Operationalizing Brexit – What is at Stake?

The process of withdrawal of the United Kingdom from the European Union has become nerve-wracking, with the British Parliament expressing serious reservations. While the negotiations between the EU and the UK had not been as tough as in the earlier case of the much-feared Greek exit, the deal seems to have got stuck in the British Parliament. As per the current legal statute, the UK would exit the EU on March 29, 2019; and both the parties have to enter into a deal before that to avoid disruption to businesses and life, in general.

Here is a look at the economic aspect of the withdrawal, and why an orderly withdrawal matters. The economic separation could be classified into three groups: separation of trade in goods, trade in non-financial services, and trade in financial services. A look at the goods trade shows that it is the EU, which stands to lose more from the separation, contrary to general perception that the UK would be affected more.

This is because the EU’s export to the UK is more than the imports. As per a WTO report, the EU accounts for 53% of $644 bn of goods imported by the UK. Against this, of the total goods export of $445 bn from the UK, only 48% goes to the EU. This implies a trade surplus of about $130 bn for the EU, which may partially come back to the UK after the withdrawal.

However, trade in total commercial services (such as travel, transport, financial services, services linked to goods, etc.) gives a small surplus of $23 bn to the UK. While the UK exports 37% of $347 bn of services to the EU, it imports half of $210 bn from the EU.

Within commercial service comes financial service, which is small in value but is the most complicated of the three segments (while a separate figure for exports to the EU is not available, it could be about half of $83 bn of total exports of financial services from the UK). This is because the integration is much deeper; and unlike other segments, it is largely B2C. More importantly, the net value of exports does not indicate the total exposure, which is capital in nature, or notional in value.

To begin with, as per an IMF report, the UK banks provide around half of banking services to EU customers. Similarly, UK-based insurance companies have liabilities of £55 billion towards nearly 4 crore customers in the EU, whereas EU-based companies’ exposure in the UK stands at £27 billion and 1 crore customers.

The capital nature of exposure is reflected in the fact that the total Assets under Management (AUM) in the UK for EU clients is close to $1.4 trillion (as per the latest Financial Services Trade & Promotion Board, UK’s report). It is the fear of outflow of this capital, which drove down the British currency after the referendum; and continues to put pressure even now (the UK has total AUM of close to $7 trillion, which includes UK, EU, and rest of the world clients). The notional exposure refers to the servicing of derivative contracts, which is the most complicated of all. As per the IMF report mentioned above, contracts with a notional value of around £16 trillion maturing after March 2019 is being handled in the UK for EU clients. Similarly, UK-based clearing agents handle nearly 90% of euro-denominated interest rate swaps with a notional amount of around £38 trillion for EU customers. In the absence of clearly defined permission, the validity of these contracts could be in jeopardy.

An important risk-mitigation measure undertaken by the UK government is that it has agreed to bring in stopgap legislation. That would give temporary permission to EU-based financial companies to continue providing financial services to UK citizens. That would help avoid disruption of services being received by UK citizens from EU companies.

Even after the agreement is reached, both sides would need to get the necessary legislation passed by their respective Parliament, and operationalize the agreement. Subsequently, the companies operating across the border may accordingly need to secure permissions, registrations, and so on. The sequence of events before implementation of GST could give some idea of what to expect in the months to come.

And at the end of this all, one is left wondering, was the separation worth all this?

Ashish Agrawal Founder,
India Business Analysis | IIT Roorkee, IIM-C alumnus