“We have no eternal allies, and we have no perpetual enemies. Our interests are eternal and perpetual, and those interests it is our duty to follow”. (Lord Palmerston).
The December elections were an absolute game changer. Brexit is back on track and the landslide victory resulted in one of the strongest Tory governments for decades. By January 31 2020 PM Boris Johnson will be praised for leading the country out of three years of uncertainties that slowed the economy and put investments on hold, sticking to his promise to “get Brexit done”. The 11-month transition period has pushed the risks of a no-deal and cliff edge to end-December 2020, giving business more time to mitigate disruptions and adjust to the new reality, whatever it might be.
According to the PM’s narrative, from February 1 Brexit will belong to the past while the government’s “Taskforce Europe” and the EU should draft their future relationship. Both parties are keen to sign an “ambitious” Free Trade Agreement (FTA) but the negotiating positions remain distant. Johnson has ruled out an extension of the transition period, stressing the will to diverge from EU rules and regulations. What deal might be struck within such tight schedule?
From the UK viewpoint, the challenge is how to balance the new opportunities that might arise out of regulatory divergence with the interests of businesses that benefit from EU membership, like market access for financial services, and the costs of divergence in the short run.
With “radical” Eurosceptic Tories in power, it should come as no surprise if the government plans to achieve most of the objectives of Theresa May’s January 2017 Lancaster House Speech, no matter how unrealistic and “cherry-picking” these might sound to EU ears. Feared by the City and businesses with closer ties to the EU, some of the theorists behind “Global Britain” (S.Singham, B.Reynolds, etc.) are rather influential within the government. Regardless of their political views, research groups and think tanks in turn are united to help get the best deal for the UK.
The UK government is confident about signing a CETA-like FTA allowing tariff-free and quota-free trade in goods, possibly including services and financial services as well. The second best option is, if the time is too tight, a “multi-tiered trade deal”, with a core deal facilitating the free flow of goods followed by subsequent sectorial agreements. The final goal for the UK is to take back control over its borders, waters and trade while maintaining access to EU markets.
The EU position is understandably quite different. Without an extension of the transition period, the initial deal will probably cover only goods. A Canada-style FTA would still require stringent “level playing field provisions” (art. 77 of the “Political declaration”, not legally binding): robust commitments to prevent distortions of trade and unfair competitive advantages implying common high standards applicable in the EU and UK.
For the City on the verge of losing access to EU markets at the end of the transition period, the interpretation of “alignment” will be crucial. From the EU viewpoint, the equivalence recognition – however “enhanced” – will still be a unilateral process, granted by the European Commission (EC) after an assessment based on alignment with EU rules (“rules-based principle”), and the European Court Justice as the sole tribunal in charge. “Brexit theorists” claim instead that the EC should recognize the equivalence of UK legislation according to an “outcomes-based principle”. The outcomes should be defined at an international level so that neither party is a “rule-taker”. Should the EU deny market access, the UK could attack the EU for being inherently discriminatory, in violation of the World Trade Organization’s “Most Favoured Nation” principle, as a “regional trading bloc”. Worth noting, this view was expressed in 2017 also by Andrew Bailey, the newly appointed Governor of the Bank of England, while Mark Carney, the outgoing Governor, recently urged the government not to align financial regulation with EU rules and to benefit from new opportunities (including those arising from the transition to a low-carbon economy). And it is not the first time Carney states that the leading financial centre should not be a rule-taker from Brussels.
The future of UK-EU relations in financial services remains unclear. The interests of the City were not a priority for the previous government: the Leave vote was in fact also a protest by the “left-behind” areas outside London. The new PM does not share this view. Nevertheless, “radical” Tories regularly criticise the City for exaggerating Brexit-related risks while dismissing the benefits. And no-one in the government will publicly support the City.
As a result, the City is preparing for the worst, still hoping for the best. Relocation of business and people has so far been limited, but all large institutions have created new entities or extended their legal vehicles inside the Eurozone. By end-June 2020 the EU should grant an initial equivalence recognition (PD art. 36), although this is a fragile foundation for future access to the EU market.
Misalignment vis-à-vis EU rules does not necessarily mean deregulation, but in the Johnson government’s approach autonomy, namely the ability to diverge, is the non-negotiable mantra. Even if this should cause frictions at the border and the potential denial of EU market access. As a consequence, the City might be “trapped” between the conflicting negotiating positions of the UK (autonomy) and the EU (alignment). At least publicly, however, the City is aligned with this narrative. But by December 2020, contingency plans should be wholly implemented.
A temporary downsizing would damage the economy before the short-term costs can be offset by long-term opportunities. The City is a formidable asset for the UK: it accounted for 7% of GDP in 2019 and 10.5% of all tax receipts. London is a unique ecosystem underpinned by the weakness of its potential competitors in the Eurozone: FFM, Paris, Amsterdam, Luxembourg, Dublin. In a post-Brexit world London would probably still be a, if not the, leading financial center while a fragmentation of the financial services industry might not benefit the EU.
In turn the City is not a monolith: within the financial industry there are those who favour a divergence from the EU, like asset managers (to lessen taxation), insurance companies (to mitigate Solvency II Directive) and hedge funds. In the fast-changing world of finance, therefore, the words of Lord Palmerston might fully apply to the City itself.
The views expressed in the articles are those of the author and do not involve the responsibility of the Bank.