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The British proposal

The British proposal, put forth in the speeches made by Theresa May on March 2 and by Philip Hammond on March 7, is based on full alignment of the UK and the EU’s financial regulations as of the date of withdrawal. This would allow the UK and the EU to agree to free access to their respective markets under the principles of mutual recognition and reciprocal regulatory equivalence. Such a framework would cover all financial services and issues.

The proposal recognizes that the United Kingdom will recover its legislative sovereignty and therefore foresees the consequences of potential future regulatory changes in the UK: if the outcome of any new rules breaks the equivalence, there would be “reasonable and proportionate” consequences.

The British even offer special “mutually satisfactory” treatment for the supervision of major clearing houses in London that conduct euro-denominated activity which may translate into greater safeguards to avoid future regulatory nonequivalence.

The United Kingdom would leave the EU’s supervisory agencies but would continue to work closely. The entire system would be based on a proper governance structure and feature independent dispute resolution mechanisms, as well as sensible notice periods for authorities and market participants.

The European response

Not only did President Donald Tusk leave aside the topic of financial services in his March 7 draft guidelines, but also, on March 8, he rejected Phillip Hammond’s proposal and reproached him for attempting to define what is in the EU’s best interest. The European Parliament’s resolution of March 14 on the framework of the future relationship confirmed the end of passporting in financial services and of branches in the EU under UK supervision. It also stressed that decisions on equivalence will continue to be of a unilateral – and not reciprocal – nature and that safeguarding financial stability will require carve-out and limitations in the cross-border provision of financial services.

The European Council’s definitive guidelines have not softened the position put forth by President Tusk and the European Parliament. In terms of trade in services in general, the guidelines merely cite the aim of allowing market access to provide services under host state rules, including as regards the right of establishment. However, such market access will only be to the extent consistent with the fact that the UK will become a third country and the Union and the UK will no longer share a common regulatory, supervisory, enforcement and judiciary framework.

Any mention of financial services is conspicuously absent, and the guidelines’ express reference to the predominance of host state rules clearly goes against the mutual recognition and regulatory equivalence system proposed by the UK. The guidelines include the call by the European Parliament to safeguard financial stability and regulation in the Union, which presages that more restrictions will be placed on financial services than on other services.

The transition period and necessary adaption

The broader definition of the transition period to be set out in the withdrawal agreement also reveals when the United Kingdom will leave the single financial services market, namely January 1, 2021. Until then, the UK will continue to be subject to all EU acquis, including any new rules passed in the interim.

The consequences are many, and they run deep. In February 2018, the European Commission issued a battery of notices to stakeholders, warning of the repercussions in each financial services segment. Firms must finish up their adaptation processes and even bear in mind that there is no certainty yet that the transition period will be agreed.

Can all this be undone? In its guidelines, the European Council states that if the United Kingdom were to revoke its rejection of the single market and customs union, the EU would reconsider its offer. However, the British government does not show any signs of changing its stance. The withdrawal agreement has yet to reflect the specifics of the December 2017 pact to avoid a hard border in Ireland, and it is not yet clear how this will be reconciled with the United Kingdom’s withdrawal from the single market and the customs union. However, it would be quite a leap to think that the complicated hard border issue could be enough to reverse the course of the withdrawal and allow for a soft Brexit and, with it, a future relationship that will keep the UK within the single financial services market.