The Brexit Bombshell

There are many ways to describe what’s going on with the Brexit imbroglio—particularly in England, but also by extension Europe at large, and indeed the world—but here’s perhaps the most chilling one: It’s a Lehman moment. It might see premature, even blatantly unfair, to see it that way, but it’s already the considered opinion of some highly credible industry observers. And if that’s even a little bit true, let’s acknowledge it could affect wide swaths of the entire banking industry, and what all of us do.

Lehman, after all, is now the ultimate cautionary tale. Back in 2008, the financial services provider was 158 years old, had been highly regard throughout its existence, and was the fourth-largest investment back in the country. Then, to the surprise of many (even some industry insiders), the company filed for bankruptcy protection. It turned out that the blue-chip firm was deeply enmeshed in the rapidly expanding subprime mortgage crisis, and was also facing other accusations of improprieties. The surprise crash sparked tremors industrywide, crashed the stock market, triggered other defaults and generally devastated the entire financial services sector.

Now that the deal is done—unless the British Parliament doesn’t consider the vote binding, or calls for a re-election—could that happen with Brexit?  Or could it be even worse?

First, let’s acknowledge that one reason for the current chaos is that absolutely no one saw it coming. The idea that Britain would vote to leave the European Union was so absurd that even the idea’s strongest proponents were stunned when it actually did happen—so much so they’ve stepped down from their current posts, as did its strongest opponents. Every leader across the political spectrum has taken a hit.

But there’s one question bigger—much bigger—than why this happened, and it has to do with what happens now. In particular, what will become of the financial foundation of this creaky arrangement called the EU? And since in this interconnected economy a cold in one sector could cause sneezes everywhere, how will it affect the rest of the world?

The immediate aftermath was both shocking and predictable: Markets took a massive hit in many regions, the British pound fell to its lowest point since the mid-’80s, and even the UK’s perch as the world’s fifth-largest economy looked precarious. Sure, there’s inevitably been some recovery, but to say we’re uncertain what comes next is definitely an understatement.

One possibility is for European banks and their regulators to start doing what they didn’t do during the 2008 crisis: reset some regulations and adjust the dangerous liabilities many companies have. The banks are essentially undergoing a hard stress test, which actually makes it the perfect environment to implement changes that will cause pain in the short term but offer big benefits eventually.

None of this will be easy. Ahead of the actual Brexit vote, consulting firm Boston Consulting Group surveyed some 360 decision makers from banks in the UK, USA and Germany on what might happen if the British people actually did opt to leave the EU. One possible result: About 20% will take their business elsewhere, with Frankfurt proving the most desirable destination. (For the record, survey participants are likely as stunned as everyone else by the results: 38% believed the risks of a genuine Brexit would outweigh the opportunities, compared to 26% who went the other way. In fact, well over half, 59%, predicted a sharp downside to a Brexit vote, with serious impediments to Europe’s common market.)

Next, the role of technology will be particularly interesting. Numerous multi-tenant data centers are hosted in Britain, and more than 1.5 million people are employed by ‘digital companies.’ Many representatives of this industry were vociferous in their opposition to leaving the EU.  Moving forward, according to 451 Research, it’s apparent that even a slight reshuffling in this environment will affect operations throughout the world, but a full-scale migration to other European countries would potentially trigger large changes in for example, hosting capabilities, privacy laws and other compliance regulations, taxes and tariffs, M&A and capital markets, and even currency volatility.

One other set of predictions comes from Capital Economics, which was commissioned by Woodford Investment Management to analyze the potential impact of a successful Brexit vote. This study concludes that the financial services sector arguably has more to lose from this outcome than most other vertical. It predicts that London in particular will likely be hurt in the short term, but new trade deals with emerging markets could pay prove even more beneficial. (Again, these findings were developed before the actual vote.)

The reality is that we’re in totally uncharted territory—the fallout might be catastrophic, there might be only limited ramification, and the breakup might not take place at all. After the Lehman bankruptcy, the entire industry knew it was in for a bumpy ride. This time, we’re not even able to see the big picture, let alone the consequences for a given institution. But there will definitely be consequences, and it would be wise to be prepared.

Written by Jack Dougal