Mifid II coming into force, which places greater transparency and investor protection at the heart of the new regime. While the exact impact of how Mifid II will be enforced in the UK once the transition has been completed is another unknown, Esma and the European Commission have both acknowledged that there will be issues to address on this subject going forward.

German member of the European Parliament, Markus Ferber, who spoke as part of an earlier panel at the Esma event, went so far as to suggest that there should be a review of Mifid II—in effect, a review of the review: “When we negotiated Mifid II and Mifir, no one knew the UK was going to leave the EU,” he said.

Silver Linings

While the shadow of Brexit continues to loom over the capital markets, there are many challenges for the industry to overcome. However, there will also be opportunities to take advantage of, in a similar fashion to the introduction of Mifid II. Corley said there were “substantial areas to win” but that the industry must “keep our eyes on the much bigger game of what happens beyond Brexit.” 

Pierre-Henri Conac said the industry, particularly the rest of the European Union nations, should make the most of a bad situation and focus efforts on creating a harmonized capital markets union that could operate on an international level.

Whichever way the Brexit situation unfolds, it’s clear that the capital markets in the UK and Europe will play a pivotal role, either by shaping the course of negotiations in the short term or by their reactions once a deal has been made. For the financial institutions themselves, much of this will depend on how pro-active they choose to be.