City A.M. answers the need-to-know questions behind the City's key Brexit report.
Why is this necessary?
In January Prime Minister Theresa May announced the UK will leave the EU’s Single Market after Brexit, in the biggest upheaval in trade between Britain and Europe since the UK joined.
For the City’s financial services firms wishing to trade in Europe (and vice versa) that leaves two options: using existing arrangements for third countries outside the EU, or a free-trade agreement (FTA). The former would represent a big increase in trade barriers, so a “bold and ambitious” FTA has become the central objective. The report, led by former Conservative City minister Mark Hoban at the International Regulatory Strategy Group (IRSG), is being taken seriously by government. It is to date the most detailed effort to go beyond rhetoric and envisage a detailed deal which works for the City.
And, if it gains traction on the continent, it could serve as the blueprint for a Brexit deal which allows financial services firms to continue to access European markets.
What does it call for?
The report’s objectives are ambitious, to say the least. The IRSG calls for the UK and the EU to “agree a wide-ranging FTA, covering substantially all trade in goods and services, including financial services”. The proposals in the paper cover financial services, but could have lessons for other sectors as well.
The central aim is to retain market access for British firms to the EU without having to apply to separate authorisation. Currently the Single Market means firms can rely on “passporting” rights, guaranteeing they reach a common standard, to trade in the EU, but the IRSG envisages a free-trade deal aligning regulatory standards and opening market access. This level of market access would be unprecedented in a free-trade agreement, the report’s authors say.
What would regulation look like after Brexit?
An agreement would be reliant on a “high degree of regulatory alignment” between the UK and the EU, with “agreed supervisory co-operation mechanisms”. It sounds more difficult than it is: the UK and the EU are currently equivalent, so any regulatory agreement would start from a solid base.
The issues arise as soon as regulatory divergence comes into play. The chance to deregulate the City has been cited by some people as an advantage of Brexit, but that idea has received short shrift from the EU.
The IRSG hopes to solve this central issue by introducing a “Forum for Regulatory Alignment”, a joint EU/UK body which would assess and manage regulatory change. “Not every instance of divergence should mean that two regimes are regarded as being insufficiently aligned,” the report suggests.
Both sides could agree areas where regulatory divergence could be tolerated, the IRSG suggests, although the UK would have to be careful to avoid accusations of “cherry-picking” the best bits of the EU.
What about the ECJ?
There will, inevitably, be disputes – particularly if an FTA is created with divergence in mind. Any deal will have to involve a central arbitrator, a role that currently falls to the European Court of Justice (ECJ).
The ECJ is one of the most important red lines for a significant chunk of the Tory Brexiters, who are vehemently opposed to being subject to a foreign court. However, any trade deal will need a dispute resolution mechanism.
The report points to a “judicial structure for the resolution of disputes”, similar in practice to the ECJ, although likely with a greater UK representation. Possible models include the EU-Swiss joint committees or the World Trade Organization (WTO) Dispute Settlement Body. The FTA would also include provisions for “either or both parties to withdraw access in relation to a particular area of activity”. Then, the nuclear option: an Article 50-style process allowing either party to leave the FTA.
How likely are they to succeed?
The stated aim of the report is not to impose its solution, but to show that some kind of deal is legally and technically possible.
The Brexit negotiation is unusual in international diplomacy because both parties start at the same point. That means there should be less need for exemptions and reservations – common sticking points in agreeing a trade deal.
From businesses’ point of view the focus of negotiations will be about keeping standards as close as possible, at least in the short term.
The report aims high: much of what it is proposing is unprecedented, and will take significant concessions from the EU. The ultimate aim of the report is nothing less than a brave new world of financial services trade liberalisation, with the same model used in FTAs around the globe.
What could go wrong?
Politics. The report deliberately avoids anything to do with political considerations in one of the fiercest political debates in British history. The report could face some opposition at home if the dispute resolutions are too similar to the ECJ, as well as disapproval of any arrangement which is seen to bind the UK to the EU after Brexit.
Yet perhaps more importantly, the 27 nations of the EU need to be on side for proposals to gain any traction. The report suggests the language of the Single Market Directives could be used for some parts of the deal. However, that might be seen in some quarters of the EU27 as an attempt to secure the benefits of the Single Market, without keeping to the four “pillars” of the bloc – an approach which has been explicitly and repeatedly ruled out.
The IRSG already has the implicit backing of some of the City’s biggest firms – both London- and EU-headquartered – but from today the authors have the unenviable task of a roadshow across Europe to try to build support for an entirely new way of doing business with the UK.