Ongoing harmony and goodwill between the UK and the remaining EU 27 will be essential. Not simply to assist the securing of a mutually optimal Brexit deal, but in order that continental cooperation persists during the uncertain, turbulent economic and diplomatic times ahead.
In late November, Bank of England governor Mark Carney rightly warned Brussels that the City of London’s status as the EU’s major global wholesale financial markets hub increased the risk of disruption to services provided to the European real economy if Brexit were rushed.
Funds raised by City-based banks from global investors are critical in promoting economic activity throughout the continent; it is at least as much in the rest of the EU’s interests that there is an orderly transition as part of the Brexit negotiations giving continued access to City expertise and services. Charged as our central bank is with maintaining financial stability, Carney understandably sees a transitional arrangement for financial services extending into the next decade as important to uphold the EU’s broader financial capacity.
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Continued Eurozone upheaval and the seemingly perennial struggle to boost its weakened banking sector, especially in Italy, may yet fuel contagion and result in the rapid withdrawal of funds at this critical moment from overseas. But make no mistake, such an outcome would also ramp up the risks to our own domestic UK economy as a result of our continental trade and financial interdependencies.
Politically, however, a move to reinforce stability may prove impossible. Some Brexiteers now regard a transitional deal, even one limited to financial services, as a Trojan horse for delay in exiting the EU. According to this view, unless the UK has conclusively left the EU by 2020, the next General Election will essentially become a proxy second referendum.
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The arrival of President Trump is widely expected to herald a plan to hike US government spending and slash taxes. Conventional economic theory suggests that a sharp rise in US interest rates would then be on the cards.
However, the new US administration might have a more fundamental impact on the Brexit negotiations in the financial services sphere. For all the speculation that UK finance jobs will migrate to other European financial centres (and some euro-denominated business will surely continue to do so), by far the biggest threat to the City from a suboptimal Brexit deal comes from New York.
During the weekend following the US elections, I participated in a global finance conference attended by over 20 re-elected US congressmen. It was clear from Republicans and Democrats alike that the Trump administration has repeal of the Dodd-Frank Act in its sights as an early priority. This financial services overhaul from the first Obama term is widely regarded as an over-complicated regulatory reform which has resulted in US banks becoming too risk averse in their domestic lending policies to the detriment of small and mid-sized US business.
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Regulatory arbitrage of this sort will only make Wall Street even more competitive against a City of London already grappling with the challenges of Brexit. It could prove a game-changer in what promises to be a protracted negotiation process with the EU 27 over passporting, equivalence and Single Market access arrangements.
It is also worth recalling that, in contrast to the gridlock of the past six years in Washington, the US political process may now move quickly as the Republicans hold the Presidency and both Houses. Where there is a will, there should now be a way. If the dismantling of Dodd-Frank enables US banks to liberate themselves from overly strict capital requirements, they will be well positioned to attract business from London. The City may fast discover that protracted discussions with the EU 27 about future coexistence within Europe hinder its ability to compete effectively with New York.
In truth the current equivalence regime, for example, fails to cover banking, retail brokerage or lending. Likewise any disputes arising out of a future equivalence arrangement between the UK, outside the EU, and the EU 27 will require adjudication by the European Court of Justice – something that our Prime Minister has specifically ruled out for the UK in the post-Brexit era.
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If, as some suspect, the EU Commission attempts to play hardball against the departing UK over financial services arrangements at the same time as New York is liberated from the shackles of overly-rigid compliance and regulation, the clamour for a quick-fire exit will only grow louder.
Moreover, the political pressure on US banks across the globe to onshore employment back home will become ever more acute if the new administration radically reduces levels of corporate taxation to become much more competitive with the historically low rates here in the UK.
Indeed, if a future deal over equivalence is only available under strict conditions or with a time delay, especially in the near certain event that the Eurozone plunges into fresh crisis, it will become ever more difficult to make the case that the national interest is best served by a painstakingly pragmatic negotiation over the financial services sector.