As the UK leaves the EU, Brian Polk considers the big questions relating to financial services in a post Brexit world and what institutions should be doing now.
The UK left the EU on 31st January under the terms of the Withdrawal Agreement agreed with the EU in October 2019.
The UK has left the political institutions of the EU, entering a transition period: the UK will no longer have representation in the European Parliament (UK MEPs elected in May 2019 are recalled), and UK ministers no longer attend or vote on EU rules in the various European Councils of ministers.
In the FS sector, UK regulators will no longer participate in the supervisory Boards of the EU’s main rule-setting agencies for the industry: the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA).
During the transition period (until 31 December 2020), EU regulation will continue to apply in the UK and the UK has committed to continue implementing new EU legislation and rules for the industry, and will also continue its payments to the EU budget. So there will therefore be no changes during transition to:
Eleven months (the length of the transition period) is an exceptionally short period in which to negotiate and ratify a comprehensive trade deal. The UK government has now legislated against extending the transition, an option that had been included in the agreement itself. This implication is that if a new trade deal cannot be agreed by the end of the transition period, EU-UK trade will take place on basic WTO trade terms.
Before the EU will start negotiations, it needs to prepare and agree a “mandate” for its negotiators, describing what the EU wants from the talks. This is a complex task, managing stakeholders in 27 member states. Its preparations are underway, with the expectation a mandate can be agreed during February, allowing trade negotiations with the UK to start around the beginning of March.
Industries in the UK are pressing for more details on the UK’s negotiating objectives, but there is little information available so far. Stephen Barclay, Secretary of State for Exiting the EU, suggested in an interview that the government will publish its objectives in February, but there is no requirement for the Government to seek Parliamentary approval of its negotiating mandate, so it is unclear what form such disclosures may take. The UK government is conducting a range of formal and informal discussions with industry sector groups, to hear more about business’ priorities.
Before the trade talks start, both sides are setting out strong positions, and seeking to improve their leverage. UK ministers have set out the need for the UK’s regulatory independence (i.e. divergence) and the possibilities for trade deals with other countries. EU officials are floating ideas about the tradeoffs the UK can expect for regulatory divergence, limiting the scope of talks to EU priority areas, and hinting that the FS regulatory equivalence assessments due by the end of June may be subject to wider political considerations.
Before the actual trade negotiations start, the sides will need to agree the format and timing of the stages of the negotiations … there will be “talks about talks.”
Prime Minister Johnson and other UK ministers have stated that they are seeking a “Canada-style” free trade agreement with the EU – that is, a trade agreement with low/no tariffs, but also with no obligation to implement EU laws, no payments to the EU budget for market access, and without requiring freedom of movement for people.
In a prominent press interview in January, Sajid Javid, the UK Chancellor said “there will not be [regulatory] alignment, we will not be a rule taker, we will not be in the single market and we will not be in the customs union”, and he urged businesses to adjust to the new reality. Since then, he has clarified his remarks to say that the UK would “not diverge for the sake of it” and the government would “always protect the interests of UK businesses.” The right to diverge is an important objective that will underpin its approach to future trade with the EU.
Trade-offs between regulatory divergence and the market access that can be achieved should be expected. A high degree of regulatory independence suggests complex negotiations, which could mean a more limited, sectoral deal, or even the possibility of a no deal at the end of the transition period.
Trade talks will be guided by the Political Declaration (PD) which was negotiated alongside the Withdrawal Agreement in October 2019. The PD says very little about FS, but it does suggest that future market access will be governed by third country equivalence provisions in existing FS legislation. These provisions are very limited in scope compared to the broad passporting rights enjoyed by FS businesses in the single market (currently and during the transition), so FS firms need to be prepared for more significant changes at the end of 2020.
Where third country significant equivalence provisions exist in EU legislation (e.g. in MiFID II, EMIR and AIFMD legislation), the PD suggests both sides will “endeavour” to complete their equivalence assessments independently by the end of June 2020. Equivalence determinations will not be negotiated, rather they will depend on the approach and degree of regulatory divergence involved. The UK wants an “outcome-based” approach to assessment, rather than “line-by-line” equivalence of rules. An outcomes basis would allow some flexibility for divergence, as long as the outcome of the regulation was deemed to be equivalent. The EU is prioritising ongoing monitoring of equivalence, and higher thresholds for UK equivalence based on the systemic importance of the UK financial sector to the EU.
One of the EU’s main concerns is to ensure a “level playing field” for competition. Arguments for regulatory divergence suggest that lower standards could at some point become a policy choice upon which to seek competitive advantage. Rules will also, naturally, diverge over time.
Equivalence determinations also have a political dimension; they will not be purely technical assessments. Determinations in the EU are ultimately made by the European Commission, following technical assessments and advice by the relevant sectoral regulator. Steven Maijoor, Chairman of the European Securities and Markets Authority (ESMA) briefed journalists in recent weeks that while it would be “possible” to make a technical assessment on whether the UK’s equivalent to EMIR are equivalent to the EU’s by June, the decision would “ultimately be affected by what is decided during the political negotiations”.
FS firms should not be surprised if equivalence determinations promised by the end of June are delayed or circumscribed if wider trade negotiations are proving difficult and contentious.
For the FS industry, a trade deal is still important, not least for the regulatory and supervisory cooperation that would result from it. Although market access under legislative equivalence provisions may be limited and uncertain, a deal can provide a positive backdrop against which supervisors will be able to set priorities and make decisions that respect each others’ competencies and protect against further politically-driven industry fragmentation, to the detriment of end-users. The PD suggests that “close and structured cooperation on regulatory and supervisory matters is in their mutual interest.” Industry regulators have shown willingness to cooperate, having signed Memorandums of Understanding (MoUs) formalising approaches to information sharing and combating money laundering even in the event there is no deal.
In the UK, approving a new trade deal should be straightforward. With a large Parliamentary majority, the Government can be expected to pass any legislation quickly that is needed to implement new trade treaties.
In the EU, the European Commission has the authority to negotiate trade treaties. Once agreed, the approval of both the Council (i.e. the member states, voting on a qualified majority basis (QMV) in Council) and the European Parliament (acting on the recommendation of its trade committee (INTA) by simple majority of the whole assembly) is required.
But if the scope for the EU-UK agreement includes policy areas beyond just trade, where jurisdiction is the responsibility of individual EU countries, it becomes a “mixed” agreement. Mixed agreements need approval by all individual EU countries, according their national procedures for international agreements. So ratification of a mixed agreement can take much longer, and be subject to veto by just one country (or even a regional assembly, if that is required for approval under the country’s system). In the EU, provisions exist for agreed trade treaties to be provisionally applied, pending final approvals.
It would provide a useful signal for businesses about the timing, scope and prospects for a deal if, during the initial discussions about the format and timing of talks, both sides could also agree about whether they are aiming for a mixed agreement, or not. And if so, whether any areas of scope could be separated from an underlying trade deal, where the EU has sole competence.
In preparing its negotiating mandate, the EU’s documents signal that they expect to negotiate a trade treaty, rather than a mixed agreement. Some EU trade officials have suggested in interviews that a narrow trade deal in 2020 could focus on goods, (protecting manufacturing jobs on both sides), with negotiations on services largely deferred or dealt with outside the free trade agreement.
In the run-up to the start of negotiations, FS firms should:
Director, PwC United Kingdom
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