UK/EU financial services after the UK’s exit from the single market– the story so far

Introduction

This is the first in a series of articles looking at the regulatory framework for UK/EU financial services after the UK exits from the EU’s single market. Following the UK’s departure from the EU last week, the relationship between the UK and the EU is now governed by the Withdrawal Agreement. This provides for a transition, or implementation, period[1] to the end of 2020. At the end of the transition period, the UK will cease to be part of the EU single market.[2]

If the planned UK/EU free trade agreement is successfully negotiated and takes effect at the end of the transitional period (and covers financial services as envisaged under the political declaration), the new framework for UK/EU financial services will be made up of:

1. The UK/EU free trade agreement;
2. The regulatory regime in the host state – partly derived from common EU regulation but with key areas left to differing domestic law;
3. Improved access and other mutual recognition benefits resulting from any EU/UK ‘equivalence’ decisions; and
4. Any transitional measures intended to smooth the impact of exit from the single market (either unilateral or bilateral under the free trade agreement).

We will look at each of these in more detail in our second article ‘The new framework for regulation’ later this week.

The political declaration plan for financial services

Background - The City’s ambitious plans ‘pre-Chequers’

EEA membership (or the equivalent) was never going to be a long-term solution for the UK. It would have been extremely difficult for the UK to regulate a major global financial centre as a pure rule-taker from EU institutions from which the UK was excluded. It was therefore unrealistic to think the UK could maintain single market-level mutual recognition, such as passporting, across all sectors including retail markets.

The City had hoped that the Government would seek treaty-based (preferential) mutual recognition with the EU. This would have been much reduced compared with the single market but would have gone beyond the scope of the EU’s limited and patchy third-country equivalence provisions and would have been on a more secure legal basis.

Mrs. May dashed these hopes when she adopted her ‘Chequers’ White Paper. This sought to solve the Irish border issue with a quasi-single market/customs union relationship in the goods sector. The price for this objective, was acceptance of the EU’s demands for a third-party relationship in financial services with no preferential mutual recognition or deference. The UK’s proposals for financial services were further watered down during the negotiation of the political declaration text which Mrs. May agreed in late 2018.

When Mr. Johnson came to power, he abandoned Mrs. May’s plans for the goods sector. Without her ‘bifurcated approach’, it would have been possible to look to ‘improve’ the political declaration text on financial services. To this end, draft amendments were prepared for the Government[3]. These amendments, however, never found their way into the political declaration text (either because Mr. Johnson did not wish to signal a move towards EU norms or because the EU refused to open that part of the package for renegotiation). A revised political declaration, and Withdrawal Agreement, were agreed by Mr. Johnson in October last year but the text on financial services remains word for word as agreed by his predecessor back in November 2018.

The role of the political declaration text

The political declaration text can best be seen as a set of non-binding heads of terms for the final free trade agreement. It has specific provisions on financial services and the broader services sectors. The EU has recently spelled out the political declaration text approach to financial services in one of its briefings[4]. The May negotiations with the EU appear to have been consumed by the Withdrawal Agreement itself, and, only a week before negotiations were concluded, a draft political declaration text was published which was very sketchy and brief. A longer version was hastily concluded over the following week.

The drafting of the political declaration text is highly political, and it contains a variety of styles and drafting:

• Some text is vague and aspirational. For example, ‘The Parties are committed to preserving financial stability, market integrity, investor and consumer protection and fair competition…’;
• Some text reflects agreed objectives. For example, ‘The economic partnership should through a Free Trade Agreement ensure no tariffs, fees, charges or quantitative restrictions across all sectors’ - but, of course, the demands of each side before agreeing that objective are not set out. The EU, for example, is now starting to emphasise the link between level-playing field provisions and tariff free access.

The political declaration text also reflects areas where agreement has already been reached, including limits on what is, and is not, ‘on the table’ for negotiation. This is particularly relevant to the text on financial services.

The four key points from the political declaration text are set out below (in each case, the text in italics is taken from the political declaration text and the EU’s recent explanatory presentation (our emphasis)):

1. No treaty based mutual recognition – a third-country relationship:‘The arrangements should include provisions on market access and national treatment under host state rules for the Parties' service providers..’ ‘This is without prejudice to the Parties' ability to adopt or maintain any measure where necessary for prudential reasons.’
2. Free trade agreement chapter on financial services – to improve on multilateral World Trade Organization commitments but subject to a regulatory override (a broad ‘prudential carve out’): “Wide prudential carve-out – keep ability to adopt or maintain any measure for prudential reasons.”
3. Structures to promote regulatory cooperation on a strictly ‘voluntary basis’: ‘While preserving regulatory autonomy,….. a framework for voluntary regulatory cooperation in areas of mutual interest,….. ‘‘Preserve the EU’s regulatory and supervisory autonomy. Key elements

• Cooperation will be voluntary….’

‘..a framework for voluntary regulatory cooperation in areas of mutual interest,..’

‘This cooperation should be grounded in the economic partnership and based on the principles of regulatory autonomy, transparency and stability’

• Any regulatory equivalence decisions to be on a strictly ‘autonomous’ basis and remain a trade policy tool:

“while respecting the Parties' regulatory and decision-making autonomy, and their ability to take equivalence decisions in their own interest.”

The text on financial services was a disappointment for supporters of the City’s pre-Chequers plans. In effect, it accepted the EU’s opening demands for a strict third-party relationship, removing all single market mutual recognition and reverting to host state regulation, whilst leaving the EU free to use ‘equivalence’ as a trade policy tool in its relationship with the UK. On the other hand, those who were opposed to the UK becoming a rule-taker – i.e. being tied too closely to EU regulation (which was the chief concern over the City’s original proposals) - were relieved to see that the EU’s hardline had won the day.

With so much already agreed, it should be relatively easy to negotiate the full financial services chapter and annexes for the free trade agreement itself. There is, however, considerable uncertainty over the outcome. There are risks that the UK leaves the single market (whether at the end of this year or after an extension to the transitional period) without a free trade agreement to replace single market arrangements or with only some free trade agreement provisions being in force or with an free trade agreement that does not cover financial services. Whilst the political declaration text makes provision for each side to conduct equivalence assessments, there is no certainty as to precisely what, if any, EU equivalence decisions (or the terms or basis of any such decisions) will be in place at the end of the transitional period. We shall explore these risks in later articles.

[1] The transitional period is of course not a transition or implementation period but is deliberately mis-named to meet UK political concerns. It is a period for negotiation (of the UK/EU FTA/treaty and to enable the UK to negotiate with non-EU countries).

[2] Under the UK’s withdrawal legislation –the European Union (Withdrawal) Act 2018 and the European Union (Withdrawal Agreement) Act 2020 - this date is referred to as ‘IP Completion date’.

[3] By the Alternative Arrangements Commission – see their 2019 Draft PD (2/9/19).

[4] European Commission slides. This is one of a number of presentations/slides recently published by the EC as part of the process of agreeing the negotiating mandate on the EU side.