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How to Strike the Financial Services Trade Deal. What to Watch for in the EU negotiations

Now that the Brexit talks are under pressure, the Government must ensure its proposals for financial services trade are proof against EU demands that would weaken the sector’s global standing and competitive edge. In Free Trade in UK-EU Financial Services: How Best to Structure a Brexit Free Trade Deal, published this week, I explain how the basis for EU-UK free trade can best be achieved in one of Britain’s flagship industries.

The Government has been clear that it intends future UK-EU services trade to be on the general principle of mutual recognition, with enhanced equivalence for financial services. Each side would recognise the other’s financial rules make for equivalent high-level outcomes. In practice, businesses from both the EU and the UK would operate in the other’s jurisdiction under the laws, regulations and supervisory arrangements of their home country: they would not be subject to the duplicative regulatory regime and supervision of the other state. This is an arrangement that already exists, developed by the UK and EU over many years and established with the US, Singapore, Mexico and many other jurisdictions. It gives the EU the cheapest possible access to capital across Europe from the global capital pools based in the UK. It is in everyone’s financial interests, across the whole of Europe, for that to be preserved.

The Government set its position out in its July White Paper reflecting the plan in my Template for Enhanced Equivalence with proposed draft legislation and treaty provisions. However, it omitted two important proposals and now is the time to reverse them: first, the decision about what constitutes equivalence should not be for each party’s courts but for independent supervisory arbitration (holding the parties objectively to their word); second, all of the services now traded should be included from the start.

But there is a case for the Government to make the agreement as legally robust as possible. As pressure mounts on the UK to make further concessions to the EU, it has become more important than ever that the chancellor’s aim not to be a ‘rule taker’ in this important sector is met.

Free Trade in UK-EU Financial Services: How Best to Structure a Brexit Free Trade Deal therefore sets out how to place all the operative provisions into a Treaty so as to ensure the arrangements are at their strongest. Not only would this ensure the U.K. is not a rule taker but it would reassure the EU that international standards are observed and there is no race to the bottom – though in fact the UK has a history of applying higher standards with more focused (and fewer) rules.

We see in the current negotiations, as often happens in such talks, different narratives being developed which seek to reduce the UK’s position. These can often be self-serving or ideological. If followed for financial services they would damage the financial markets and raise costs for European citizens and corporates.

Three particular narrative strands need special watch as false claims are made by interest groups in the EU.

  • First, some talk about “repatriating” financial business to their jurisdiction. But this business was never materially there in the first place. Global financial centres are just that – centres. Citizens benefit from them across the world. Forced fragmentation merely adds costs to the detriment of Europe and the markets themselves.
  • Secondly, there is talk of the unacceptability of some levels of financial risk being located outside the EU, implying any arrangement should force some business to the EU27 – or, in the true desires of the proponents, their specific member state. But the unusual feature of financial services is that the efficiencies and benefits arise from a concentration of business, face-to-face dealings and localised supervision. The UK is merely a custodian of a market that happens to be here, for the benefit of all.
  • Thirdly, that the UK is somehow risky in its approach to regulating the City, again implying the need to force business away from it. This is demonstrably incorrect. The UK has hugely experienced regulators of exceptional sophistication. It avoided the main effects of the Wall Street Crash. It was affected in the 2007-8 financial crash but, notably, when operating under EU regulation which permitted certain member states (not the UK) to attract business by ignoring EU regulations entirely, thereby distorting supervisory decisions and piling up financial risk.

However, on top of these false claims, a further narrative emanated (quite significantly from Brussels) after the 2007-8 financial crisis about the dangers of Anglo-Saxon capitalism. This was too readily accepted. A wave of regulation swept the EU, going far beyond what was necessary, from funds to insurance to the notorious Markets in Financial Instruments Directive No. 2 (MiFID2). M Barnier, who drove and implemented this programme, was himself appointed instead of a traditional UK financial services commissioner on the back of this narrative that the UK somehow messed up. In fact the situation in the UK and Europe was caused at root by a lack of effective systemic risk regulation around the world. Other factors were at play, but all of these could have been addressed were it not for the systemic risk. The situation arose from a misjudgement by central bankers across Europe, the US and beyond.

The UK Government and negotiating team should understand what for trade and regulatory lawyers is second nature: any successful negotiation will depend on understanding one’s own position and not being influenced too much by the other party’s attempts to talk it down.

When Brexit happens in March next year, reality will return. That reality remains that the gravitational pull of the City as a global financial centre is extremely strong. In the meantime, its pull can be augmented significantly provided the Government takes certain steps discussed in my The Art of the No Deal. The UK’s preferred outcome is rightly Enhanced Equivalence, which would be to the greatest benefit of both parties. However, in striking a deal the UK must focus on the needs of the financial markets and how they best operate, which is something the UK has numerous decades of experience in achieving. If it maintains this focus it will optimise the outcome for the financial markets as a whole – and for the UK.

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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