Financial and Economic Impact of Brexit and COVID-19 in the United Kingdom

Introduction

Brexit is an abbreviation for “British Exit” which means the last day of British long-time membership in the European Union. The United Kingdom left the European Community on January 31, 2020 and that was the commencement of the transition period that ended on December 31, 2020. No-Deal Brexit outcome had become more probable, i.e., no agreement on trade relations between EU negotiators and the UK Parliament, so that a so-called “hard Brexit” was the most likely scenario. As we know nowadays a Trade deal was signed in December 2020, but not sufficiently prepared, therefore Hard Brexit strategy to leave the European Union with a limited trade deal became reality. The United Kingdom, after leaving the international community of EU member states, is treated as a third country that has almost no trade arrangements with the EU. Consequently, the United Kingdom will no longer benefit from European fundamental freedoms. In particular, the essential free movement of capital for the country, to mention at least this aspect, and the associated financial pass rights, which allowed that UK-based financial institutions accessed to the European single market for financial products, ceased to be guaranteed. The following article gives an overview of the resulting (probable) consequences of a “hard Brexit” scenario and what, indeed, may be observed within 9 months of post-Brexit period. The EU’s chief negotiator stressed trade barriers, limits on citizens’ movement and work visas changes are the most striking features since January 1^st, 2021, alike cultural and educational vandalism can be observed after Brexit Day (Erasmus students exchange stopped, being replaced by Turing scheme financing of students’ study abroad privileged certain group to obtain financial resources and it was not fair).

Economic Power of the Financial Sector

Globalization consists in the functioning of interactive relations and affairs among global institutions and enterprises. More than one-third of all banking business for major customers in the EU was conducted in the UK. (Theurer, 2016, p.1). The share of the country in the European banking business was thus higher than the shares of Germany, France and Italy together (Bundeszentrale für politische Bildung, 2016). In addition, a large part of the interest and currency derivatives denominated in euros was traded in London, where around 500 foreign banks were based (Berberi, 2014, p.5). Their daily trading volume was estimated by the Bank for International Settlements to be up to one trillion euros (Deutsches Institut für Wirtschaftsforschung, 2016, p. 687). The UK financial sector accounted for more than 10% of UK GDP, accounting for much of Britain’s economic performance in 2016 but the vision of Brexit brought its consequences, because in 2019 the financial service sector contributed to the UK economy only by 6.9% of total economic output. (Moran, 2021) But still financial services industry employs over million people not even comparable to fishing industry (approximately 8000 people) and attention by the Government as if they paid more attention to fishing in the negotiation process that was criticised by the finance services industry, since the financial sector represents 7 percent of British GDP and more than 10 percent of its tax revenues. Such a centurial decision required a sensible leader and articulate negotiator for such a strategic step preparation supported with higher quality and thorough analysis of possible Brexit scenarios (Singh et al. 2020). In particular, the city of London developed a prominent role within Europe as its largest financial centre (Jackson, 2016). The financial centre alone covered over 250 Banks enjoying free access to the single market because the United Kingdom was a member of the European community of states. It was making the financial centre the world’s largest exporter of financial services according to the Economists (2014). London had also become the most important currency trading centre in euros and was considered the largest international insurance market. Half of the European investment banking activities were also supposed to be handled in London (Berberi, 2014, p.8). In addition, the European Banking Authority (EBA) was based in London with objectives of consistent and effective regulation of European banking institutions. The attractiveness of London as a financial centre was also a magnet for foreign direct investment as international investors considered London as a hub between the US, EU and Asia, as confirmed by the Institute of the World Economy. The City of London had therefore achieved an outstanding position as an international financial centre alongside New York and has continued to expand its leadership since the introduction of the euro compared to other European countries (Berberi, 2014, p.7). Worries to lose the financial centre position became reality as the EBA was already dislocated from London to be headquartered in Paris. The uncertainty, chaos and risk that was introduced into the market as a result of the Brexit caused volatility into many aspects of the economy and financial sector (Ghosh, et al. 2020). But accounting information systems should help to pacify and enhance the quality of management in an organization, and more importantly, the management performance (Khalid & Kot, 2019), especially under such critical conditions. The contribution of value generated by the financial services sector is shown in Figure 1. The value that has been added by the financial sector has been declining in both the UK and the EU since 2009, however in 2020 the UK financial services sector increased its value added in line with 2018 levels.

Fig. 1. Value Added by Activity: Financial ServicesSource: Constructed by authors based on (OECD, 2021)

Free movement of capital and the European financial passport

The British financial sector was growing much faster than the OECD average since the accession of the United Kingdom to the European single market in the early 1990s, but coming Brexit brought clouds and not clear future. The main reason for the strong growth and attractiveness of the trading venue was in addition to liberal legislation on financial services mainly the possibility of using the European financial passport, which was at the center of the discussions about the consequences of Brexit (Deutsche Bundesbank, 2017). It formed part of the free movement of capital and determined the scope of the regulation and supervision of European financial services, such as loans, bank accounts and other financial services to customers (Fahrholz & Hohlmeier, 2018). It also favored financial institutions’ access to the single European market, which was the largest trading area for UK-based banks with its 28 member states and more than 500 million consumers at those times. The rules of the financial pass stipulated that banks domicile in the EU had free access in all member states to offer financial products without operating a branch there (Huong Le & Karlsson, 2016). Financial institutions established in a Member State, therefore, do not need additional authorization from another European State to offer financial services under the European legislation. Hwang and Kim (2018) in their research stress that financial institutions such as underwriters are motivated to maintain long-term business relationships with firms that appointed them as underwriters, and this relationship is considered more important to ensure a successful IPO process for IPO firms (Hwang & Kim, 2018). In the case of a “hard Brexit”, the European Union’s fundamental freedoms also eliminated the financial passport rights and the unimpeded access to the single market as it was predicted by Fahrholz & Hohlmeier (2018). Banks, insurance companies and other financial institutions would be forced to open a branch within the single market in order to maintain access to it (Huong Le & Karlsson, 2016). Since the European financial passport also applied to institutions from non-EU countries, provided that they had a place of business in an EU country, they would be affected by the abolition of the regulations too. Amsterdam overtook London as Europe’s largest share trading center in January after Brexit saw about half of the city’s volumes move to the continent. An average 9.2 billion euros ($11 billion) of shares a day were traded on various Dutch stock financial markets in January, a more than fourfold increase from December 2020, according to data from CBOE Europe. That compares to average daily volumes in London of 8.6 billion euros. Swiss shares trade returned to London which was not included to the table figures yet. The European Union has not permitted investors inside the EU to trade shares in companies such as Airbus SE and BNP Paribas SA from the United Kingdom. Other areas including euro swap trading also shifted from the U.K. capital to both the EU and New York’s Wall Street.

Table 1: Shares trading shift out of the City of London

Source: Constructed by the authors based on (Bloomburg.com) and (Vaghela, 2021).

In particular, for the many US and Asian financial services institutions that operate their European headquarters in London and transact their predominant EU business from there, the UK is no longer the gateway to the European single market. For the institutions of the financial sector, but also the companies of adjacent sectors, it was necessary to open a new location within the single market, which has a European banking license, to safeguard access to this large market. Following initial clarifications, the EU will not accept banking licenses to pure “mailbox companies” within the single market which continue to operate from London. In particular, “for critical functions such as management, controlling and compliance, qualified personnel need to be present at the non-UK EU subsidiary at all time” emphasised by the experts from Deutsche Bundesbank. In order to meet these requirements, the large-scale relocation of jobs with further consequences resulting from them were assumed. Brexit already impacted on the relationship of financial groups within the financial market when several headquarters of London’s financial centre’s withdrawal occurred, and the future will show the investors’ behaviour possible change. About £1.5 trillion in capital and assets amounting to about 14 percent of the total assets of British-based institutions and up to 10,000 jobs decline due to leaving from British industry outside UK as companies set up EU subsidiaries after Brexit. UK insurers lost their passporting rights and they cannot provide cross border services to any European Economic Area member states and vice versa. The UK-EU trade and Cooperation Agreement did not confirm equivalence for financial service providers. Cross -border contracts will be facilitated by obtaining this equivalence, which is necessity for setting a framework to enable bilateral agreements between the UK and the EU. (Simon, 2021) (Vaghela, 2021).Shortly before the Brexit deadline (January 31, 2020), Barclays, a British company, sent nearly $265 billion of its assets to Ireland. JPMorgan Chase transferred $230 billion to Germany, on February 21, the Financial Times reported that HSBC, Britain’s largest bank by far, was relocating most of its revenue-producing divisions to Hong Kong as part of a larger pivot to Asian markets, where HSBC has traditionally been strong (Moran, 2021).

Economic Impact

Institute for World Economy stressed that with the loss of single market access and the elimination of the privilege of the financial passport, the influence of the UK financial sector and, in particular, London’s influence as an international financial center threatened to slacken. The finance sector generated the United Kingdom’s largest trade surplus of any economic sector, according to the Bank of England, with a positive balance of $50 billion in 2019. There was a risk that many of the European functionalities that were located in London would be relocated to other European financial centres or that international functionalities would be relocated back to New York (Oxenford, 2016). Lavery and his research team (2019) examined the issue of Brexit as a creator of an opportunity for alternative European financial centres, since two of the main ‘rivals’ to the City of London, in the aftermath of Brexit, are Frankfurt and Paris. According to their opinion, the emerging competition between Frankfurt and Paris is shaped through four related axes: diversity, path dependency, territory and regulatory stability. (Lavery, McDaniel & Schmidt, 2019). European disintegration by interrogating the interaction of fragmentary and integrative dynamics in the sphere of European finance has been focused on by many researchers recently. In addition to shifting capital, large-scale relocation involves relocating personnel and the entire infrastructure to alternative locations within the single market (Fahrholz & Hohlmeier, 2018), (Saxunova, Le Roux, Oster, 2019).

Labour Market

Preliminary estimates suggested that 70,000 to 100,000 jobs may be affected by job relocation and job losses in the London financial center alone (Pricewaterhouse Coopers, 2016). Various major banks have already announced, immediately after the Brexit vote, to transfer parts of their workforce to European cities in the remaining EU states. HSBC plans to relocate 1,000 jobs to Paris, JPMorgan to relocate 4,000 jobs from London, and Morgan Stanley to deduct 1,000 jobs from the UK (Wohl, 2016). The total workforce jobs that the financial services sector contributes is shown in Figure 2. The percentage of total workforce jobs for the financial sector as compared to all jobs in the UK is shown on the right axis. The financial sector contracted in the period before Brexit was announced, and since then the value remained stable. A slight increase was observed in 2020, however, the value returned back to the level seen from 2016 to 2019, in 2021.

Fig. 2. Total workforce jobs: Financial Services

Source: Constructed by authors based on (OECD, 2021)

The impact of Brexit’s uncertainty on the number of available jobs in the financial sector in London was already evident. While the number stagnated at a high level before the Brexit vote, the first slump in the months following the vote reached its lowest point in December 2016. The ensuing jump recovery was not long lasting. Since this high point in January 2017, which could be seen as a countermovement to the previous month, the numbers were declining. The closer the exit date was coming, the higher the uncertainty in the financial sector seemed to be; so, fewer jobs were created in the financial sector. Insurance and reinsurance companies also benefited from the financial pass rights and can offer their products and services throughout Europe, subject to approval and control of their home country. Related to a relocation of banks or with the relocation of business fields, therefore, would be the insurance industry and other border industries, which work closely with the financial institutions. The fear of a “hard Brexit” and the associated cuts seemed to be growing bigger. A decline could be seen to be continued, as seen in Figure 3.

Fig. 3. Development of New Financial Service Jobs in the period of 2017- 2021

Source: Constructed by authors based on (Morgan McKinley, 2021),

The relocation of jobs and the decline in the UK financial sector activities also affect European institutions such as the European Banking Authority (EBA). With the UK’s exit from the single market, they no longer have a legal basis to control and regulate financial institutions. Consequently, the establishment must be relocated to the single market. Here, the corresponding deduction of jobs threatens with cuts in influence at the previous London location too. The Ministers of the remaining EU Member States had already voted on this issue in a meeting on 20 November 2017 and decided that the seat of the Authority would be relocated from London to Paris. More ominous still for the United Kingdom’s financial sector, which represented nearly 7 percent of the country’s GDP in 2019, is that it was starting to see real evidence of job loss. A modest 7,500 jobs left the United Kingdom for European Union cities by October 2020, Dublin became the most popular relocation city marked the most popular new location, according to the Ernst & Young Financial Services Brexit Tracker. The comparison of the UK employment rate and the UK job vacancies (right axis) is shown in Figure 4.

Fig. 4. Total UK job vacancies and unemployment rate

Source: Constructed by authors based on (OSN, 2021)

In 2021, the UK is facing job crisis, however not as initially expected. New job vacancies have been increasing to higher levels, at about 20 percent higher than their pre-pandemic levels. The crisis being faced is that even though the new vacancies are rising in the UK, the vacancies that are available do not match the requirements of the unemployed in what they are able and willing to do. The wage subsidies distributed to people that the UK provided as a result of the COVID-19 pandemic, as part of its furlough scheme (Coronavirus Job Retention Scheme) since March 2020, are planned to end in September 2021; after this period, many people may lose their working positions. The need for workers has been visible in nearly every occupation, including computer programmers, health care assistants and farmworkers.

More than 200,000 European Union citizens who were working in the UK moved out of the United Kingdom after Brexit so far. The future rights of the estimated 3 million non-British European Union citizens living in the UK and 1.8–3.6 million British citizens living in the EU fell directly within the scope of the Withdrawal Agreement, and are the subject of the citizens’ rights negotiations. Before the EU Referendum in the UK, the intra-EU migration of Western Europeans was largely unremarked within their countries of residence (Favell and Nebe2009). The rights of citizens have faced a large degree of uncertainty and confusion, which will have lasting effects.

GDP and Foreign Investment

The level of the financial services predetermines the attraction of the foreign investment as the investors prefer stable economic environment (Novackova et al., 2018). British business environment always represented an environment of stability and high quality of financial services. The UK financial sector, which accounts for less than 10% of the total UK value added (Fuest, 2016), would inevitably decline as a result of the developments above, resulting in declines in the UK economic growth and rising unemployment. Endangering the UK financial sector and related jobs poses significant risks to social security systems, which at least partially offset income losses. In addition, the reduction of jobs directly and indirectly entails the reduction of tax revenues. This concerns the abolition of the income tax in the same way as the excise duty on the associated decline in private consumption. Globalization of the automotive industry implies the extension of the operations of a company beyond the borders of the country of origin, for the purpose of exporting products on new markets, with smaller costs and greater profits and Jaguar, Land Rover, would not be an exception; opening a new plant of Jaguar in Slovakia was believed to serve this purpose utilising the network of skilled labour force in SMEs – the automotive suppliers’ network for JLR. (Bajzikova et.al, 2017; Saxunova et al, 2018). A specific source of Japan’s competitive advantage in the automotive industry is the long-term cooperative relationship between automakers and suppliers (Asanuma, 1989; Cusumano & Takeishi, 1991; Sako & Helper, 1998). This competitive advantage may be distorted by the Brexit for Jaguar Land Rover (JLR). The loss of single market for the UK is predicted to be especially enormous for car industry. For instance, JLR production stresses that more than 40% of its parts are imported from Europe. The manufacturing process goes through plants in Germany, Italy, Scotland, Poland, UK JLR plant, Czech Republic, UK again, to be finalised in Slovakia. JLR manufactures more than 600,000 cars a year, its production is dependent on the efficient and effective transport management from suppliers to the manufacturing plants. It often has 10 trucks a day on the routes in order to support production. “Car industry utilises the free and frictionless trade offered by Europe’s single market more intensively than almost any other sector: every car that rolls off the production line in a UK plant is made up of tens of thousands of parts that between them will have made hundreds of thousands of movements across the continent.” (Henley, 2018) Industry experts calculated that falling back on World Trade Organization tariffs, if Britain leaves the EU without a free trade agreement, would add 10% to the cost of assembling a car in the UK. The development of the coming months will show how precise the experts were. The car industry operates with low margin; therefore, the reduction costs is essential, and if there is an unexpected increase in manufacturing costs, this may be the reason for producers to consider setting up business elsewhere to stay competitive. Increased tariff barriers will become the significant impact of a bad Brexit, apart from them non-tariff barriers will make production across borders more expensive due to the factors as: rules-of-origin checks; customs controls; compliance with different product standards and regulations between countries. The car industry pointed out that Britain needs to remain in the customs’ union with a deal that “maintains the benefits of the single market”. The total possible cost of post-Brexit tariffs for the UK car industry is estimated by industry analyst about £3bn a year – of which JLR would bear approximately one third, since it exports one in three cars from the UK. (Henley, 2018).

Data And Methodology

The changes that occurred in the UK economy and financial sector can be observed in economic indicators, financial and investment variables. This paper will show a historical evaluation of key variables in order to demonstrate the evolution of the changes and relationships that exist. The historical data of 34 variables will be analysed to determine the changes and relationships. The majority of the analysis will be focused on the 2016 and 2021 period in order to observe the longer-term effects of Brexit, followed by the impact of COVID-19. The data were obtained from Refinitiv DataStream and the European Commission (Eurostat, 2021). The variables included in the study are detailed in Table 2. All these data were used for analysis of the individual indicators of the Economic Sentiment Indicator (ESI) and illustrated in the following figures numbered from 5 to 13.

Table 2: Economic and financial variables included in the study

Source: Refinitiv

Variables will be grouped together in order to determine effects in different parts of the economy and financial sector. The initial analysis will be based on the sentiment in market based on the Economic Sentiment Indicator (ESI) as well as two confidence indicators and an insolvency indicator. GDP and CPI will be evaluated along with the confidence indicators, followed by the unemployment and claims values, balance of payment data and money supply. The final parts of the analysis explore the foreign direct investment, interest rates, exchange rates and indices to demonstrate the various effects caused by Brexit and Covid-19.

Findings and Analysis

The Economic Sentiment Indicator (ESI) is a composite indicator provided by the European Commission and is composed of five sector specific confidence indicators with different weights: · IND: Industrial confidence indicator (40%)· SER: Services confidence indicator (30 %)· CSM: Consumer confidence indicator (20%)· RET: Retail trade confidence indicator (5%)· CST: Construction confidence indicator (5%)· ESI: The Economic sentiment indicator is a composite measure (average = 100) The ESI is a weighted average of the balances of replies to selected questions addressed to firms in five above-mentioned sectors covered by the EU Business and Consumer Surveys and to consumers. The composite indicators from the ESI for the UK for the period from 2009 to 2021 are shown in Figure 5, with the ESI on the right axis, and the five sector specific confidence indicators on the left axis.

Fig. 5. Economic Sentiment Indicators for the UK

Source: Constructed by authors based on (Refinitiv, 2021)

Figure 6 shows an overall downward trend since the referendum held in June 2016. COVID-19 had a drastic effect of the indicators in April 2020 shown by the volatile drop in all the indicators, except for Construction confidence indicator which reduced to zero in November 2019, followed by the remaining indicators in January 2021 due to the official exit of the UK from the EU.