How do you take your Brexit? Soft or hard? Quick or slow? It might all seem semantics but for the UK and Europe it is the £1.1tn question. That is the amount banks based in the UK are lending to the companies and governments of the EU27, keeping the continent afloat financially. The free trade in financial services that crosses the Channel each year, helping customers and boosting the economies in the UK and Europe, is worth more than £20bn.
Brexit means Brexit and we are all Brexiters now. But if we get it wrong, that £20bn trade in financial services is at risk and the public and political debate is taking us in the wrong direction. At the banking industry’s annual conference last week, the atmosphere was, as one of the panelists, Lord Mandelson, noted,
“gloomy”. The government, and in particular the chancellor, Philip Hammond, and the Brexit secretary, David Davis, are making the right noises. The golden rule of negotiations is start big and never ask for less than you want. But we are in danger of talking ourselves into defeat before negotiations have even begun.
There is a consensus that the EU’s integrated financial market is one of its great success stories. It makes it easier and cheaper for French farmers, German manufacturers and Italian fashion designers to secure funding. It helps EU citizens get better returns for their savings. And it also creates jobs, not least in the UK, where financial services as a whole employs more than a million people, two-thirds of them outside London.
But it is now at risk. It is underpinned legally by the “passporting” system enshrined in EU legislation, which allows banks based in the UK to sell services to customers in Europe, and banks based in Europe to sell services to customers in the UK, and access the global financial center that is London. It also allows banks based in one EU country to set up branches in any other EU country without going through local regulators.
Banking is probably more affected by Brexit than any other sector of the economy, both in the degree of impact and the scale of the implications. It is the UK’s biggest export industry by far and is more internationally mobile than most. But it also gets its rules and legal rights to serve its customers cross-border from the EU. For banks, Brexit does not simply mean additional tariffs being imposed on trade – as is likely to be the case with other sectors. It is about whether banks have the legal right to provide services. As an industry, we have asked for some form of that passporting to continue once we leave, enabling customers on both sides of the Channel to continue getting the services. But in European capitals, and among British Eurosceptics, the rhetoric is hardening. The European council president, Donald Tusk, told Theresa May at her first EU summit last week that she was entering a
“nest of doves”, but these are clearly doves that can growl. The French president, François Hollande, said a few days earlier that the UK has to
“pay the price” for leaving the EU. Other European leaders have said we have to give up passporting if we don’t want freedom of movement of people (even though there is no rational link between the two policies). Other voices in Paris have gone further, insisting that it must be made as hard as possible for banks based in the UK to serve customers in Europe.
On this side of the Channel, some high-profile Brexiters have poured scorn on the idea that we need passporting at all and that “third-country equivalence” will do. But the EU’s “equivalence” regime is a poor shadow of passporting; it only covers a narrow range of services, can be withdrawn at virtually no notice and will probably mean the UK will have to accept rules it has no influence over. For most banks, having equivalence won’t prevent banks from relocating their operations. It is understandable that other European cities want to attract jobs from London. Delegations from Frankfurt, Paris, Dublin and Madrid are all coming to the UK to pitch to bankers. I am pro-competition and long may they try to make their labor market and fiscal policy more attractive to international investors.
That is not the problem. The problem comes – as seems increasingly likely, judging by the rhetoric – when national governments try to use the EU exit negotiations to build walls across the Channel to split Europe’s integrated financial market in two, in order to force jobs from London. From a European perspective, this would be cutting off its nose to spite its face. It might lead to a few jobs moving to Paris or Frankfurt but it will make it more expensive for companies in France and Germany to raise money for investment, slowing the wider economy.
“Most international banks now have project teams working out which operations they need to move.”
Banker colleagues in other EU countries all agree that disrupting the free trade in financial services would be self-inflicted damage. The top regulators in the UK and EU also agree that we must retain the integrated financial market. If we left it all to the regulators, we would have a relatively quick and rational economic solution. But politics trumps economics and it will be the politicians who decide. They seem keen to enter what will in effect be anti-trade negotiations. Normally in trade talks you start with barriers and each side negotiates to reduce them in order to increase trade. Here, we start with virtually no barriers and the negotiations will be about which barriers to put up. This economic irrationality is highlighted by the fact that while the EU27 governments are trying to reduce trade barriers with the US and Canada, they want to put up trade barriers with their biggest trading partner, the UK.
The political process also makes it difficult for business. Trade talks between the UK and EU will take years to agree and more years to ratify. In big trade talks, nothing is agreed until it is all agreed, normally at three in the morning. In the meantime, we will have left the EU in 2019.
The real challenge for business was not the day after the referendum – it will be the day after we leave the EU. For banks, there could be a cliff edge, with passporting rights suddenly disappearing and nothing to replace them. Much of the £20bn a year cross-Channel trade in financial services will be thrown into, at best, legal doubt; at worst, it will just become illegal, with banks losing, overnight, regulatory approval to provide services. There is a real risk of disruption to Europe’s financial markets. That is why we have asked for transition arrangements, to ensure an orderly change-over to whenever the new trade deal comes in.
But businesses can’t wait to the last minute. It takes years to move operations. Banks might hope for the best but have to plan for the worst. Most international banks now have project teams working out which operations they need to move to ensure they can continue serving customers, the date by which this must happen and how best to do it. Their hands are quivering over the relocate button. Many smaller banks plan to start relocations before Christmas; bigger banks are expected to start in the first quarter of next year.
London will survive as a global financial center. Finance is inventive and will find a way through. But putting up barriers to the trade in financial services across the Channel will make us all worse off, not just in the UK but in mainland Europe.