The Association for Financial Markets in Europe (AFME) has sent out a stark warning against a so-called ‘hard Brexit’. Particular focus lay on the effect of funding and access to finance for SMEs from the EU. Leasing Life explains the AFME’s findings and concerns

UK Prime Minister Theresa May’s assertion that “no deal is better than a bad deal” did not travel well across the Channel.

‘Hard Brexit’, in which the UK severs financial ties with the European single market, is not a situation many businesses would like to consider. The AFME released a report, in collaboration with the Boston Consulting Group (BGC) and Clifford Chance, to warn against it.

The report, Bridging to Brexit, brought together the views of chief executives, treasurers of large companies, investors, industry associations and SMEs from across Europe, and asked about their opinions and anxieties about Brexit. In addition, the group introduced its own analysis, calculating the Brexit burden, and the cost of restricted financial access.

According to the AFME, €1.28trn (currently £1.13trn) of bank assets, which include loans, securities, and derivatives, would have to be moved to EU jurisdictions if the UK loses passporting rights as a result of Brexit.

These are the key concerns and arguments of the AFME’s 44-page hard Brexit warning.

SME funding restricted

A major area of concern for the report’s respondents was the funding of European SMEs.

According to the report, SMEs account for 67% of all employment within the non-financial sector in EU. In certain countries, such as Lithuania and Bulgaria, this figure exceeds 75%.

The AFME argues that SMEs will be the most impacted from restricted access to UK financial services, including wholesale banking functions.

In its numerous case studies, the body presented companies from across Europe which had concerns about increased tariffs, customs barriers, and switching banks.

A third of the SMEs that AFME surveyed feared that they would be the first to be hit by any restrictions on the banking sector. The report found that SMEs had fewer banking relationships than large corporates, with 60% linked to just one. The impact of bank assets having to move to EU-based entities has the potential to disrupt SMEs’ access to finance and financial products.

The AFME warns that UK banks may withdraw from lending to EU clients, which, according to its estimates, reached €180bn. It adds that large corporates would be insulated from a reduction in aggregate lending capacity, while SMEs would suffer.

“Should the loss of this €180bn cross-border loan exposure fall entirely on EU27 SMEs, we estimate this would represent about 7% of SME loans outstanding,” the report reads.

One case study profiled a business in Eastern Europe that banked with a Scandinavian bank. The business also made use of the bank’s London branch for UK business, and feared increased administrative burdens were it to lose access.

“Switching banks would not be easy; we would have to reconsider our whole system. This would be something new for us and we would find the process difficult,” one EU-based SME told AFME.

The UK is home to the subsidiaries of more than 50 foreign banks, many of which the AFME says operate across the EU on the basis of a UK banking license.

From the perspective of UK-based SMEs, the fear of potential tariffs and funding restrictions may lead some to seek a base within the European single market. One such business told the AFME that it had already begun to establish a base in the Netherlands from which it would seek invoice discounting and an asset backed facility.

Investment issues

Larger, corporate businesses and investors also have much to lose from a hard Brexit, according to the report.

The AFME claims that some larger businesses have indicated that they are reconsidering or delaying their planned UK investments, citing fears over tariffs, access to finance, and access to employees.

The loss of passporting rights was a major concern that corporates and investors raised. Investors feared increased friction in their fundraising processes. In the case of insurers, they feared their right to apply policies across the EU.

Corporates also echoed such concerns over passporting. The report highlights the financing arm of a car manufacturer, a prospect which could apply to lessors of other assets as it could limit their ability to provide finance across borders.

The loss of euro clearing to the EU27 is also a concern, with one source telling the AFME: “We are concerned we will no longer be able to issue euro-denominated debt via a UK banking entity; having to use a European bank based in Europe would create a lot of added complexity and additional cost.”

While corporates and investors believe wholesale banking across borders could be disrupted following Brexit, the majority believe they will be unaffected. While most corporates and investors, have cross-border banking relationships, a majority have multiple banks, and find it considerably easier than SMEs to switch.

Corporate treasures told the AFME that they feared Brexit could make pooling cash across borders more difficult, thereby increasing the cost of liquidity management. “We have moved our cash pool out of the UK,” one unidentified source told the AFME.

The potential loss of access to funding from the EIB Group, which includes the European Investment Bank (EIB) and European Investment Fund (EIF), was also a concern for corporates based in the UK.

One UK corporate said: “The EIB is our single biggest lender for capital investment,” adding that it would be forced to rely on debt capital markets to fill the void in its finances.

Risk management, especially related to long-dated derivatives, was also an issue. The AFME says Brexit could cause a fragmentation in the derivatives and currency markets, which would increase the cost of risk management.

The potential need to rewrite contracts was seen as an administrative burden that may inconvenience larger firms, and cause significant financial hardship to smaller businesses.

The AFMEs estimates the total cost of bank restructuring would reach €15bn, which, if stretched over three to five years, would reduce return on equity by 0.5% to 0.8%.

A soft landing?

Many businesses, despite the rhetoric coming from the UK government, held out hope for a ‘soft Brexit’. In such a scenario, the UK would remain in the single market – at least for a transitional period – and retain a similar customs arrangement.

The AFME warns that trade tariffs, differences in regulation, and curbs on freedom of movement for workers could increase the costs of doing business.

It says that these developments may cause institutions to retreat into their domestic markets, and reduce the supply of wholesale banking services to the EU27. SMEs, it says, will be hardest hit, as marginal investments become unprofitable.

“Above all, businesses want the status quo preserved,” the report reads. “Approximately 80% of our interview participants – EU27 and UK – hope Brexit negotiations will result in no material change in their access to wholesale banking services or to the price of them.”

In the case of a hard Brexit, the AFME report contains a number of recommendations. It sought the ‘grandfathering’ of existing cross-border contracts, which would allow them to run to term on current laws after Brexit, to prevent legal and operational disruption.

The AFME suggests that firms be given regulatory support and sufficient time to prepare for life after Brexit.

It says that in order to minimise disruption to everyday business, firms should have “adequate time” to create new documents for their client relationships and set up new legal entities.

Transitional arrangements to allow financial institutions to transfer risk between the UK and the rest of the EU is another suggestion. The report says that capital for EU27 risks should be allowed to remain in London until continental banks build up the capacity to support them.

Finally, the AFME urges the UK government to create alternative funding schemes to fill the gaps from the loss of EIB and EIF funds after Brexit.

“Interviewees feel strongly that the political negotiations should keep in mind the impact of Brexit on real economy end users,” the AFME says.