The single greatest risk of Brexit is the repatriation of financial services companies away from the UK to the European Union, a report from Rathbones warns.
Rathbones says the effects of evolving legislation could push financial services activity towards the continent if the UK votes to leave the EU, calling it “the single greatest risk” of Brexit.
The report states: “We believe the single greatest risk to the UK if it were to leave the EU is that evolving legislation and regulation could start an ineluctable repatriation of financial services activity back towards the continent.
“This would have profound effects on the economy and exchange rate: the UK’s trade surplus in services is almost entirely in financial and other professional and technical services.”
However the report stated that this is “not a risk that would be realised overnight”.
In terms of financial regulation, Rathbones research found that “extra-territorial activity” for financial services firms is likely to become “increasingly difficult”, with the asset management industry “likely to suffer more than most”.
The report says: “The UK is the second-largest centre for fund management, with assets under management totalling £6.2trn in 2013. Under the EU’s Ucits directive, collective investment vehicles, such as unit trusts, are permitted to be sold across the region on the basis of authorisation from one member state.
“The regulatory burden on the UK fund management industry outside of this special zone would be severe, and it is highly likely that many European or international fund houses currently choosing to headquarter in London would move at least part of their operation back to the mainland.”
The asset manager says this would be one of the main focal points in the negotiations with Brussels and may go on for two years if the UK decides to leave the EU.
The report says: “Although we can assume the UK’s financial services industry will be compliant on the date of Brexit, the extra burden of proof that would be required outside of the EU would probably cause a significant dent in national productivity and company profits.”
Overall, Rathbones’ view on Brexit is that the UK financial markets could become increasingly volatile as a result of the upcoming uncertainty of the EU vote, “but emergence of any pervasive trends” remains “unlikely”.
In the short term, the firm does not expect a divestment of foreign investment, but says investor uncertainty could interrupt future inflows.
Within stock market flows, Rathbones expect volatility and lower earnings in the FTSE 250 companies as they are more domestically-oriented compared to the FTSE 100.
Edward Smith, asset allocation strategist and author of the paper, urges investors to view holdings that rest on the result of the referendum “with considerable circumspection.”
He says “The referendum result could push the UK in several different directions, which makes it difficult to forecast the long-term effects on the economy. In an increasingly globalised world, the UK economy should do well if the country can successfully negotiate new treaties of economic integration with higher growth nations.
“In the short term, the referendum is unlikely to have a substantial directional impact on financial markets. Yet we expect markets to react to any lack of clarity and associated uncertainty. Sterling is likely to suffer the most volatility, and there are indications that currency traders are positioning for some extreme moves.”