For Member States, issues such as tax policy or other structural reforms come with huge social and political sensitivities. Differences on these issues alone are enough to highlight deep splits within the EU27; think Ireland’s lower corporate tax base; or France’s proposed digital tax; or residual resentment in Greece to troika-imposed structural reforms following its bailout. In truth, it has until recently been easier to avoid a further push on the CMU, because the opportunity cost of inaction was better hidden. Indeed, the EU could worry less about the costs of fragmentation elsewhere because these were compensated to some extent by one dominant financial centre lying within its borders. London, a financial centre of gravity with its aforesaid deep and liquid markets, did what all gravitational centres do: attracted greater and greater mass, in this case, more and more transactions, enabled by EU passporting. But Brexit blows the current status quo apart, because from 1 January 2021, the transition period will end and London, having already left the EU, will no longer sit within the Single Market. Passporting will no longer apply.
While there are countries that rely on an extra-territory financial centre (Canada, for example), it is probably safe to assume that such reliance, which in turn implies a loss of control and concomitant ability to protect, would be unpalatable to the EU. What next? In principle, the EU either has to find a way of working with London, or it has to find a way of replacing it. In answering this question, the EU has to consider what it wants to achieve from its future relationship with the UK.
Negotiations on the future relationship between the EU and the UK have been underway for much of the year and, to date, appear to have yielded little progress. While an agreement remains possible before the end of this year, what is almost certain is that it won’t touch on financial services. This seems ironic given how crucial a subject it is to both sides. For the UK, financial and intermediary services are its largest service export to the EU. Likewise, the EU is about to lose its major financial centre. In tacit acknowledgement of this, the Commission has just extended the right to use UK-based clearing houses for a further 18 months after the end of the transition period. This is in effect an admission that the EU doesn’t have equivalent provision amongst the EU27 at the moment.
Early commentaries on the UK-EU FTA negotiations talked up the idea of ‘fish for finance’ whereby both sides, the EU being a demandeur on fish and the UK being a demandeur on finance, would find a mutually-agreed compromise. The reality has been different: the UK hasn’t asked and the EU hasn’t offered, and thus financial services haven’t been part of the discussion. From the UK perspective, it perhaps made tactical sense not to have included financial services as part of its asks. It probably didn’t feel the need to provide the EU another source of leverage, particularly given the prevailing sentiment that the City could survive the lack of passporting, at least in the short-to-medium term. In preparation for Brexit, firms have moved necessary staff to the EU, but have kept a large majority of their services based in London.
Equally, even if the EU had unilaterally offered to maintain the passport in financial services, it would have, understandably, never have accepted doing so without equivalent regulatory oversight. This would have trampled over the UK’s red lines over sovereignty. Hence, de facto no deal. The two sides will instead rely on each other (or not) regulatory equivalence in the areas they deem fit. This blog post won’t be the first to say that equivalence doesn’t represent a solid foundation for cooperation on financial services. The granting of equivalence is ultimately a political decision and it can be unilaterally withdrawn at short notice, as indeed the EU did to the Swiss stock market in 2019. Equivalence also relies on regulatory alignment and it is possible that the UK and the EU diverge in the future – already there is discussion about differences in how and when the two will implement the next round of Basel III banking regulations.