Brexit is set to splinter Europe's financial markets, posing long-term problems for London and weakening other EU financial centers, market observers say.

The British capital could struggle to attract top talent, while a fragmentation of businesses throughout the continent could pose financial stability problems for centers such as Dublin.

Fragmentation

The U.K. is scheduled to leave the bloc Oct. 31. Prime Minister Boris Johnson has consistently said he will not ask for a further delay, although he is bound by law to seek a further extension if no deal is agreed by Oct. 19.

Amid the threat of a no-deal Brexit, cities like Frankfurt, Paris and Dublin have benefited from financial firms moving staff out of the British capital, but the relocation of business fractures a market that works best when it is integrated.

"There is a reason why resources have been pulled together in London," Hubertus Väth, CEO of lobby group Frankfurt Main Finance, told the Mondo Visione Exchange Forum 2019 in London.

The post-Brexit landscape will be "significantly more fragmented" and spreading demand across various locations "is not the most efficient way to do business," he said.

Also speaking at the event, Philipp von Restorff, deputy CEO of lobby group Luxembourg for Finance, said "champagne hasn't been popping in Luxembourg" in the wake of the Brexit referendum.

"There are a lot of winners but everybody has lost too, especially Europe and the European single market," he said. "We have lost a key ally when it comes to integration of the financial market."

It also raises questions about financial stability risks in centers such as Dublin, according to the Irish central bank. For instance, because a large share of financial intermediation may be provided by countries outside the EU in the future, problems may arise around how to organize regulatory relations, it warned in a recent study.

Furthermore, financial activities fragmenting across different sectors implies greater financial complexity at companies, although the central bank said it may also mitigate concentration risk.

London safe, for now

London will remain the undisputed leader among European financial centers regardless of the Brexit outcome, market observers agree. The city is a well-established, reputable and safe place to do business, with a large connected banking sector and a broad ecosystem of financial and auxiliary services. It is also among the most advanced technology centers globally.

But there is still uncertainty around its future standing. Even though the impact of fundamental factors is likely to be small, the city also enjoys a premium not captured by fundamentals that could be eroded if future perceptions about London deteriorate, the Irish central bank said. Abrupt changes in regulation and disruption in global value chains could have an impact too.

The negative effects are already starting to emerge. London's competitiveness has been gradually declining over the past two years, while Zurich, Frankfurt, Paris and Luxembourg have all been gaining, according to the latest global financial centers index from think tank Z/Yen Group.

In March, London was still the most competitive global financial center for banking, but in September it had slipped to No. 4, according to the index, which is compiled using instrumental factors and a survey of 3,360 financial services professionals.

Staffing

Staffing is a key issue. Companies looking for a place to locate subsidiaries will consider access to staff before all other factors, according to Michael Mainelli, executive chairman of Z/Yen.

Nearly half of the firms in London's fintech sector — often flagged as a big growth area — are owned by EU nationals, and 28% of people working in fintech come from elsewhere in the bloc, Mainelli said. Another 14% are non-EU nationals.

Following Brexit, fintech firms could see the proportion of staff who would have to go through the visa process treble, from the low teens to more than 40%, he said — and those companies now employing non-EU staff understand how much time, complexity and cost is involved.

According to financial services lobby group TheCityUK, foreign staff currently make up 37% of those employed in the financial services sector, more than half of whom are EU nationals.

Without the freedom of labor movement from the EU to the U.K., global firms may look elsewhere, Chris Kerridge, an employee engagement expert at U.K.-based HR and payroll provider MHR told Open Access Government. The biggest impact could be from U.S. companies looking to branch out in Europe, he said.

Frankfurt top beneficiary in EU

Several cities in the EU27 have picked up London business already, and there will probably be more movement after the final outcome is known, Frankfurt Main Finance's Väth said.

A recent study by S&P Global Market Intelligence found that 34 global finance firms have chosen, or are considering, Dublin as a post-Brexit EU base; 22 have selected Germany, 18 have picked France and 20 have chosen Luxembourg.

Väth said Frankfurt is emerging as the top center for banks and Paris as the leader in asset management and insurance. These two cities will also bolster ties, including by improving transport connections, Väth said.

The various EU centers will actively target businesses that are vulnerable to relocation, such as clearing, fintech, asset management and regulation, according to a study by the Sheffield Political Economy Research Institute.

And they will need to club together to ensure Europe remains competitive on a global scale.

"What matters is that the European financial industry is stepping up against competition from the U.S. and the rising Asian financial centers," Väth said.