Worth Breaking the Bank? Brexit Fine Print Risks Finance Sector
Published in Nouvelle on June 24, 2020
After three years of uncertainty and two general elections following the referendum on withdrawal from the European Union (EU), British parliament officially ratified a withdrawal agreement on the 31st of January, 2020.
In Short: Although Brexit has fallen off the public agenda since the spread of COVID-19, trade talk impasses and the withdrawal agreement’s loose ends may hurt the United Kingdom’s (UK) vital financial service industry.
Since the UK began its formal withdrawal from the European Union last January, Prime Minister Boris Johnson has been hesitant to use the word ‘Brexit’ in his speeches or in Downing Street’s public statements. However, after nearly five months on hiatus due to COVID-19, the British public has turned its attention back to the language of ‘hard Brexit’ and trying to strike a deal with Brussels. Amid the ongoing negotiations for a trade deal between the EU and the UK, both parties announced last Monday that they will not seek an extension to the Brexit transition period beyond December 2020.
While this announcement has little impact on either the withdrawal or trade talks for now, the statement limits how much time the UK has left to secure its future relationship with the rest of Europe. By the end of 2020, the UK will either (A) have a bilateral deal with its largest trading partner or (B) have its EU-bound exports subject to checks and tariffs (resembling the worrisome ‘hard Brexit’ that British lawmakers have sought to avoid).
After four years of Brexit debates, why are the trade talks only starting now? Following the 2016 Brexit referendum, the UK had to negotiate and ratify the Withdrawal Agreement before trade discussions could even begin. After countless summits with European leaders, five Parliamentary attempts to approve Britain’s withdrawal, and a snap election in 2019, a consensus was finally reached: trade negotiations would take place once the UK began its formal transition out of the EU.
Little progress has been made since the trade talks began in March. The UK has been adamant in seeking a deal resembling the Comprehensive Economic and Trade Agreement (CETA) between Canada and the EU. While a ‘Canada-style’ deal could eliminate virtually all tariffs between the EU and UK, negotiations stalled over key issues. For example, the EU wants to maintain its access to British waters for commercial fishing. The UK wants the ability to diverge from EU regulations on environmental protection, workers’ rights, and commercial subsidies. There is uncertainty of what role European legal institutions (such as the ECJ and the European Convention on Human Rights) will play in arbitrating future UK-EU trade disputes.
Arguably the most contentious point of negotiations will be regarding the UK’s most valuable asset in a post-Brexit world: the British financial service industry. London’s numerous financial service providers have led the UK’s capital to become the world’s largest financial hub, second only to New York City. The British finance sector accounts for almost 7% of the UK’s economic output and almost 5% of the country’s jobs. The size and relative stability of the UK’s financial service industry have permitted the country to become especially attractive to investment from multinational institutions and generationally wealthy families.
What makes the UK a global financial powerhouse? Britain’s financial industry advantage can be attributed to:
- The UK’s historical dedication to finance which allowed for “the agglomeration of services, the pool of skilled labour and a flexible labour market” in London;
- The ‘four freedoms’ offered by the Single Market (free movement of goods, capital, services, and people); and
- The UK’s passporting rights that allow British subsidiaries of multinationals to interact freely with customers throughout the EU.
These elements have permitted the UK to become Europe’s leading financial hub, but trade talks have placed this status in jeopardy because the UK will no longer have passporting rights for its financial service providers after December 2020. The EU’s Chief Negotiator Michel Barnier has ruled out passports for British financial firms, having previously noted that passporting rights were never part of the original CETA deal from which the UK drew its inspiration. Instead, the Withdrawal Agreement’s Political Declaration allows for ‘equivalence frameworks’ that would grant Single Market access for some forms of British financial services if reciprocated by the UK. As a result of the Withdrawal Agreement’s emphasis on equivalence, the UK has been aggressively pursuing this option in negotiations for the finance sector.
Even if the UK manages to obtain this regulatory alternative before the December deadline, there are a number limitations associated with equivalence:
- The conditions associated with equivalence will require the UK to become a ‘rule-taker’ and comply with the EU’s financial regulations.
- The EU can revoke equivalence with little notice (unless specified in the trade deal).
- Certain subsectors of the financial industry (such as banks and primary insurers) legally cannot be covered by equivalence and will likely have to establish subsidiary companies within the EU itself.
The elimination of passporting rights, paired with the drawbacks of equivalence frameworks, leave the UK’s financial service sector in a precarious position. Unless regulatory concessions are made by the UK, actors in the British financial service market will either have to move their operations across the English Channel or search for new investment outside of Europe. Although Britons might be keen on looking across the globe for their economic future, the rest of the world might not reciprocate if the UK cannot offer Single Market access.
The Bottom Line: Historically, the conglomeration of services, Single Market access, and global recognition as an international hub for stable growth have allowed the UK’s financial service industry to become one of its most lucrative assets. Without guaranteed access to clients in the EU, Britain’s financial sector may shift from being the country’s golden goose to an albatross around its neck.
