The City can and must strengthen its hand to get a successful Brexit deal

The City can and must strengthen its hand to get a successful Brexit deal

Unilateral actions that change the potential outcome for the other side in a negotiation can make your preferred outcome more attractive to them. If the Government rapidly and credibly commits to a pro-growth agenda for the financial services industry, then the EU’s best strategy will be to seek an accommodation with it.

In 1519 Hernán Cortés landed in Mexico with just 600 men, 16 horses and 11 boats. With this small force, he managed to wrest control of the Yucatán Peninsula from the Aztecs where, for many years prior, far better resourced attempts had failed. He did so by burning his boats.

Until then, the Aztecs had been able to view a “no-deal” scenario as one where the Conquistadors could be bruised in battle before retreating to their boats to flee home. Now, however, a “no-deal” scenario would entail a much longer and more costly fight. Cortés had made a big show of burning his boats, so that the Aztecs would be sure to know it. The Aztecs’ “no-deal” pay-off was thus made less attractive and they retreated, setting in motion the Spanish conquest of Mexico.

In our recent paper, Liquidity and Brexit – The currency of negotiation for financial services, the Financial Services Negotiation Forum proposes some less drastic ways that the Government can use a similar approach to improve its negotiating position over financial services.

The paper starts by recognising that the EU is incentivised to compete with the City because the EU prioritises its social and political goals, while the UK is focusing largely on the commercial and economic aspects of the relationship. Put another way, we are negotiating over apples while they are more concerned about pears. This is despite the significant economic costs that would be faced by the EU if the negotiations failed. The effect of this disconnect is compounded as any economic loss for the EU will be dispersed across its citizens and corporates, whereas the impact of a “no-deal” would be more concentrated and noticeable for the UK, given our relative strength in financial services.

However, there are steps that the UK can take to affect the EU’s “no-deal” pay-off and make an accommodation more attractive. The UK’s dominance in liquidity is driven by the network effect (where the value of the network increases with the number of people using it), product availability (and product innovation) and a cost advantage (the result of economies of scale and a deep learning curve). These form a formidable competitive advantage and overcoming it will require, amongst other things, the EU to complete Capital Markets Union (a difficult and time-consuming task even before the UK voted to leave). This will give the UK time to bolster its position. However, in order for any bolstering to influence the negotiation, the Government must act now.

In particular, we noted that:

  • The UK can protect its current position by enabling EU institutions to “fast-track” a presence in the UK in order to maintain access to the liquidity here
  • The F4 Alliance – a proposal from the Swiss Bankers Association to pool ideas and resources across the UK, Switzerland, Singapore and Hong Kong – can be pursued to increase the pool of liquidity and strengthen our negotiating position regarding equivalence
  • A pro-growth agenda (which would include tasking regulators to promote growth alongside their existing responsibilities), accompanied by a tax and regulation regime that reduces barriers to entry for new entrants, will nurture innovation in products and services.

If the British Government rapidly and credibly commits to such an agenda, the EU’s “no deal” scenario is much less attractive to them and an accommodation becomes preferable.

Several potential solutions for accommodation (such as the ‘Triangulation approach‘ proposed by the FSNForum/Norton Rose Fulbright, or ‘Dual Regulation Coordination‘ proposed by the Legatum Institute) have already been mooted. These all ensure that the EU maintains access to the UK’s liquidity while providing it with an enhanced supervisory role in a way that could be acceptable to all parties. The UK and EU will both have been operating under MiFID II for over a year by the end of the negotiations. The practical barriers to an accommodation will be mainly political in nature.

This strategy differs from Cortés’ in one key aspect – there is no burning of the boats. Quite the opposite. All of the steps we mention could have been taken, in some form or other, even without a negotiation to contend with. They will prepare the City for the global challenges ahead, whatever the outcome of the negotiation.