Last week brought with it one of the more significant surprises we have had in UK politics in recent months. I hesitate even to write the sentence for fear that it falls apart immediately, but it seems that we have found a Brexit-related issue on which the cabinet, including its chancellor, is both able to agree and willing to set out a clear policy. Better yet, their position is supported by the governor of the Bank of England and key lobbying groups within the relevant industry. Finally, and most disarmingly of all, the subject matter is no niche area, instead concerning the future relationship between the UK financial sector and the EU’s Single Market.
The proposal in question is for “mutual recognition” of financial regulations following the UK’s departure and transition period, resulting in continued access to EU markets for UK-based firms. Under this regime, the two sides would agree on common objectives (financial stability, consumer protection, and so on) but would each have the freedom to set their own rules in order to achieve these goals. A separate monitoring authority would be set up to assess any regulatory divergence, and impose measures to redress this.
Mutual recognition would be an alternative to the ‘equivalence’ regime usually applied by the EU to third countries seeking market access for their financial services firms, and one that is sought by the UK with very good reason given the disadvantages of the latter. Equivalence rules cover only around a third of financial services activities, and force the external country actively to shadow new EU laws despite having limited or no input to their drafting. Most damningly of all, the equivalence designation can be withdrawn by Brussels with only 30 days’ notice – hardly the kind of security that firms trying to decide whether or not to keep their UK bases are looking for. In short, it amounts pretty precisely to the vassal statehood warned of by Conservative backbencher Jacob Rees-Mogg.
If, by contrast, the mutual recognition paradigm seems rather too good to be true, that is because it almost certainly is. Its benefits are strikingly similar to those already enjoyed by countries with access to the Single Market, and the key difference appears to be a greater degree of regulatory freedom for the UK. This does not only sit badly with Michel Barnier’s repeated insistence that preferential access to the Single Market for particular sectors is not an option. There is also a very real danger that it would activate any number of most-favoured-nation clauses in the EU’s trade deals with other third countries, in essence cracking open a part of the Single Market and removing one of the key benefits for all member states. Like the vast majority of UK proposals to date, this one is therefore likely to be subject to significant and heated amendment.
That said, it would not be remotely to Brussels’ advantage to hamstring Europe’s financial hub without a viable alternative already in place. On this score, London looks an awful lot more secure than the negotiating positions would suggest. It is of course not sufficient to assume that an industry which was born in Tuscany and reached its zenith in New York will always retain an important base in London simply because that is where many of its practitioners are currently located. A number of HR departments are currently finding, however, that convincing financiers to move to a different city is no mean task. It appears that, when it comes down to the prospect of actually leaving, even many of the EU nationals who make up London’s financial community find the attractions of the city’s schools, entertainment, and social attitudes difficult to resist.
More importantly, moving a financial centre is more than a matter of convincing a sufficient number of financial sector workers to emigrate. The auxiliary industries that support the financial profession need to move with them, from accountancy and other professional services firms to law firms that specialise in a legal system which is accepted across the world as a convenient one within which to draft contracts. Most crucially of all, in order to set up a genuine hub, they all need to move together, to the same place. Given the plethora of different cities currently vying to replace London – from Paris, to Dublin, to Amsterdam, to Frankfurt – the chances of this happening seem slim at best. It might be relatively easy for Brussels to defenestrate the UK’s financial sector, but setting up a viable alternative would be another task altogether.
None of this is intended to suggest that the City of London will certainly survive Brexit unscathed, or that any agreement protecting its position will come quickly. Indeed, knowing that it is one of the UK’s most valued assets, it is deeply unlikely that Brussels will want to reach a settlement on it until the rest of the withdrawal negotiations are close to being complete. In the meantime, the UK financial markets are likely to be in for a particularly wild ride. Interest rate expectations will have to weigh inflationary pressures and hawkish central banks (both at home and abroad) against the prospect of severe damage to an industry the employs more than 7% of the country’s workforce and generates more than 11% of its government income. As for sterling, the strengthening we have seen so far this year against the dollar – almost entirely on the back of negative US factors rather than positive UK ones – has once more created room for a sell-off should the outlook start to appear bleak. Rumours of the UK financial sector’s demise, however, are exaggerated. It is down, but not yet out.
Upcoming Economic Releases
This week sees a number of key data releases, including:
• UK average weekly earnings growth on Tuesday (expected at 2.5%, same at last month)
• Eurozone PMI figures on Tuesday (manufacturing expected at 59.2, down from 59.6 last month; services expected at 57.6, down from 58.0 last month)
• UK GDP growth for Q4 2017 on Wednesday (expected at 1.5% YoY, same as last quarter)
• Eurozone final January inflation figures on Thursday (CPI expected at 1.3% YoY, down from 1.4% last month)
All views expressed here are the Author’s own and are based on information available at the time of writing