Yet again, we have the spectacle of various UK commentators getting their knickers in a twist over the EU doing what it had either said or had effectively said so often that the message could hardly have been considered to be in dispute. But even more so than on other fronts, the UK was particularly disinclined to hear what it did not want to hear regarding its lone national champion, the financial services industry.
The UK’s misguided hopes on that front were dashed today, as we’ll discuss more specifically below.
The EU had set forth the critical parts of its position early on: outside the EU means outside the EU. That means if you are a financial services firm, if you want to operate in the EU, that’s all well and good, but you need to get local licenses. That also means that for certain products, you need to have the individuals selling those products be licensed by the appropriate regulatory body. We have that sort of regime in the US for anyone selling securities, even to professional investors. This is hardly an exotic concept.
The UK has continued pinning undue hopes on “passporting,” that UK financial services professionals would have their UK credentials recognized in the EU. But that had been given a thumbs down previously too.
Another fudge the UK had hoped to get was “equivalence,” which was if UK financial services regs were kinda sorta aligned sufficiently with EU financial services rules, UK firms in those products/services could operate freely in the EU. One can see why the EU wouldn’t go for that. Unless the foreign country hewed precisely to the EU’s rules, “equivalence” equals ceding some, potentially a lot, of control over your own regulations to an unaccountable foreign country. Now admittedly, the EU has done that, in a couple of areas, commercial lending and some insurance products. But neither of these are heavily regulated activities and companies already shop for them across borders. 1 The idea that they’d extend equivalence beyond narrow bounds was never on save in the fevered brains of Brexit boosters.
I know I may sound like a broken record, but reading the English language press gives the impression that the EU rebuff is a new development. For a sanity check, below is a section of a post from February 27, 2017, almost a full year ago:
The Financial Times obtained access to a European Commission document that puts paid to a pet proposal for how the City could have its cake and eat it too in a Brexit, that of the implementation of an “equivalence” regime. We had been skeptical that this arrangement would be approved by the European side. Our view appears to be correct.
While this had not been fleshed out in any detail, the UK proponents argued that London could be permitted to service customers on the Continent more or less as before if UK regulations were deemed to be “equivalent,” since the EU had already allowed for that with some financial services.
The idea had been bandied about before, with a recent sighting in January. Then, an “influential” banking industry lobbying group, TheCityUK, published its demands for Brexit talks. We wrote at the time that they showed how the British side was in a bubble, and that the document pressed for several ideas that had already been rejected by the EU.
The only good thing that could be said about equivalence was that it at least had not been previously nixed. The equivalence proposal resulted from the fact that the industry did recognize that one of its pet asks, “passporting,” was a non-starter. Passporting would have allowed UK-based employees of UK firms to sell services to customers in the EU. It’s not hard to imagine why the EU would not be keen about that in a post-Brexit world.
So shorter: as of eleven months ago, the UK had already been told no once on these pet issues, and was having to be told “no” yet again. Frankly, I am astonished that Michel Barnier and Jean-Claude Juncker can keep up a veneer of politeness with this sort of mind-boggling obtuseness operating on every front. The UK keeps acting as if it ignores clear and persistent rejections, somehow the EU will relent.
The one difference with the EU’s latest “non” is that it stooped to tell the UK that it heard and was unmoved by its argument for being nice to the City: that somehow the Continent would suffer if British bankers were inconvenienced. As we’ve said, that idea is silly. The world is awash with bankers. The Continent had perfectly good ones that would be delighted to eat the lunch of their London competitors. Moreover, the firms that now do Continental business out of London (and that includes US as well as European players) are fully capable of moving staff to Europe (or hiring) and getting any needed licenses. The biggest impediment seems to be figuring out where to bulk up and securing more office space, but the large financial firms were scouting virtually from the day after the Brexit vote. They could read the handwriting on the wall.
Note that Barnier was reported as making some accommodating noises but he’s gotten out ahead of his principals before and has been slapped down. The reality is that as we have said before, “equivalence” in any complex financial products (and the high margin ones are complex) would require the UK to stay strictly aligned with EU rules. That would also mean rapidly implementing any EU regulatory changes and accepting ECJ rulings, and almost certainly the ECJ as final arbiter. That’s a non-starter politically. As Reuters reported yesterday:
As Britain was leaving the EU’s single market and rejecting its rules, including arbitration by EU courts, one EU diplomat said, “it’s clear that they will lose passporting rights as this is part of the internal market and our regulatory regime.”
“When they do that, the only other alternative is what we have in some of our FTAs,” the person added, referring to free trade agreements the EU has with other countries.
Barnier has said that free trade accords have in the past offered only limited access for financial service providers. He has said there was a willingness to look at the possibilities of equivalence.
Some envoys expressed caution about how far that could be done. Others were more open to closer cooperation…
“The key message was that given the UK’s red lines,” another diplomat said, “a free trade agreement is the only possible cooperation scheme.”
So in light of the foregoing, consider the Financial Times’ account, EU rejects Brexit trade deal for UK financial services sector. Key sections:
EU Brexit negotiators have set out a tough line on financial services, ruling out an ambitious trade deal for the lucrative sector and arguing that Europe would benefit from a smaller City of London, according to confidential discussions among the other 27 EU member states…
“There was a strong commission message that there would be no special deal,” said an EU diplomat briefed on the discussions — a first attempt to thrash out the bloc’s position on the issue before negotiations with Britain start in March. “The UK is being told from the beginning what the situation is.”
Another EU diplomat said: “They are out of the internal market, that’s it. There can only be a much less ambitious agreement.”
And consider this new argument, which strikes me as correct, that the EU has safety and soundness reasons to want financial firms to be operating mainly in the domestic currency and under the supervision of the ECB. In the immediate wake of the crisis, there was a push to move away from the “home-host” system, in which international financial firms were primarily regulated by their “home” regulator and regulators in other countries didn’t look very hard at the financial adequacy of the subsidiaries operating in their country. The assumption was that the home country regulator would make sure the financial firm was strong enough on a global basis, and the local regulator would demand more capital from the mother ship only on an as-needed basis. After the crisis, there was some thought about having major operations be adequately capitalized in each country and having the regulators in those countries kick their tires. But that would have led to banks being less “efficient,” which is a feature, and not a bug, of greater safety.
Here is the high level version of the issue:
Brussels’ fear is that, in a financial emergency, UK regulators would prioritise continuity in companies’ UK operations over their activities in the EU27. This could lead to outflows of capital and liquidity or the withdrawal of vital services at a critical moment.
One senior diplomat said that the commission had underlined the importance of making sure that the EU did not lose “influence” over the UK financial sector, which could “have such a huge impact on the EU”.
Recall it was, ironically, the UK that was on the receiving end of a mini-event like that, when Lehman stripped its London operations of cash and collateral right before it collapsed.
This example should put paid to the idea that the EU is being mean to the UK. The fact that the EU hasn’t shouted down the UK in frustration and is willing to entertain an idea that it is highly confident the UK will reject once it again explains what the EU requirement are is far gentler treatment than the UK deserves, given its childishness and the seemingly never-ending presumptuousness and whinging of its officials and commentators.
1 The US is an exception in having pretty strict regulation of insurers. Former Australian Treasury official, now investor and blogger John Hempton contends that is because the US uses private insurance, such as disability insurance, in lieu of social safety nets, and thus the government has a vested interest in making sure those products perform adequately.
Yesterday, Reuters confirmed that while the EU does had a significant number of equivalence pacts, all are narrow and thus not precedents for the sort of arrangement the UK has been pining for:
[European] Commission data showed the EU now has agreements with 38 countries on equivalence of regulation in certain areas of financial services, often narrow in scope.
For instance, the EU has equivalence agreements with Egypt and Russia, but only on the audit framework and transitory regime. With Argentina, it is just the legal and supervisory framework covering credit rating agencies.
But it has equivalence agreements in 22 areas of financial services with the United States and 20 with Japan. Those cover prudential requirements for credit institutions and investment firms, insurance and reinsurance or over-the-counter derivatives, central counterparties and trade repositories.
None of the 38 countries has equivalence agreements in all areas of EU financial services.
Nor are there equivalence agreements with any country on prospectus rules, the transparency of securities financing transactions, or on short selling and certain aspects of credit default swaps, among others, according to the Commission data.