31 October 2017

Financial Times: Post-Brexit financial regulation cannot be left to negotiators

Negotiations on free trade in goods are hard enough, but at least there is the World Trade Organization to fall back on. Trade in services raises even more complex issues and there is no treaty-based international organisation to act as referee. Countries have not been willing to cede any control over their financial sectors to a supranational body. Informal organisations such as the Financial Stability Board and the Basel Committee have no legal authority.

The European single market in financial services is an unusual creation, and has worked remarkably well. It has brought particular benefits to London — not a foregone conclusion when the euro was created. In London the lion really does roar, for now.

Brexit will alter the picture, whatever the outcome of the negotiations. Foreign-owned firms have concluded that keeping all their eggs in a British basket being shaken vigorously by changeable political winds is risky. Other European cities have not been slow to seize their chance of attracting business. Office space, and international school places, are being snapped up in Frankfurt, Luxembourg, Dublin and Amsterdam.

But there remains a lot to play for. The huge clearing systems in London cannot easily move in short order. EU banks have centred their trading operations here and are reluctant to dismantle them. And it is not clear that regulators elsewhere can quickly be equipped to cope with complex businesses they have not supervised before. The reality is that London will remain core to the European capital markets for a long time to come, even if with reduced dominance.

That means new, bespoke arrangements to supervise those markets. Unless a different decision is made, British regulators will leave their positions on the boards of the European Supervision Authorities: the EBA (banking), Esma (securities markets) and EIOPA (insurance and pensions). The governor of the Bank of England will no longer sit on the European Systemic Risk Board at the European Central Bank — he is currently vice-chairman.

That would not be a sensible outcome. Because of the importance of London’s markets, UK regulators have had a lead role in the development of EU regulation. The notion that they should in future only meet European counterparts in Basel corridors is absurd. There must be structured co-operation, and almost certainly shared supervision of entities in London which will remain systemically important in the EU.

Since negotiations on future market access have not yet begun, no progress has been made on those structures. They are of the highest importance to market participants and their customers, and the debate has been impaled on the horns of a false dilemma. The choice is presented as being between continued market access, as a rule taker from Europe, or taking back control of our own regulation and losing market access. The dilemma is nothing like so stark — much EU regulation is derived from international codes and rules, to which we will still be party. EU bank capital regulations derive from the Basel Accords, and the UK remains a full member of the Basel Committee.

Working out a new arrangement which responds to these realities will be hard. Suspicion of UK intentions is evident in Berlin and Paris. References to eating cake are frequent whenever two or three regulators or central bankers are gathered together. Nonetheless, they recognise the need for a prompt and creative solution, to avoid serious market disruption in March 2019.

On previous occasions when EU financial markets have faced a serious issue, and a potential discontinuity, a group of Wise People has been brought into being. So Alexandre Lamfalussy was commissioned around the turn of the millennium to address the cumbersome process of agreeing and implementing directives. His 2001 report set up three supervisory committees. In response to the financial crisis Jacques De Larosière was asked in 2009 for a second review, creating new authorities, whose powers the commission now proposes to strengthen.

A similar group is needed now to produce an artful solution to the post- Brexit conundrum. The Wise People could advise on how enhanced regulatory co-operation, which reflects the high interest the EU27 would continue to have in London’s markets, should be structured. It could opine on how far a regime of mutual recognition can safely be extended to third countries. It could grapple with the complex question of contract continuity. [...]

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