Finance has been notable by its absence from the first stage of the Brexit negotiations. That cannot continue. Britain’s priority in the next phase must be to maintain London’s primacy as a hub for wholesale markets while not becoming a “rule taker” of European regulation. EU-related business makes up about a fifth of activity in the City of London. Adopting another bloc’s regulation to preserve this would not be appropriate for a hub of its size with such critical importance for the British economy.
Hostility and anger at the Square Mile because of the financial crisis may have fed into the Leave vote, but financial services’ beneficial impact on the economy stretches far beyond the capital. HSBC in Birmingham, Citigroup in Belfast and JPMorgan in Bournemouth are all major employers. “Levelling up” the country depends on maintaining these jobs as well as funnelling tax receipts from employers and their well paid staff into capital investment.
Some jobs and business have shifted to the EU27 already, as companies have prepared for a “no-deal” Brexit. But the flight so far has been limited.
Maintaining the City’s prowess as a provider of international capital — in insurance, through the asset management industry and in corporate finance — should be a priority in Brexit negotiations. It must be possible to establish a mutually acceptable regulatory framework that allows rules to diverge without undermining financial stability.
The two sides are not far apart. The European Commission’s draft negotiating mandate calls for the “key instrument” for managing interactions between the financial systems to use its standard third-country deal based on “equivalent” regulatory standards, granted by the EU and rescindable unilaterally at 30 days’ notice. The UK wants a more structured approach, albeit still based on equivalence.
The EU, as an open economy without capital controls, may find it harder to raise the drawbridge than it may like. If London remains the cheapest and most liquid market then European companies will want to continue using it. It could be costly to force businesses to move. Attempts to reduce London’s dominance in clearing euro-denominated derivatives brought ire from the US, whose exchanges would have been collateral damage. Given the considerable pressures on the European economy, it would be unhelpful to deny EU companies access to the financial resources of the City of London, as a punishment for the UK’s regulatory independence.
There are in any case only a few areas where the City chafes under EU directives, most notably Solvency II, which applies to insurers, and Mifid II, which governs trading and research. Yet the burdens of these are not vast. Diverging from them is not worth the cost of losing all access to European markets.
Neither should regulatory autonomy mean a race to the bottom. Ill-informed discussion of a “Singapore-on-Thames” fails to take account of the south-east Asian city’s reputation as an effective and diligent regulator.
A compromise can be found. The EU is already looking at ways to improve the equivalence framework that it applies to those outside the bloc: the UK can be a test case. Divergence of rules should be minimal, since the building blocks of much financial regulation are decided at a global level.
For the UK, this debate cannot be separated from the rest of its trade strategy. The City’s competitive advantage comes from its role as a global hub. British negotiators have an opportunity to consolidate that status to the benefit of the UK, Europe and the world. If they can, they should take it.
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