Assessing Options For U.K. Aviation Industry Under Brexit Scenarios

With the U.K.'s imminent departure from the EU, what options does the U.K.'s GBP 60 Billion aviation industry have? The table below outlines the framework that could take shape under each Brexit scenario.

According to the Airport Operators Association, only one EU multilateral air services agreement has been extended to the European Economic Area (EEA) countries – the EU-U.S. Open Skies Agreement – and that too only by mutual consent of both the signatories. This grants the right to operate services between any point in the U.S. and any point in the European country with no restrictions on intermediate and final points of destination. The Irish subsidiary of Norwegian Air had been blocked from access to the U.S. aviation market even though access should have been allowed under the Open Skies agreement. Hence, negotiating a separate agreement with the U.S. and other countries looks far from easy for the U.K. aviation industry.

Further, the interest of the Member States in any bilateral agreement is contingent upon the U.K.'s share in their respective domestic aviation markets. In Ireland and Cyprus, the U.K. represented 50 percent of the seats, whereas in France and Germany, it was less than 10 percent. ¹¹ The International Air Transport Association (IATA) noted that Swiss Airlines, despite a series of bilateral air services agreements granting them the right to operate services between two Member States, couldn't operate carriers on domestic routes within a Member State. A number of U.K. airlines are now looking to set up EU-based subsidiaries which would enable them to carry on their European operations after Brexit. In July 2017, EasyJet announced that it will establish a new Vienna-based airline to carry on its European operations after Brexit. The establishment of EasyJet Europe will allow the low-cost airline to keep running flights across the continent and within European countries regardless of the outcome of talks on a future U.K.-EU aviation agreement. ¹² It also stated that it was in the advanced stages of receiving an Austrian Air Operator Certificate and airline operating license, and expects to secure them in the coming months.¹³

Potential Risks And Scenarios In Case Of A 'No Deal'

In the event of the U.K. leaving the EU without any bilateral agreement in place with third countries such as the U.S., the U.K. has the option to fall back on the Bermuda II agreement (which predated the Open Skies agreement) with the U.S. In simple terms, the agreement imposed restrictions on the number of entry points, or 'gateways', in the U.S. which could be served from London.¹⁴ However, this agreement is extremely restrictive and both the U.K. and the U.S. will try to secure a liberal bilateral agreement fairly quickly.

The issue of Gibraltar is also a potential deterrent to Brexit negotiations. Spain has repeatedly pushed for Gibraltar to be excluded from the Single European Sky II agreement. The Gibraltar airport has expressed concerns about being potentially excluded from current and future arrangements between the U.K. and the EU. However, the U.K. is an important aviation destination market for Spain and, hence, it will have an interest in ensuring that negotiations on air trade services between the U.K. and the EU take place as smoothly as possible.¹⁵

Leaving the EU without a bilateral agreement in place with Member States would disrupt important trade and tourism links for the U.K. The IATA has highlighted that these bilateral agreements could take 'longer than 2 years' to negotiate, with the European Commission still struggling with a backlog of incomplete mandates with countries such as China and India.¹⁶

In contrast with other sectors, the aviation sector is not covered under the World Trade Organization rules, and hence, there is no 'fall -back' option for the U.K. aviation industry. It is also questionable whether any bilateral agreements concluded with individual Member States in the past would still remain valid, since these were in place before the EU extended its hold on aviation matters and, hence, are at a risk of being considered outdated and not fit for purpose. In case of Spain, there is no right to fly as the bilateral agreement between Spain and the U.K. has been repealed.

Conclusion

In the last few decades, the U.K. has emerged as a world leader in air services. Partnership with the EU, cemented over the years, has played a major role in contributing to the U.K.'s image as a global front runner in air services. Membership of the ECAA and the single market in air services have been the pillars of this strong U.K.- EU alliance. The U.K. government needs to clarify its position with regard to the aviation market during the course of the Brexit negotiations. A choice between retaining membership of the ECAA or a bilateral air services agreement with the EU as a bloc or with individual Member States has to be made in order to ensure that the U.K. aviation industry functions smoothly post Brexit. The U.K. will also need to re-think its aviation strategy with regard to third countries, such as the U.S., which is also its single largest trading partner after the EU. Departure from the EU without a definite plan for U.K. aviation will be catastrophic not only for its own industry but also for international aviation markets spread across the globe.

Banking

The U.K. has the third largest banking center globally. London hosts over 250 foreign banks² - more than any other center. The U.K. accounts for 17 percent of international bank lending³ - more than any other center. The EU has the largest share in the U.K.'s banking sector by way of assets and claims.

The EU banks collectively held 17 percent of total bank assets in December 2016, second only to the U.K. banks, and surpassing both Japan and U.S.-based banks. The EU held 38 percent of the consolidated claims of U.K.-owned banks and their branches and subsidiaries worldwide, second only to the U.S., which held 41 percent of the claims.
The above statistics demonstrate the importance of the EU to the U.K.'s financial services sector and vice-versa. This interdependence between the two regions has been made possible because of certain regulations and systems, which now need to be restructured in the wake of the referendum.

'Passporting' and Banks

For over two decades, the scope of the EU single market has expanded to trade in financial services, with a particular focus on banking, made possible by the harmonization of regulatory framework and the establishment of a single rulebook of financial services across the EU. In order to facilitate this trade in financial services, EU states have opened their national markets to the provision of financial services directly from other EU states, or by making it easier to establish branches and subsidiaries of banks and financial services firms of other EU states. Once a bank or financial services firm is established or authorized in one EU country, it can apply for the right to provide defined services throughout the EU, or to open branches in other countries across the EU, with relatively few additional authorization requirements. This pan-EU authorization is regarded as its financial services 'passport'. These passports are not available to third-country firms, i.e. firms incorporated outside the EU. Even if a non-EU firm obtains a license to conduct business in an EU Member State, it will be able to provide services only to customers of that Member State, thereby restricting its ability to conduct pan-European business operations.

Passports Used By Banks And Financial Services Firms

There are various types of passports that banks use, including core banking services such as lending and deposit taking, market services such as sales and trading, asset management, payments services and electronic money services.

Fourth Capital Requirements Directive (CRD)

An EU legislative package encompassing prudential rules for banks, building societies and investment firms. U.K.-based banks use it to provide advisory services, lending or custody or deposit services to a business in another EU state. A U.K.-based bank may also serve clients in the rest of the EU through a branch established in another EU state under the preferential terms created by the passporting framework.

Markets in Financial Instruments Directive (MiFID)

This EU legislation regulates firms who provide services to clients linked to financial instruments, and the venues where those instruments are traded. It is used by U.K.-based banks to help a business in another EU state take a derivatives position to hedge a loan, debt issuance, or exchange rate exposure through London- based markets. The U.K.-based banks also use their MiFID passports to help clients buy and sell shares, bonds or other financial instruments and trade on exchanges and trading venues around the EU.

A U.K.-based bank might use its CRD and MiFID passports to assist a customer in an EU state in arranging a line of credit, managing an investment portfolio or to advise on financial planning.⁴

Payment Services Directive (PSD)

It is a key piece of payments- related legislation in Europe, designed to develop the Single Euro Payments Area (SEPA) and regulate payment institutions. Eighteen top U.K.-based banks use passporting to operate across the EU. These banks are on the brink of losing their passporting rights, a major fallout of the Brexit referendum.

According to the U.K. Financial Conduct Authority (FCA), 8,008 firms based in the European Economic Area (EEA) make use of 23,532 passports to provide financial services in the U.K. Furthermore, out of 2,229 companies and a total market cap of GBP 4 Trillion, 112 companies from other EU Member States are listed on the London Stock Exchange with a market cap of GBP 378 Billion.⁵

How Does Passporting Work?

A passported U.K. bank can do the following:

• Provide its customers with the widest range of banking services across the U.K. and all of 27 EU countries
• Establish a branch in any other EU country from which it can offer cross-border banking services to other EU Member States
• Do so efficiently, without duplication and at low cost

What Does the Loss of Passporting Mean?

Once outside the EU, a U.K. bank has no 'passports'. Instead, it has to apply for a license for each EU country:

• A license is not available in many EU countries
• The range of licensed banking services is much more limited
• The license is usually available to one country at a time, i.e. no cross-border rights
• Duplication and substantial additional costs

Banks Outside The EU

The passporting system has been extended to cover the EEA, which comprises the EU states and Norway, Iceland and Lichtenstein. Passporting services are extended to these countries based on their commitment to honor the basic freedoms of movement, capital, goods and services in the EU Treaties and to incorporate the EU financial services rulebook into their own domestic law.

The referendum has forced a large number of banks to rethink their future strategy in the U.K. in terms of jobs, trade operations and EU staff. In January 2017, HSBC and UBS outlined plans to shift about 1,000 jobs each from the U.K. to the EU. The same was already announced by Citigroup, Deutsche Bank and JP Morgan Chase. In July, Deutsche Bank announced its plans to establish a new Frankfurt booking center to transfer most of the investment banking assets that it currently books in the U.K. Deutsche Bank books hundreds of billions of euros of non-U.K. business through its London broker dealer, which is the single biggest EU bank branch operating in the U.K. It will keep its London-based booking center but this will only serve clients in the U.K. and those who have a preference for keeping their contracts under British Law.

Citigroup has decided to base its EU broker dealer, its main trading operation, in Frankfurt and plans to distribute other businesses across Amsterdam, Paris, Dublin, Luxembourg and Madrid.⁶ Lloyds of London has confirmed that it will set up a subsidiary in Brussels as its new European base. The subsidiary is expected to be up and running by January 2019. Goldman Sachs announced its plans to relocate 'hundreds of jobs' from Britain to the EU. Several Japanese banking giants such as Nomura, Daiwa and Sumitomo Mitsui Banking Corporation have confirmed their plans to shift their European headquarters to Frankfurt. In July 2017, Bank of America moved its investment and market operations to Dublin. It confirmed its plans to move staff from the bank's London office, which employs about 4,500 people. ⁷ Banks shifting large-scale business operations along with their European headquarters from the U.K. to other places in the EU will result in a loss of strategic bank assets of the U.K., thereby causing a serious blow to London's status as the world's most favored destination for business in financial services. This also means high costs associated with staff relocation and setting up new office premises.

Substitute For Passporting 'Equivalence'

Equivalence is a system pioneered and developed by the EU, in which one State asserts that the standards of the other in a specific area match its own and hence can be pronounced 'equivalent'.⁸ Equivalence has an important role in financial services trade between the U.K. and the EU. It is used by the EU for two main things. Firstly, it grants rights to non-EU Member States to carry out certain defined services within the EU. Secondly, it defines the EU legislative and regulatory framework for banks in non-EU Member States to carry out operations.

How Does The EU Use Equivalence?

Equivalence is a system pioneered and developed by the EU, in which one State asserts Some important examples of the way the EU uses equivalence in banking and related areas are:

• In assessing the regulatory standards in their home market of non-EU banks that operate branches in the EU. These judgments are reflected in the way in which EU supervisors treat foreign branches and determine the imposition of additional requirements. For instance, these judgments are used in determining how to assess the risk posed by EU banks taking exposures to banks in these markets.⁹
• The range of licensed banking services is much more limited
• In assessing the standards that apply to market infrastructure in countries outside the EU, especially central counterparties for clearing securities trades. These judgments are used to determine how freely EU firms can use these market services to clear trades.¹⁰
• In assessing the data protection standards of non-EU countries. These judgments are used to determine how freely the personal data of EU citizens can be moved by banks to these countries for processing or storage.¹¹

U.K. Banks And Equivalence

For the U.K. as a country outside the EU, seeking access to the EU single market based on judgments of equivalence will mean weighing various political and policy priorities. There is currently no equivalence regime applicable for the EU's core banking rulebook - the Capital Requirements Directive (CRD IV). CRD IV applies to core bank services such as lending and deposit taking.¹² This is the most distinctive feature between the breadth of the EU passporting system for EU and U.K. banks and the restrictive treatment of non-EU banks under the limited equivalence frameworks. The EU has recommended a limited number of equivalence regimes that would allow non-EU banks to export specific services to EU Member States. One of them is the Markets in Financial Instruments Directive II (MiFID II). This covers a range of investment services, including the design, sale and trading of securities and the provision of investment advice, all the central functions of an investment bank. However, the services covered by MiFID II are narrower in scope and coverage in comparison to those under the MiFID Passport.¹³

Outlook For Bank Assets Hard Brexit Vs. Soft Brexit

The five-year outlook for the U.K.'s consolidated bank assets can be assessed in two scenarios - Hard vs. Soft Brexit. A hard Brexit means the U.K.'s complete departure from the EU single market and a subsequent loss of passporting rights for majority of the banks that rely on these to conduct cross- border business with the EU. The biggest loss will be for the non-U.K. banks, which control majority of the bank assets in the U.K. The U.K.'s status will be reduced to that of a third country which will have to determine a new set of financial services trading framework with the EU.

The current uncertainty regarding Brexit negotiations has had an impact on the banking sector in two ways. Firstly, with a large number of banks already in the process of shifting their European headquarters and consequently majority of their business and trade operations from London to other parts of the EU, the U.K. will see a loss in its consolidated assets over the medium term. The decline in assets will continue until mid-2019, when the Brexit framework has been finalized and the U.K. has officially departed from the EU. Bank assets will see some stabilization from 2019 onwards, and will pick up from 2019 to 2021, when the U.K. political framework post Brexit is in its final form.

Secondly, the initial impact of the referendum has been the depreciation of the sterling, resulting in higher costs for companies exposed to imports and a more favorable environment for exporters. Rising domestic costs resulting from higher import prices may impact household incomes and affordability of consumer loans and home loans, important subsets of bank assets. This, in turn, may affect businesses dependent on consumers for revenue. Real estate markets, both commercial and residential, have also been impacted negatively leading to a lowering of value. Bank assets will continue to decline in the near term, as a direct fallout from banks moving their operations from the U.K. to the EU and a declining sterling, but how fast they pick up and the magnitude of the increase from 2019 - 2021 will be determined by the final framework of Brexit and the deal the U.K. ultimately strikes with the EU. The U.K. stands to lose a large number of assets by the end of the Brexit negotiations in the event of an exit from the single market and loss of their passporting rights. A soft Brexit, with continued access to the single market and retention of passporting privileges for banks, will imply a healthy growth in assets in the forecast period from 2019-2021

Insurance

According to data published by the Association of British Insurers (ABI), the U.K. insurance market happens to be the largest in Europe and the third largest in the world, and contributed GBP 29 Billion to the U.K.'s Gross Domestic Product (GDP).¹⁴

The U.K. insurance market differs from the London Market. The wider U.K. insurance market refers to the underwriting by insurers of standard insurance policies, such as home, motor etc., while the London Market has become, over time, a leading market for specialty commercial insurance and reinsurance business, providing coverage for complex or wholesale specialty risks such as natural catastrophes, marine and aviation, and where virtually all business is placed by brokers on behalf of their clients. Insurers and reinsurers, Llyod's syndicates and managing agents form part of the ecosystem of the London Market that is worth an estimated GBP 60 Billion in gross written insurance premiums.¹⁵

Currently, over GBP 8 Billion of premium is brought annually to the London Insurance Market by brokers on behalf of EU customers. Over GBP 6 Billion of international business is written in London by firms with a parent company or principal base located elsewhere in the EU, demonstrating the importance of continuing mutual market access between the U.K. and the EU post Brexit.¹⁶

Passport In The Insurance Industry

The Solvency II Directive, which became applicable on January 1 2016, is the EU directive for insurance companies. It is based on requirement rules pertaining to the valuation of assets and capital, risk management and disclosure. It is the 'passport' through which insurers operate in other EU Member States through branches and sell products and services across borders.

Equivalence Under Solvency II

In the event of a hard Brexit and the subsequent loss of their passporting privileges, insurers have the option of relying on Equivalence to be able to continue their cross-border operation with the EU.

If the solvency regime applied to reinsurance activities of a third country is found equivalent, reinsurance contracts concluded with reinsurers established in that third country shall be treated in the same way as reinsurance contracts concluded with EU reinsurers (Article 172 of the Solvency II Directive). As a result, Member States may not consider contracts concluded with third countries less favorable than those concluded with EU insurers (Article 172-173). Thus, these provisions provide reinsurers with passporting rights. In case third-country insurers pursue activities in the EU as a parent undertaking of an EU insurer, an equivalence decision under Article 260 of the Solvency II Directive exempts these insurers from some aspects of group supervision and requires Member States to rely on the group supervision exercised by that third country. Supervisors of Member States will then form a college led by the third-country group supervisor. Also, Solvency II does not include a third-country regime for solo entities of third-country insurers.¹⁷Furthermore, if an EU-based insurer pursues activities in third countries, the presence of an equivalence decision under Article 227 allows them to carry out the solvency calculations for prudential reporting for the subsidiary in the third country in compliance with the rules of that country instead of rules under Solvency II.¹⁸ The future of the U.K.-EU insurance industry is reliant upon how clearly the equivalence framework is spelt out during Brexit negotiations in the face of a hard Brexit, while a soft Brexit will imply continuance of cross-border rights for insurers.

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Asset Management

Assets under management (AuM) in Europe reached EUR 22.8 Trillion by the end of 2016, bringing the size of the industry to 138 percent of the GDP. Investment fund assets accounted for 51.8 percent of all AuM, totaling EUR 11,800 Billion, whereas discretionary mandates represented 48.2 percent of total AuM, or EUR 11,000 Billion.¹⁹

The majority of the investment fund assets managed in Europe remain concentrated in a small set of European countries. The U.K., followed by France and Germany, is the biggest asset management market in Europe. Altogether these three countries own 63 percent of the total AuM in Europe, reflecting the size of their economies.²⁰

The large AuM/GDP ratios in the U.K. (320 percent), Switzerland (242 percent), the Netherlands (184 percent), France (174 percent) and Denmark (135 percent) give an indication of the relative importance of asset managers in these countries, and the responsibility they have taken in managing investors' assets.²¹

Passports In Asset Management Industry

In the area of collective investment schemes, European law currently comprises two main pieces of legislation covering two types of harmonized investment funds Undertakings for Collective Investment in Transferable Securities Directive (UCITS) and Alternative Investment Fund Managers Directive (AIFMD). Designed to enhance the single market while maintaining high levels of investor protection, the AIFMD is the main passport used by non-EU investment fund companies to conduct business across the EU. The aim of the AIFMD is to set up a regulatory framework for monitoring the risks posed by unregulated investment funds. The directive targets fund managers. The AIFMD includes requirements for authorization, registration of the fund manager, conduct of business, regulatory capital, safekeeping of investments, marketing and leverage.²²

Access to EU markets for U.K. fund managers will be negatively impacted in case of a hard Brexit since the UCITS directive does not have a third-country regime with European Commission equivalence in place for third-country alternative investment fund managers (AIFMs) and third- country alternative investment funds (AIFs). Under AIFMD, third- country AIFs either need an authorized EU AIFM to market their units or shares in the EU or the third-country AIFM needs to be authorized by the competent authority of the 'Member State of reference'. These requirements effectively mean that the third- country AIF and the third-country AIFM need to comply with the AIFMD rules in order to benefit from the EU passport.²³

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Conclusion

The financial services industry is the backbone of the EU-U.K. trade in services. Its success is essential for the sustenance of both the EU's and U.K.'s positions as unrivalled centers of financial business excellence. The industry in both the regions draws its strength from the mutually beneficial economic and political partnership between them, built and sustained over centuries. However, the events of the last one year pose a threat to this successful partnership. The Brexit referendum of 2016 has shaken the foundations of the banking, insurance and asset management industries in these regions. With the Brexit negotiations seeming to hit a roadblock and consequently jeopardizing the City of London's future as a favorite of the world's leading financial groups, we can expect more financial firms shifting the majority of their operations from London to other cities in the EU. If London has to safeguard its position as the world's most favored destination for business in financial services, it is for the politicians in the U.K. and Brussels to reach an amicable agreement that ensures regulatory fairness for all parties concerned.

Tariff-Free Access To The EU Single Market

Goods currently traded between the U.K. and the EU 27 enjoy a tariff-free movement. Access to the EU's single market has made the U.K. a formidable competitor as its supply chain companies can do business with other EU automotive companies and the OEMs (Original Equipment Manufacturers) can tap into a lucrative market of over 500 million consumers. ² If the U.K. leaves the single market without a proper replacement for the current system, it could result in the introduction of automotive tariffs of 10 percent on passenger cars, 10-22 percent on commercial vehicles, and 3-4 percent on average for automotive components. ³

The U.K. produced a total of 1.8 million motor vehicles in 2016, of which more than 900,000 were exported to the EU. The EU represents 81 percent of the U.K. vehicle import volumes ( 44.7 billion euros) and 52.8 percent of U.K. vehicle export volumes (EUR 14.6 Billion).⁴ Many OEMs sell 75 percent of their production within the EU. For engines, this figure stands at 55 percent. The chart below outlines the sales of the biggest car manufacturers in the U.K. According to these figures published by the Society of Motor Manufacturers and Traders, U.K., the EU unit sales of Nissan and Toyota, the largest vehicle manufacturers in the U.K., was double the number of their non-EU unit sales. Between them, Nissan, Toyota and Honda made half of the 1.7 million cars built in the U.K. in 2016 and employed 16,000 people.⁵

Production Outlook Scenarios: Hard Brexit Vs. Soft Brexit

Reassuring Nissan, Toyota and the other leading auto manufacturers has been a priority for the U.K. government after the June 2016 referendum to leave the EU. Eight months after the referendum, Nissan and Toyota have signaled their commitment, with Nissan announcing in October 2016 that new versions of its Qashqai and X-Trail would be made in the north- east of England, thereby turning its Sunderland plant into a 600,000 plus production plant.⁶ In March 2017, Toyota announced GBP 240 Million worth of investment into its Burnaston site in Derbyshire, with an additional investment of up to GBP 21.3 Million from the government, thereby underlining the company's resolve to continue to manufacture in Britain even if trading conditions were to change.⁷

However, whether the big auto manufacturers continue with their commitment to treat U.K. as a major manufacturing hub depends on how well the U.K. is able to negotiate the terms of Brexit and is able to retain the current structure of its access to the single market. Recent falls in the value of sterling have made U.K. exports cheaper, while the value of sterling against the euro and the dollar is approximately 15 percent below the long-run average. While the lower value of sterling will improve the competitiveness of U.K. exports in the long term, it will also increase the costs of imported components from the EU, which account for nearly 60 percent of components used in U.K. built cars.⁸

The latest figures published by the SMMT on car and commercial vehicle production for the first five months of 2017 suggest that production has slowed down across the U.K. following the referendum and the resulting uncertainty it brought with regard to the U.K.'s position as a strategic manufacturing hub in the EU. British car production fell by 9.7 percent in May 2017 in the wake of a slowing auto market across Europe. Cars produced in the U.K. for export fell by 9 percent to 109,591, while those made for the home market fell by 12.8 percent to 26,528. Production of commercial vehicles also slowed down to hit an all-time low of 6,875 in May 2017, declining by 28.3 percent from May 2016.

Cars produced in the U.K. for export fell by 9 percent to 109,591, while those made for the home market fell by 12.8 percent to 26,528

Despite the recent slowdown in auto production, British auto manufacturing industry remains in good health with several new models to go into production over 2017 to 2021 and expansion in investments by leading auto manufacturers. WNS DecisionPoint™ projects an upward trend in auto production over the forecast period. However, this forecast is contingent upon U.K.'s continued access to the EU single market with minimal disruptions to the current trade structure. A hard Brexit scenario without any access to the single market will result in a slowdown in vehicle production from 2018-19, when Brexit negotiations will be underway. But it is expected that 2019-2021 will see some improvement in production, albeit a slow one, owing to finalization of the Brexit agreement.

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Vehicle Registration Outlook: Hard Brexit Vs. Soft Brexit

Although the U.K. is a significant consumer market, it is not large enough to support the size of the British auto manufacturing sector. According to the figures published by the Association Auxiliaire de l'Automobile, 2.7 million new passenger cars were registered in the U.K. in 2016, 18.5 percent of the 14.2 million that were registered across the EU and the European Economic Area (EEA) as a whole. The export market will always be vital if the U.K. plans to sustain and expand the existing auto manufacturing sector. The regional nature of the automotive sector is such that that the EU will remain U.K.'s single largest export market, which makes export tariffs critical to the existence of the current sector.

The final sale price of a vehicle is determined by factors other than the costs of manufacturing the vehicle; however, even a 10 percent tariff on automotive components imported from the EU will raise the manufacturing costs significantly.⁹ This will be passed on to consumers by manufacturers, thereby curbing the demand for cars and commercial vehicles. According to the figures published by the SMMT, the year-to-date new passenger cars registered from 2016-17 declined by 0.6 percent to 1,158,357. This slowdown can be attributed to the uncertainty caused by the surprise announcement of a June 2017 election, with buyers holding back until the election outcome. Demand was driven by business purchases, to offset declines from private and fleet buyers.

A comparison between the commercial vehicle registration figures for the first five months of 2016 and 2017 shows a slight decline of 862 units in the registration figures for the month of May, which is lower in comparison to the relatively larger decline of 4857 units for April. The British referendum in June 2016 and the snap election called in the first quarter of 2017 are primary factors leading to the decline, coupled with an ongoing inflationary squeeze on consumer and investment spending brought on by a depreciating sterling.

We expect car and commercial vehicle registrations to grow at a stable rate for the remainder of 2017. This will continue into the first half of 2018, supported by declining oil prices and a depreciating pound which will add to the competitiveness of U.K. auto exports. Our outlook for the period 2019-2021 remains stable, with both car and commercial vehicle registrations forecasted to grow at a steady rate, provided that the U.K. is able to retain its current trade agreement with the EU. A hard Brexit, which implies a shift away from the current system of a single market, will lead to a slide in vehicle registrations in the forecast period, exacerbated by new trade tariffs, thereby aggravating costs of production and final sale prices. A soft Brexit with access to a single market will ensure a rapid increase in registrations from 2019-2021 when the Brexit framework for the British auto industry is finalized.

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Access To EU Talent Essential To The Success Of The Sector

The U.K. automotive industry benefits from access to the skills and experience of the EU and global employees. EU skills and talent are utilized in all aspects of businesses in the U.K. There are three principal reasons for the use of EU migrant labor in U.K. plants. Firstly, U.K. automotive manufacturing has a skill gap of around 5000 people, which is projected to increase. Secondly, with many companies having multiple plants across the EU, employees are moved from one plant to the other for specific engineering or manufacturing needs. Thirdly, many companies choose to move their employees for professional training and development, in order to improve the quality and competitiveness of their business.¹⁰

According to a survey conducted by the U.K. Automotive Council and the Automotive Industrial Partnership, majority of vacancies in the top 10 current and future priority jobs are engineering positions, with a particular concentration around design and production engineering, accounting for 40 percent of immediate vacancies. However, the potential loss of access to the EU workforce and uncertainty over the status of current EU workers is a challenge for the U.K. automotive industry's plans from a perspective of continued innovation, productivity and output as well as future growth potential.

One of U.K.'s many advantages as a member of the EU is labor market flexibility, which is essential for ensuring that workers are allocated to their most effective use in the economy. High labor flexibility allows easy shifting of workers from one economic activity to another, rapidly and at low cost - and allows for wage fluctuations while minimizing social disruption. It gives companies the confidence to rapidly take on employees to meet market demand. Additional administrative and cost burdens for moving skills, and a reduction in the ease of access to skills will reduce U.K. industry competitiveness and risks creating the perception that the U.K. is not an easy place to do business.

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Cross-Sectoral Regulatory Issues

The EU allows financial institutions established within the region to operate a branch network across Member States by virtue of the EU Capital Requirements Directive passport for the provision of banking services, which is crucial to the automotive industry. Motor vehicles are expensive, and hence, dealers need assistance in order to make their purchases. Likewise, motor vehicles are expensive to manufacture, and therefore manufacturers need to be paid quickly for the vehicles that they sell in order to have enough liquidity to fund the manufacture of more vehicles.

To alleviate the cash-flow concerns of both sides to the transaction, a third- party financial institution will finance the sale of the vehicle from the manufacturer to the dealer. In this way, the manufacturer gets paid quickly for the vehicle that has been sold and the dealer is afforded a period of credit for making the payment. Most automotive manufacturers operate in this manner, as this is essential to the maintenance of healthy dealer networks. Many automotive manufacturers set up their own financial institutions created specifically for the purpose of providing wholesale dealer finance, known as 'captives'.

Captive finance companies based in one EU Member State will often operate a branch network to other Member States within the single market. The ability of those companies based in the U.K. to continue to support a branch network once the U.K. leaves the EU may be severely impeded if there is no future provision made for the continuation of the passporting regime. If the U.K. leaves the single market (and sits outside the EEA) and the EU single rulebook on financial services, captive finance firms based in the U.K. would be required to take mitigating action to ensure continuity of service, including relocating their headquarters from the U.K. to another EU Member State.¹¹

Uncertainty regarding the application of cross-sectoral regulations following the U.K.'s withdrawal from the EU will negatively impact business operations. The Great Repeal Bill, a new legislation put into place by the U.K. government to ensure an orderly transition from the EU membership and that same rules and laws apply after the U.K. leaves the EU, should provide some certainty. However, clarity is needed regarding the maintenance of regulatory equivalence in areas that are critical to ensuring that the automotive sector can continue to access the single market without any barriers.

References:

1. The Society of Motor Manufacturers and Traders (SMMT).

2. Ibid

 

3. European Automobile Manufacturers Association, Position Paper Brexit.

4. SMMT

 

5. Article by Financial Times, Toyota and Nissan take different roads to Brexit, March 2017.

6. Article by Guardian, Nissan to review Sunderland plant's competitiveness after Brexit, January 2017.

 

7. Article by Financial Times, Toyota and Nissan take different roads to Brexit, March 2017.

8. SMMT

 

9. SMMT

10. SMMT Issue Paper, November 2016.

 

11. Ibid

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U.K. Hospitality: Shortage Of Skilled Eu Staff Could Be Hazardous For The Sector

The U.K. hospitality sector is one of the key pillars of the tourism and leisure industry, incorporating 45,000 businesses that include hotels, serviced apartments, private rental schemes, private members' clubs, self-catering accommodation, restaurants, food service management companies, attractions, sports stadiums, and leisure outlets located in coastal and rural parts of the U.K.⁵ EU workers comprise approximately 700,000 of the 4.5 Million people that work in the U.K. hospitality industry.⁶ As the U.K. unemployment rate continues to decline, businesses in the hospitality industry have become increasingly reliant on EU nationals to fill vacancies. While the unemployment rate fell from 8.1 percent to 5.4 percent between 2011 and 2015, the percentage of EU nationals being employed by the industry increased to 46 percent.⁷ As fewer U.K. nationals became available with the requisite skills, the industry grew increasingly reliant on foreign labor to fill vacancies. Many in the U.K. look down on hotel and restaurant jobs. The Pret A Manger coffee and sandwich chain estimates only one in 50 of its job applicants are from the U.K. because Britishers do not consider it a “desirable place to work”.⁸ Many of these jobs, such as working chefs, are highly skilled and require a commitment to quality, service and fierce work ethic. Many non-U.K. EU workers applying for jobs in the U.K. hospitality sector are overqualified, with useful language skills. U.K.- based pizzeria chain, Franco Manca, has expressed concern over the shortage of skilled European staff since the Brexit referendum, as it looks to expand to cities outside London, such as Bristol, Oxford, Cambridge and Edinburgh. The shortage of EU staff in the hospitality sector will aggravate employment costs for businesses operating in the sector as they compete for limited number of skilled workers and spend a lot more on training. These costs will in turn be passed onto the consumers, making the hospitality sector less competitive in the EU and other international markets. Future availability of skilled EU staff in the sector is heavily reliant on the future of migrant EU workers in the U.K. after Brexit.⁹ In its 2017 position paper on safeguarding the status of EU citizens living in the U.K. after Brexit, the U.K. government announced a series of measures and systems to be put in place after Brexit

The government has stated that it intends to end free movement but will allow migration between the U.K. and EU. The paper states that all EU citizens in the U.K., regardless of when they arrive, will need to obtain an immigration status in U.K. law. They will need to apply to the U.K. Home Office for permission to stay in the U.K. post Brexit, which will be evidenced through a residence document. This document will serve as a license to live and work legally in the U.K. The government has outlined details of a grace period of blanket residence permission which will start immediately upon U.K.'s exit from the EU. Termed as 'deemed leave' in U.K. law under the Immigration Act of 1971, this blanket permission will apply to all lawful EU residents in the U.K., giving them sufficient time to apply for their residence document during the period between the formal departure of U.K. from the EU and the time they obtain their residence documents. However, things remain uncertain for EU citizens since there is no decision yet on a specific date of U.K.'s departure from the EU. If the specified date is set at the date of U.K.'s departure from the EU, these post-Brexit arrangements will apply to all legal EU citizens in the U.K. For EU citizens arriving in the U.K. after the specified date, the ability to obtain a residence permit will depend on the rules in place at the time at which they apply.¹⁰ Given the looming uncertainty regarding the future residence status of thousands of EU citizens working in the U.K. hospitality industry, a number of companies have started pursuing other alternative means of filling vacancies. Pret A Manger has started to look for U.K. workers through social media and local job centers. However, this presents a challenge, since majority of the businesses in the hospitality industry are located in London and South-East England, where unemployment is low and living costs are high.¹¹ Automating tasks is not an option that the hospitality industry would want to explore, since a human touch is a prerequisite for the services it provides. This sector needs more clarity with regard to migration and residence status of EU workers if it wants to flourish at the same pace in the future as it has done over the years.

Brexit And The Falling Pound

While the Brexit referendum has cast a gloom over what lies ahead for the U.K. tourism and leisure industry in terms of likely staffing challenges and travel regulations, it has also been a blessing in disguise for the industry by way of a rapidly depreciating pound sterling. The unpredictability created by the referendum and the events thereafter have created ripple effects on the pound, with the domestic currency experiencing rapid falls against both the euro and the U.S. dollar in the last 15 months.

The pound fell to record lows within a month of the referendum, declining by 16 percent each against the euro and the U.S. dollar toward the end of July 2016. The double digit fall in the exchange rate continued till the beginning of January 2017, amidst mounting uncertainty with regard to the future of U.K. business and industry after departure from the EU. While the decline stabilized to some extent by June 2017, the depreciating trend continued until August 2017. The pound is expected to show a downward trend through the rest of 2017 and 2018 as Brexit talks between the two regions tread an uncertain path toward a final amicable agreement. A strengthening euro and dollar vis-à-vis the pound will exert further downward pressure by the end of 2018. The falling pound has given a boost to the U.K. tourism and leisure industry, making the U.K. one of the most attractive destinations for overseas visitors, including those from the EU and North America.

The U.K. has seen an upsurge in the number of overseas visitors since the referendum, taking comfort in the falling pound. The 3-month average of EU visitors to the U.K. was at an all-time high of 2.3 Million in the second quarter of 2017, up from 2 Million in the quarter ending September 2016. The number of American tourists visiting the U.K. in June increased by almost 34 percent since June of last year. Visitors to the U.K. have spent GBP 10.6 Billion so far in 2017, according to the ONS, which is over GBP 1 Billion more than what was spent in the same period in 2016. ¹²

Keeping in line with the upswing in international visitors to the U.K., hotel occupancy rates witnessed an upward trend following the months after the referendum, with rates rising from 77 percent in June 2016 to as high as 81 percent in July 2016. This trend continued into the latter half of 2016, with rates rising to 79 percent and 80 percent in August and September, respectively. The U.K. summer of 2017 has also seen an upturn in occupancy rates, with the May occupancy rates rising to 73 percent, an increase of 4 percent from April 2017. Hotels, in particular, have been impacted positively by the downswing in the pound. InterContinental Hotels Group and Whitbread, which owns the Premier Inn chain, have both reported strong trading in recent weeks. ¹³ Butlins, a premier hotel chain in the U.K., has seen an influx of visitors in its seaside resorts in Bognor, Skegness and Minehead, which welcomed more than 1.2 Million visitors last year, generating record revenues of GBP 224.8 Million and profits of GBP 45 Million. Pre-bookings for 2018 are already showing an increase of 18 percent from what they were during the same period last year.¹⁴ Butlins is one of the many hotel chains in the U.K. that has benefitted from the Brexit referendum and a weak currency making EU and other foreign destinations more expensive. Its resorts are located in faded seaside communities such as Bognor, which voted heavily in favor of Brexit during last year's referendum.¹⁵ A further fall in the pound could lead U.K. tourists to start holidaying more at home, with the domestic tourism industry and economy reaping the advantages of a weak currency.

With the pound expected to continue its downward spiral, U.K. holiday attractions and hotels are set to witness a spurt in visitors. We expect hotel occupancy rates to reach 64 percent this year, a 3 percent jump from last year. Occupancy rates are set to grow to 66 percent as the pound's downhill path is expected to continue into 2018. The U.K. will be an attractive destination for holiday goers, both overseas and domestic, even after Brexit. This will be seen in increased occupancy rates of up to 71 percent. However, majority of this demand will come from holiday goers and leisure travelers, rather than corporate and business visitors, reflecting the business uncertainty brought on by Brexit.

Outlook For EU Residents' Visits To The U.K.

While the Brexit referendum has brought gloom for the hospitality sector in the form of EU labor shortage and EU migrants in general, it has also brought ample amount of good news in the form of a falling domestic currency, making U.K. the most favored tourist destination for international visitors, particularly EU residents. Uncertainty with regard to travel package regulations and visitor visas for EU nationals traveling to the U.K. will prevail until the final outcome of the Brexit negotiations. However, this uncertainty will be undermined by the weak position of the pound with regard to the euro, thereby attracting increasing number of EU visitors to the U.K. for tourism and leisure purposes.

Helped by a depreciating currency which will continue to decline for the remainder of 2017, we expect the total number of visits by EU residents to the U.K. to rise to 2.7 Million in 2017, marking an increase of over 6 percent from the visits in 2016. This trend will continue into 2018 as a final Brexit agreement between the two regions is expected to take shape only by the latter half of that year. With the pound expected to stabilize to some extent in 2019-20, the number of visits by EU residents will increase between 3 percent to 3.5 percent from the previous year. The uptick in EU residents' visits to the U.K. will continue through 2021, as business confidence picks up following the completion of Brexit.

Conclusion

The U.K. tourism and leisure industry has built its foundations on a strong reciprocal relationship it shares with the EU. Access to the single market has ensured hassle-free and privileged movement of citizens of both the regions in each other's territories. The U.K. hospitality sector has benefitted the most from this mutually advantageous partnership by access to inexpensive and low-skilled EU migrant labor and the ease of visa and travel regulations for EU nationals visiting the U.K. However, the current deadlock in the Brexit negotiations is a threat to the sector's prosperity as there is still very little clarity on the future of thousands of EU migrant workers the sector is dependent upon and owes its success to. As an increasing number of EU migrant workers employed in the sector flock back to their home countries, the industry faces an unprecedented staff crisis which will be hard to overcome. On the other hand, the referendum has also been a blessing in disguise for the sector as a weaker currency has attracted an increasing number of overseas visitors, including those from the EU, thereby providing an impetus to the domestic industry.