By Lionel Laurent
London (Bloomberg): London wasn’t always the be-all-and-end-all for European finance. It took a deregulation drive under Margaret Thatcher in the 1980s — known as the Big Bang — and Britain’s contribution to the launch of the European single market in the 1990s to decisively lure the headquarters of US, European and Japanese banks to the City.
By serving as a magnet for money, talent and office space, UK financial services now account for 7 per cent of the country’s economic output and over 1 million jobs. It’s a national cash cow.
While that has meant a lot more prosperity for the UK, it has also created a lot of disgruntlement on both sides. The 2016 Brexit vote was an obvious wake-up call exposing the capital’s disconnection from the rest of the UK when it came to wealth, house prices, culture and politics.
Yet even before then, on the continent, regulators were fretting over London’s dominant position in euro trading and the risk to its financial stability. The symbiotic relationship between the two was a “master-slave” dynamic, as one EU official termed it.
A gradual separation?
As the UK and its biggest trading partner begin talks on their future ties after Brexit, they should keep front-and-centre the reality that they each have a lot to lose from a sudden break in the cross-border financial-services trade; but equally a lot to gain if they carefully engineer a long-term, gradual drift away from one another.
For policymakers on the continent, Brexit is a chance to reduce the excessive concentration of euro trading on British soil — London currently accounts for about 86 per cent of euro-denominated interest-rate swaps — and build up local hubs like Paris, Frankfurt and Dublin. For the Brits, Brexit is a chance to diversify trade ties away from the EU: The bloc’s services deficit with the UK was about £28 billion ($37 billion) in 2018.
These are intertwined markets with very different ambitions.
Achieving these aims will mean more regulatory autonomy for both sides. The EU wants to push for more integrated capital markets inside the bloc, and for a single rule-book that smooths out the inconsistencies between 27 very different member-states. That’s incompatible with letting financial firms use their London base as a launch pad for frictionless trade into the bloc.
Likewise, the UK has its own ideas about what it wants to do with financial regulation, and they don’t involve copying EU rules to the letter. If the UK’s ambition is to trade more with Asia or the US, or to promote other types of financial business, it may want new regulation.
The good news is that a system already exists that would make such a split amicable and manageable: Regulatory equivalence, an EU structure that the bloc uses to give controlled market access to non-members based on its rules being more or less the same. It’s a concept that both the UK and the EU have signed up to as part of their political declaration on post-Brexit ties, with each jurisdiction having the right to review the other’s regime and decide whether it’s similar enough to keep allowing for cross-border business.
Equivalence is not the same thing as frictionless market access — there are approximately 40 different equivalence provisions across 17 pieces of EU financial law, according to one study — but it’s not the same thing as full transposition of the law, either. The EU considers the US an equivalent market in some areas, for instance.
The bad news is that equivalence has a fair amount of political risk attached to it. The EU has used the prospect of withdrawing equivalence as a negotiating pressure tactic in the past in the case of Switzerland. There’s a fear on the UK side that it will meet the same fate if it is perceived to be deregulating too quickly. That the UK has made some pretty outrageous statements about the economic levers it could pull to compensate for a drop-off in EU trade after Brexit — including tax cuts and a slashing of EU rules — doesn’t help matters.
It’s also likely that finance will become tangled up in negotiations over other sectors, such as fishing rights.
Get it done in 11
Both sides should pursue equivalence in good faith. With only 11 months to go before UK Prime Minister Boris Johnson’s stated deadline for a new bilateral trade deal with the EU to be done and dusted, neither side can really afford a “no-deal” scenario. Losing access to its biggest customer would be a blow to the City of London, while the hubs of Paris, Frankfurt and Dublin would be in no shape to take its place.
Rather than assume Brussels or London always knows best when it comes to regulation, equivalence should allow market forces to influence both. Given they are starting at the same point in terms of rules, whichever side manages to achieve its goals first will have more influence to export its rules. And the threat of losing equivalent status should prevent the worst fears of a Singapore-on-Thames on one side or a Fortress Europe on the other from materialising.
The hope of keeping financial regulation free from political sabre-rattling may be wishful thinking. But it would be a welcome surprise for businesses and investors after three years of messy uncertainty.