Yet another set of articles in today’s Financial Times confirms what we’ve observed about the UK’s stance towards Brexit from the outset: an astonishing capacity for denial. For Americans who’ve observed the Clinton bubble and the heroic post-election attempts to keep it pumped up, the Brits are managing to do them one better.
One of the sightings is on how foreign banks in the UK will make “transition arrangements” if there’s no clear post-Brexit deal likely to be in place by the presumed Brexit date of March 2019. As we noted last week, Japanese banking leaders had a tea and cookies chat with British regulators and told them they’d start moving operation out in six months if they didn’t get reassurances. That puts them behind pretty much all other foreign banks, who started getting licenses and looking into foreign office space locations pretty much as soon as they’d recovered from the immediate Brexit vote shock. Late last week, Lloyds of London was the first prominent City institution to set a schedule for relocating part of its operations to the Continent as a Brexit hedge.
As we’ve stressed, the surprising thing is that anyone is acting as if this a a surprise. The EU treaty rules are very clear: the UK can’t negotiate any trade or services with the EU or bilateral deals with individual EU members as long as it is still a member of the EU. EU leaders, with a single voice, have said they are not going to be nice to the UK in the Brexit process. And more generally, as we have also stressed, Europeans are far more procedural and literal-minded about contracts and treaties than Anglo-Americans are.
So the only way Britain will get to negotiate any new deal before the drop-dead date of March 2019 is if it completes its exit negotiations a meaningful amount of time before then. How likely do you think that is? Look at some of the impediments. From the Financial Times:
But the first priority of Michel Barnier, chief EU negotiator, is to sort out the terms of the divorce. This means Britain must offer assurances on issues such as the rights of EU expats and paying an exit bill of up to €60bn before a deal on a “soft landing” is possible.
Senior EU diplomats admit the timetable also reflects a cold calculation of interests: delaying agreement on a transition would spur companies to move some of their business to the EU to cope with the danger of a hard exit.
Again, we’ve stressed that Continental countries see Brexit as an opportunity to take a bite out of the City’s business and they look determined to do so. Recall that the EU plans to launch the procedures to require Euroclearing take place in EU-ex-UK countries immediately on the heels of the UK pulling the Article 50 trigger.
Remarkably, another Financial Times article last week showed that the City thinks it has a magical wand to get a deal that is nowhere in the offing, that of negotiating a “transition deal” before a Brexit, an idea that the EU has rejected each and every time a British leader has mooted any such idea. And the next fantasy is that the EU would be sporting and give the UK an “equivalence” deal:
And ECB chief Mario Draghi sees no financial stability impediment to playing hardball. Again from the pink paper:
Equivalence is in principle extremely attractive. EU business is, after all, only a subset — say 20 per cent — of most investment banks’ activities, and zero for domestic institutions such as building societies. The beauty is that it would not require the UK to replicate the EU rule book in its entirety — and certainly not for domestic business.
When Michel Barnier, now the EU’s lead negotiator on Brexit, cut an equivalence deal with the US over derivatives a few years ago, he stressed the principle that when two countries’ rules were “comparable and consistent” with each other’s objectives, it was “reasonable to expect [each] to rely on those rules and recognise the activities regulated under them as compliant”. Few could argue that Britain’s rules were not equivalent to European ones — they are currently identical. And with both sides following the same G20-led process of financial regulation, their objectives are carbon copies, too.
The comparisons here are disingenuous. The US and EU are comparable in size as economies. With the EU to move Euroclearing out of the UK, any institution that wants to deal with customers in Euro will have to have operations and licenses on the Continent (or in Dublin) or deal through correspondent banks, which is unattractive for reasons of cost and speed. This is no different than for banks who want to deal in dollars. They have to have a US operation, which is almost always a New York branch, so as to have direct access to dollar clearing facilities.
The UK banks can whinge all they want about how they will initiate a race to the bottom to get a competitive leg up. They won’t be able to deal in Euros or directly with concerns that have Euro banking accounts unless they have operations licensed to do so, in the EU-ex-the-UK.
And that’s before we get to the fact that the banks themselves aren’t so hot on the transition rules idea:
So why are the banks not keener on equivalence? The biggest issue is the lack of certainty. There is no agreed definition of what is equivalent when it comes to assessing different jurisdictions. There has been talk in Brussels of tightening the rules to make it tougher for non-EU jurisdictions to gain access. And, in principle, equivalence can be withdrawn at 30 days’ notice, leaving everyone in the lurch. Of course, it is worth noting that withdrawal would cut both ways, and would affect EU banks branching into London. Past experience also suggests that shared interests militate to keep these deals intact once they are going. An equivalence deal on futures between the US and foreign exchanges has lasted for more than two decades.
Back to the story from today. ECB chief Mario Draghi does not see any reason to cut the UK slack:
Speaking at an EU summit in Brussels last week, Mario Draghi, European Central Bank president, repeated his assessment that Britain would “first and foremost” bear the economic pain of Brexit, according to diplomats.
Despite warnings from the Bank of England and UK ministers, Mr Draghi has been relaxed in private meetings with eurozone officials about the financial stability risks of Brexit, arguing financial services is a mobile industry able to bridge regulatory uncertainty.
Another Financial Times today is the functional equivalent of a press release from hedge fund lobbyists titled Hedge fund lobby groups outline Brexit wishlist. I’m at a loss to understand why anyone would mistake Angela Merkel for Santa Claus.
How is it, now nearly six months after the Brexit vote, that UK leaders (including a disconcerting number of business executives) and EU authorities are still taking past each other? A fundamental reason seems to be that many in Britain believe the Brexit PR, that leaving the EU means they will regain national sovereignity and the EU must deal with them as a prospective equal.
Putting aside the substantial difference in size between the two economies, the fatal flaw of this logic is that the UK cannot be meaningfully sovereign due to its degree of economic integration into the EU. They’ve run up against Dani Rodrik’s trilemma, which he first wrote about in 2007:
Sometimes simple and bold ideas help us see more clearly a complex reality that requires nuanced approaches. I have an “impossibility theorem” for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full.
Here is what the theorem looks like in a picture:
To see why this makes sense, note that deep economic integration requires that we eliminate all transaction costs traders and financiers face in their cross-border dealings. Nation-states are a fundamental source of such transaction costs. They generate sovereign risk, create regulatory discontinuities at the border, prevent global regulation and supervision of financial intermediaries, and render a global lender of last resort a hopeless dream. The malfunctioning of the global financial system is intimately linked with these specific transaction costs…..
So I maintain that any reform of the international economic system must face up to this trilemma. If we want more globalization, we must either give up some democracy or some national sovereignty. Pretending that we can have all three simultaneously leaves us in an unstable no-man’s land.
In other words, if the UK wants to have more national sovereignity, it must become more economically self-sufficient, as in more of an autarky. Yet making that sort of change would require a national economic policy, meaning having the government identify sectors where the UK has or could develop competitive advantage and do more to promote their growth. The failure to do planning (and better yet, some preliminary execution) means the UK, despite the phenomenal arrogance and ignorance of its officials, is approaching these negotiations as a beggar: it wants and needs to preserve substantial elements of the status quo, such as access to the single market and passporting rights for UK financial institutions, or face meaningful shifts of activities out of its economy (and please don’t try the dubious statistic that the EU will face bigger trade losses than the UK. What matters isn’t the absolute dollar, or in this case, pound and Euro hit, it’s the cost of the losses relative to the size of the economy. Measured properly, UK citizens will suffer considerably more than their EU counterparts).
And that’s before you get to the fact that this sort of industrial policy is anathema to Thatcherites and neoliberals.
As they say in Maine, you can’t get there from here. While greater national sovereignty is an estimable goal, the UK has gone down a path for decades that means it will take a long time to get the economic independence that would allow it to have more political autonomy. And despite all their bluster, UK leaders aren’t taking that objective seriously either.