Finally, after months of anxious waiting, the Brexit vote is behind us. And boy did it feel good to see the British pound rallying into the close of polls, and reading the results from a YouGov on-the-day poll announcing that the remain campaign had won. Even Nigel Farage had conceded defeat twice, relying on independent exit poll data from his close associates in the financial industry.
But the comfort wasn’t meant to last. Shortly after the first regions started reporting the tally of the votes, the market started discounting the risk that a Brexit might actually be possible. By London breakfast time it became clear that Brexit won and the forex industry along with many others will have to adjust to a different reality involving more complex risk scenarios.
In the following lines we will take a look at what the first risks that come to mind are and will analyze how different brokerages and jurisdictions might be affected by Brexit both short term and long term.
Risk Scenario One: FCA and EU Regulation
The regulatory framework in the industry is the pillar that is generating a substantial amount of trading volumes, namely from across the European Union. So what will happen in case an FCA regulated brokerage suddenly gets cut off from offering its services in the European Union?
The answer is simple at first glance – it will have to get regulated in another EU member country in order to get access to the single market. But here comes the biggest uncertainty stemming from the vote – would there be a domino effect for other member countries in the EU? The answer at this point appears to be closer to ‘probably yes’.
The Netherlands is holding a parliamentary election next year and its population has become very eurosceptic in the years since the last vote. The party of Geert Wilders has been gaining ground and by the time the March 2017 election comes, he could become the dominant factor in Dutch politics. To put this into perspective, imagine Nigel Farage as the Prime Minister of the U.K..
France is the other big unknown with the far right performing decently during the last round of local elections in 2015. The next Presidential election in the country is set for April and May 2017, and last time Marine Le Pen got 18 per cent of the vote.
These risks are obliviously political but have substantial effect on the industry in the long run. For the time being they are not immediate in any way, just because the United Kingdom will have at least 2 years of time within the E.U. after filing its application for exclusion.
Let’s add a positive note here though: the FCA’s regulatory framework is the model for the rest of the continent about how a financial regulator should do its business. While it has many shortcomings, there is no better alternative to the FCA at present and the EU knows that.
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Risk Scenario Two: Market Volatility, Banking Stability
The markets have become jittery at best with liquidity thinning out and financial turmoil engulfing the industry. The stability of the European banking system has been called into question with several big systemically important banks in the U.K. trading limit down at the open of trading in London.
The confidence in the financial industry is evaporating by the hour and the regulatory repercussions from market volatility are usually surprisingly big (just look at the way Dodd Frank has stifled the industry in the United States). So much for the long term effect, lets turn our attention to the positive point from market volatility.
As many brokerages are now seeing, the financial markets have been increasingly volatile which in the near term should lead to substantially higher trading volumes. Moreover, during periods of such volatility the interest of the public towards trying is rising substantially.
One more aspect of the market volatility risk involves the ongoing high level of margin requirements. With traders accustomed to trading with margin rates which are much different than they are now, we could see some decrease in interest towards trading. That of course can be mitigated by the sheer size of the moves on the markets – i.e. lower leverage, but larger daily moves.
Risk Scenario Three: Can London be Replaced as the European Financial Capital?
This is where things are starting to look a bit rosy amidst all the gloom floating around. The infrastructure of the financial industry in London is unparalleled. The amount of trading technology, buy side and sell side companies focused in the capital of the U.K. are unmatched. It will be virtually impossible to replace London as a financial capital of Europe.
Unfortunately, a number of European bureaucrats might disagree on this point. The negotiating process for the next three years is likely to he very heavy and tough for both sides of the aisle. The European Union and the United Kingdom will have to bridge a lot of gaps during the two year grace period when the countries will be discussing how should they get a divorce.
Risk Scenario Four: Collapse of the Monetary Union
This is where things get heavy not only for the financial industry and not only for brokerages and tech providers, regardless of their specialties, but for the global economy as a whole. While seemingly remote at this stage, the risk of the disintegration of the European Union should not be forgotten.
What will happen to the single European market if the European Union disintegrates altogether? With this risk becoming apparent, the industry could be facing even more challenging times than anyone expected. Should a couple of stronger European nations leave the European Union, the debt burden on the weaker members will become even more unsustainable (let’s face it, it already is in both Greece and Cyprus).
With the threat from disintegration hanging in the air, protectionist policies and 28 different regulatory frameworks could be part of a grim future for the European Union. While this seems remote for now, let’s remind ourselves about how many people thought that Lehman Brothers would go bust in September 2008 after Bear Stearns got bailed out in April 2008.
Finally.. all of the above is valid if the United Kingdom does indeed leave the European Union after this non-binding vote.