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What does Brexit mean for South African Financial Services?

24 November 2016

On 23 June the UK voted for Brexit. More precisely: in an advisory referendum on whether the UK should Leave or Remain in the EU, of those who voted, 51.9% voted to Leave. Several months later, exactly what Brexit entails remains unclear, but UK Prime Minister Theresa May is clearly committed to it. In her words, "Brexit means Brexit", and she has said she plans to trigger Article 50 of the EU Treaty,  starting the UK's two year formal process for Brexit, by the end of March 2017. However, a High Court decision requiring the UK government to obtain parliamentary approval before triggering Article 50 has complicated matters (the government is appealing) and at present – although Brexit is still widely expected to ultimately go ahead – it is by no means clear that the UK will have left the EU by summer 2019 as Prime Minister May had planned. For now, the only certainty is uncertainty.

What might Brexit, and the uncertainty that surrounds it, mean for South Africa's financial services sector? The country has a developed and well-regulated banking system with many links to the UK. In particular, some of the largest banking groups doing business in South Africa have headquarters or parent companies in the UK. What is more, much of South African banks' offshore funding comes from Britain. Therefore any significant change to the UK's financial services sector will inevitably have knock-on effects for South Africa's financial services sector – especially in relation to South Africa's capital markets and currency. 

Capital markets

In uncertain times, investors tend to seek safe assets such as US bonds and gold and to eschew risker options such as emerging markets. For South Africa, this is a matter of particular concern. In recent years, South Africa has had a large current account deficit and therefore needs money to keep flowing into its financial markets to keep the rand stable. However, this is a challenging time to attract foreign investment; in June ratings agencies downgraded South Africa to the lowest investment grade possible and some analysts fear a further downgrade to junk status. What is more, some domestic investors have seen Brexit as an opportunity to move money out of South Africa to invest in the London property market, which has become more affordable due to the pound's depreciation following Brexit. 

Currency

A corollary of the capital flight described above is a fall in the value of the rand as money is moved out of South Africa. Notably, the rand dropped 8% against the US dollar the day after the Brexit referendum, and it has not recovered fully since. Further depreciation of the rand against the dollar and other currencies could cause import prices to rise and cause inflation and possible interest rate hikes as a result.

Against the pound, however, the rand has sharply increased in value since the referendum. This reduces the impact of each pound of investment into South Africa, which can now buy less than it could pre-Brexit. The fall in the value of the pound is also a concern for South African trade. The UK is one of South Africa's main export destinations, especially for products such as wine and fruit, which have become more expensive for UK importers since the referendum. Tourists from the UK may also be less likely to come. A weaker pound could therefore harm South African growth, which would undermine the country's already precarious credit rating. 

Hard or soft Brexit?

It is important to remember that Brexit has not actually happened yet – only an advisory referendum has. The full impact of Brexit is therefore yet to be seen and will depend, to a large extent, on the form that Brexit takes. Commentators have distinguished between two broad possibilities: a hard Brexit, in which the UK extricates itself completely from the EU, and a soft Brexit, in which the UK retains some of the substance of its relationship with the EU, such as free movement of people, access to the single market and EU passporting rights, which enable an authorised business in the UK to operate throughout the EU without needing to establish branches and gain authorisations in other EU Member States. 

A hard Brexit would involve more uncertainty and volatility than a soft Brexit, as the UK would have to redefine and negotiate more relationships with the EU and elsewhere. The loss of passporting rights might also lead banks and other regulated businesses in the UK to relocate elsewhere in the EU, to cities such as Paris, Dublin and Frankfurt – places where South Africa does not have such strong links, as compared with the UK. Any movement of regulated business out of the UK would also weaken the UK financial services sector and the UK economy in general, exacerbating the knock on-effects described above on South African financial services. A hard Brexit would hit South African financial services harder than a soft Brexit.

Notwithstanding the above, it is important not to overstate the effect of Brexit on South African financial services, which sources much of its funding from countries other than the UK. Moreover, South Africa's banking and financial institutions have shown their ability to withstand global financial shocks before, and Finance Minister Pravin Gordhan has drawn attention in particular to the resilience they showed during the run up to the global recession of 2008/2009. South Africa is also currently in the process of moving to a "Twin Peaks" model of financial sector regulation, based on the UK, and it is hoped that this will further strengthen the country's financial services sector. 

Nevertheless, we can expect to see Brexit-related uncertainty continue to affect South African financial services for some months to come – at least until it becomes clearer what "Brexit means Brexit" ultimately means. 

Lodewyk Meyer

Lodewyk Meyer,

Johannesburg

Micah Smith

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