Lord Flight is Chairman of Flight & Partners Recovery Fund, and is a former Shadow Chief Secretary to the Treasury.
The Government has been wisely silent about its Brexit negotiation objectives and potential options and trade-offs, but a picture is emerging of what sort of deal might and might not be acceptable. By contrast, Jean-Claude Juncker and some of his colleagues have been making intemperate speeches but I suspect these are, essentially, for political propaganda reasons.
It has become apparent that an European Economic Area/European Free Trade Association deal would not work, largely, as it would not achieve a return of sovereignty, would involve ongoing EU payments and the free movement of EU citizens. The Norway and Swiss models are, therefore, not suitable options. The closest, existing option is the Canada deal, although this has still not been implemented as, apparently, the EU exceeded its powers and still requires the agreement of all member states and EFTA members. Consent is currently being withheld by Liechtenstein!
It is apparent that the arrangements for the City of London will be the key battle ground of the Brexit negotiations although the deal for UK/EU traded goods and other services is more important in the aggregate. Here it would be in the interests of the EU, arguably more than the UK, to have free trade arrangements, where last year’s EU current account surplus with the UK was £107 billion. Germany has most at stake in terms of car and other exports to the UK.
If a free trade arrangement cannot be achieved, the likely next option would be to negotiate a World Trade Organisation regime. Here, the most vulnerable areas with the highest tariffs are cars and food, but the total extent of tariff costs would be less than £3 billion a year considerably less than the impact of the Sterling exchange rate.
When it comes to the negotiations pertinent to the City it is probably helpful that for the EU, Michel Barnier will be in charge of these. He understands the financial services industry and realises the huge importance of London to the EU, particularly, as regards the raising of capital. Financial services are the UK’s largest industry employing nearly three million people and producing £66 billion in tax. Approximately 50 per cent of our financial services are exported, of which 30 per cent ( so 15 per cent of the total) are EU exports, worth of the order of £30 billion annually.
Whatever the deal, the investment management and insurance industries are not significantly EU dependent. Approximately 80 per cent of investment management exports and 88 per cent of insurance exports are to non-EU countries – largely North America and Asia. The investment management industry has largely structured its EU retail Funds offerings as Luxembourg investment fund SICAVs (Société d’Investissement à Capital Variable) and Dublin’s one UCITs (Undertakings for the Collective Investment of Transferable Securities) which are anyway more acceptable to the EU retail market place.
The key sectors substantially reliant on EU exports are investment banking and standard banking services. 85 per cent of Pan-EU capital raising is handled in London. The main investment banks are, not surprisingly, pressing hard for the continuation of Passporting. The Financial Conduct Authority has found 5,476 UK firms dependent on Passporting arrangements into the EU but, interestingly, 8,000 EU firms needing Passporting to do business in London.
This illustrates that London is as important to the EU, if not more important, than is the EU market to London. There are, however, two different sorts of Passports; what I would describe as Single Market Passporting and Equivalence Passporting. Unless exemptions can be agreed, the problem with Single Market Passporting is that the UK would not have Sovereign power over its financial regulation law, and part of a Single Market deal involves accepting the free movement of people.
The EU was, effectively, obliged to accept that foreign providers could export financial services to the EU if their regulatory regimes were broadly equivalent. Continental Europe, as well as the UK, needs to be able to access the financial services of, e.g. Asia, when needed. Markets in Financial Instruments Directive II, which comes into operation in 2018, provides an Equivalence Regime for both investment banking and investment management.
Interestingly, it also operates already “in reverse” with regard to banking services, where the Bank of England did not participate in the EU banking reforms of two years ago, but rather organised its own broadly equivalent arrangements. The EU’s Equivalence Passporting arrangements for the Alternative Investment Fund Managers Directive are also set to be agreed later this year with Hong Kong, the US and Guernsey, covering, in particular, Hedge Funds.
Equivalence Passporting will involve a significant amount of detailed agreement as to what constitutes Passporting. If, as is likely, the UK writes all the existing EU regulations into UK law post Brexit, there should be little initial problem with the EU accepting Equivalence; but if, as will be desirable over time, the UK gets rid of excessive regulation, there will have to be negotiations that adequate Equivalence remains.
It is also apparent that if an EU institution chooses to come to London to use the services of a London institution, e.g. to raise funds, the EU could not stop them, although some member countries, e.g. France, have requirements that the foreign (London) institution could not attend client Board meetings in France unless Passporting arrangements are in place.
There is also the important issue of branches versus subsidiaries. Most of the large London institutions already have branches or subsidiaries within the EU and even more EU organisations have branches in London. If EU entities were required to establish subsidiaries in the UK, this would be extremely costly. There are over 70 EU banks in London under branch “passports” and thus not under Prudential Regulation Authority regulation.
The MiFID II Equivalence Passporting will include investment banks and should, therefore, enable branch operations to continue both ways. Equivalence Passporting arrangements will need to be registered with the EU Securities and Market Authority (ESMA). Already Australia, Bermuda, Hong Kong, Mexico, Singapore and the US have achieved deemed Equivalence for reinsurance services.
Moodys have already argued that the City can cope reasonably without Single Market Passporting, rather using Equivalence Passporting. Where there are specific country requirements, which may limit the scope of Equivalence Passporting, the larger investment banks can surely use their subsidiary operations within the EU to book the business, with the work being done in London.