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In reality, this “wedge” is unlikely to benefit the economic prospects of the City or the United Kingdom.
There can be no doubt that the EU will use the “autonomy of its decision-making process” – as stressed in the TCA. If the UK wishes to row alongside the EU super-tanker and “take” its rules, then the UK will remain “equivalent[1]”. But current UK policy intentions suggest there will be an ever-widening gulf by the end of this Commission’s term in 2024 – as the logical outcome of UK policy. The internationally mobile financial services industry will undoubtedly take account of this probability in planning the location of future business opportunities.
How might this play out by say 2024? Could the divergence cause the end of the City’s dominance of European finance? It might well do.
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The relative scale of the EU and UK economic systems after the Brexit cleavage needs to be kept firmly in mind. The City makes a great play about the location of trading in euro-denominated investment assets such as equities, bonds and derivatives. But the euro assets being traded overwhelmingly belong to EU savers – not British – as the data below show:
Data sources: European Commission, City of London Corporation, European Fund and Asset Management Association
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The treaty texts are indeed massive – running to 1259 pages – but only about six pages are relevant to financial services and largely covered in just four Articles.
The Commission provides a simple Q&A to illustrate that the TCA has treated financial services in much the same way as in the EU’s other Free Trade Agreements (FTAs). Crucially, it is very explicit about equivalence in an effort to dispel some illusions in the UK: “The Agreement does not include any elements pertaining to equivalence frameworks for financial services. These are unilateral decisions of each party and are not subject to negotiation.” (Details in the Technical Appendix)
There is an “MoU” to be agreed by March 2021 and some commentators appeared to believe that it would be the mechanism to introduce a wide range of equivalence decisions. However, reading the actual text (link) should disabuse any expectations about the EU giving up any of its autonomy. The MoU may well amount to little more than an agreement to talk to each other – presumably with appropriate telephone numbers/e-mail addresses provided!
All these statements imply that British polices may well be radically different in future, and that the UK will certainly not feel bound to “take” any future EU rules. Instead, the UK may well seek to “lead” international rules. The stage may now be set for a period of serious divergence in rules – driven by the new goals of UK regulatory policy.
Anyone familiar with “Yes Minister’s” Sir Humphrey Appleby may notice striking parallels when reading this officialese! Carefully translating the officialese into plain English, this means that “Ministers” (the Economic Secretary for this year), let alone the elected Members of Parliament, will not have “taken back control”. Instead, Brexit will have taken power away from the people and handed it to the officials – Sir Humphrey (aka “Sir Braddick-Bailey”[3] ).
Market participants are now used to the open, inclusive EU process and may not be willing to buy in to `Sir Braddick-Bailey’s’ new British rules when globally-accepted EU rules are already being used – especially after a major `sunk cost’ investment in compliance. Moreover, they will need to ask if UK rules will make firms acceptable to their trading counter-parties and customers.
There will be a narrow band of acceptability for these new rules:
(i) If the levels of, say, required capital – always a key issue –
are raised beyond standards in competing jurisdictions, then firms will migrate
to the cheaper area.
(ii) Conversely, if capital adequacy is lowered in the UK, banks elsewhere may
face capital add-ons to reflect their exposure to apparently-weaker UK firms.
(iii) However, the third
option is politically the most fascinating: if rules remain closely
aligned as EU rules change, then the UK will have become a vassal “rule-taker”
so Brexit was entirely pointless. Hardly the clarion call of the Leavers!
UK commentators and academics devote much effort to studying the details of policy proposals from the EU in an attempt to infer the underlying policy goals – a kind of reverse-engineering. However, there is an easier (and more certain) approach: simply read the policy goals formally adopted by the EU’s co-legislators – the European Parliament and the Council of the EU.
Every five years, a new European Commission is elected to office – upon nomination by the Member States and then election by the European Parliament as direct representatives of the peoples of Europe. In September 2019, Ursula von der Leyen (UvL) published her “Agenda for Europe” – the Political Guidelines for the incoming Commissioners for the period 2019-24. This Agenda is the equivalent of a British political party’s Manifesto. Unsurprisingly, the civil service – in this case, the Commission Services – then set about implementing the new policies mandated by Europe’s democratic system.
The Agenda stated “A strong, integrated and resilient capital market is the best starting point for the single currency to become more widely used internationally.” (More) These goals define what the EU sees as its “interests” and it has stated unequivocally in the TCA that it reserves its autonomy to pursue its “interests”.
About a year later, DG FISMA (Financial Stability, Financial Services and Capital Markets Union) published its “Strategic Plan 2020-2024” to deliver these policy goals, naturally taking the Commission’s political agenda as the starting point. As would be expected in a management strategy, the texts are accompanied by Key Performance Indicators – 10 pages of them. The plan is to calibrate objectives in every field of financial activity. The EU has detailed its “interests” and the means of measuring progress in achieving them. This is “autonomy” in action.
Some of this work was already underway before the new Commission took office. But a glance at the list of Consultations since then shows 19 items that cover most aspects of banking, capital markets, asset management, insurance, and payments systems – as well as digital and sustainable finance. A hallmark of the EU’s system of financial regulation since the 2001 Lamfalussy Report has been regular reviews of existing legislation. All measures since then have incorporated a review requirement – usually after two years in force – to ensure the legislation remains up to date with technology and market developments (currently those driven by Covid) yet ensures financial stability through proper prudential standards.
The entire development of the Single Market during Britain’s membership has been designed to incorporate these “prudential” goals since EU Commissioner Lord Cockfield’s White Paper “Completing the Internal Market”, was published in 1985. This 300-directive programme implemented Mrs Thatcher’s vision of a single market throughout the EU and came into force in 1992. Successive waves of subsequent financial services legislation responded to market and technological developments. The global financial crash of 2007-9 produced a tsunami of reactions and the combination of Covid and climate change is triggering another.
Accordingly, it is a racing certainty that virtually every aspect of the EU’s body of financial regulation will be reviewed by 2024 – even if legislative proposals are not fully enacted by then. This acquis (and the implementing measures of the European Supervisory Agencies) has now grown into something of a super-tanker as national rules are steadily replaced by European rules designed to provide a genuinely single market. There will be tweaks on the rudder at times, and maybe significant course corrections as storms such as the Covid pandemic hit. But the EU’s course is clear and will take no account of the “interests” of a former member that is about one-sixth of its size. Why should it?
This approach highlights that jobs may well shift by switching recruitment for new posts from the UK to the EU. Morgan McKinley’s data (left) shows a strong reduction in UK recruitment as firms implemented their Brexit plans.
But the Brexit pressures are superimposed on other driving forces – Covid most recently. Many firms have realised that their staff can achieve much by working from home. But does that home have to be in the UK and close to the City? Technology has delivered the means to disperse employment – challenging the old ideas of critical mass in `localised clusters’ such as the City of London.
As a student 50 years ago, this author recalls that Stock Exchange firms were obliged to have their office within 400 yards of the Exchange so that messengers (including students!) could quickly walk round to banks with bearer securities that were just pieces of paper. A necessary technique was to stick a foot in the bank’s door to stop it being closed (at 3pm sharp) while the security was delivered against a cheque drawn on the Bank of England: delivery versus payment!
All that was swept away long ago and Covid may have accelerated the next phase. Half a century ago, banks and stockbrokers clustered close to the Bank of England; insurance close to Lloyds of London; shipping round the Baltic Exchange etc. Now, the exchanges are clustering in Amsterdam, the asset managers in Dublin or Luxembourg; mid-offices in Warsaw etc. But they are all linked by technology so that physical location is increasingly unimportant.
The EY Brexit trackers show how firms have been preparing for a `hard Brexit’ for quite some time – as they were required to – very forcefully by the regulators on both sides of the Channel. EU regulators are now insisting these plans be fully implemented. Once these changes have been made, would firms dismantle their new structures if there were a sudden rash of equivalence decisions by the Commission in the fullness of time? They might contemplate that the Commission decisions are unilateral and can be withdrawn at short notice. As they observe the probable gulf between UK and EU rules opening up (see above), what chance of any equivalence decisions surviving for long? In any case, the TCA itself is up for review in five years. Might parts of it (for example, in financial services) just be allowed to lapse if the UK has systematically breached its commitments e.g. on `best endeavours’?
The financial services industry is very innovative so the question always has to be answered: where to locate the new “sunrise” business? It is all too clear where the “sunset” businesses are located – London. There is a danger that these “sunrise” businesses will gradually migrate to the EU. If for instance an originally UK-based organisation sends a few of its key and most profitable staff to Amsterdam, then the business there will be hugely profitable because all the back-office costs are still booked in the UK. Dutch tax inspectors will notice the `super profits’ generated in their country and want their fair share of the tax take. The natural commercial response will then be to shift those back-office costs into the EU entity in [Amsterdam] to minimise the `super profits’ subject to [Dutch] tax. Such a process would be spread over several years but the logic is inexorable – leading to reduced profits (and therefore taxes) in the UK as revenues/profits are now located in the [Netherlands]. As UK tax revenues fall, could that be the trigger for the standard rate of UK income tax rising from 20p to 28p?
Brexiteers may not have grasped that the international financial services industry is both highly mobile and highly profit-seeking. After an initial burden of `sunk costs’ from post Brexit re-configurations, the international financial services industry will not be damaged, but its former home – the UK – may well be.
The revenues that leave the UK will not all go to the EU but maximising purely `economic transactions’ has never been the EU’s objective. Instead, it continues to strive for the vison of European unity launched by Churchill in his series of great speeches after World War II. The modern, mile-stone along the long road to achieving that objective is to maintain the financial stability of the Single Market – through the mechanisms agreed for the period 2019-24 in the election of the current European Commission. If British financial rules are not designed to achieve the same outcome, then they cannot be “equivalent”.
The Brexit chickens are quickly coming home to roost after only a month. Quelle surprise! Amsterdam has overtaken London in share trading and will be the new home for trading the ICE carbon contract. Swap Execution Facilities (SEFs) in the US are seeing a rising share of derivatives trading. Apparently technical changes – but the jobs that operate these activities (and the taxes) are on the move very quickly. In perhaps half a decade, the City may look very different – with major impacts on the UK’s tax revenues, employment and foreign exchange earnings. But the global financial services industry will have accommodated itself permanently to the new situation.
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