With the UK having left the EU on January 31, one uncertainty has been traded for another: the post-Brexit UK-EU relationship, which could take years to stabilise, writes Justin Pugsley.

What is happening?

Following a UK parliamentary vote on January 9, the UK will leave the EU on January 31. If prime minister Boris Johnson sticks to his guns, the transition period will end on December 31. In theory that means a completely independent UK. 

Unlike his predecessor Theresa May, Mr Johnson has a strong electoral mandate to pursue his vision, and, for the first time, EU Brexit negotiator Michel Barnier may face genuine opposition. 

Reg rage anxiety

There is little time to forge a ‘comprehensive’ relationship, though the two sides have been talking about this for more than three years, and begin from a position of regulatory alignment. 

However, the City of London is concerned that this rush to leave might result in a no-deal Brexit. 

Some bankers are hoping Mr Johnson, with his sizeable parliamentary majority, will opt for a ‘soft’ Brexit and agree to most of the EU’s demands, meaning a quick deal can be struck.

Though stances can shift, the language coming from the UK government suggests that it wants to escape the EU’s clutches. And whereas the EU demands ‘dynamic’ alignment on rules – that is, for the UK to follow Brussels’ lead – the UK wants divergence. These are difficult positions to reconcile. 

Why is it happening? 

For the EU, the loss of the UK, one of its biggest financial contributors and strongest economies, not to mention home of Europe’s most important financial centre, is a fraught situation. If the UK thrives post-Brexit, other EU members states might also depart. The bloc is already trying to cope with some unruly eastern European states. 

Therefore, there is little incentive for the EU to be agreeable, unless the UK leaves in name only. 

On October 13, 2019, German chancellor Angela Merkel said that a post-Brexit UK would be a potential competitor to the EU alongside China and the US, hence EU demands for a level playing field in exchange for better market access. 

The bloc fears the UK may go on a deregulatory bender, which seems unlikely, but it could tweak its regulatory regime to be more effective. 

Indeed, the UK wants equivalence rulings allowing access to the EU’s financial services market to be based on the outcomes of the rules rather than the letter. Globally, the EU is in a minority as most countries view outcomes as a better basis, allowing them to make rules that fit their circumstances. 

However, regulation is one of the EU’s proudest exports, so there is little scope for change there. 

What do the bankers say? 

Most bankers hate Brexit. The split will create two sets of reporting, regulations and cost centres within their European operations, plus a great deal of extra uncertainty. 

Naturally, most want the UK to closely mirror the EU’s regulatory framework: less divergence means less fragmentation.

However, departing Bank of England governor Mark Carney, a Brexit critic, recently told the Financial Times that the UK must have the freedom to set its own rules. 

In the long term, he is correct. The most the UK will ever be offered by the EU is equivalence rulings on certain financial sectors, which can be swiftly withdrawn. And in the long run it would be dangerous to the City for rule-making to be outsourced to another jurisdiction, which does not have its best interests at heart. 

Will it provide the incentives?  

As much as some in Europe would like to freeze the City of London out of EU financial markets, the bloc cannot do so without damaging its own economy. 

Fortunately, both sides have made preparations for a hard Brexit, covering vital areas such as clearing to avoid a financial crisis. 

What will probably emerge is a bare-bones agreement followed by a patchwork of temporary sector specific deals, as happened with the EU and Switzerland. 

But like with Switzerland, the EU will probably then want to tie those up into one overarching agreement. 

This means much wrangling between the two as the UK tries to plot a new course in the world while untangling itself from the EU with minimal damage. The EU, meanwhile, will want to keep the UK as closely tethered as possible with a mixture of threats and economic temptations. It is a tension which will take years to resolve, and could at worst become permanent. 

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