The financial consequences of a European Union without Britain

As published on TVO.org:

Banking, insurance and pension firms based in the Greater Toronto Area and elsewhere in Canada would be left scrambling for solid ground if Britain decides to exit the European Union next month.  

If the vote were held today, 40 per cent of Britons would vote to leave the EU, according to the Financial Times poll tracker.

“We think it would be a great mistake for the U.K. to exit from the EU,” says Janet Ecker, president and chief executive officer of the Toronto Financial Services Alliance. “London is the world’s financial centre, and one of the reasons it is, is because it is such a great jumping-off spot into Europe, into Asia, the rest of the world.”

“That kind of disruption could undermine London’s global position as an international financial centre,” Ecker says. “It certainly could impact our financial companies who have so many investments and operations there.”

The United Kingdom is Canada’s most important trading partner in the EU, and Canada’s third largest trading partner, after the U.S. and China. So the stakes are high for Canadian financial firms: about 18 per cent of Canada’s financial services exports go to the EU, according to a report by the Conference Board of Canada.

Toronto is the centre of the action for financial services in Canada. About 30 per cent of the industry is headquartered there, according to the Toronto Financial Services Alliance.

It’s also a growing business: Canada has more than tripled its exports of financial services since 1999. Between 2004 and 2014, exports of financial services grew at an average rate of eight per cent per year.

Pension plans are also heavily involved in the U.K. market. The Canadian Pension Plan Investment Board, for example, has $20.9 billion invested there, about 7.5 per cent of its fund.

Even though the terms of a possible “Brexit” remain foggy, most scenarios would mean that the U.K. would not be a part of the soon-to-be-ratified Canada-EU free trade deal, argues Charles Pentland, professor emeritus at Queen’s University.

“At a stroke, then, Canada’s chief economic partner in the EU and arguably one of its principal incentives for pursuing [a trade pact] would be lost to the agreement,” he writes.

The trade deal is meant to further liberalize services trade between Canada and the EU, and the deal is “very important” to the financial services industry in Canada, Ecker says.

Take the U.K. out of the equation and the agreement becomes far less attractive to Canadian banks and firms. “A financial services deal with the EU is essentially a financial services deal with London,” said Mark Warner, an international trade lawyer based in Toronto.

Canada could renegotiate a similar pact with the U.K. on its own, but Canada would likely be low on Britain’s list of priorities, coming after key trading partners like the EU and the United States.

If Prime Minister Trudeau is considering free trade deals with the EU, a Pacific Rim deal, and maybe a deal with China, the U.K. might come low on the Canadian priority list as well, says Ms. Ecker.

The U.K. Treasury has modelled three scenarios should citizens vote to leave the EU. In the first, the U.K. would seek membership in the European Economic Area, like Norway or Iceland. This would mean they would trade freely with countries in the European Union and be part of some programs and agencies, but would not have input on EU regulations.

In the second scenario, the U.K. would negotiate a bilateral trade agreement with the EU, the way Canada has.

And the third option: Britain would not have any sort of agreement with the EU and would deal with Europe like any other member of the World Trade Organization, such as Russia or Brazil.

With any of these schemes, it will take time to sort out what a leave vote would look like, meaning uncertainty for businesses in the interim. Bank of England governor Mark Carney recently told British members of Parliament that it would be reasonable to expect that firms would be making contingency plans, and considering relocating their operations.

Fotios Raptis, a senior economist with TD Bank Group, agrees: “What you could see is some Canadian financial firms postponing their investment opportunities within the EU or with the U.K. until the uncertainty subsides after the referendum results,” he says.

Some North American firms could potentially consider moving to Dublin because the city is English-speaking and still would have unfettered access to the EU, Raptis adds.

In all these scenarios, the U.K. Treasury argues, Britain would be “permanently poorer” should it choose to leave the EU. The Organisation for Economic Co-operation and Development recently estimated that if the U.K. voted to leave, by 2020 Britain’s economy would be three per cent smaller than if it stayed within the EU, shrinking to five per cent smaller than it would have been with EU membership by 2030.

Yet not everyone shares such a gloomy view. Advocates of the leave side argue that the U.K.’s global stature, use of English, and legal system would mean that the country would continue to be an attractive hub for business, including financial services companies, according to a recent report by TD. Proponents also believe the U.K. government could boost the economy by having the ability to write regulations and negotiate trade deals specifically tailored to the British economy, the report adds.

Regardless of the outcome, while the U.K. leaving the EU would be a blow to Canada’s financial sector, it would not be a fatal one. Canada’s large global banks are well diversified, and not entirely dependent on business in London, says Ecker. It will be emerging economies, she says, that will provide the largest source of growth for Canadian financial services in the future.

Sarah Reid is a freelance journalist based in Toronto.