The phoney peace is shattered. Longstanding tension between the Treasury and the Bank of England on how the UK’s financial services should be regulated after Brexit has become increasingly public. The Treasury, keen to keep as much of the City and its juicy tax revenues as possible in Britain, is keen to hew closely to EU regulation to maintain business with the EU27. The BoE, concerned about being a rule-taker, wants more autonomy.
The phoney peace is shattered. Longstanding tension between the Treasury and the Bank of England on how the UK’s financial services should be regulated after Brexit has become increasingly public. The Treasury, keen to keep as much of the City and its juicy tax revenues as possible in Britain, is keen to hew closely to EU regulation to maintain business with the EU27. The BoE, concerned about being a rule-taker, wants more autonomy.
Assuming that the UK does leave the single market overall, the BoE’s philosophy is more convincing. Even if the City of London loses some business overseas, the gains for financial stability and regulatory independence are likely to weigh more heavily.
As elsewhere in the Brexit negotiations, domestic peace between warring factions in the UK has been bought by proposing something already ruled out by the EU. For financial services, the BoE and Treasury have united behind “bespoke dynamic mutual recognition”, where the UK would agree regulatory outcomes with EU authorities and then the central bank would continue to set its own supervisory rules.
This plan seems quixotic. The EU dislikes mutual recognition of any regulation with third countries, particularly anything as potentially destabilising as financial services. Michel Barnier, the chief EU Brexit negotiator, ruled it out from the beginning. He seems unlikely to be overruled by the member states, not least because of the mercantilist interests of countries such as France trying to attract financial business away from London.
The resistance has pushed the Treasury to a fallback position of “equivalence”, where the EU recognises foreign regulatory regimes as being similar enough to its own to facilitate their financial services companies operating in Europe. However, the granting of equivalence is unstable, being a unilateral recognition that can be withdrawn at a month’s notice. Theresa May, UK prime minister, has already said that equivalence is inadequate for the City.
Moreover, the EU is tightening up its equivalence regime to demand more supervision of foreign institutions. This implies the UK would become a rule-taker.
The BoE contends that the more the UK pushes for an enhanced form of equivalence, the less predictable its regulatory environment will be. And some EU financial regulation, such as the latest capital requirements directive, has been inimical to UK interests.
Another option, to write market access for financial services into a bilateral EU-UK trade deal, looks highly optimistic. There are few examples of substantial financial regulation agreements in trade deals. The EU’s proposed provisions in the Transatlantic Trade and Investment Partnership with the US — in effect drafted by the UK, and in any case comprehensively rejected by Washington — were weak.
In essence, they would have constructed a system of organised dialogues between regulators with the aim of ensuring that equivalence agreements covered more parts of the financial services sector. But they stopped well short of mutual recognition.
In the end, unless the EU improbably changes its mind on mutual recognition, and if the UK leaves the single market and moves towards regulatory independence, it seems likely some of the City’s business will depart to the EU or elsewhere. So be it.
The choice between autonomy and market access exists for financial services as for the rest of the economy. In an area in which the UK has clear comparative advantage and the EU will regulate in its own interest, Britain’s ability to set its own rules assumes particular importance.
