Saturday, October 8, 2016

Oliver Wyman's Brexit Analysis is Straight Out of the Project Fear Playbook

While the report contains some useful information, it only considers one side of the debate. Osbourne's Treasury would be proud of it.

Brexit presents risks but there are also opportunities. We may disagree which outweigh the other, but the referendum is over and the country voted to leave. We must now put our best minds together and work to realise these opportunities as well as mitigate those risks.

Rather than rehashing the debate, we would rather support organisations such as the Financial Services Negotiation Forum. The FSN Forum is bringing Leavers and Remainers together with the goal of producing evidence-based research that can provide our negotiators with the information necessary to maximise their effectiveness at the negotiating table.

Oliver Wyman's recent report for TheCityUK on Brexit is a relic of the referendum debate. They have made a reasonable job of analysing the current contribution of Financial Services to the country's coffers (albeit with disagreement over numbers - their estimate 1.05m employees conflicts starkly with TheCityUK's own estimate of 2.2m). They have also managed to acknowledge opportunities for the Financial Services industry post-Brexit arising from the "new networks of trade and investment agreements that the UK will negotiate with its partners", although these were only given a couple of small paragraphs.

Disappointingly, they made no effort to quantify these opportunities or include them in their scenarios.

For example, the report mentions the world's first "masala" bond (a rupee-denominated bond issued outside of India by an Indian company), which was issued on the LSE in August this year. This raised the equivalent of USD450m for HDCF (one of India's largest banks) and is a significant achievement considering that UK has fallen from India's #3 trading partner to #12 over the past 15 years (source: TheCityUK). India's economy grew by 7.3% in 2015 compared to 1.5% for the Euro area (source: IMF) so it is surprising that opportunities such as these - in high growth markets - didn't feature in the scenario analysis.

They also failed to play through some of their scenarios to their logical conclusion. Consider the perceived risk that "Clearing of all currencies relocates away from the UK to retain capital efficiencies" and ignore the recent op-ed from Xavier Rolet, the French CEO of the London Clearing House, entitled The City of London will be fine after Brexit – and a vengeful Europe would be shooting itself in the foot (in which, to come back to Masala bonds briefly, he notes that India and China "need trillions of dollars for new infrastructure, which their banks and governments say they cannot provide"). Outside of the EU, the ECB is powerless to prevent London from clearing Euros. They could revisit their plan to mandate Euro clearing within the Eurozone, but Polish clearing house KDPW might have something to say about it. How would this be enforced for a USD-EUR swap? What would the Fed's response be?

So how confident are Oliver Wyman of their predictions in general? A quick word-count of the paper shows us that "could" appears 36 times, "likely" appears 14 times and "may" (with a lower-case "m"!) appears 8 times (excluding footnotes). An impressive amount of hedging in a 24 page document which includes a cover page, a back page, a disclaimer and 5 pages of appendices.

We applaud their identification of the "Challenges Associated with Changing Legal Entity Set-up and Operating Models" but are disappointed that they have presented these solely as a justification for an extended "transition period" rather than recognise them as reasons for Financial Services firms to stay in the UK. The authors are correct to say that the sector is "an interdependent and interconnected ecosystem comprising a large variety of firms providing world-class services, products and advice." Far from being a source of risk, however, this set of complementary and mutually reinforcing activities is a hard-to-replicate competitive advantage. It is difficult to think of a better text-book example of one. It is a great platform from which to build a post-Brexit financial services industry.

We do, however, wholeheartedly support their conclusion - that "EU businesses have an interest in retaining access to the UK as an international financial centre, not only for the services provided directly but also as a conduit for global investment into the EU. The best outcome would recognise these dynamics and deliver mutually beneficial results for the UK, the EU and the rest of the world."

We are leaving the EU, not Europe, and we will continue to be allies, partners and friends with our neighbours. Working with Europe to help them achieve their goals is not mutually exclusive to our own best interests. Although we may follow a different ideology to that of the European Commission, a strong and liquid financial market across all of Europe will fuel growth across the continent and be beneficial for all.