27 June 2016

LSE Commission on the Future of Britain in Europe: Financial regulation and the protection of Eurozone outs

Summary

• All participants expected job losses for UK banking but nobody expected the UK to lose its status as a financial centre. Banking is vulnerable to losing its role as a gateway into the euro area, while other financial and business services would remain competitive.

• The extent of job losses would largely depend on the equivalence of British regulations to EU regulations. This points to a Norwegian solution in which the UK would either keep or adopt the core of EU financial regulation even though it is outside the Union.

• Keeping most of the existing EU regulations was not seen as a major drawback for the UK and its financial services, including insurance, because the UK had been influential in shaping these regulations. Exceptions, in which the UK was overridden by an EU majority, concern the regulation of hedge funds and bankers’ bonuses.

• The rather limited outcome of the February 2016 re-negotiation of the UK of an emergency break for euro –outsiders was in line with what the participants in this hearing expected. This reform allows euro-outsiders to throw sand in the wheels of euro area legislation, but not stop it entirely.

• An explanation is the UK’s own ambivalent position vis-à-vis further integration of the euro area. Chancellor Osborne conceded a “remorseless logic” of further integration required to stabilise the euro area but the government also fears being left outside the room where agreements are prepared.

• Assets and liabilities of UK-resident banks are largely denominated in currencies other than the British Pound, hence a liquidity crisis will typically require swap arrangements with other major central banks.

• Central bank cooperation is likely to continue, because it has a long tradition predating the euro and is of vital mutual interest. The size of financial institutions and the length of emergency support required would make this imperative for the Bank of England and the European Central Bank.

• This continued cooperation would not stop the European Central Bank pressing for euro-denominated business to move to a member state of the Eurozone, bringing it under the ECB’s jurisdiction as a prudential authority and lender of last resort. [...]

Conclusions

The UK financial system is different, given its enormous size, the significant role specific sectors in it play, and given the interconnectedness of the City. Whether these differences matter for financial regulation of banks, capital and insurance markets has been quite controversial among the participants. Handling third country regimes seems the only issue where all saw the UK to have a fundamentally different position, both now and in a potential future outside the EU.

This singular difference suggests there are no easy wins for renegotiation in this area. The paradox of the City’s weakness of strength, noted by John Springford also contributes to this: the City is the most important European financial centre and these strong business interests weaken its bargaining position. Sharon Bowles did not even believe that the UK is seeking so-called safeguards in respect of financial markets “other than the wider general check on merits, subsidiarity and reduction of legislation”. One may of course see these general checks somewhat ignored in the present frenzy of building a banking union, and Raoul Ruparel certainly was of this view. But what may help are some moves in the EU, namely “a more capital market friendly environment through the capital market union and together with increasing international coordination of market regulation,” to quote Sharon Bowles again. Another issue, forcefully argued by Nicolas Véron and Graham Bishop, is the regulation-driven rise of central counterparties.

They should be an obvious cause for common concern, especially after the Court ruling strengthened the UK’s position.

The position of David Cameron’s administration seems to reflect this weak case for major negotiations in this area. This is, as Tony Halmos reminded us, a far cry from the situation in 2011, when David Cameron tried to use his leverage in the negotiations on the fiscal compact to extract concessions from other member states. “There was coincidentally a meeting of senior people from across the City. The crucial point was that because [the list of demands] was created without any consultation and was all written from the point of view of excluding Britain, basically the City was up in arms about it. And it was presented by the media as ‘we are saving the City,’ to which the first reaction was ‘well if we want to be saved we will go to St Pauls and pray and nobody asked us if we wanted to be saved.’” It is the government that has changed its position: “The way it is now being presented is obviously a hundred miles away from that, and it is absolutely spot on to do it as formulated in the Dear Donald letter. That’s the way to handle it. There are Eurozone-outs, we are not the only one, and that is the right way to put it. The chances of success for this to work are rather high.” This optimistic conclusion may not be shared by all participants but it is a fair summary of the deliberations to see the Eurozone outsider status of the UK as a challenge but not as an obstacle to EU membership.

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