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Why FinTech Could Be a Casualty of Brexit

A demonstrator for the "Leave" campaign holds a placard outside Houses of Parliament in London, U.K., on Wednesday, June 15, 2016. The Brexit battle took to London's River Thames as boats supporting the "Leave" and "Remain" campaigns jostled for space, while Irish rock star Bob Geldof harangued U.K. Independence Party leader Nigel Farage using a sound system. Photographer: Luke MacGregor/Bloomberg via Getty Images

By Aaron Klein for Fortune

But London may remain a finance hub.London’s role as Europe’s financial services center has been called into question as a result of the UK’s decision to leave the European Union – the “City’s” future in the world of finance is very much in doubt.

Yes, London will remain a financial services hub, as it has been one for a long time. After all, the UK is still the world’s 6th largest economy. But the size and scope of that hub could be very different depending on how things shake out with Brexit. Frankfurt is a logical landing spot for financial services firms given its secondary role behind London. Amsterdam has a long history in banking. And France’s Prime Minister has made clear his country’s strategic desire to lure financial services firms to expand their operations in Paris , even promising to keep taxes on expats living in France the most favorable in Europe to attract London’s finance sector.

Meanwhile, major American firms like JPMorgan JPM 2.06% , Goldman Sachs GS 2.30% , Bank of America Merrill Lynch BAC 1.15% , and Morgan Stanley MS 2.65% , as well as Britain’s Standard Chartered made a pledge to British finance minister George Osborne to try to support London’s financial sector in the wake of Brexit, although details on what this means are not clear.

In order to understand what may happen and where the future of financial services may go, it is important to understand how and why financial services hubs exist.

London was the global financial services hub for a long time; after all, London was the largest city in the world in 1900. As the capital of the British Empire, with a strong rule of law, history of financial services, and the world’s reserve currency, London was the natural landing spot for the global financial system. Financial services, particularly for activities like payments and settlements between banks, requires economies of scale, and both legal and physical security. When London was viciously bombed during World War II, large portions of the global payments system were forced to move, choosing New York City as a logical landing place. As the United States emerged as the global economic power with the world’s new reserve currency after the war, given the cost of movement, and the reality that its location in New York was working, large portions of the global payment and financial system remained. Recently, New York and London have battled each other for the title of global financial capital (with Singapore and Hong Kong rising over time). Brexit is likely a self-inflicted knock-out punch (or to use a soccer metaphor, an “own goal”) that will solidify New York’s claim to the title.

London may suffer more as it relates to financial technology (aka FinTech) firms. FinTech is a growth industry with new firms emerging daily to challenge the existing system of how we transmit money (PayPal), use credit cards (Square), get a loan (Lending Club), or even what we think of as money (Bitcoin). Before Brexit, London had many advantages, including a smart regulatory system for FinTech and a strategic desire to attract and grow that part of the industry. Already there are over 60,000 FinTech jobs in the UK — more than in other potential hubs like Hong Kong, Singapore, and Australia combined. A report by E&Y ranked the UK over states like California, cities like New York and countries like Singapore in terms of attractiveness to FinTech, leading the UK’s Economic Secretary Harriet Baldwin to conclude that “We are the global capital for FinTech.”

In fact, policymakers in the United States were racing to think through what could be done to match the UK’s innovative approach for FinTech. The White House and the Comptroller of the Currency recently held FinTech summits in Washington, which I attended where this exact question was raised. However, that was all BB – Before Brexit.

Today, in a post-Brexit world, if you were a start-up financial services firm, would you locate in London?

Given the uncertainty about access and rules going forward to reach the European Common Market, as well as reaching the United States (recall that the US and UK have no independent free trade agreement), it is hard to justify choosing London over the alternatives. Leaving or locating outside of the UK can be a rational choice even if you are expecting that deals will ultimately be worked out in the UK’s favor, just because of the large downside and uncertainty of what would happen in the event that deals cannot be reached to guarantee favorable access. Major European Union members have publicly stated that they are opposed to granting the UK financial services access (passporting) without agreements by the UK on freedom of movement, which was a major driver of the vote for Brexit. The risks are just too high if you are a start-up, assuming that alternative environments can be found.

For start-up FinTech firms, however, they may want to change more immediately as they do not have the large, sunk costs of already being London-bound. This is where the biggest impact could be felt longer term, even if established financial firms stop expanding in London and target their growth elsewhere on the continent. London is not going to go the way of Constantinople (the world’s largest city in 500 AD). But in a post-Brexit world, growth in financial services, particularly FinTech, where London was poised to thrive, is likely to look elsewhere.

First appeared at Fortune

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