What a Brexit means for the responsible finance sector
1 July 2016
On 23rd June the UK voted in a referendum to leave the European Union. The assumption is that the current arrangements will remain in place until new frameworks are put in place, likely in two years but possibly longer. The UK is in an unprecedented position, so there are high levels of uncertainty around the many facets of this outcome, and in many ways this significant uncertainty will have repercussions as well.
In the briefing below we outline the direct points of impact we see the Brexit outcome having on the responsible finance sector in the UK.
Much of financial services regulation originates from EU law and is legislated into UK law. The FCA has issued a statement that its regulation will remain the same, until any changes are made through the negotiations between the UK Government and the EU.
They state that consumers’ rights and protections, including those laws derived from EU law, are unaffected by the outcome of the referendum and will remain unchanged unless otherwise specified by the Government.
We are in close contact with the FCA and will be kept informed about any policy changes as a result of the referendum. In the meantime, firms including our members, are expected to comply with current FCA rules and requirements.
European Investment Fund Facilities
The European Investment Fund (EIF) offers a range of facilities available to microfinance intermediaries in EU member states such as the EaSI and COSME guarantees, and the Progress Microfinance initiative which includes both funded instruments and guarantees. At least five responsible finance providers currently access these EIF facilities, and a further number have applications in with the EIF, with future funding contingent on their success.
We expect the future availability of EIF facilities such as the above to be contingent on negotiations between the UK and the EU; however in the meantime for existing agreements to continue as normal, and new applications to be considered until final arrangements are negotiated.
In the coming weeks we will advocate for clarity on the future of EIF programmes, so that intermediaries such as responsible finance providers, and their small business customers can plan appropriately.
Wholesale funding from the European Union has long been a source of funding for the sector, particularly for SME lenders, but also in supporting social enterprises and programmes that benefit low-income consumers. In 2015, responsible finance providers reported receiving £10 million in new funding from the EU, a figure that has been increasing over time. European structural funds (made up of the ERDF and ESF) allocated €10.8 billion to the UK for the period 2014-2020, €6.5 billion going to English LEPs, €895 million to Scotland, €2.4 billion to Wales and €513 million to Northern Ireland. A portion of these funds will have been allotted to microfinance in each jurisdiction.
Future European funding allocations were also fundamental to the UK’s plans for Devolution in England. Both the Northern Powerhouse Investment Fund and the Midlands Engine Fund were contingent on ERDF allocations to the regional LEPs through the JEREMIE 2 funds. The Northern Powerhouse Investment Fund planned to use £400 million of new EU allocations, and a £50 million loan from the European Investment Bank (EIB). This would be matched by a £50 million loan from the British Business Bank (BBB), totalling £500 million across the Northern regions. Similarly, the Midlands Engine planned to use £180 million of new EU funding, to leverage in EIB and BBB loans. Both of these funds had a microfinance element that consortia of responsible finance providers tendered to deliver (or plan to).
In the long-term, proponents of Brexit indicated that the UK Government would replace any EU funding committed; in the short-term it is expected that allocated funds will continue to be released until negotiations between the UK and the EU are complete.
We will advocate for any committed funding to economic development and in particular microfinance to be replaced. In the meantime we will speak to BBB for further clarity on these new planned funding streams in the short-term.
Business financial health and demand
Uncertainty about the long-term business environment including regulation, employment, trading, and exporting, has the potential to cause short-term instability, particularly if the Government does not delineate its plan for moving forward.
As seen in the weeks leading up to the referendum, this has the potential to cause businesses to postpone decisions that require investment, thus subduing demand for finance. In the coming weeks we will advocate for clarity on the plans for moving forward, to give the business community the confidence and assurance to continue its planned trajectory, and make the decisions to start up, invest, grow, and hire new people.
Banks loans to SMEs suffered in the wake of the 2008 financial crisis. Holding risk constant, the rejection rate for overdraft applications rose from 10.9% to 16.4% and for term loans rose from 5.4% to 8.8%. At the moment, we are experiencing financial shock rather than a liquidity crisis and shouldn’t expect the same results, not least the new capital buffer regime will mitigate against insolvency fears, but it can be expected that bank lending will tighten.
We will also continue to lobby BIS to quickly resolve the RGF recycling issue, as it is likely that future uncertainty will cause banks to act even more cautiously, thus excluding more businesses from mainstream finance.
Consumer financial health and demand
Consumer wellbeing is also impacted by the short and long term consequences of Brexit. In the days following the referendum the market swings may reduce the value of consumers’ savings and pensions accounts, and a devalued pound overall reduces peoples’ purchasing power against more expensive imported products. Other short-term effects could include a hiring slowdown and job losses as businesses try to navigate a post Brexit operating environment. Banks already act cautiously when providing services to segments of the market such as foreign nationals and people on low incomes, so the current uncertainty may make it harder for the underbanked to access services.
Longer term effects on consumer wellbeing, with a focus on low income consumers, will be influenced by the UK’s plans for trading, foreign direct investment, regulation, immigration, and replacing the EU’s contribution to job and skills training in disadvantaged regions.
In the coming weeks and months we will lobby for committed EU funds to social inclusion programmes to be replaced, that current initiatives underway such as the Prime Minister’s Life Chances Strategy are not stalled, and that the new Government’s plans seek to benefit those populations potentially most at risk of the referendum’s negative externalities.
Social enterprise financial health and demand
The social enterprise sector has already been facing challenges in that it has stepped up to fill gaps in public services, addressing social and environmental issues, and is expected to do so sustainably. The direct and indirect implications for the social enterprise sector is that direct funding from the EU will need to be replaced by the UK government, and that the social issues that charities and social enterprises are set up to tackle may become more pronounced due to the economic uncertainty and instability that could ensue. The social enterprise sector has not been guaranteed additional resources to cope with this potential increase in need.
The UK has developed a sophisticated supply side market for social investment, and one important factor is to continue to develop the demand side market, so that organisations delivering social services can access appropriate investment that enables them to grow. We will lobby for a pathway that keeps the UK’s social investment market competitive, and that it remains a priority on the policy agenda.
The long-term outcome of Brexit could be to establish a system that is favourable and fit for purpose by fostering continued economic growth and prosperity. In the interim, there is potential that the current levels of uncertainty can be disruptive. We will lobby alongside our partners and stakeholders for clarity on the Government’s plan, and the new Cabinet’s strategy on access to finance and financial inclusion. Over the course of the negotiations we aim to help shape the discussions so that in the future we have a strong ecosystem for supporting those people, businesses, and social enterprises that need to access finance to achieve their goals. We will also lobby for a favourable environment that encourages the growth of non-bank finance such as responsible finance providers, through access to the tools and resources that will leverage in new investment.