HSBC: Banking on Brexit
Following a shocking June 2016 referendum result, the United Kingdom announced its intent to withdraw from the European Union (EU). This process, termed Brexit, created mass uncertainty in the largely interconnected European financial system. Immediately following the unexpected referendum result, the British Pound hit a 31-year low and British banks lost £40 billion in market capitalization.
The British government triggered Article 50 of the Treaty of Lisbon in March 2017, beginning the Brexit process. The treaty gives the U.K. only two years to negotiate an exit deal with the EU, which would settle issues like the adoption of EU laws, establishment of a U.K.-EU trade agreement, and flow of capital and people across the reinstated borders. In March 2019, the U.K. will be forced to leave the EU with or without a deal. Soon after triggering Article 50, Theresa May’s administration called a snap election with the objective of consolidating power to prepare for Brexit. While her Conservative party did win re-election, it was on a thin margin, resulting in a minority government that could lead to a period of further instability. With this unstable environment leading into Brexit negotiations, British and other European companies will face an uncertain political and regulatory landscape when considering the implications of Brexit for their business operations.
Brexit has significant ramifications on the British banking system, primarily due to the loss of the UK’s passporting rights. These regulations allow banks registered in a country of the EU to operate in any other EU-member state, without needing further authorization. Banks can use these rights to provide traditional lending services, cash management, financing, and trade solutions without added fees, levies, or regulatory complications. British banks are estimated to generate £25 to 38 billion in gross profit per year through passporting, and incumbents are scrambling to restructure their businesses to be able to serve the post-Brexit European market.
To continue operations in the EU without access to passporting rights, U.K. banks will need to re-establish their European presences through creating legally distinct subsidiaries. This includes constructing new balance sheets, integrating new management teams, developing new risk management and compliance processes, and transferring existing business operations and accounts into these new financially separate subsidiaries. In addition to these heavy operational requirements, U.K. banks will need to go through rigid licensing processes with E.U. governments. As a result, they face significant administrative costs and time delays, exacerbated by the fact that many financial institutions will be applying for these licences simultaneously. It is estimated that most U.K. banks will take more than six to 12 months to obtain all of the required licensing, and more than 18 months to build the foundations of their new European subsidiaries.
While Brexit has created business obstacles, it also represents a potential opportunity for companies with the ability to capitalize on post-Brexit complications. Businesses across the U.K. and E.U. are looking for stability in this time of uncertainty, and HSBC is a bank that is particularly well-positioned to provide this. Investor confidence in the Big Four British banks following the referendum reflects the view that the market has the most faith in HSBC to navigate the twists and turns of Brexit.
The World’s Local Bank
HSBC is one of the largest banks in the world, with access to 90 per cent of global trade flows and operations that span across 67 countries and territories. In 2017, HSBC was recognized as the World’s Best Bank by Euromoney for “sticking to its mission of financing cross-border capital flows and trade in a more protectionist world, even as other banks retreat to their own borders.” This award showcases HSBC’s core competency of facilitating international financing through its corporate banking network, even in complex markets.
HSBC was originally headquartered in Hong Kong during the formation of the European Union and subsequent creation of bank passporting. This caused HSBC to establish legally distinct subsidiaries within the EU for regulatory and tax purposes, which include HSBC Trinkaus & Burkhardt AG (Germany), HSBC France, and HSBC Bank Malta. When HSBC moved its group headquarters to the U.K. in 1993, it kept its subsidiary network in place. After Brexit occurs in 2019, these subsidiaries will keep their passporting rights as fully incorporated banks in their respective countries, while still retaining the backing of the HSBC global group. This unique structural difference gives HSBC a significant advantage over its British competition in adapting to a post-Brexit world.
Barclays is the only other major British bank with a European subsidiary network. It is currently revitalizing its Irish subsidiary, which holds passporting rights, to manage its EU business. However, it still faces significant capital and managerial constraints in the short term and will require a moderate amount of time before it becomes operationally autonomous of its U.K. parent. On the other hand, HSBC already has established subsidiaries in numerous countries, many of which have had centuries of independent operating experience.
HSBC will also be competing against European banks, like Deutsche Bank, whose EU operations will not be affected by Brexit. However, similar to how British banks will lose passporting access to the EU, European banks will also lose access to the U.K. This further solidifies HSBC’s structural advantage, as European banks will face a similar predicament in the U.K. as British banks will in the EU.
Corporate Banking in Europe
Small, mid-market, and multinational businesses in the EU and U.K. will all be affected by Brexit in different ways; increased complexity in doing business due to new trade tariffs and bank levies will threaten existing business practices. If the U.K. and EU cannot agree to a new trade deal by 2019, trade will revert to standard WTO regulations and disrupt cross-border operations. For instance, cars would face tariffs of 10 per cent and agricultural products would have tariffs between 20 and 40 per cent. To continue operating across the border, businesses may have to relocate staff and set up bank accounts in both jurisdictions.
The expected volatility in the market will allow HSBC to proactively pursue new clients before Brexit takes effect, thereby leveraging its short-term advantage. Customers will value stability in their financing, and increased ease of using other bank services. Greenwich Associates estimates that 40 per cent of large companies in the EU express a strong willingness to switch banks in the year ahead due to the geopolitical risks presented by uncertain banking regulations.
Mid-market enterprises are likely to be most adversely impacted by the burdens of a post-Brexit EU. They are not large enough to have extensive in-house expertise in global regulations or significant enough to lobby for preferential treatment like their multinational counterparts. Additionally, they are too large to benefit from government incentives and support provided to small businesses. This would be HSBC’s ideal target market, as these firms will require specific cross-border services in the short term and can be converted to long-term clients through product-based incentives and careful relationship management.
An Investment into the Future
HSBC must strategically adjust its operations in Europe to reflect its core competencies, which include its international framework, expertise in managing complexity, and stability as a well-financed and established bank. HSBC should focus on offering products that will be newly required for post-Brexit European firms, and that it has a structural advantage in providing. For instance, it can use its already-established subsidiary network to facilitate new cross-border cash management and trading solutions that U.K.-EU companies would not have previously needed to use. HSBC can use Brexit as a catalyst for change, with the goal of acquiring customers in need of these specialized products. HSBC will then have the opportunity to cross-sell other products and services to clients, aiming to increase its customer switching costs and lock them in as long-term customers.
Although the bank is already unique in its ability to provide specialized cross-border services in the short term, it can drive more conversion by offering potential clients further financial incentive to switch through a loss-leader pricing strategy. HSBC can acquire clients through select low-priced products, but achieve profitability by cross-selling and upselling customers to different services and products to suit the rest of their banking needs. As dealing with multiple financial institutions increases administrative costs for businesses, HSBC would be able to drive mid-market enterprises to eventually move over all of their business. Financial services typically have high switching costs due to sticky relationships and administrative hassles, but HSBC can use the Brexit opportunity to trigger short-term conversion, eventually making it difficult for customers to switch back for the same reasons.
HSBC is able to offer lower prices for two reasons. First, it is one of the best-capitalized banks in Europe, with access to cheap global deposits to fund potential client acquisition. Second, it does not have to incur the cost of building new subsidiaries, like its British competitors. These savings can be passed on to new clients in the form of price discounts, enabling HSBC to deliver on its loss-leader strategy and ensure that customers switch banks within this short window of opportunity.
HSBC’s corporate banking services are currently segmented into global banking and markets and commercial banking business lines. Most large multinational corporations with complex global trade and financing needs are serviced by the global banking and markets segment, while small and mid-market companies are typically covered through commercial banking. To maximize the success of its conversion strategy, HSBC should align these business lines and facilitate increased resource-sharing to better serve new clients in commercial banking, providing cross-border expertise and services that have been traditionally available only to large multinationals. This strategic shift in operations will cater to new cross-border needs upon the loss of passporting rights, and will enable HSBC to provide close and knowledgeable service to prospective clients in line with its core competencies.
Banking on the Change
U.K. banks that have lost their EU passporting access will attempt to take back lost business after establishing their own subsidiary banks. Significant investments in time and resources could deter a full-scale relaunch into Europe, but British banks will eventually return in the long run. Likewise, European banks will make significant efforts to establish subsidiaries in the U.K. Consequently, HSBC’s discounted pricing strategy may need to remain in place until relationship managers are confident in the bank’s relationship with its new clientele in Europe.
HSBC is poised to significantly increase its presence in the EU in the wake of Brexit if it can execute a bold and aggressive strategy rather than a reactive one. By revitalizing its European operations to reflect its core competencies as an international bank, it can capitalize on a rare opportunity to drive customer conversion and emerge as the undisputed leader of corporate banking in post-Brexit Europe.