BREXIT: financial firms would face 'costly upheaval' should UK vote to leave EU, says Treasury

This is part of Out-Law's series of news and insights from Pinsent Masons' lawyers and other experts on the impact of the UK's EU referendum. Sign up to receive our Brexit updates by email.

The document, which sets out two potential scenarios dealing with the immediate economic aftermath should the UK vote to leave the EU next month, said that financial firms in particular would face "costly upheaval". Over 5,000 UK banks, investment firms and insurers are currently able to provide services and establish branches in other EU member states, something that they would no longer be entitled to do unless the UK remained a member of the European Economic Area (EEA) as a minimum, according to the report.

"In order to continue trading across the single market, firm could have to restructure themselves," the Treasury said in its report.

"This could include creating or reconfiguring subsidiaries in EU member states which, by being located in the remaining EU, would have access to [the passporting rules]. Such actions would involve relocating activities and jobs to the remaining EU. Restructuring businesses and relocating staff would take a considerable time ... It would be rational for firms to plan their response, soon after a vote to leave, to ensure they could continue to provide services to their EU clients," it said.

The Treasury has concluded that the UK voting to leave the EU would "cause an immediate and profound economic shock across the country", which would then be made worse during the complex negotiations surrounding a 'Brexit' itself. The effect would be to "tip [the] economy into a year-long recession", with gross domestic product (GDP) ultimately 3.6% lower than it would have been had the UK voted to remain based on "cautious assumptions".

The immediate impact of the vote would be driven by three factors, according to the analysis. First, the 'transition effect' of the UK becoming less open to trade and investment than it would have been had it maintained membership of the single market; secondly, the effect that uncertainty following the referendum would have on business and household spending; and finally, the 'financial conditions effect' of financial market volatility.

The extent to which the financial markets would be impacted would depend on the extent of the uncertainty and transition effects, according to the analysis. This would then be "amplified" by the effects of falling asset prices, such as property or equity prices, and any reassessment of the UK's economic prospects by the financial markets, the Treasury said.

"The UK would be viewed as a bigger risk to overseas investors, which would immediately lead to an increase in the premium for lending to UK businesses and households," the Treasury said in its analysis. "The value of UK personal investments would also decline, and the fall in the value of the pound would put upward pressure on the prices paid by consumers. This would add to the transition and uncertainty effects and influence a wide range of financial conditions facing businesses and households."

The general economic downturn anticipated in the immediate aftermath of a Brexit vote would impact on all businesses, regardless of whether they operated in or traded with other EU member states, according to the report. All businesses would "be unsure of the continued demand for their products and services and all could face higher borrowing costs if credit markets became constrained", while businesses that are part of international supply chains would be "particularly hit by uncertainty over their ability to move products across borders", the Treasury said.

Banking expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, said that financial firms were generally "abstaining from transactions" until the result of the referendum was known, unless there was an underlying business need for these to happen quickly.

"The presumption is that there will be an uptick in activity if there is a 'remain' vote," he said.

"If there is a Brexit, I suspect that lending conditions will remain constrained which may lead to deals being pulled rather than simply postponed – particularly if a recession does occur following a 'leave' vote," he said.

Pinsent Masons competition law expert Guy Lougher said: "There are some simple things that businesses can do. Foremost among those should be identifying any business-critical contracts and considering if they are future-proof. Any agreements which specifically reference the EU as the territory governed by the contract may lack clarity. It is likely to be easier to agree amendments to those agreements now, especially where contracts have not yet been signed, rather than after a vote when the people on the other side of the table will know that the clock is ticking."

The report is the second to be published by the UK Treasury, following the 'long-term' economic analysis it published at the end of April. It previously predicted a long-term drop of 6.2% in UK economic output. Each of the three commonly discussed alternatives to EU membership would create barriers to trade and investment with the EU, whether EEA membership like Norway; a negotiated bilateral agreement with the EU like Switzerland or Canada; or relying on trade terms through membership of the World Trade Organisation (WTO), the earlier report said.