Why the City's post-Brexit future presents a dilemma for ministers

11 February 2020, 18:06 | Updated: 11 February 2020, 20:00

Ever since the UK voted to leave the EU, most discussions around the country's future trading relationship with the bloc has focused mainly on 'tangibles', like manufactured goods.

The UK's biggest single export earner, financial services, has by contrast been ignored.

That may be because Theresa May's government calculated that the City was big enough to look after itself.

Many in the City also suspected that the former prime minister, in the wake of lingering hostility towards bankers following the financial crisis, was reluctant to be seen canvassing too hard on behalf of financiers.

However, now Brexit has happened, ministers have begun thinking about financial services.

An indication on government thinking came when, on Monday, a long-lens camera captured an image of an unpublished briefing note being taken into Downing Street.

This suggested that the UK would be seeking a 'permanent equivalence' deal with the EU when it comes to financial services.

Equivalence, in this context, is where the UK's regulatory regime is regarded as 'equivalent' to that of another jurisdiction, such as the United States or the EU.

This would allow financial firms based in the UK to continue trading in the EU's single market on broadly the same terms as they did prior to Brexit.

Equivalence would also allow EU firms to access UK markets after Brexit on the same terms as before.

But the financial services sector is uncomfortable about this because of the ease with which the EU can revoke equivalence agreements.

This can, in some cases, be as little as 30 days.

There is wariness that as the EU wishes to reduce its reliance on London after Brexit and build up its own market capacity, as well as seeking to poach some business from the UK, it will be tempted to do just that.

This would hit the ability of businesses to serve their clients effectively.

Hence the preference of the UK government for so-called permanent equivalence.

Under this arrangement, the equivalence rules would remain in place for "decades to come", giving City firms clarity about the terms of future trade.

It would provide reassurance that their business is not about to vanish due to sudden regulatory changes.

Sajid Javid, the Chancellor, expanded on this in an opinion piece for the newspaper City AM today.

He wrote: "We hope to agree a chapter on financial services in the UK-EU free trade agreement that establishes a baseline for the trading relationship.

"This should establish regulatory cooperation arrangements with the EU that facilitate dialogue and reflect the degree of access between both markets.

"If the EU, like us, wants a durable relationship, we should also include measures to directly address the long-term needs of industry for a reliable equivalence process.

"This would provide the certainty on which internationally mobile businesses can depend."

But the government's negotiating stance is not without risks.

While it would go down well with parts of the financial services sector, particularly the bulge bracket Wall Street banks that employ thousands of people in the City, signing up to a permanent equivalence deal could, in some cases, expose the government to accusations that it has become a 'rule-taker' of EU regulation.

Industries like insurance, which have not enjoyed adapting to the EU's regulatory regime, would prefer greater divergence.

And any suggestion the UK had become a 'rule-taker' would play badly with eurosceptic MPs on the government benches - even with PM Boris Johnson's thumping majority.

It would also run counter to Mr Johnson's frequently stated desire to diverge away from EU regulations if it will benefit the UK's economy.

Among those who have urged ministers not to align the UK's future financial regulatory regime too closely to that of the EU is Mark Carney, outgoing governor of the Bank of England, who told the Financial Times last month that it was "not desirable at all…to tie our hands".

Mr Carney's successor Andrew Bailey, who has huge experience in financial regulation, shares that opinion.

The point was reiterated today by Sir Jon Cunliffe, deputy governor for financial stability at the Bank, in a speech delivered in Berlin.

Sir Jon, a former UK ambassador to the EU, said: "Self-evidently, the UK cannot outsource regulation and supervision of the world's leading complex financial system to another jurisdiction."

So this is the dilemma for the government.

On the one hand, it wants to avoid disruption to the UK's vitally important financial services sector, not to mention protecting hundreds of thousands of well-paid City jobs.

On the other, it does not want to be a 'rule taker' of EU regulations and needs to be able to set its own regulatory course.

Squaring that circle will be very difficult.

As if to emphasise that, Michel Barnier, the EU's leading Brexit negotiator, wasted no time today in shooting down Mr Javid's proposals.

He told the European Parliament in Strasbourg: "I would like to take this opportunity to make it clear to certain people in the United Kingdom…that they should not kid themselves about this.

"There will not be general, open-ended, ongoing equivalence in financial services…we will keep control of these tools and we will retain a free hand to take our decisions."

Yet there are good reasons for both sides to come to an accommodation.

As Sir Jon noted today, London's importance as a global financial centre means EU businesses will not want to walk away from doing business there, while an abrupt disruption of cross-border activity in the financial sector could be a source of risk.

Sir Jon also made the very sensible point that divergence might even be desirable in some cases.

He added: "As EU regulation no longer needs to cater for the greater complexity and scope of risk and activity in London, and as the complex processes and structures needed to manage the regulatory framework within the EU are no longer needed in the UK, there may well be divergence."

Accordingly, while negotiations in this area will be complex, coming up with a solution is by no means impossible.