15 February 2017
Europe’s governments should think twice before using the Brexit negotiations to force financial services to leave the City of London
The European Commission’s thinktank of choice warmed the hearts of euro-federalists this week with a study claiming that Brexit will lead to a haemorrhaging of jobs to disparate parts of the EU. However, it also warned that many of Europe’s centres are not prepared to handle the added volumes financial activity and the risks they carry with them.
The study, by the Bruegel, opens a little-considered aspect of the complex arrangement of regulators, legal services, accounting professionals and consultants of various kinds needed to support a high performing and diverse financial sector.
According to the study, “Brexit involves risks for market integrity and stability, because the EU including the UK has been crucially dependent on the Bank of England and the UK Financial Conduct Authority for oversight of its wholesale markets”. Following the UK’s exit from the EU, “the EU 27 must swiftly upgrade its capacity to ensure market integrity and financial stability”.
Presently, British-based financial institutions are regulated by a thick layer of EU rules, many of them the result of the EU’s chief Brexit negotiator Michele Barnier’s tenure as EU Commissioner for the Internal Market in the aftermath of the financial crisis. But, the real risk prevention function is fulfilled by the Bank of England’s Financial Conduct Authority and Prudential Regulatory Authority. These institutions monitor the balance sheets of financial institutions operating in the United Kingdom. The PRA and the FCA aim to flag up worrying behaviour well before a crisis can occur and then address the issue directly with the institution. Given the size of UK finance, it is a herculean operation that financial regulators across the EU are ill-equipped to copy, and they know it.
The Bruegel report therefore acts as a stern warning to the EU. There is a huge temptation, particularly in France, to make life difficult for the City of London over the course of the Article 50 negotiations and win extra business once Brexit comes into effect. But finance, almost by definition, is a cross-border sector, European businesses rely on the City’s massive agglomeration of banks, insurance companies and various funds for access precious capital and much else.
Another sliver of helpful insight from the Bruegal study is the expectation that rather than a winner takes all outcome, whereby Paris, Frankfurt or Dublin becomes the main recipient of jobs from London, the spoils will be divided across the continent and as a consequence the benefits of a having a single, utterly dominant financial centre will be lost.
Nose cutting and face spiting
Spiting the UK financial industry carries the double and very high risk of restricting the availability of capital and also increasing the possibility of yet more financial instability. The financial crisis may be approaching its ten year anniversary, but as the latest flair up in the Greece and the meltdown in Italian banking have shown, its consequences remain very real. EU growth has not exceeded 1% since before 2008.
In typically Gallic style, Paris is not taking heed of these warnings. The city’s financial sector began a charm offensive to attract UK banks even before the EU referendum, but it remains a deeply unattractive place to set up.
It may be an attractive place to live, but that carries little weight when it comes to strategic business decisions, as Rene Proglio from Morgan Stanley, an investment bank points out, it is not something banks and the like are concerned with, “so don’t get carried away with a humanist philosophy. Like it or not, their only objective is to defend the interests of the shareholders”.
And then there’s France’s famously asphyxiating legal restraints: a 3,000-page labour code, a legal system has 400,000 business norms and regulations and 360 separate taxes, some dating back to before the French Revolution.
The push factor
Paris, Dublin and Frankfurt may not offer much pull, but what of the push factor? Much has been made of EU passports – permits issued by the EU that enable financial institutions to operate across borders. Financial services worry about free movement of people, but the real Brexit factor threatening to push them across the channel is lower access to EU markets. The passporting regime can only (in theory) apply to countries in the single market, following Theresa May’s welcome decision to take Britain out of the internal market Britain looks set to lose these permits, indeed TheCityUK the financial services industry’s has no withdrawn its calls to retain passporting rights. The focus is now on so-called ‘equivalence’, a feature of a key EU financial directive enabling cross-border activity so long as standards are equivalent in the non-EU country.
The City of London, and chiefly the Bank of England, is now putting together a proposal for financial services to continue to sell into and buy from the European Union with the EU recognition that UK standards are equivalent to those on the continent. Britain already regulates her financial markets to an exemplary standard so acquiring EU recognition should be a formality.
The Bank of England also wants a transitional period to apply straight after Brexit, a sensible enough plea, especially when the government already intends to adopt all EU legislation into UK law, including that thick layer of EU financial rules before picking off that bad stuff.
Whether UK financial services decide to hold onto all those EU rules to retain maximum access to the EU market or trade off some of it and cut costs by shedding off the most (and perhaps least) onerous regulations to have been cooked up in Brussels, that is the UK government’s choice, we are in the driving seat. This highlights a gross negligence on the part of the mass media, it consistently fails to highlight the strengths of the Great Repeal Act as a negotiating platform.
Commentators should also strive to point out the need for many of these EU regulations to be purged as soon as they are adopted. Earlier this week, co-leader of the Green Party Caroline Lucas warned of disaster in the event that Britain repeals all that environmental legislation. What she, and the media in general, fail to mention is that it is our choice. The EU is at its worst (and that is saying something) when legislating over the environment. The sheer volume of environmental regulations and number of well-funded lobbyists in Brussels desperately fighting them off are testament to that. So when we retain control over these laws, we can decide what to do with them. What is not to like.