Mark Hoban chairs the Regulatory Strategy Group, which is co-sponsored by TheCityUK and the Corporation of London. He is a former Financial Secretary to the Treasury and Employment Minister.
The Prime Minister’s successful conclusion of Phase One of the Article 50 negotiation now opens the way to agree the future trading relationship. We had a taste of the challenges this will bring with discussion about the relationship between the Republic of Ireland and Northern Ireland. The description of the rules that govern cross-border trade went through three iterations. Originally, the language proposed was “no regulatory divergence”, which was rejected by the Government, then “regulatory alignment” which was rejected by the DUP, and the final Phase 1 deal used “full alignment”. Each phrase includes a degree of ambiguity to tide us over to Phase Two and the agreement on the future trading relationship.
As we move to the next stage, constructive ambiguity will have to be replaced by linguistic clarity. Sometimes, different words are used for exactly the same thing. For example, I have heard the period between leaving the EU and the completion of all the necessary legal changes described as either the transition or an implementation period. I have to say I am left scratching my head to understand quite what the difference is between standstill and status quo when it is applied to the transition. The bigger issue is where the same or similar words are used to describe radically different things.
I have heard politicians and others use the word “equivalence” to describe the future regulatory relationship with the EU; for example, “equivalence of regulatory outcomes”. This sounds reasonable, but in the EU “equivalence” is as much a process as an end state. Equivalence is the basis on which the EU allows countries access to its financial markets. But granting “equivalence” is a unilateral process by the EU, and implies that the country seeking equivalence is a rule-taker. Equivalence decisions are as much technical as political and can be withdrawn at 30 days’ notice. Indeed, the consensus view within the financial services sector is that equivalence does not provide a robust basis for a deep and broad trading relationship between the UK and the EU27. The casual use of the word “equivalence” to describe the future trading relationship is liable to create a huge misunderstanding between the UK and the EU when negotiating the future relationship.
From the perspective of the financial services sector, I believe that the basis for our relationship with the EU should be the mutual recognition of each other’s regulatory regimes where the detail of regulation will diverge over time but deliver the same regulatory outcomes. (The detailed thinking behind this is set out in a series of reports published by the International Regulatory Strategy Group, a cross-sectoral financial services think tank co-sponsored by TheCityUK and the Corporation of London.) Indeed, Free Trade Agreements are based on granting access to each other’s markets where regulatory regimes differ. Usually, however, these are predicated on rules converging, whereas as the UK and EU27 have the identical rules at the date of Brexit, which over time will diverge.
Because our rules will be the same at the point of departure and the UK and EU27 want to maintain high levels of access to each other’s markets, we need a bespoke deal: there is no off-the-shelf solution. Michel Barnier said on Monday that no previous FTA included financial services, but given the mutual benefit to the UK and the EU27 that comes from accessing each other’s markets, its exclusion would damage our economies. The Government needs to fight for its inclusion: financial and related professional services are a huge UK export success and employ over two million people, two thirds of whom are outside the M25.
It is highly unlikely, however, that the EU would allow high levels of access alongside the unfettered ability for detailed rules to diverge. This would be akin to being inside the Single Market without accepting its rules, and is a clear red line for the EU27. The IRSG has explored the concept of permitting access to each other’s markets unless there is material divergence. To use another word thrust to the fore by the Brexit debate, this would introduce a degree of friction into the trading relationship, compared to the frictionless access we currently enjoy.
Divergence takes us back to the Irish border. It is not surprising that the Government rejected the phrase “no regulatory divergence”, as this would imply that our rules do not diverge and therefore we would be a rule taker. So why then is “alignment” acceptable? Alignment can cover parallel processes, working towards a common aim. This which would be consistent with delivering shared regulatory outcomes through different approaches or mutual regulatory recognition.
I believe that maintaining access to each other’s markets based mutual recognition of each other’s regulatory systems in return for no material regulatory divergence is the right way ahead. It recognises each other’s red lines: the UK can’t be a rule-taker post-Brexit, and from the EU’s perspective we can’t be members of the Single Market, but can have access to it. It ensures the deepest possible trading relationship and the minimum disruption. And if either side decides that they must materially diverge, they can do so without risking access across the whole financial services market. We can only move ahead, though, by being clear about what we want.