An equivalence ‘deal’ for the City and EU is doomed to fail

The writer, a former member of the Bundesbank board and the ECB’s supervisory board, is a global senior adviser at Oliver Wyman.

There are those in Europe who would be delighted to see the City of London cut down to size and suffer as a result of the UK’s departure from the EU. I am not one of them.

I spent my entire career as an investment banker, working in or dealing with the City of London, before I became a board member of the Bundesbank, where I engaged closely with the Bank of England. As a dual German-US national, I was brought up with an international perspective. I also have a deep affection for the UK. My daughter studies there and I have been honoured by the Queen with an OBE for services to Anglo-German trade relations. 

It is in the interests of both the EU and the UK to have a close and deep relationship in financial services. As Brexit supporters in the UK have pointed out, the City is an important talent pool for EU businesses as well as a source of finance and liquidity. And the City needs good access to the European market, which accounts for a significant portion of its activities.

However, those who believe all this can be achieved via the “equivalence” mechanism, whereby the EU recognises UK financial rules as equivalent to its own and vice versa, are deluding themselves. It is simply not going to work. The UK faces some tough choices soon about the future relationship of its financial services with the EU.

There are many weaknesses in the EU’s equivalence regime, which is no doubt why many in the City argued it was not a viable UK option. That it is now being discussed as the way forward is clutching at straws.

Equivalence does not cover many activities, such as retail banking or insurance. It is inherently political and can be withdrawn unilaterally by the EU at little notice. But the main reason an equivalence deal is not an appropriate long-term solution is because it is not a viable foundation on which to base a business strategy.

Just imagine a big international bank or asset manager, with large numbers of employees in London, telling its board of directors and EU supervisor that it is basing its planning and long-term investment decisions on the shaky foundations of an equivalence ruling by Brussels.

Until now the City has been the production hub for much financial activity in Europe with traders, syndicators and portfolio managers in London servicing their firms’ activities across the EU. This model is now being reviewed in many boardrooms, and EU supervisors are putting pressure on firms to demonstrate that their strategy is still sound. If they cannot, supervisors will probably insist they move activities to within the EU.

The only viable option for the City to retain relatively free access to the EU market is a deep and detailed financial services agreement with Brussels, with contractual commitment on both sides — in other words, a binding treaty. This would require the UK agreeing to stick closely to EU rules, until such a treaty is in place.

I understand the concerns of Andrew Bailey, the governor of the Bank of England and a much-respected colleague from our work on banking supervision, about the problems of the UK becoming a rule-taker for its most important industry.

I also understand the domestic political problems for the UK. Agreeing to stick closely to EU rules would be hard, given that the British have been fed a diet of the beauties of divergence. But without a deep and binding commitment by the UK, I fear a deep rupture on financial services.

Brexit was about taking back control, and it is for the UK alone to decide what route to take. However, I do know what is in the best interests of both the future of the City and the future of financial markets in Europe: a close working relationship built on stable, legal foundations. I hope our politicians are imaginative enough to resolve the political difficulties on both sides.

It should not be impossible. Much decision-making on financial supervision is already taken internationally by groups such as the Basel Committee, to which both the UK and the EU subscribe. Recognised standards that apply across many regulatory regimes should continue as the cornerstone of good, international co-operation. The recent change in the US administration makes multilateral agreements more likely.

To help ease concerns about sovereignty and rule-taking, creative governance structures that oversee the future EU and UK relationship in financial services should be possible. The one certainty is that an equivalence regime is not a satisfactory answer. A binding bilateral treaty is needed instead.