30 September 2021

Veron: Brexit and European Finance: Prolonged Limbo

the full impact of Brexit on the financial sector has been delayed by risk aversion.... in part related to the Covid-19 pandemic. It will take longer than many had anticipated for the dust to settle on the post-Brexit financial landscape and its respective implications for the EU and the UK.

It is still early to assess the impact of Brexit on the
European financial sector, including both the UK and
the EU. In sharp contrast to the politics of the bilateral
EU-UK treaties negotiation and its aftermath, which
have been and will probably remain full of sound
and fury, the implementation of the British exit from
the European Union and its single market has been
carefully prepared and cautiously managed by regulatory
authorities and market participants, with additional
risk aversion in the Covid-19 pandemic phase
since March 2020. While the prudent approach has
successfully averted any disorderly developments so
far, it also implies that the current status is far from
a steady state, as many impactful decisions remain
to be made. Just as the initial negotiation has taken
significantly longer than initially envisaged, the transition
to a truly post-Brexit financial sector in the UK
and Europe more generally is turning out to be more
protracted than many had anticipated.

SUCCESSFUL TRANSITION
The period of Brexit negotiations lasted nearly four
years, from the British government’s formal notification
of its decision to leave the Union in March 2017
to the signature of the EU-UK Trade and Cooperation
Agreement on 30 December 2020. As the memories
of the related twists and turns rapidly fade away, it
becomes increasingly easy to forget the radical uncertainty
and cliff-edges that marked the process
at various junctures. At no point, however, did that
result in financial turmoil.

To some degree, this success
has been a consequence of the very high-profile
nature of Brexit, a development that captured the
attention of a considerable number of participants
for a long time. A critical mass of players worked hard
at mapping scenarios and planning for Brexit-related
contingencies, and that reduced the likelihood of
market disruption.

In particular, there is every indication that the
principal authorities in charge of financial stability,
the European Central Bank and the Bank of England,
were able to continuously maintain a high level of
mutual information and cooperation throughout the
period, in contrast to the toxic politics and abrupt
breakdowns in the parallel relationship between the
European Commission and the UK government at the
same time. While personalities surely mattered, this
is also to the credit of the strength and distinctiveness
of the central banking community’s culture and
routines of cross-border coordination.

The political negotiators also deserve credit for
a shrewdly designed feature of the Brexit sequence
that acted as a check against instability at the point of
most tangible change in the financial services sector,
namely the moment of British exit from the EU single
market. The Withdrawal Agreement, whose final text
was published in October 2019 and ratified in January
2020, established a transition period beyond the formal
point of UK exit from the EU (on 31 January 2020)
during which most aspects of EU law would continue
to apply and thus the UK would effectively remain in
the single market (and customs union, the latter being
of limited or no significance for most financial services).

The transition period was set to end on 31 December
2020, but Article 132 of the Withdrawal Agreement
allowed for an extension “for up to 1 or 2 years”
if jointly agreed (i.e., requested by the UK—there was
never much doubt about the EU’s willingness to concur)
before 1 July 2020. The flipside of that option
was that, once the UK government
decided as it did not to exercise
it in June, there was no longer
any uncertainty as to the date
of exit from the single market—
since changing it would have required
amending the Withdrawal
Agreement itself, an implausible
prospect given the need for
separate ratification before the
end-2020 deadline in every EU
member state. Thus, amid all the
uncertainty, market participants
knew one thing for certain during
the second half of 2020, namely that Britain would indeed leave the single market on
31 December 2020, as it did. That allowed for simpler
planning than if an option had been left for extension
until the end....

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