On Monday 11th January The Treasury Select Committee discussed the UK's future economic and trading relationship with the European Union; Bruges Group speaker and friend, Barney Reynolds was invited to give evidence as a witness. Present at the meeting were Select Committee Chairman, Mel Stride MP (Conservative), Rushanara Ali MP (Labour), Steve Baker MP (Conservative), Harriett Baldwin MP (Conservative), Anthony Browne MP (Conservative), Felicity Buchan MP (Conservative), Dame Angela Eagle MP (Labour), Mike Hill MP (Labour), Siobhain McDonagh MP (Labour) and Alison Thewliss MP (SNP). Another witness called as well as Barnie Reynolds was Conor Lawlor, Director for Brexit at Capital Markets and Wholesale.
Siobhain McDonagh MP: I want to look at what the trade and co-operation agreement provides for financial services.The Government summary of the trade and co-operation agreement with the EU states that the agreement includes provisions to support trade in services, including financial services. How far do these provisions go?
I agree with all of that. The reason it is valid to say it is CETA-plus is that there are some commitments on services that go further than CETA, for instance for legal services with the ability to practise under homecountry qualifications in the EU. In financial services and across services generally, there is a general commitment not to require a local presence and to permit cross-border services.
The way financial services regulation works is that, on top of that beneficial commitment, one also needs to navigate the authorisation perimeter and requirements of the EU and the member states. The perimeter of EU regulation requires certain types of financial services to be licensed—it is very complicated which ones, but there are certain ones that require a licence, even if cross-border—when they are provided to local customers. If you want to have a presence, you need to have a licensed branch or to seek authorisation.
There is a commitment to treat that application for a licence pari passu with local applications. It is not nothing, but it is not a full suite of recognitions. Where the EU stands at the moment in financial services around the world is that it has a concept for equivalence in numerous of its laws, including most recently, although it has not been fully activated yet, for investment banking, which would cover an awful lot of what would be cross-border. It has declared equivalent status for various countries around the world, including the US, Mexico, Singapore and so on. It is to be hoped that it will do the same for the UK.The framework in the MoU that has to be agreed by March, as per the trade and co-operation agreement, should provide the packing for that. It remains within the EU's discretion as to whether to grant each and every one of those equivalence determinations and we will have to see how things play out.
Siobhain McDonagh MP: As a layperson, with financial services accounting for about 79% of GDP in 2019, are you not surprised that there is not a fuller agreement, given how important this is to the UK?
You could say that that would have been a big ask for the UK, and I suspect it was. It is clear that France at the very least, and possibly Germany, wanted financial services carved out of the agreement, so you get into a trade-off discussion.Not having been in the room, I do not know whether this outcome was essential, but I would imagine the EU would not move on that. Equivalence determinations made by the EU for financial services around the world are unilateral. They are not subject to commitments to make them, so this would have been a first to get it. It would have been possible to enhance the equivalence arrangements in theory and create a framework around granting equivalence declarations in either direction, but we did not do that.
Siobhain McDonagh MP: Would it be reasonable to say we got fish and they got financial services?
No, because fish is a matter of UK sovereignty anyway and it is UK waters, so the question is access to the EU. The ask for financial services is for something that has not been done by the EU with anyone. The ask, which may still be forthcoming, and there may be an arrangement in due course on this, is for a unique layering on in relation to equivalence. To do that, one would have to apply leverage over the EU negotiations. There may be that leverage through the Eurozone structure and the fact that they need London to manage their risk for the Eurozone, but it is that kind of analysis, which may still play out over the next few months as financial services starts to be dealt with. We will have to see.
Siobhain McDonagh MP: It sounds scary to me. What is the position as of right now if a British bank wants to give a mortgage for the purchase of a property in the EU, sell a pension within the EU or sell an ISA?
Those are retail financial services. Retail financial services within the EU itself are pretty domestic. There is a passporting regime where authorisations in one member state are recognised in others, but an awful lot of those sorts of products are quite difficult to provide cross-border within other EU countries. It is really in the wholesale markets, businesstobusiness, that the passport, which is what you are talking about, has the most benefit.There are equivalence arrangements, in fact, for wholesale and retail that could, in theory, be triggered. We will have to see how that plays out.
Otherwise, you would offer those products from a local presence and that has been done by businesses from all over the world for ages. There are businesses with branches in numerous EU member states offering those sorts of things locally.
I just want to add one point that is relevant in understanding where we are, though.There is something pretty unusual also going on here, which is a mercantilist attempt to control business in financial services. Generally, that is pretty difficult and often has not succeeded historically. In EU law, in recognition of provisions in the treaties that allow EU citizens and businesses access to global capital flows, there is a general concept of reverse solicitation, where businesses and systems are entitled to reach outside the EU regulatory regime and buy financial services and products from abroad, with some exceptions, from businesses that are selling under their own home state regime, protected only by the seller's regulations. That is going to be a key part of the jigsaw puzzle going forward. It would be a very significant thing indeed if the EU was to close that down because of the provisions in the treaty and the general way in which the EU works.
Siobhain McDonagh MP: An awful lot of hospitals would close.
Quite possibly, yes.
Rushanara Ali MP: How do you and your members see this in terms of the overarching numbers, in terms of both jobs and what is lost to the UK economy in relation to the financial services sector?
It remains to be seen. The movement of jobs has settled from the original numbers that were quoted 18 months or two years ago from 100,000 to 7,000. Many firms hired organically in the EU rather than lift and shift EU staff. There may be different requirements in the EU, six, 12 or 18 months from now, that require you, if you have a substantial presence based in the EU, to move some of your board, further operations and further capital and liquidity.That increases the costs of operating for these large institutions.
We are now seeing the beginning of market fragmentation.If you increase the costs of doing business, it is economics 101. Where do those additional costs begin to land over time? Again, this increases the importance of making sure our regime here in the UK is equally attractive and competitive and it maintains UK business.
Rushanara Ali: Barney, do you want to comment on this point about fragmentation and how you see things evolving? Do you share Conor's analysis or do you have a very different take on this?
I broadly share it. I would add a couple of extra points. The reason why the UK is a global financial centre, along with New York, is because of the synergistic benefits of the various services and products offered here, the quality of those services and products, and their pricing and liquidity. In fact, the capital markets shift around to where they get those benefits. The US drove Eurodollar business into London in the 1960s through legal and regulatory measures.
As a general matter, yes, there will potentially be an element of additional cost for service delivery into the EU, depending on EU behaviours, but it will largely involve incurring cost within the EU by EU businesses and consumers.That cost, ultimately, will be resisted by people, because people will want the cheapest services and they will find ways around it. We should not stand still. The EU regulatory regime has itself imposed huge unnecessary cost on business.
Rushanara Ali MP: I am going to move you on to the MoU, because that is the key opportunity through which we can try to build on the trade agreement. Can you talk us through what you would like to see in that MoU, which needs to be agreed by March? Talk through what is vital for members and the wider financial services sector, and what would be nice to have. We have lost passporting. We are going to have to rebuild those things that are missing now in some way. Could you reflect on those?
There will be arrangements anyway for regulatory co-operation. I believe there are good relations already between the regulators. What then is in question is whether we can have more clarity, notice periods, predictability and so on around equivalence determinations. That is the most important thing.There is a political tussle going on at the moment, because the EU is dangling those determinations and saying, "I will only give them if you commit to certain rules in the shape of your future regime," which the Governor of the Bank has rightly rejected. There is something to play out.
What I would layer into the analysis is this. I mentioned Eurozone risk earlier. The UK is the only place in the world where the regulators, and the Bank of England, in fact, mitigate Eurozone risk and have the expertise to do that. The EU creates that risk through a whole swathe of rules, and then does not manage or mitigate it. I do not actually think it can; the costs would be extraordinary. It is mitigated in London, where the EU market meets the global market. A key part of this discussion is going to be how we mitigate that risk going forward. The safest way to do it for the world, and the cheapest way for EU consumers and businesses, would be through an enhanced equivalence deal. We should look to put back in.
Rushanara Ali MP: Do you think we are going to get it or do you think it is going to be difficult, given the points Conor raised? How optimistic do you feel about that happening?
It is the direction of travel. There will be a tussle in the first instance, because I do not know yet that the EU is reconciled to the gravitational forces of financial business, so there will be a period where it tries to see what it can get. Whether they are all behind that, I do not know. That policy, driven by one or possibly two states, is at the cost of businesses and consumers across the EU, so whether the other countries go along with it remains to be seen. That may not happen and they may do it. I am pretty optimistic that ultimately we will get it.
Rushanara Ali MP: Conor, can you pick up on those points? Earlier, George Peretz was talking about the state of constant negotiation that non-EU members have to be in. Is that not the state of our future now, even if we get the optimistic version of that future for financial services vis-à-vis the MoU?
The relationship between the UK and the EU for financial services will continue to evolve, not only because there may be political differences between the mechanisms for market access, but the UK and the EU work at an international and global level as well to set standards. If you can get it right at a global level, and you can agree generally the output and direction of travel as to how you regulate and supervise international wholesale markets, that is a fantastic start.Doing that at a UK-EU level through this regulatory framework thatwould be codified by the MoU would, again, be a fantastic start.
You end up having discussions about equivalence determinations as opposed to having it pulled from underneath your feet at the last minute, because you have re-fostered trust, discussions and dialogue between regulatory authorities. You can talk about rules you are making or evolving at their conception, as opposed to doing it in two completely different contexts and then arriving at very different end zones. As a result of having different rules, the more you differ, the higher your risk of not being able to access each other's markets because you are operating in a very different way.
You asked a moment ago about what matters for our members. Ensuring that we are aligned to international and global standards as much as we can is incredibly important. The MoU is not trivial. It is not in itself a new deal for financial services. It is simply a mechanism that codifies how regulators communicate and speak to each other. For financial services, that is incredibly important.
You can delegate as much power to your regulatory authorities as possible and they can work with each other within the powers they have been given, but both sides really need political will to integrate markets and work together. This comes back to my point from a moment ago. If one party has a very different objective, which might be to move or shift business and to have less of a dependence on the UK, that is going to weigh into your ability to have a fruitful financial services relationship.
I agree with all that. The extra thing to layer into that understanding is that this was going on within the EU and the passporting regime, and increasingly so. There were those who introduced the passport in order to take business from London. There have been all sorts of other attempts to take business from London. There was a constant tussle within the EU on rules. Finally, there was the David Cameron negotiation, where there was a carve-out, because the whole position of the Eurozone is an ongoing problem for the UK as to how it relates to the Eurozone and how we mitigate that risk. That led to a right to renegotiate, which was in flux. The counterfactual is not that different from where we are now. The fact is that the UK, in fact with more power, needs to recut this relationship.
Anthony Browne MP: Barney, if you were the Chancellor, just to promote you temporarily, what would you do, now you have control of financial services regulation in the UK?
I would start by understanding the full implications of the current EU law system that we have inherited. There is a blanket of regulation far more prescriptive than anything the UK would have done on its own, because we have a different way of regulating and making laws. The whole purpose of financial regulation is to manage and mitigate risk, and it does not actually do that. It creates risk for the Eurozone and then does nothing about it. That is where we are now and EU financial regulation operates across the entire sector. That process started basically in 1989 and it has taken 20 years, but we are basically subject to an entire EU law infrastructure.
Scots law is similar to common law,in that neither of them is codified.They are very different from the EU way of legislating and regulating. The EU model basically originates from Franco-German thinking, where you make a rule for everything. You create a code that covers everything and deals with every eventuality, and when you have something new come along, like fintech, you make another rule. You therefore have a permanent staff in the Commission making rules.
We need to go back to our method. Our method is that everyone is presumptively free to do business and do whatever they wish. Then you create laws and regulations for things that need to be restrained, either with liabilities attached or, if something really should not happen, you create rules to say,"You cannot do this particular thing".It is focused on risk. We need to go back to the common law approach.It is a big shift, but it is intrinsically superior. Economic research shows the superiority of the common law to countries that use it for growth.That has been modelled across the whole of the Commonwealth, the US and so on. It also is better in this context, most importantly, for financial services. Notably, all the main financial centres where people come and do business, rather than being forced to by the local mercantilist-type regime, are common law‑based. That is London, New York, Singapore and Hong Kong.
We need to go back to our roots on that and we need to do it very quickly. It is easy to do, but one needs to understand the big difference between how we do things and how the EU does things. Strip away all the unnecessary red tape. Focus in on what we actually need to regulate. Rewrite the rules. EU law is unclear, partly deliberately and partly because of the political processes in making it and the way it is written, and that chills business. People do not quite know where they stand and they go and ask officials whether they are able to do something, applying a purposive method: "Did the law intend me to do it?"
Common law does not work like that. It is self-executing. You write things in a very clear way and then market participants are able to evaluate whether they can do something. If it is tricky, they ask a lawyer and that is it. Then, if you are challenged, you end up in a court process.We need to go back to that. It will mean a little more legalism around a much more limited rule book, but that legalism is key.
The regulators themselves need to be overseen. There is a process within the EU system as to how the regulators operate, with the ESAs and so on, across the EU. That process is highly unsatisfactory. We need to look across the Atlantic at how the Americans do things because there are lessons to be learned there, but the regulators themselves need to be operating under the rule of law in a way that is challengeable and predictable.Otherwise, you get what we have under the EU system, which is regulatory challenge in one direction only, where the regulators challenge the industry, as they have done since the 2007-08 crisis. This is hugely cramping on business activity and there is nothing pushing back in the other direction.
There are two ways of doing that. The most important one, in fact, is your Committee. The Treasury Committee oversees the regulators and it needs to do so on a more US model than we currently have, because we have been operating in the EU architecture with ESAs, the Commission and so on. There now needs to be far more check and balance on the regulators, which they should welcome. They should be writing clear rules. They should be consulting on them and doing cost-benefit analysis.
The other people who come into play are the courts, the judges and the independent judges, which are not found in civil law systems to the same degree. They will then evaluate whether proper processes have been followed and the principles of judicial review should be applied. You and the courts will provide the check that makes the regulatory system operate in a predictable, self-executed way on the common law model; then we will get the economic and financial market benefits for businesses of our traditional system, which we know works. We did not get caught up in the Wall Street crash in the way that the Americans did. We have a very sophisticated pedigree of rule making, law‑making and expertise in that,which is second to none.That is what we need to deploy, but it does mean a big shift.
Anthony Browne MP: That is a very interesting point you make about the role of the Treasury Committee. As it happens, we are going to do a hearing about our role in future financial services regulation. I was just wondering if you could set out how you think we should change our role with regard to regulation. If you could send us a letter setting that out, that would be very helpful. Finally, I have one very last question. I am running out of time, I know. A delegation of UK financial services people went to Brussels recently and met one of the top officials, who said that, in his analysis, it is a race between the EU trying to get more of London's market business and London trying to get more of the world business, and we all know who is going to win that race. Do you share that analysis?
I think I know who said it. No, I do not. We should not get caught up in thinking about this as a battle with continental EU financial centres. In fact, in the last edition of the Global Financial Centres Index, Paris and Frankfurt went down three places in each case, whereas London has solidified its role as equal top. Really, we need to think about financial services differently. We are not a G5 power in financial services; we are a G2 power.
There is a global element. There is an element of truth in what your interlocutor said there, but it is not right that we are racing with the EU. In my view, we are racing back to how we do things very well, on the tried and tested basis that we gave up as the price of the passports.One can debate whether that was a price worth paying, but we did give it up. The way we do things works for financial business and we need to get back to that as soon as possible. That is not a race with France or Germany because they cannot do it. Their system does not support that and the EU one does not either.
Anthony Browne MP: I agree with that. Thank you very much.