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Deal or No Deal, There is Hope for the British Banking Industry

BREXIT - The United Kingdom departs from the European Union.

Those who were in the UK during 2016 might remember the Remain campaign’s repetition of John Donne’s adage “No man is an island,” referring, of course, to a belief that we fare better together.

That was a sentiment that struck with business leaders too – free trade, free movement, economic interdependence; the lack of which prompted then Prime Minister David Cameron to warn that Brexit is ‘a ticking timebomb’ placed under the UK’s economy.

The slow ticks of the timebomb have played as a soundtrack for four-and-a-half years. They have haunted three consecutive Prime Ministers, on election campaigns, in the House of Commons, and throughout negotiations in Brussels.

As midnight approaches on the 31st December, the ticks may have been eased this week from a breakthrough in negotiations. London and Brussels have reached an “agreement in principle” on a variety of issues.

An agreement in and of principle

Chiefly, Northern Ireland’s border with the Republic of Ireland will remain open. This is good news, to say the least. It rules out the threat that the UK would violate the Good Friday Agreement (the name given to the 1997 treaty which restored peace in Northern Ireland and established power-sharing between Unionists and Republicans), which in turn would have ruled out a UK-US trade deal.

Secondly, it guarantees the status of Northern Ireland, making it a more stable territory for trade and investment. And finally, it makes the UK a far less antagonistic neighbour in the eyes of the EU, which can lead to further economic cooperation down the road. 

The main negotiating target for the British now is that of securing an equivalence agreement, which the “agreement in principle” in part gestures towards.

The EU runs a passporting scheme – this means that if a firm is authorised to participate in financial services by the regulator of one member state, it can do business throughout the rest of the EU.

The UK would need an equivalence agreement for its firms to continue to apply for these passports, which requires the EU to recognise that the UK’s own regulations are congruent enough with its own to allow firms to operate in both territories.

What does this mean for the investment banking industry? 

The Financial Times reported an estimate that should the passporting agreement expire, the British financial services industry could lose up to 35,000 (which may eventually rise to 71,000) of its one million jobs. It is understandable, then, that passporting rights are at the centre of the henceforth negotiations. 

However, New Year’s Day is not necessarily time up for the UK. A report from King’s College found that the difference between any likely deal and a no deal at this point is not significant. Both are, it argued, “likely to be unsustainable endpoints. Over time, both sides will need to get back around the negotiating table.”

Under no deal, the EU may begin by imposing harsher restrictions on UK goods entering member states. But in reality, 80% of the UK’s economic output is in services, and the EU practices equal treatment which means they will have to treat British services in the same way that they treat services from any other non-EU state.

A similar equal treatment policy (this time from the WTO) also affects the UK’s no-deal reality – it won’t be able to offer the EU preferential treatment without a deal. WTO terms provide the base for how states organise trade, but most tend to go further and set up specific trade agreements with allies.

The difference between a deal and a no deal is whether the UK starts from scratch. Either way, the coming decade will likely see consecutive British governments negotiating better trade agreements with the EU. 

Shifting directions

There is an argument that the UK should position itself similarly to Singapore or Hong Kong – taking away any import duties on goods and doing away with border checks.

After the exodus of banking jobs from the UK to (mainly) Dublin, Amsterdam, Paris and Frankfurt, this would give London an economic identity again.

There would be a debate over whether this runs contrary to the ideological arguments used to justify Brexit: on the one hand it places the UK further away from Europe, but on the other hand it is likely to anger those who voted for Brexit out of a dismay for the sort of neoliberal globalism that the EU represented.

The latter constituent might not be too impressed by any possible outcome from the current negotiations.

Nonetheless, the sound coming out of Downing Street is less clear on Britain becoming a North Atlantic Hong Kong: the hope for equivalence on the part of the British government implies continued access to European markets.

The “agreement in principle” suggests Brussels may be giving in on equivalence. The UK’s attractiveness is in foreign direct investments, for which it was a prime market pre-Brexit.

The UK is also a centre for asset management, particularly pensions funds, which are eleven times larger than those owned by German and French asset managers.

This allows the UK to have more leverage in dealing with the EU and, crucially, gives the EU something to look for in its estranged neighbour. 

What next?

Earlier this week the European Commission published its plan should there not be a deal by the end of the month. Amongst other things, road freight and passenger transport will remain open, which should alleviate concerns particularly about the Dover-Calais crossing.

The temporary nature of these plans – just six months – suggests that even if the transition period has officially shut, it will de facto continue.

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The tone from the EU at this point also suggests less hostility. They want a deal done, but one which promises a “level-playing field” between the competitive abilities of British and EU firms.

From Brussels’ perspective, the UK making cherry-on-top demands is them punching above their weight; the view from British-based firms is that they may need this cherry when seeking investment from elsewhere in the world to make them competitive compared to firms in the wider European market.

However, if the EU and UK eventually do agree on a “level-playing field”, the EU is likely to grant equivalence. When the transition period began, the FCA advised that passporting rights will continue for the foreseeable future.

Most of the European Commission’s contingency plan remains ambiguous, but the aim is to mitigate as much disruption as politically possible, with the terms that “the United Kingdom continues to apply sufficiently high and comparable standards.”

Will the UK return to the EU like a boomerang? Almost certainly not. Will it drift out into the mid-Atlantic to become some non-aligned financial services centre? Possible, but there isn’t any signalling from the government for this.

Will it, like the prodigal son, attempt trade agreements with the EU over the coming years? Something which is far more likely.

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