4 February 2019

The Government’s presumption it can negotiate a special deal to prevent UK-based banks being frozen out from lucrative business within the EU after Brexit is highly likely to be proven wrong in time, according to our latest study: ‘Equivalence, mutual recognition in financial services and the UK negotiating position’.  

The Briefing Paper by Dr Andy Tarrant, Dr Peter Holmes and Prof Dan Kelemen warns that the EU is almost certain to reject any approach to a future trade deal that seeks to retain UK-based banks access to EU markets while giving the UK the ability to vary its regulation away from that applied by the EU.

If the UK insists on this approach, financial firms will be forced to move significant operations to the EU and it could cost the UK treasury billions in lost tax revenue.

The study warns that EU negotiators are likely to find a number of aspects of the UK vision for a future financial services relationship unpalatable including:

•             The removal of the EU’s unilateral ability to decide whether UK regulation is sufficiently rigorous for the EU to permit financial services based in the UK to sell cross-border into the EU and its replacement with a fully independent arbitration process.

•             The UK Government’s wish that in cases where UK regulation is legitimately found to be inadequate, any UK cross-border provider that had already been allowed to trade, should be allowed to continue to do so, even if it is no longer covered by adequate regulation.

•             The UK’s hope to extend the range of services covered by a deal as there are sets of significant services which third countries cannot currently sell into the EU.

Dr Tarrant, an independent public policy adviser, said:

“From an EU Member State perspective, the problem with the UK’s proposed special deal is that the UK could lift regulation previously agreed with the EU that is intended to prevent market failures or refuse to adopt new regulation which the EU thinks is necessary, while deregulated UK providers could still trade across borders into that Member State. In other words, the UK is proposing a deal which prioritises its regulatory sovereignty over the sovereignty of a partner. And in this case not just one Member State but 27 others. In addition, the UK is proposing this in the financial services sector, a sector whose decisions about credit create risks for entire national economies.”

The new report also dispels the misperception voiced in some quarters that the EU would be treating the UK unfairly in not discussing a special deal for financial services because it had previously agreed similar deals with other countries.

The report makes clear that what the UK is seeking is unprecedented and even if a post-Brexit EU-UK Free Trade Agreement (FTA) were to include provisions on financial services equivalent to those found in recent “comprehensive” EU FTAs with trading partners such as Canada, this would entail a serious reduction in trade in UK financial services compared to the current position.

While extending the range of products covered by equivalence in any FTA might be more feasible, even then the EU might have to offer it to other countries like Canada and South Korea under most favoured nation clauses in their agreements which could potentially raise the “price” the EU would demand of the UK.

Report co-author Peter Holmes, a Reader in Economics at the University of Sussex and a UKTPO member, said:

“In the absence of the UK staying in the Single Market, it is highly unlikely that the status quo for UK-based banks’ access to EU markets will be maintained post-Brexit and in anticipation of this risk, banks will be forced to move significant operations. This will be a heavy blow for both the Treasury and its tax receipts but also for the employees who can’t simply up sticks and move their lives to the Continent.”

Inside the EU, financial services providers have the right to trade on a cross border basis and UK financial service providers have dominated EU markets.

The report warns that this domination is very likely to be eroded post-Brexit because the ability to sell financial services on a cross-border basis is currently much more limited for providers from countries outside the EU.

A study by Oliver Wyman estimated that, in a worst-case scenario, exiting the EU could see UK tax revenues fall by up to £10bn and 70,000 financial services jobs lost. The UKTPO report warns those losses could be even greater if the UK opted to vary its regulatory regime and subsequently lost equivalent status with the EU in product markets where third country providers are allowed to sell on a cross border basis.

The authors conclude:

“London is the financial powerhouse of Europe at the moment, but as the Government’s own internal documents reveal, that position is now at risk of erosion because of Brexit. Whatever decisions UK authorities take they should be aware that Brexit likely implies less EU market access for UK based financial services providers with knock on consequences for tax revenue and jobs. It is extremely unwise to assume the likelihood, as the Government currently does, of a deal which retains cross-border access to EU financial services markets while giving the UK the ability to have a different regulatory regime. ”