Is the European Union really being unreasonable over the City of London?

The governor of the Bank of England has suggested that the EU is behaving unwisely in dragging its feet on granting the UK regulatory ‘equivalence’ on financial services. Ben Chu examines whether this correct

Andrew Bailey worries the UK will become an EU ‘rule taker’ (Reuters)

The post-Brexit future of the City of London, in relation to one of its largest markets, is in jeopardy.

The last-minute free trade deal between Brussels and London excluded any provisions over the ability of UK-based financial firms to sell services into the European Union after 31 December.

Billions of euros of daily share trading activity have already shifted from London to Amsterdam this year as a consequence.

Some significant cross-border financial activity continues – such as the use by EU firms of UK-based derivative clearing houses – although only on a temporary (18 month) permission basis from Brussels.

The best Britain can hope for from the EU is the granting of “equivalence” for UK regulators, which would enable lucrative cross-border financial trade to continue indefinitely.

But the granting of such equivalence by Brussels does not look imminent and UK frustrations seem to be boiling over.

The governor of the Bank of England, Andrew Bailey, this week suggested that the EU is behaving unreasonably in dragging its feet on the subject - and even suggested the EU seems to be trying to excise the UK from its market.

"Is the EU going to cut the UK off from itself? There are signs of an intention to do so at the moment but I think that would be a mistake," Bailey said in his Mansion House speech.

UK financial lobbyists argue that it would be in the EU’s own economic interests to grant equivalence, pointing out that the City provides many services that simply cannot be provided within the EU at the moment and that cutting off the UK would push up costs for EU companies.

So is the EU behaving unreasonably and self-destructively over the City of London? Or is all this merely a natural (and much warned about) consequence of a Brexit that prioritised “sovereignty” over financial services?

The EU already has various financial services equivalence arrangements with countries ranging from Switzerland, to Mexico, to Canada, to Japan, and the United States so, on the face of it, it’s not reasonable for the UK to expect similar treatment – not least because London currently, unlike those other countries, has identical financial regulations as the EU having been in the same regulatory bloc for decades.

Yet the view from Brussels is very different. Lobbyists and civil servants on the continent argue that the City of London cannot be sensibly compared to Switzerland, Japan or even New York because of its sheer size and dominance.

They are uncomfortable about the financial stability risk of so much of the bloc’s financial services being provided from outside the EU and by the prospect of effectively, as they see it, outsourcing financial regulation over a large share of the bloc’s financial activity.

The EU’s current position that it wants to better understand how the UK intends to amend or alter the rules going forwards before granting equivalence.

Some in the City regard this as an impossible demand because no one, they argue, can predict what future rule changes might be needed or implemented.

Bailey, for his part, senses a looming demand for the UK to effectively commit to copy and paste all EU regulatory financial rules and not to ever change its own unilaterally – for the UK to become a EU “rule taker”.

This is a scenario he thinks should be rejected out of hand by the UK.

“It is not acceptable when UK rules govern a system 10 times the size of the UK GDP,” he said in his speech this week.

The concern from the Bank of England, then, is the mirror image of some in Brussels: both fear the potential consequences of diluting regulatory autonomy on financial services.

When the UK was within EU this circle could be squared because they mutually created and enforced financial regulations together. Brexit means there are none of those institutional safeguards for either side.

Underlying this from the EU side are more opportunistic motivations.

“The EU clearly has an objective of trying to suck business in [from the City] because they will end up gaining from it,” says one financial lobbyist.

And French politicians have not sought to disguise that they hope that Brexit will end up boosting Paris’s financial sector at the expense of London’s.

Whether this mercantilist motivation is bigger than concerns about financial stability is hard to say – and will probably vary by country and individual regulator.

Yet whether the EU is being unreasonable or not over equivalence, there is a rather brutal reality for the UK.

Outside the bloc, it has zero political, legal or institutional leverage over Brussels on this particular subject. It will just have to make its case for equivalence and hope that it is successful.