London calling
Brexit surrender won’t save City tax gusher Jeremy Warner
‘Some member states”, Philip Hammond, the Chancellor, said in his Mansion House speech just a month ago, believe “that the only possible route for future financial services access [to Europe’s single market] is through the EU’S existing, off the shelf, equivalence arrangements. I don’t agree with that”.
He then went on to explain why the equivalence regime would not work for UK-EU financial services trade. “It is piecemeal, unilateral and unpredictable,” he said “and therefore does not provide the stability that a well-regulated market requires.
“I have heard talk of ‘enhanced equivalence’, [but] I have not yet seen a credible proposal for what it might mean or a clear articulation of how it might work.” Instead, he proposed to stick with the existing strategy of attempting to convince EU negotiators that “mutual recognition” of standards would be the most practical way forward for Europe’s financial markets.
It has taken little more than a few weeks for this negotiating position to unravel and for some ill-defined form of “enhanced equivalence” to take its place. Mutual recognition is perhaps the least eye-catching of the Brexit ambitions to have fallen by the wayside as the easy, cake-and-eat-it divorce from the EU once promised collides with harsh economic and political realities. One by one, the red lines are being breached. Presumably, Theresa May cannot concede free movement too and hope to remain in power; that would be a surrender too far. But under a different leader, this red line may eventually disappear.
The City is a mass of different and often conflicting interests; it rarely speaks with one voice. On the one hand, there are those who urge regulatory alignment with the EU so as to preserve market access. On the other there are those who see freedom from the dead hand of EU bureaucrats as crucial to the City’s future in a globalising world.
And no doubt those opportunities abound. But that doesn’t alter the reality that as things stand, a very sizeable proportion of City revenue – between a fifth and a third – derives from intra-eu business and is therefore directly dependent on permission access to Europe’s single market. To outsiders, the City’s natural advantages of law, language, timezone and culture pale alongside this over-riding attraction. Many foreign banks choose to locate operations in London specifically to avail themselves of these rights of access.
A mighty powerful position they have carved out for themselves too. Banks operating from Britain underwrite around half of the debt and equity issued by EU businesses; 17 Uk-located banks are counterparty to over half of the over-the-counter interest rate derivatives traded by EU companies and banks; and around £1.4 trillion of assets are managed in the UK on behalf of European clients.
As part of its White Paper on Britain’s future relationship with the EU, the Government conceded that there was no hope of the current passporting regime, under which banks regulated in London can sell their services throughout the EU, surviving the UK’S exit. Mutual recognition too has self evidently hit the buffers. So officials have alighted instead on the existing system of equivalence, under which the EU grants rights of access provided it is satisfied that foreign regulation is equivalent. For now, these dispensations operate in quite narrow areas of activity, are entirely discretionary, and can be withdrawn by the EU on minimal notice. The UK
‘Either the City becomes a rule taker, subject to anything the EU throws, or it finds its access denied’
proposes to extend the regime to cover a much wider range of activities, and to make equivalence more dependent on dialogue than EU diktat. Small wonder that Michel Barnier, the EU’S chief negotiator, is unimpressed. “The difference between mutual recognition and the enhanced equivalence proposed is only one of semantics”, one seasoned veteran of the Brussels scene told me. “There is no midway course here; either the City becomes a rule taker, subject to anything the EU throws at it, or it finds its access denied. And even if rule taker, access would be entirely discretionary on the EU’S part.”
By choosing regulatory flexibility for Britain’s service based economy over market access, the Government has essentially offered the City up by way of sacrifice. For the great bulk of Britain’s service industries, not being part of the single market doesn’t matter. These are overwhelmingly domestically based businesses that don’t trade with the rest of Europe. There is in any case as yet no single market in services to benefit from.
But for certain high end activities, such as finance, digital services, architectural, legal and business services, it matters a lot. It also matters that Brexit is increasingly used as an excuse to challenge the supremacy of English common law in contractual matters and bring in cruder, Continental formats. That’s not going to be good for our lawyers either.
There are just three things the City wants to know about our future relationship with the EU – can EU markets continue to be served from London, can you write that business in London, and most important of all, can you continue to manage the risk through London? We are as yet no nearer knowing the answer, but it doesn’t look hopeful and if it is no to all three, then no doubt about it, there is going to be a serious hit.
If there is no direct access to Europe, maintaining a London hub will lose its purpose for many overseas bankers. The great irony is that London’s loss is quite unlikely to be Europe’s gain; as a simple matter of economic efficiency, the business will instead gravitate to rival hubs with abundant liquidity – New York and Asia in particular.
Britain is good at finance; it has, moreover, the right legal and regulatory structures to be easily able to accommodate it. These attributes will remain, however spiteful Europe’s land grab gets.
But it is not just Brexit the City needs to worry about. In the US, Donald Trump’s economic agenda – deep cuts in tax and regulation included – has thrown a great rock into the pond which is already beginning to render London seriously uncompetitive with New York. Loss of access to Europe further lessens the attractions of retaining expensive, stand-alone London operations.
The way to respond is for the UK to match Trump step for step, but this creates its own challenges. It may indeed be impossible to duplicate Trump’s initiatives within the constraints of European equivalence.
Large parts of the City find themselves caught between a rock and a hard place, putting in jeopardy the Brownite contract under which, in exchange for a free hand, finance would provide the tax gusher necessary to fund the Government’s social programmes. That era too may be drawing to a close.