Brexit & Financial Risks

When former Prime Minister David Cameron made the promise in 2013 to have a Brexit referendum for the British people to decide on the fate of the United Kingdom (UK) in the European Union (EU), he probably never foresaw that it would eventually cost him his job.

Similarly for the bankers and other participants in the financial markets, most expected market volatility but did not expect that the 'Leavers' would eventually 'win' the referendum last 23rd June 2016. As a result, they were left scrambling to manage and mitigate the financial fallout immediately after the results of the Brexit referendum.

Currency Risks and Euro Clearing in London

London is the world biggest forex market. The daily average of forex trading in London is about $2.4 trillion, representing about 47.5% of the global daily forex trading activities. Moreover, the British pound is the 4th most traded currency in the world.

It is without doubt that Brexit will affect the exchange rates of the British pound against the currencies of UK's major trading partners. For instance, since 2012, the British pound has been in fact appreciating against some of the major currencies like the US dollar, yen, euro, Australian dollar, Canadian dollar and even the Indian rupee. However as the Brexit referendum drew nearer, the British pound started to depreciate against all these currencies.

Right after the referendum results, on 24 June 2016, the British pound depreciated by about 9% against these six currencies. From 1st June 2016 till 17th August 2017, the lowest (daily) level reached is US$1.21, ¥126.09, €1.10, A$1.59, C$1.59 and INR79.63. The maximum drawdown for these respective currencies has been -18.2% (US$), -20.1% (¥), -15.4% (€), -20.5% (A$), -15.9% (C$) and -20.1% (INR). Although the British pound has relatively 'stabilised' at the moment, it will remain 'volatile' due to the political uncertainties in the UK. Like during the Brexit referendum, it may eventually slide further as 29th March 2019 draws nearer, when the UK will be officially out of the EU.

Besides the currency risks, the future of the Euro clearing and trading (spot, derivatives and options) in London remains unclear. While Britain is still procrastinating on the Brexit negotiations, the European Union is slowly but surely preparing for an EU 27 without Britain.

 

The European Commission and the European Central Bank is setting out proposals to have 'more control' (and probably taking back from London) the Euro clearing businesses after Brexit. This will likely mean that banks and other financial institutions, that depends on the Euro trading, as well as some of the biggest Euro clearinghouses will eventually have to move out of London and base themselves somewhere in the main European continent.

Equity and Debt Markets

The London Stock Exchange (LSE) is the biggest European stock market, but its future is not looking too bright with Brexit. After many failed attempts to merge with Frankfurt based Deutsche Börse, the LSE will have to deal with the fact that Brexit will curtail further its growth prospects in the future.

The full impact of Brexit on the LSE and the London financial markets is still unknown and there will be major financial risks that will come along. The LSE is not only the place where the stocks of some of the world biggest companies are traded, but it is where companies launch their initial public offering (IPO) to raise funds. Besides stocks, London is the place where corporate and government debt are traded. Lastly, London is a highly sophisticated and globally connected (to Europe and other global financial centres) financial cluster, that enable financial institutions to trade all types of financial instruments in the most efficient and timely manner.

 

With Brexit, not only the London financial centre may eventually be 'cut off' from the Euro trading activities, but the European and other global companies may be 'forced' to re-list their stocks in other European financial markets. Similarly, the debt capital markets will be affected. Hence, corporate leaders in the financial and non-financial sectors will have to plan and manage all these risks accordingly.

As a result of all these potential scenarios, the British and global banks as well as other financial and non-financial institutions may be forced to delocalise their activities to other financial markets in mainland Europe or other global financial markets. With Brexit, the City of London will drastically change and will no longer be what it is currently.

Steel Advisory Partners Brexit

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