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Davos – More Good News Than Bad?

Despite the concern prompted by some of the Chancellor’s remarks at the Davos Economic Forum, what he said about the deal for financial services, a major earner for the UK, was robust. It sets the groundwork for a good deal for both the EU and the UK.

Mr Hammond indicated that financial services must be part of a final trade deal, with ‘some kind of enhanced equivalence regime.’ It ‘has to be a regime that is robust and objectively determined… It can’t be something that is dependent on the whim of the European Commission, it’s got to be more robust than that.’ Separately, the Brexit Secretary, David Davis had said the previous day that the UK would seek a regime based on ‘outcome equivalence’ rather than full harmonisation.

These statements should be welcomed. It is indeed possible to construct a financial services relationship along these lines, by applying an Enhanced version of the existing EU concept of Equivalence. This notion of equivalence – in its unenhanced form – is already applied to the EU’s relationship with other countries across many aspects of financial services. Equivalence is also already based on outcomes. The question is how to determine those outcomes objectively, and what other steps can be taken to enhance the regime. Perhaps helpfully, A Template for Enhanced Equivalence: Creating a Lasting Relationship in Financial Services Between the EU and the UK (Politeia, 2017) addressed all these issues in detail, and set out exactly how the concept of equivalence can be made to work.

Some key principles must be respected by both sides in reaching the deal.

First, to make such a relationship work while ensuring that the UK does not become a rule-taker, the outcomes must be defined at a high level. For example, a sensible outcome to be achieved is that banker pay should not be capable of incentivising the taking of too much risk in the name of the firm. The EU seeks to achieve that outcome through a bonus cap. The UK does so through deferring bankers’ access to bonus monies for longer periods of time. Either approach is legitimate, and it would be wrong for the EU to insist the UK adopts the EU’s approach.

The best way to ensure that high level outcomes, not processes, are key is to look primarily to the international standards that drive them, such as those embodied in the Basel rules. The UK helped to develop these rules and generally follows such international standards anyway. Where international standards do not exist to a helpful degree of specificity, the UK and EU will need to agree them at a technocratic level. This needs to be done in good faith and in a collaborative spirit which does not seek to do down the UK’s competitiveness or make the UK a rule-taker through requiring the wrong outcomes. Given the UK’s long history of collaborating with the EU-27 member states through the EU and before, it is to be hoped that such a spirit will exist.

After Brexit, the UK will wish to end much of the EU red tape now shaping UK financial services law and rulebooks. A good place to start could be the EU’s amended Markets in Financial Instruments Directive (MiFID 2) with its many examples of unnecessary and damaging prescription set out over the course of 1.7 million paragraphs. Or the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation for investor protection could be reconsidered given its flawed delivery – another example of inflexible EU requirements that national regulators must apply with little discretion possible.1  The UK’s Financial Conduct Authority has been unfairly maligned for the sometimes absurd results of these regimes; in fact, much of the agenda has been driven by the EU’s European Securities and Markets Authority (ESMA) and the European Commission. The UK is now paying the price as certain markets have already migrated to the US as a result, defying the objectives of the legislators. This lesson must guide future policy: insensitive legislation and regulation merely wards off business, displacing risk rather than protecting against it.

Secondly, the arrangements must be binding, through a UK-EU agreement that provides for certainty and predictability. The EU (and UK) should commit to maintaining equivalence determinations so long as the outcomes-based criteria are objectively satisfied. One way of doing this is by making express commitments not to ‘pull the plug’ on an equivalence determination unless and until agreed consultation and dispute resolution processes are carried out, verifying genuine, objective divergence from the relevant high level outcomes. The UK will also want the EU to collaborate on future regulatory initiatives, such as the project for the so-called capital markets union, so that these work for the UK as well as the EU. Such initiatives will not generally succeed without UK involvement in any event. The UK must be offered equivalence on all such topics where it is prepared to achieve the same high level outcomes. In general it is actually in the interests of the EU to establish two-way equivalence-based access with the UK. And, because the EU already operates with other states on the basis of equivalence, the precedent contained in existing equivalence rules can be built upon.

Thirdly, there must be a judicial or quasi-judicial body overseeing the process which is independent of the EU and is not required to defer to, or pay undue regard to, ECJ jurisprudence. It should be the sort of independent tribunal that the EU has agreed to in CETA as well as in other contexts.

Much work needs to be done to ensure any deal is win-win and durable, but the Chancellor seems to have taken the right first steps. He and his colleagues must also take on board that any attempt to control the UK, or to hold it back from being competitive will (were it even to be accepted) prove brittle. The UK Parliament is unlikely ever to agree to such terms, even temporarily. In order to be safe, the global financial markets located in the UK need to be regulated and supervised here, by experienced regulators who are close to the markets and able to operate autonomously and dynamically in response to market developments. The EU system has increasingly inserted systemic risk into the UK’s markets through seeking overly to control those markets from afar. That systemic risk is as bad for businesses, for the markets themselves and for the world’s economies, as it is for the UK’s taxpayers. And they are ultimately the ones on the hook for any missteps.

1 ‘FCA lambasted for ‘worst piece of financial regulation ever’, Financial Times, 25 January 2018.


Barnabas Reynolds

Barnabas Reynolds is a partner at Shearman & Sterling LLP and Global Head of the Financial Services Industry Group. He is the author of Restoring UK Law: Freeing the UK’s Global Financial Market, (2021) and co-author of The Lawyers Advise: UK-EU Trade and Cooperation Agreement – Unfinished Business? (2021).

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