14 January 2018

Financial Times: There is no beau idéal of a Brexit deal on finance

[...]The prime minister has set some expectations by spelling out what she will and will not do to get one. For instance, she has firmly ruled out Britain remaining in the single market and quickly slapped down suggestions last week that the country might pay contributions towards the EU’s general budget after its departure.

But these “red lines” have already put her on a collision course with Brussels, at least so far as Michel Barnier, the EU’s chief negotiator, is concerned. While the EU27 have yet formally to define their position, Mr Barnier has warned that Britain cannot expect its own special one-off arrangement.

The UK can be a Norway and abide by the rules of the single market or it can be like Canada and have a free trade flavoured agreement with plenty of regulatory freedom but few, if any, provisions for financial services to trade freely cross-border. What it cannot expect is to have the best of both worlds.

As with other complex “boundary” Brexit issues, such as the Irish border, there is no simple way to square this circle. Any progress will depend on whether both sides can accept the uniqueness of the situation. History, after all, presents few parallels to the City’s position with regard to the EU after Brexit. It is as though, by some twist of fate, Toronto had ended up hosting much of the US capital market.

This cannot be un-invented without a degree of mutual disruption. Britain would certainly face a shock in the short term were barriers to be abruptly thrown up, costing it some of the City’s juicy banking business with its outsize earnings and taxes.

But things would not be so great for the EU either. The sudden Balkanisation of the London’s efficient capital market would raise swift demands for new capital from European institutions that are scarcely noted for their abundance of equity. The cost of financial services to EU consumers would have to rise.

City lawyers and lobbyists have wracked their brains looking for an elegant solution, one that gives Britain the access it wants while allowing the EU to say that cake has not been had and eaten simultaneously.

The UK argues that all trade deals are, to some extent, bespoke and that there should be no barrier to an agreement that makes provision for services. There is a certain logic to this given the dependence of both the UK and EU economies on these sectors. Just a few years ago, it should be remembered, Mr Barnier was arguing for financial services to be included in a trade deal with the US.

The difficulty is that services, unlike goods, are much less amenable to global standards, being more tightly tied to local law. Britain would like both to preserve its access and maximise both sides’ freedom to set their own regulations while preserving protections for customers. Its aim, understandably, is to avoid becoming a taker of EU rules.

But these aspirations pull against each other. The more freedom to vary regulation either side demands, the more likely each is to want to retain a unilateral right to cancel the deal should the other use this freedom too freely.

The City has grown used to the legal certainties of the access conferred by the passport. Yet short of single market membership, these may not be replicable in the post-Brexit world. The EU has recently published draft legislation that would actually tighten the established mechanism through which it grants equivalent status to third countries, seeking to enforce closer compliance with its rules.

This, it should be said, is largely scorned by City financiers because it depends on Brussels’ unilateral consent and can be withdrawn at short notice. That the EU is seeking to toughen even this position hardly suggests that anything as liberal or certain as the passport will be up for grabs.

The truth is that there is no beau idéal of any post-Brexit financial services arrangement. The glue for any deal will not anyway be legal text but perceptions of mutual advantage.

The EU cannot easily cut itself from the UK’s financial markets. The trade then is some say for Brussels on how those markets are governed, in return for some additional surety of access however imperfect. The strength of those cross-channel ties will determine whether such a deal is done. [...]

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