Brexit will create fragmented financial markets, with the UK and EU also likely to become regulatory competitors. That was the message from lawyers, economists and British government representatives at Securities Industry and Financial Markets Association (Sifma) event on Brexit earlier this month.
Participants see much at risk for wholesale capital markets and the banking sector, and according to Christopher Bates, partner at Clifford Chance in London, regulatory competition is likely.
“Even if there’s a commitment to international standards, moving everything upstairs to the Financial Stability Board (FSB), there will still be regulatory competition between the UK and EU,” said Bates.
According to Bates, there’s evidence for this process already, with challenger banks questioning their capital charges. In addition, the UK has previously been unhappy with third country arrangements particularly in derivatives regulation where the UK would have made different choices. On that and other issues, and Brexit, the UK may be able to free itself of what some might consider the EU’s regulatory shackles.
“There will be significant pressures to diverge and compete,” said Bates.
- US industry and counsel are weighing the risks of the UK’s June 23 referendum on EU membership;
- Fragmented financial markets loom, with the UK and EU also likely to become regulatory competitors;
- The EU’s core objective its own integrity; the UK can’t expect too many concessions.
- EEA membership is probably out of reach for the UK, with a free trade agreement more likely;
- A grand bargain on regulatory equivalence, with the City grandfathered in, won’t happen.
Other speakers warned of the need to avoid fragmentation. “The resolution of Brexit will have global impact, especially on financial services. We should not regress back to the days of fragmented markets,” said Kenneth Bentsen, president and chief executive officer of Sifma speaking at the event.
At the same time, the message from the UK government is clear. “Given the crucial role of financial services in UK economy, the UK government is determined to listen to the industry on key issues including access to single market,” said Antonia Romeo, HM’s consul general in New York also speaking at the event.
Access to the Single Market will, however, be a decision made as much by Europeans as by the British, with much depending on the future of the UK-EU relationship. It is this dynamic about which US market participants are not overly optimistic.
“The EU’s core objective is to keep its union together right now – that conflicts with the US policy of wanting as harmonious a divorce between the UK and EU as possible,” said Clay Lowery, vice president of Rock Creek Global Advisors. The assumption is that, rather than grant the UK concessions that preserve existing economic ties, the EU will seek to demonstrate that leaving its trading bloc comes with a cost. Any such cost will likely impact US firms: 80% of US bank assets outside the US are in the UK.
A key issue for US financial institutions in the UK, then, is the level of disruption caused by the UK eventually triggering Article 50, the Lisbon Treaty’s provision for exiting the EU. That’s set to happen in January 2017, after which much will rest on the two-year negotiation of a new relationship with Europe. “There isn’t limitless time – Brexit will mean Brexit at some point but we won’t invoke Article 50 until at least next year,” said Romeo.
According to Bates, the most minimal disruption for financial services would thereafter involve the UK achieving an arrangement similar to Norway’s membership of the European Economic Area (EEA). That, or a similar arrangement, would preserve the UK’s prized Single Market access in something like its current form. There are, however, problems.
“Industry say it wants the EEA option, but I’m not sure the industry is that keen on the lack of influence over EU laws,” said Bates. The UK has always been an active contributor to the content and sophistication of EU financial regulation and the City may find it hard to live without that influence. In addition, EEA membership would face political headwinds in the UK – the EEA involves the free movement of people, and many within the UK electorate cited inward migrant flows to the UK after voting to leave the EU.
Other options for the UK include a Turkey-style customs union with the EU, a Canadian or Singapore-style trade agreement, or simply a standard World Trade Organisation (WTO) agreement. None are perfect.
"We should not regress back to the days of fragmented markets"
“The general options, the readymade options, are really all very difficult for the UK. All have significant disadvantageous,” said Bates. The core implication for financial services is that there’s no easy way to carry on as before.
“I would counsel strongly against the financial services believing there’s some sort of regulatory equivalence for operating in the EU and that somehow the City could be grandfathered in,” said Jacob Funk Kirkegaard, senior fellow at the Peterson Institute for International Economics.
“The EU and euro area are simply not going to allow the City to remain the overwhelming centre for the euro. Unless the UK agrees to a Norway situation and hollows out what Brexit means,” Kirkegaard said.
That option would seem unlikely, given the UK prime minister’s repeated assertion that the UK will leave the EU.
“The market access issues that will be important for London will be tied-up in regulatory equivalence issues – the best mechanism will be a free trade agreement (FTA),” said Lowery.
Regardless of any such agreement, however, other dynamics may come to define the future UK-EU relationship.
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