Report: what do EU capital markets look like on the other side of Brexit?

September 2019 • Topic: Rebooting UK capital markets post Brexit • by Panagiotis Asimakopoulos

This report shows that post-Brexit capital markets in the EU will be significantly smaller and less developed relative to GDP than they are today. The UK’s current dominance of EU capital markets activity will be replaced by the dominance of France and Germany.

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With Brexit just a few weeks away, this snapshot of what capital markets in the EU will look like after the departure of the UK makes for sobering reading.

EU capital markets will be far smaller and less developed post-Brexit, and the EU economy will be even more reliant on a struggling banking sector than it is today. Brexit also means that the EU will replace the current dominance in capital markets of the UK with an effective duopoly of France and Germany, who will account for nearly 45% of all capital markets activity in the EU.

A shift in tone?

This is likely to lead to a shift in the tone and direction of policy around capital markets in Europe, not least on the future of the capital markets union initiative and the future supervisory framework. The EU will lose its largest and deepest capital market and the supervisory and regulatory expertise that has built up in the UK over many decades. A significant part of the EU’s footprint in global capital markets will also be lost, with its share of global activity shrinking by nearly one third.

At the same time, large parts of EU capital markets activity will effectively be based offshore in the UK – particularly in sectors such as trading and asset management where firms have chosen to concentrate large parts of their EU activity in London. In highlighting the relative underdevelopment of capital markets in the EU27, the report also underlines the urgency for policymakers across Europe to focus on developing bigger and better capital markets to support growth and investment in the EU economy.

• That shrinking feeling: Brexit means that the EU is losing its largest and deepest capital. The UK accounts for nearly a third (31%) of all capital markets activity in the EU across 26 different sectors that we analysed, meaning that EU capital markets post-Brexit will be nearly a third smaller than they are today. The UK’s share of activity today is nearly double that of France – and more than France and Germany combined.

• A smaller global footprint: Brexit will significantly reduce the EU’s global footprint in capital markets. Today the EU is the second largest capital market in the world with a combined share of 21% of global activity. That is nearly half the size of the US, but a significant lead over its nearest rival China. The departure of the UK will reduce this share of global activity to 14% – around one third the size of the US and roughly the same as China.

• The impact by sector: Brexit’s impact on the size of capital markets in the EU will vary hugely between different sectors. In derivatives and foreign exchange trading, activity in the EU27 is only around one fifth of the wider EU. Bond markets in the EU will be around one fifth smaller, equity markets will shrink by around one quarter, while pensions assets and assets under management will shrink by more than half.

• Less developed: in addition to being significantly smaller, capital markets in the EU will be less developed relative to GDP than they are today. Capital markets in the UK are roughly twice as deep relative to GDP as in the rest of the EU, meaning that on the other side of Brexit the overall depth of capital markets in the EU will shrink by around one eighth.

• A wide range: there is a wide range in the depth of capital markets in the EU27 between different sectors. In all but two sectors markets in the UK are bigger relative to GDP than in the EU27. In some sectors of the fixed income market, such as high-yield bond issuance and leveraged loans, Brexit will have a minimal impact on the depth of EU capital markets, but in others, such as pensions and asset management, the depth of EU capital markets relative to GDP will fall by nearly one third.

• Banking on banks: Brexit means that the EU economy will be even more exposed to a struggling banking sector than it is today. The share of corporate debt coming from bank lending in the EU27 is 77% (compared with 74% if you include the UK), with corporate bonds representing just 23% (versus 26% for the wider EU). Market-based financing, such as stock markets or corporate bonds, will represent a smaller share of GDP in the EU post-Brexit than today.

• Safety first: the same effect is apparent with savings and investments. The share of household financial assets held in bank deposits in the EU will increase slightly as a result of Brexit to 32%, while the share held in pensions or insurance products will fall. Total household assets as a percentage of GDP in the EU will decrease by around one tenth to 224%.

• A loss of UK dominance: the UK currently dominates EU banking and finance and is the largest market in the EU in 24 out of 30 sectors that we looked at (France is the largest market in four sectors). This has given the UK an outsize influence in EU banking and finance: it will lose much of that influence, and the EU will lose much of the UK’s experience.

• Vive le Brexit?: France will be by far the biggest capital market in the EU on the other side of Brexit with a share of total activity of around 24%, ahead of Germany on 19%. It will be the biggest market in the EU in 14 of the 30 sectors we looked at, ahead of Germany with 10 sectors.

• A change in tone and direction: this shift in influence from the UK to France and Germany is likely to lead to a shift in the tone and direction of policy and regulation in EU capital markets post-Brexit. Not least, the capital markets union initiative is likely to look very different under the leadership of France and Germany than it does today.

The full report includes:

• A country breakdown of the 12 largest capital markets in the EU today and their contribution to the EU economy
• The EU’s changing share of global capital markets activity
• A sector breakdown of the size of EU capital markets activity post-Brexit
• A country breakdown of the wide range in the depth of capital markets across the EU
• Analysis showing the underdevelopment of EU27 capital markets by sector compared with the UK
• Analysis of the EU27 economy’s reliance on bank lending and the banking sector
• Analysis of the size of pools of long-term capital in the EU27
• A breakdown by sector of the UK’s dominance in EU capital markets activity today
• A breakdown by sector of the future dominance of France and Germany in EU27 capital markets
• A full methodology
• Links to six of our previous reports on capital markets, financial centres and Brexit