Brexit poses a challenge for London but an opportunity for other European capitals

Seven months have passed since the British voted to leave the EU and the economic consequences of this striking decision have not been as bad as expected, so far.

Although definitive data is lacking, the British economy grew at an acceptable rate of 2.2% in 2016. The pound has dropped and become more volatile, but its overall outlook has not changed. The International Monetary Fund (IMF) also recently raised the U.K.’s growth outlook for 2017 from 1.1% to 1.5%. However, the British economy has not yet passed the real Brexit test, as it has not yet initiated formal procedures to leave the EU.

London is expected to take this official and administrative step in March, or at least that is U.K. Prime Minister Theresa May’s intention. On Wednesday the U.K. governement won the Brexit vote in the House of Commons, after MPs voted 498 to 114, the first step to invoke the EU's treaty article 50 exit clause.  This will mark the beginning of a very long and complex negotiation process, expected to last for two years.

One of the options on the table is the so-called hard Brexit, or a complete divorce from the current agreement between the U.K. and EU for free trade and freedom of movement. This was the approach Prime Minister Theresa May emphasized in her speech on January 17th. The fintech market is one of the most vulnerable to this possibility, as London’s momentum has made it a world fintech capital, even beyond places like New York.

The small fintech industry contributes approximately £20 billion (around €23 billion at the current exchange rate) to the British economy, according to estimates by consulting firm EY.

The House of Lords’ report

Several heads of British fintech firms came together to produce a report for the House of Lords (the upper house of British Parliament) with the goal of analyzing how Brexit could affect them. This document expresses three main fears:

1. The possibility of fintech firms having difficulty accessing international talent due to stricter migratory policies.
2. The divergence between the U.K. and EU regarding regulation, especially in terms how data is treated.
3. London losing its status as a world fintech capital.

In terms of regulation - especially the way data is treated - the fintech sector has one thing clear: It would be a bad idea for the U.K. to make things more complicated for them. Experts say it is essential to avoid changes in regulation from what the U.K. currently has under the EU.

In their appearance before the House of Lords’ Commission that prepared the report, Dan Morgan, the head of the pro-fintech regulation lobbying group Innovate Finance, said that “any layer of friction or disagreement [in the regulation of data between the U.K. and EU] would have an impact on investment and on business models, so it is essential that the U.K. not go its own way, given the size of its neighbors.”

Giles Andrews, founder and chairman of fintech firm Zopa, stressed the need to not go too far from the EU for data issues, adding that from a conceptual point of view, the U.K. is closer to Europe than to the U.S. in data sharing matters.

The fight for international talent and London’s strength as a global fintech capital after Brexit bring more nuances. In fact, they are closely related issues. The British finance sector employs approximately one million people, of which 100,000 are foreigners and 60,000 belong to other EU countries.

The percentage of non-British people working in the sector is similar to other sectors, with the difference that financial services employ a higher portion of highly-skilled immigrants: 50% of these foreigners have the equivalent of a high school diploma in the entire British economy, compared to 63% in the financial services sector.

International talent is even more important for fintech firms, where three types of international “brains” are sought after: entrepreneurs, financial experts and those skilled in what is known as STEM (Science, Technology, Engineering and Math).

Will it be harder for them to work in the U.K. after Brexit?

In his appearance before the House of Lords, Philip Hammond, the current Chancellor of the Exchequer (Finance Minister) in Theresa May’s government and former Foreign Minister in David Cameron’s government, maintained that he did not see a relationship between greater control of British borders and possible difficulties British companies could encounter to hire highly-skilled workers with high salaries.

However, the Immigration Minister Robert Goodwill has revealed that the government is considering imposing a special tax of 1,000 pounds for every year companies hire foreign workers. In principle, this will only be applied to non-EU citizens – as early as this spring – but will be expanded to everyone who isn’t British once Brexit takes place.

Foreigners having a harder time working in London would make the city lose its international appeal. The U.K. does not seem overly concerned about this possibility, however.

The House of Lords’ report contains elements of skepticism in this regard. London’s competition is New York, they say, because the fintech industry can only grow around a global financial center. That’s why many fintech firms started in California, but moved to the east coast metropolis to be close to traditional financial institutions, the report indicates. And since there are no European cities with a financial strength equitable to London and New York, the British capital does not have much to fear, according to the report.

Furthermore, the authors of the House of Lords report are convinced that the EU - whether it wants to or not - will end up knocking on the door of London, a great financial capital. “If the U.K. ecosystem cannot be replicated in the EU, which is not a realistic prospect according to the evidence we heard, we conclude that it would not be in the EU’s economic interest for services to be provided less efficiently, or in New York instead of London.”

Opportunities in Europe

The last Global Financial Centres Index – a prestigious biannual ranking of financial hubs created with data from the World Bank and OECD – listed London as the global financial capital in September 2016, as it had done two years before. Only two other EU cities are in the top 20: Luxembourg (12th) and Frankfurt (19th).

This does not mean that Brexit doesn’t represent an opportunity for other European cities with less financial strength, at least in theory. The French government was quick to offer tax breaks to companies that exchange the Thames for the Seine river. Madrid has also joined a long list of cities hoping to take London’s place.

The Spanish capital is at a disadvantage compared to other European cities with a longer financial tradition like Frankfurt, but it does have numerous advantages, such as rental prices, vacant office space and a quality of life to lure thousands of financial professionals forced to leave the U.K.

An analyst from JP Morgan published a report in July where it defended Madrid as the best alternative to London. In addition, the Swiss bank UBS plans to decide  whether 300 of its best professionals in London will be relocated to Frankfurt or Madrid in mid-2017.

As with any major change, Brexit comes with risks, but also opportunities. A long negotiation is about to commence that will determine the winners and losers in this key moment in the history of Europe.