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21 March 2018

Can the EU step up to a win-win Brexit outcome in financial services?

by Barnabas Reynolds

Originally published by Brexit Central.

In well-run and accountable democracies, citizens’ conflicting interests can be reconciled in accountable national assemblies to achieve trade arrangements best for the whole economy. With Brexit negotiations in full flow, the EU’s systems are being put to the test. The UK has a legitimate interest in whether EU institutions are sufficiently responsive to the EU public as a sensible counterparty for negotiations, or whether more direct negotiations with democratically elected representatives of member states are now required to achieve a win-win outcome.

The EU and its 27 remaining member states have rightly identified the need for free trade in goods with a post-Brexit UK. The UK trade deficit makes the need for frictionless goods trade a no-brainer for the EU27. The absence of such an arrangement would be damaging and costly.

Why the equally obvious benefits of mutual recognition in financial services, based on a recognition of each other’s legal regimes provided they reach equivalent high level outcomes, have yet to be acknowledged, is puzzling. The UK Chancellor, Philip Hammond, proposed in his recent speech some form of Enhanced Equivalence arrangement for financial services along these lines, pointing out that the costs to EU citizens by not doing so could run to the tens of billions. Such amounts vastly outweigh any small perceived benefits in terms of jobs in a handful of western member states, even for those member states themselves.

Yet the EU’s federal institutions do not seem to acknowledge or debate such fundamental matters. Member states, meanwhile, appear to place inordinate reliance upon Brussels to analyse the issues for them. The danger is that the Brussels institutions will seek to protect their priorities in such a way that the overall ‘EU’ approach is insufficiently responsive to the interests of the EU electorate. That would lead to a lose-lose result, which would be inconceivable were the democratic processes to be operating normally.

Enhanced Equivalence, being based on existing EU legal concepts, is fully compatible with EU values and its red lines. It takes the existing EU equivalence concept, fills in the gaps and makes it mutual and binding. It supports a sovereign-to-sovereign relationship already in existence in EU law and in application with numerous countries around the world, including the US, Canada, Mexico and Singapore.

The reasons given for EU unwillingness to enter into a financial services deal do not stand up to scrutiny. One of the proponents of such a view, attempting to speak for the EU as a whole, is France’s Finance Minister Bruno Le Maire. He said a financial services deal would conflict with the EU’s requirements for financial stability and effective supervision.

However, this ignores the fact that the EU already has negotiated equivalence-based arrangements with the US for the most systemically risky portion of the market, clearing houses, and has similar arrangements in place with many financial sectors across the world covering a whole patchwork of financial services provision. It has not previously been suggested that financial stability is at risk, and indeed several US clearing houses operated with EU customers throughout the 2007-8 crisis without hiccup.

As for supervision after Brexit, under the equivalence concept this would be, as is current practice, conducted in the recognised country, in this case the UK. Given the UK has some of the best regulators in the world, with decades of proven experience and expertise (and upon whom the entire EU system already places huge reliance), raising that topic in the context of whether to rely on equivalence is clearly spurious. In fact Enhanced Equivalence allows the markets to be run far more safely, avoiding the tensions between the global markets located in the UK and the more specific markets across the EU27.

Indeed it was partly the EU’s passport regime operating in the run-up to the 2007-8 crisis, through the attempted harmonisation of rules across the EU, which led to dangerous regulatory arbitrage and then the credit crisis. The UK was, as a result of belonging to that system, held back in its supervision by having to operate within a structure in which some EU member state regulators were openly offering not to apply certain key (and expensive) rules in return for business being located there.

After the financial crisis the EU has sought to address this problem by federalising control over supervision, but largely through prescriptive rulemaking, which has introduced new risk into regulation. The fact is that one size cannot fit all in regulation or supervision, particularly between the UK’s global financial markets and the very different markets in the EU27.

A new arrangement of Enhanced Equivalence, where the UK achieves the same internationally recognised outcomes through its world-class regulatory system is intrinsically a far safer way of proceeding and reflects the approach the EU is already rightly comfortable with for the US and elsewhere.

The EU maintains that it will not outsource the writing, interpretation or enforcement of its regulations to an outside party. Maybe so, but in fact no such outsourcing would be required under the Enhanced Equivalence arrangements proposed here. The EU would continue to set its own requirements and could change them when it likes. Where the UK standards meet the same high level outcomes, by whatever means, there would be mutual recognition. Where those outcomes are not met, there would be a proportionate forfeiture of access after the point has been properly checked procedurally, if necessary by an independent arbitral body.

Brussels is also concerned to ensure the UK is not overly competitive. But this politics of punishment would never be accepted by the UK. More importantly, it would damage the prosperity of the EU27’s citizens and could not for that reason be put forward in good faith by those who are democratically accountable. The whole world is competitive. The EU27 cannot reject that or seek to cushion competition within the EU timezones with the UK alone. You don’t win a race by tugging at the shorts of the next runner – at least not over any sustainable period. A competitive City of London is essential to provide low-cost growth capital to EU businesses and to finance consumers’ lives.

Some work is needed to achieve the best arrangements under Enhanced Equivalence. The EU’s existing equivalence regime would need some tweaks. The current regime, with its one-way, unilateral equivalence determinations, does not go far enough to avoid uncertainty and therefore potential harm. Many institutions have made clear that on that basis they would feel forced to establish infrastructure in the EU27, which is where the costs charged back to EU citizens start escalating. The markets and commentators have made clear that the global markets will remain in the City of London, so the fragmentation merely leads to significant cost being pushed onto EU27 citizens.

Amongst individual member states, those democratically representing the EU27 electorate would have no valid objection to Enhanced Equivalence. They would not seek to teach the UK a lesson at the price of crippling expense to themselves and ‘punishing’ their own voters with higher costs. That is not how democracies behave, nor how peoples, friends and neighbours think. Indications from Italian politicians in the running to lead the next regime are that they feel the current federal EU line is not serving them well. They wish to have a good deal with the UK, in conformity with the EU’s establishing Treaties, which provide that the EU is to seek good relations with its neighbours. The Treaties also prohibit any restrictions on the movement of capital between its member states and third countries. The Italian democratic processes are clearly working properly to push the interests of Italian citizens. The subject now needs to be aired properly with the other EU27 democracies.

This is a pivotal moment for the EU. The efficacy and accountability of its core institutions is being tested before the curious eyes of the world, wondering what the true nature of the emerging EU will be. If this test is failed, EU citizens are likely to wonder why their aspirations for economic growth and opportunity have been dashed to satisfy a bureaucratic ideal. In order to minimise the risk of such an outcome, UK citizens will want to see that their leaders have reached out to the EU27 publics in some way and have not blindly persevered in negotiating with institutions which might be structurally incapable of reaching a win-win outcome.

Barnabas Reynolds’ “Enhanced Equivalence – A Win-Win Proposition” was co-published by New Direction and Politeia



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