In fact, even if migration issues seemed to bring
tensions between London and Brussels to a head, they are only the tip of the
iceberg when it comes to what's truly at stake with this referendum. During
negotiations with other EU heads of state and government, British Prime
Minister David Cameron won concessions on several issues related to
competitiveness, sovereignty, the free movement of people, and the payment of
social benefits to EU migrants.
Clearing houses: the crucial issue
However, David Cameron failed to secure a veto on affairs concerning the euro area. This was a crucial issue in the eyes of the United Kingdom, which has had a poor view of the euro area's further integration, and of the UK's own exclusion from certain financial and monetary decisions.
The British were particularly frustrated with the unilateral decision of the European Central Bank (ECB) to require that clearing houses handling euro-denominated transactions be located in the euro area, in order to have complete supervision over this key part of the European financial system and of that system's stability. The United Kingdom even brought a case before the European Court of Justice (ECJ) in 2011, to prevent the ECB from relocating the clearing houses handling euro-denominated transactions. Although the ECJ did not rule in their favour on the substance, it did so on the form, ruling that the ECB did not have the competency necessary to impose such a measure. As a result, the European Council could still take up the matter and require that clearing houses leave the United Kingdom.
The EU therefore has considerable leverage over the UK, whether or not the British vote for Brexit. Far from being a merely technical or financial decision, this issue has political and economic consequences, and probably helped to trigger the calls for a referendum.
Taking into account the current surveys that show both sides neck and neck, and the recent econometric assessments of risk aversion among European voters, we believe that there is a 40% chance of the United Kingdom leaving the EU. In that case, the European Council would be able to immediately impose a euro-zone residency condition for clearing houses that trade in euros.
Source: YouGov (last updated 03/03/16)
If the UK decides to stay in the EU, members of the euro area will have to wait until 1 April 2017 to have free rein, based on the qualified majority they will have after new Treaty of Lisbon rules go into effect.
Softening the blow of Brexit in the medium term
While Brexit is likely to create an economic and financial shock within the United Kingdom, it is difficult to estimate the impact of this shock as David Cameron has not yet revealed the policies he would put into place to soften the blow. Of course, the Bank of England will not be standing idly by, and the impact of Brexit should be limited to a 1% reduction in British GDP for the first year, a handicap that will disappear after three years, by our calculations.
It is, however, already widely accepted that any change to the Eurosystem would permanently change the structure of the British economy. Indeed, currently, the average annual value of London-based transactions is EUR 130,000 billion (Source: BIS, ECB). Relocation would lead to increased financial activity in the euro area, creating capital inflows from the United Kingdom.
Today, there are four times as many foreign banks in the UK as there are in Germany, and five times as many as in France, with the domestic financial sector accounting for only twice as much of GDP percentage-wise. If 80% of European banks and 50% of non-UK and non-European banks were to move to the euro area to develop their activities there, potentially some GBP 680 billion (EUR 860 billion) could flow into the euro area. This is the equivalent of 34% of British GDP, and more than 8% of euro-zone GDP.
The pound plummets
In such a scenario, the pound sterling could depreciate by 34% against the euro. The euro's real effective exchange rate, measured against a basket of currencies, would rise by 10-12%. The negative effect on European exports could be limited by new, unconventional actions from the ECB, such as lowering the interest rate on deposits. According to our calculations, the euro area's GDP would grow by 1.3% over two years.
If the United Kingdom votes to stay in the EU, the euro area could require that clearing houses be relocated as early as April 2017. Until then, the United Kingdom's European future will remain uncertain – dampening investment, dragging down the value of the pound, and possibly limiting both its rise against the euro to 4% and the appreciation of its real effective exchange rate to 8% over the long term.