Journal of Financial Economics

REF 148 After Brexit

The Brexit referendum vote of June 2016 has unleashed powerful, new political and economic forces in the United Kingdom (UK) and the European Union (EU). Why and how did this happen?

The British people were never told the truth about the EU – neither its raison d'être as an international political organization to build lasting peace on the continent of Europe nor the benefits of close European cooperation in an interconnected, multi-polar world based on legally binding treaties.

Euroscepticism in the UK, built up over forty years, was left unchallenged by generations of politicians and stoked up, relentlessly, by a hostile and aggressive British press.

There is no evidence whatsoever that the UK has prospered outside the EU, on the contrary politically and economically it has regressed. It has become more untrustworthy, economically unstable and less influential internationally.

European integration, however, has advanced in some significant ways since the UK has departed from the EU, but the EU has also lost some important British assets and qualities.

Brexit: liberty or tragedy? A costly tragedy for the British people that will last generations.

While the EU-UK Trade and Cooperation Agreement and the Withdrawal Agreement, including the Protocol on Ireland/Northern Ireland, set a solid foundation for the future relationship between the EU and the UK, it by no means matches the level of economic integration that existed while the UK was a member of the EU. This is a natural consequence of Brexit and the UK's choice to leave the EU where it was fully integrated into the Single Market. This decision has had an impact across all sectors of the economy, including in both competition and financial services policy, creating frictions and barriers to trade which did not exist while the UK was a member of the EU. Nevertheless, the EU's objective is to have a stable and positive relationship with the UK based on the Agreements we both signed and ratified.

The Brexit referendum has fundamentally changed the relationship between the United Kingdom and the European Union, also within the banking sector. With the United Kingdom becoming a third country from an EU and a single European market perspective, overseeing an orderly relocation of banking activities to the EU has presented significant challenges. In fact, European customers can no longer be served directly from the United Kingdom. This contribution explains how the EU and the European Central Bank (ECB) in particular are overseeing this relocation process, and describes the ECB's supervisory approach in dealing with a number of thorny issues raised by Brexit. The ECB has been firm in its principles, particularly its “no empty shell” policy requesting banks to locate within the EU strategic and risk management capabilities commensurate with their level of risk. But it has also been flexible and proportionate in applying those principles and very keen to establish intense and transparent cooperation with the UK authorities. This is indispensable to support the significant amount of cross-border banking business which will continue to characterise our markets for the foreseeable future.

This article provides a brief overview of the efforts taken in the regulatory and supervisory sphere in the first post-Brexit phase and highlights the challenges ahead. Brexit has created a new landscape for financial institutions in Europe. Banks, regulatory authorities and supervisors worked intensely to ensure a transition without any significant distortions. Brexit has caused structural changes for credit institutions as they adjusted their operations to serve the EU market. Brexit has also brought to surface the EU dependencies on the UK financial sector, especially in the area of derivatives clearing, that will need to be addressed in the near future. Going forward, the EU and the UK should continue to show their strong commitments to preserving open financial markets and global regulatory standards in the financial sector. Those principles should help build a collaboration framework to avoid weakening financial standards, risk fragmentation or financial disruption.

Triggered by the exit of the United Kingdom from the European single market, the relocation of financial activities towards the European Union is significant. It covers all branches: banking, markets, insurance, asset management. The transition is nevertheless not ended, because European regulators have allowed time and steps to relocate.

An estimate done in spring 2021 counted 440 firms concerned, 900 billion pounds of banks balance sheets and 7400 jobs. The reality today is certainly significantly higher. Several financial places of the European Union have benefited, but Paris appears the only one to have received from all branches of the financial industry, and the place where market activities are concentrating.

Paris displays several assets: its talent pool, the city's attractiveness, the reputation of its regulators, the dynamism of its actors. There remains nevertheless handicaps that take time to correct, essentially on the side of tax and benefits costs (social levies, production taxes), which justifies a pursuit of competitiveness efforts.

It is difficult to distinguish the economic impacts of Brexit from those of the pandemic. Nevertheless, UK's GDP decreased by 5.2%. Imports from the EU declined significantly and UK became less open and less competitive internationally. A strong inflation followed the depreciation of the pound in 2016 and UK has experienced a contraction in investment due to uncertainty. The economic impact of Brexit on the EU is limited since its economy is much larger.

In the financial sector, UK is now in the position of a third country, without a European passport, subject to sectoral regulatory equivalence regimes. Team movements from the City to the Union have been rather limited (4%). London still has many assets, including market infrastructures such as central counterparties, which are complex to replace by continental structures. Regulatory competition has not much materialized so far, but can intensify by adaptations to make UK regulations more efficient without weakening the framework.

The business community has largely adjusted to the UK departure from the European Union and is inclined to move on, but Brexit itself remains unfinished business. Some of the most disruptive consequences of this historic divorce have already taken place: many of them have been less dire than predicted in the short term, although the City of London has lost its critical role as the capital of European finance. In the longer term, key questions remain to be answered about the UK economy and its overall competitiveness and about the future relationship between the UK and its erstwhile partners in Europe.

The effects of Brexit on the financial markets are still uncertain. Job transfers to the EU are gradual, with very marked effects in Paris, Dublin, Amsterdam and Frankfurt, even if London still remains the densest financial centre in Europe. But the exit of the City from the EU regulatory framework has profoundly changed the outlook for the evolution of the competitive environment. Things have already changed when it comes to IPOs. To amplify this dynamic, we must now include the Capital Markets Union in a political ambition of strategic autonomy, that is to say direct our projects towards the construction of a genuinely European model with distributed but integrated and highly interconnected financial centres. Faced with the risk of piling up secondary technocratic measures that weaken EU financial players, three priorities must now prevail in the Commission, the Council and the European Parliament: simplification, competitiveness and strategic autonomy.

Brexit was not just a major political upheaval, it has also led to profound transformations in financial services due to their importance for the smooth functioning of the Europeans and British economies, and to the interlinkages between them. Furthermore, for the European Union, Brexit is without doubt an unprecedented opportunity to assert its financing autonomy, increase its resilience with a polycentric financial system relying on european market infrastructures and establish itself as a leader in innovation. However, this does not mean a step back from ties and dialogue with the United Kingdom: a close coordination with British authorities, especially in areas of regulation relating to systemic or global risks, is of the ultmost importance to avoid fuelling the risk of harmful regulatory fragmentation.

The United Kingdom has consistently sought to benefit from the “best of both worlds” in the financial sector: access to the single market and the freedom to adapt its regulations and supervision. The renegotiation that preceded the referendum achieved this by remaining within the Union; in the context of Brexit, the ambition of the United Kingdom was to achieve this being outside the Union via mutual recognition agreements. The Union refused to go down this path, which would have increased its financial dependence on decision-making centers located in third countries. We are therefore in a situation of frontal competition in which the United Kingdom is resolutely committed to a policy of revisiting the regulatory framework of its financial sector in order to increase, partly to the detriment of the Union, its competitiveness and attractiveness via an alleviation of constraints and flexibility of regulatory responses. For its part, the Union's financial markets remain fragmented and it is struggling to improve its regulatory framework. The United Kingdom considers that having a powerful financial industry is essential, the Union has never made it a priority. Post-Brexit remains to be written, but it will be an acid test for the EU, calling for awareness of the urgency of deep reforms with the effective realization of a capital markets union including a single supervision.

Brexit has not been resolved six years after the United Kingdom's vote. While much attention focuses on the disagreement on rules for trade through Northern Ireland, the resilience of cross border financial flows between the European Union (EU) and the United Kingdom (UK) does not suggest any significant dent in the longstanding financial market ties that bind the EU and the UK. Both sides have been pragmatic, to allow for a smoother transition, guarding against the well understood financial stability risks of cliff-edge disconnections. The Capital Market Union initiative, while well underway, is some time away from offering EU entities a common intra-EU capital market, and the market liquidity and network benefits that London currently provides. Building this capital market union will even out funding costs for corporates and households, but it will require eliminating barriers to cross border capital and banking flows in the EU. Preserving ties between the UK and the EU will, therefore, benefit both sides, bridging the long transition to more integrated capital markets within the EU.

More than six years after the referendum on the UK's membership of the EU, Brexit is not entirely done. We start with recalling the main points of the EU-UK trade and cooperation agreement signed on December 30, 2020. We then make an assessment of the implementation of the agreement and its consequences on the UK economy by mid-2022, under two shocks of exceptional magnitude: the COVID19 pandemics since early 2020 and the Russian invasion of Ukraine since February 2022. Last, we address issues of the future EU-UK relationship. Liz Truss, Prime minister, wishes to abolish regulations inherited from the EU to strengthen UK attractiveness, but she seems also willing to find an agreement with the EU on the Northern Ireland Protocol and to join the European Political Community.

The meaning of Brexit means remains opaque and contested. In the immediate future, the UK-EU relationship depends on solving the Northern Ireland Protocol dispute, an essential pillar of the 2020 Withdrawal Agreement. Without mutual agreement, a major confrontation looms. The economic consequences of Brexit have so far been negative. Its fervent advocates and increasingly the electorate are disappointed – but for opposing reasons. Liz Truss, the former British prime minister, was aiming for a “new era” of economic growth, stimulated by a right-wing programme of tax cuts and deregulation, in which “taking advantage of the opportunities of Brexit” will play a big, if unspecified role. How this will work out in practice is problematic. Speedy divergence from EU rules could lead to new tensions over “unfair competition”. Meanwhile the opposition Labour party has rejected re-joining the EU, its single market or customs union: for sound electoral reasons, Sir Keir Starmer is firmly opposed to reopening the Brexit argument. However, its policy of “making Brexit work”, while deliberately vague, holds out the promise of a more cooperative EU relationship.

The Brexit is accompanied by a loss of substance for the EU, particularly in the high value-added areas of research and finance. Philippe Aghion proposes to compensate for these losses by developing cooperation markets between the continent and the UK in industry, research, transport and defence. He suggests that the constraints linked to Brexit require Europe to develop ambitious cooperation initiatives, particularly in the field of research.

Since the great financial crisis, the Modern Monetary Theory (MMT) rouses interests in political, media and academic area. In the ensuing Keynesian moment, the MMT has emerged from the confidentiality to advocate a permanent fiscal dominance in opposition to the consensus built toward a politically independent monetary policy. MMT has however been widely criticised by mainstream economists but also by the post-keynesian school from which it comes. The most vehement attacks to deny the scientific nature of the theory and to confine it to a political movement belonging to the left wing of the US democrats. More sophisticated critics tackle theorical foundation and empirical evidences of the MMT to contest their recommendations. This paper provides an overview of those critical points of view and contributes to the chorus of criticism by raising a failing political economy.