European Scrutiny Committee
Oral evidence: EU Withdrawal, HC 763
Wednesday 6 June 2018
Ordered by the House of Commons to be published on 6 June 2018.
Members present: Sir William Cash (Chair); Geraint Davies; Richard Drax; Mr Marcus Fysh; Kelvin Hopkins; Darren Jones; Mr David Jones; Andrew Lewer; Dr Philippa Whitford.
Questions 380-440
Witnesses
I: Mark Hoban, Chair, International Regulatory Strategy Group; Ronald Kent, Managing Director Capital Markets and Wholesale Policy, UK Finance; and Barnabas Reynolds, Head of the Global Financial Institutions Advisory and Financial Regulatory Team, Shearman & Sterling.
Witnesses: Mark Hoban, Ronald Kent and Barnabas Reynolds.
Q380 Chair: Good afternoon, gentlemen. We will be discussing the Brexit question in terms of trade in financial services. Before we get stuck into the first question, I want to mention that we will be looking at the policy implications of transition for financial services, at the UK proposal for a mutual recognition agreement and so on. I am conscious of the fact that you have all written quite a lot about this, one way or another, and the Government have as well—certainly, Philip Hammond made a speech on 7 March. But on this issue of mutual recognition and the role of the European Court of Justice, we are finding from our sessions that the attitude of the EU is increasingly intransigent. When you cut through all the commentary in the newspapers, one of the things that comes through the whole time is that, at periodic intervals, Mr Barnier will say, “Well, it’s all very well, but Britain wants to have a sovereign relationship and does not want to be a rule taker, and we will insist that we have it our way.” There is a kind of belligerence by Mr Barnier and the EU establishment, which is making life extremely unsatisfactory for negotiations. I want to mention that because, although there may be differences of opinion between the three of you—we will find out to what extent as we go through—none the less, it seems to me that there is an understanding, which is a foundation stone on which there can be some form of agreement.
I want to address the first question to Mr Reynolds. You have written and published papers, which have been seen by various people. I mention those because they are being pushed around in various quarters quite a lot, in the City and elsewhere. One in particular was “The Art of the No Deal”, which you wrote in 2017. There is a more recent one, “A 10-Step Plan for the UK to Prepare for a Cliff Edge Brexit”. The other issue I want to touch on is that, responding to the question of whether mutual recognition can “be easily implemented”, you answered, “Absolutely.” That was on 8 May 2018. You said, “This idea, which I proposed in June 2016, setting out the detail throughout 2017, involves a light-touch international treaty with relatively minor amendments to EU law itself. Alternatively more of the detail can be put into the Brexit agreement, as has recently been suggested.” You have also said that “fears of EU regulation making the honouring of existing financial services contracts illegal” are “misplaced”. The Association of British Insurers and the Bank of England have said that, without a specific provision in the withdrawal agreement, existing cross-border insurance and clearing contracts may not be legally serviceable from 30 March next year. Do you think their concerns are misplaced?
Barnabas Reynolds: I think it is overdone. I think that in order to execute successfully and positively on the potential eventuality of no financial services deal, which as you say, I agree is a realistic possibility, we need to get into the detail and be granular on this, and adopt the right approach. I think there is more that can be done.
On the cliff-edge assertion—the idea that whole markets, and in particular the derivatives and insurance markets, will blow up if there is no deal providing for contract continuity—four very significant areas of law push back against that and override it in certain instances. We need to get into the detail of those laws properly and look through each type of contract at a granular level to sense-check that proposition. What I have found so far is that it is not entirely correct.
On three of those areas, my firm, Shearman & Sterling, has published a note—which I believe you have—setting out the way in which the right to property under the ECHR, which sits above the EU, provides for contracts with a monetary value to continue and to be enforced despite an event such as this.
Q381 Chair: Would you include the charter of fundamental rights, in so far as it applies within the EU?
Barnabas Reynolds: Yes. The charter of fundamental rights does the same in EU law, so you can go to the courts and get that enforced as well. It is part of EU law, and they are subject to it. At an even higher level, as a matter of international law, you have got the concept of acquired rights, on which there is a lot of detailed case law, which does the same thing.
In addition to that, as a matter of English contract law—most of these contracts are subject to English law—there are all sorts of ways in which continuity is assisted in all sorts of contexts. There is a paper that the Financial Markets Law Committee, which is a body that I sit on, has put together, although I don’t know quite whether it has come out yet. If not, it will come out soon. It sets out a lot of the detail on that.
On the specific cliff-edge point—I believe it is a theme to the no deal Brexit—we need to get our sleeves rolled up and to get into the detail of each specific type. We cannot make these high-level pronouncements, because they are just not accurate. In fact, ISDA has made some helpful statements about how it sees its master agreement working.
Then, if I may, on the no deal possibility more generally, what would that mean? It would mean, in principle, that it would be harder for EU-based businesses to service EU clients, but not impossible. Just like anywhere else in the world, there is a perimeter around the EU jurisdiction, but it is permeable, allowing its citizens and companies the ability to reach outside the EU, outside EU law, particularly in the wholesale markets for investment business, and to operate subject solely to the protections of the seller—that is, the UK’s legal framework for UK-based businesses. It is a criminal offence if one gets that wrong, so a lot of businesses would obviously prefer a world where there is no requirement to be so forensic on legal analysis. But it is possible to operate like that, as people do all over the world.
The UK Government, in my view, should help with that. In the EU there are concepts such as reverse solicitation and other perimeter concepts. The French threatened, or proposed, to the other 26 in a paper two weeks ago—I don’t think getting much buy-in, and people might be suspicious of self-interest and trying to get some jobs—to narrow very dramatically the reverse solicitation exclusion, which has traditionally been in domestic member state law, and to remove the ability to recognise the UK under equivalence for own account dealing and underwriting. I would be surprised if that goes through, because it would be very damaging to the EU27 in terms of their ability cost-effectively to access global capital flows in global financial markets.
What can we do to protect ourselves? We can do 10 things. As you mentioned, I have set those out in detail in a couple of Politeia publications, but I think we should be doing things now. In summary, we should remove red tape, and that does not mean lowering standards. We have tied ourselves in a knot on this. The idea that people say “deregulation” and it means “lowering standards” is not what is meant; it means removing red tape and reverting to the traditional UK-law style of approach, which is higher standards, fewer rules. At the moment we are caught by the worst of both worlds: we have the higher standards—we are accused of gold-plating—and we have the vast blanket of EU rules that are highly prescriptive. We could strip back a lot of that, because the reason for the phenomenon is that the EU does not really have a true federal regulator; it seeks to federalise through rule-making, so it writes instruction manuals for all the regulators, particularly ours, on how to operate.
We should strip all of that away, but also remove, or reverse out of, the EU’s purposive method of interpretation, reverting to the UK’s tried and tested method, which is a literalist method—we draft something, people interpret it, it is clear what it says and, if the country or the regulators miss something, they write a new rule. That is prospective, not retrospective. The EU method bakes in officials, because it allows officials to make suggestions and pronouncements as to what those purposes are ex-post. That effectively bakes them into a sort of dialogue and actually crimps entrepreneurship, enterprise and dynamism. So I think we should be doing that now.
In relation to the monetary system, after the war we convened all sorts of people in Bretton Woods in New Hampshire to look at the laws. I think we should do the same again here and in other areas of our industry and the law, to revamp things.
Then I would help industry to move to no-move practicalities. You get out of the new law entirely if you are servicing UK subsidiaries or presences of EU businesses. I suggest we facilitate that by setting up a business—or the Government can do it—helping EU customers come to the market. That is how financial services have worked for the last 400 years, including in the UK. There is a passport, which is the issue we are solving for, which did have some benefits from our time in the EU. The passport only came in, in full effect in this context, in 2007. The idea that the position of the City is dependent on it is just wrong, and we need to assist people back to the traditional way of accessing the global capital flows.
Third—UK market infrastructure. An awful lot of trading and clearing happens on infrastructure here, and we want to make sure that you can trade in EU products and clear EU products here by setting up look-alike products—which is done round the world on platforms—in London that look like EU products, so that, actually, businesses do not have to touch the EU if the EU ends up being difficult about access to its platforms.
Q382 Chair: Can I just ask you a question regarding other people that you talk to around the world? We are talking here about one of our most important exports, and the financial services in the City are central to a lot of our prosperity. What reaction do you get when you speak in other parts of the world along the lines that you have just been describing to us?
Barnabas Reynolds: People are positive. I think a lot of businesses would prefer a deal, and we should come on to exactly what that should look like to be a win-win—a win for us as well as for the EU. People prefer not to have to grapple with this level of change. If we are forced into it, I think people understand what it means, to a degree, but we need to take a bit of a leadership role in assisting with that thought process, because it is a significant shift to happen quickly in basically the equal-top financial centre in the world.
Q383 Chair: Could I turn to the other two witnesses and ask them to comment on what they have just heard? Mark Hoban, what is your view?
Mark Hoban: I speak on behalf of the International Regulatory Strategy Group, a body that is co-sponsored by the City of London corporation and TheCityUK. It is cross-sectoral; it covers banking asset management, insurance, market infrastructure, lawyers, accountants. All the businesses that support it are UK-based, but they are headquartered globally, and its reports represent a broad consensus of views across the sector.
The challenge that we were set, Sir Bill, when we voted to leave the EU, was to work out what is the basis on which the UK could access the EU27 post Brexit, and on what basis EU27-based businesses would access the UK. The starting point of that work was to look at what are the alternative routes of access. Clearly one of those is the third country regime or equivalence, where we identified a number of failings, which made it unsuitable to support the level of business that we currently have.
We also looked at some of the proposals that Mr Reynolds suggested, such as reverse solicitation. The view of the members of the IRSG was that that was insufficiently robust to support the continuation of business, which is why we proposed a mutual recognition deal, which is core to the Government’s ask for financial services post Brexit. So what we want to see is a robust basis on which cross-border trade can continue at the same sort of levels as we see now, across the same products and services; and we do not believe that either the existing third country regime or some of the workarounds that Mr Reynolds has suggested provide a robust basis for that.
Q384 Chair: But you would certainly concede, I imagine, that if you leave the European Union you leave the treaties, you repeal the ’72 Act under the withdrawal Bill, and you then are out of the obligations and rights, and the treaties, and also, for that matter, the European Court of Justice. So how do you respond to Mr Barnier’s belligerent assertion that, actually, you have to do it their way because they have got their rules, and their acquis is sacred, and therefore nobody can do anything which interferes with their way of doing things? Do you have a response to that?
Mark Hoban: I do, of course, because we deal with this, and I have spent a lot of time in Brussels over the course of the last 18 months talking on behalf of these proposals. Absolutely, your first point is obviously correct: we will leave the EU. That means that we will leave the single market, and the passport will no longer apply. We were very quick to recognise that the passport would no longer be the basis on which trade would continue. We are arguing that both the UK and the EU27 can operate autonomously.
Q385 Chair: In parallel?
Mark Hoban: Exercising their sovereignty and developing their own rules. We are focusing on access to each other’s markets based not on the detail of rules, but on achieving the same regulatory outcomes. That does not impinge on the sovereignty of either the ECJ or the UK court system. It does not stop the European institutions developing their rules, nor the UK Parliament and regulators developing their rules. It focuses on achieving the same outcomes, in the same way that the driving test in Stafford is very different from the driving test in Strasbourg but you can still drive on the roads of both countries. The tests may be different, but the outcome is still the same. That has been a very important part of the way that we have sought to structure our proposals—that we ensure that they meet the red lines of both sides. Therefore I do not believe that the views expressed by Mr Barnier in critiquing our proposals are valid.
Q386 Chair: But they do not seem to be very interested in the notion of mutual recognition, do they?
Mark Hoban: I think, Sir Bill, that there is variation here. The Commission, in all its proposals so far—you see this across a whole range of sectors, not just in financial services but in others—are articulating the status quo: what the regime is for a third country, whether in defence, financial services or data. That is the basis on which they have started the negotiation.
We spend a lot of time talking to member states that have similar interests to us in terms of financial services and that are engaged in the detail of our proposals and interested in seeing a system in place that can ensure that consumers in both the UK and the EU27 continue to benefit from cross-border trade. So the Commission is absolutely strong on the defence of the status quo, but I think the member states’ views are more varied.
Q387 Chair: That is very interesting. Mr Kent, would you like to comment as well, please?
Ronald Kent: Thank you. Let me start by saying that UK Finance represents about 250 members who are all the international—North American, South American, Asian, Chinese, African, European, and also UK. These are financial institutions that serve European citizens, in the UK and across the rest of the continent and internationally, and that make the UK a global financial centre. We hope that we bring a perspective to the conversation that represents lots of different parts of the planet, all trying to serve customers.
To answer the two themes that have been touched on, the best outcome for those customers would be to put in place an arrangement between the UK and the EU that allows financial services to be provided to customers in both locations, in the broadest manner politically and economically acceptable. The mutual recognition model that Mark has outlined and that we have also looked at allows you to do that.
To pick up on one of your themes, Sir Bill, notwithstanding what Mr Barnier has said, I would pick him up—very politely—on two things.
Chair: I wouldn’t bother too much, because he has been pretty rude to us.
Ronald Kent: I always try to be polite to Mr Barnier and others. First, he has said that it is not possible to include financial services in a free trade agreement of the sort that is likely to encompass the long-term future arrangements between the UK and the EU. That, as a factual matter, is not the case. There are financial services chapters in free trade arrangements. Those that exist historically are not nearly broad enough to encompass the needs of both the EU27 and the UK, reflecting the fact that the UK is a financial centre.
Interestingly—the second point I would politely pick up Mr Barnier on—the EU itself has put forward, in the context of a treaty that was proposed but did not happen, TTIP, an ambitious financial services chapter that, at the end of its evolution, would have put us in a place not dissimilar to the mutual recognition model that we and Mr Hoban have suggested. The better outcome is achievable, notwithstanding the orthodox positions that, I agree with Mr Hoban, are being set out as the initial negotiating positions. Similarly, when we spend time on the other side of the channel and start to unpack how that works, particularly in the member states, those are very interesting and constructive conversations.
To go to the opposite extreme, if there ends up being a no deal outcome—we hope that will not be the case, but we agree with Mr Reynolds that it is a possibility that one must prudently look at—our members have also looked at a number of the suggestions that Mr Reynolds has put forward in his 10-point solution. Some of them are certainly interesting; for example, the UK-based treasury function that Mr Reynolds alluded to already exists. A number of our members’ largest EU27 corporate industrial customers have their treasury base in the UK and in other financial centres in the world, specifically because they are very sophisticated wholesale market users and they want access to that market. But that is very much the minority. If we are trying to look at making those the mass-market solutions, whether that is treasury functions or reverse solicitations, they are at best compromises, and very substantial compromises, to the better outcome.
Chair: Thank you very much. I would like now to move on to the question of the potential consequences of a no deal cliff edge. These would be delayed by the proposed transitional arrangements, which I am now moving on to, but in return we would be expected to continue to apply EU law after we are no longer a member state. I have to admit that, as a constitutional lawyer, I have enormous difficulty with the concept that you carry on with something that you have already disbanded, but there we are. The Prime Minister told Parliament in October that the length of the EU's legislative process means that the UK will have been able to indicate whether it approved of rules that come into force during transition. Richard Drax, would you like to ask the next question?
Q388 Richard Drax: Good afternoon, gentlemen. Are there any new or pending EU rules for financial services where the industry is of the view, “This is not a rule we wish to sign up to”? For example, what is your view of the pending proposals that target the UK’s clearing industry for derivatives?
Mark Hoban: Sir Bill has clearly indicated part of the challenge of this, which is that we are subject to EU law through the transition period, at a time when EU law is likely impossible to change. One of the points we can take comfort from is that the UK has engaged significantly in the items that are currently under discussion. There is some question as to how many additional instruments can come forward, given that we are coming to the end of this mandate and therefore the power to initiate is disappearing from the Commission, and given that we will only have got to the very early stage of the next mandate by the time we get to December 2020, assuming that that is the point at which the transition period ends, in line with the statements the Prime Minister has made.
It is a dilemma for us. We need to continue to engage. I know that institutions have engaged on the review of CCPs and investment banks, and on the instruments you have referred to. There is a question about whether these will be agreed before the end of this mandate; certainly the decision date for CCPs looks to be receding somewhat into the distance, so maybe the Commission and the institutions do not get round to concluding those. People are very heavily engaged in those conversations, and see potential parallels for the future relationship.
Q389 Chair: May I ask you a question on the procedural front, regarding the manner in which the laws are made? You are familiar with the European Scrutiny Committee. You were a Minister here in this Parliament, and you know all about this. The Council of Ministers makes decisions that are legal and binding on us under sections 2 and 3 as soon as they are made. In addition, they are made behind closed doors, largely by consensus. If we are not even involved in the process, how do you evaluate the extent to which, in the more limited context that you just described, we would be able to have any influence of any kind? At the moment we are out-voted by effect of the consensus arrangements, so to what extent do you think we are going to be able to have any significant influence on things that are in the pipeline?
Mark Hoban: You raise an important question. This will affect whatever the relationship is between the UK and the EU27 post Brexit as well—it is not just a matter for during the transition process. The message I have relayed to colleagues in the industry is that we may not have a vote, but we should certainly make sure that our voice is heard in this conversation with Brussels. We cannot stop our engagement with the European institutions.
Q390 Chair: May I make a wild suggestion, which is that they might even have a transcript of the proceedings, for a change? When you are legislating, it is quite useful, to say the least—I am being sarcastic—to have Hansard, which shows you what was discussed, who said what, what their accountability was, the voting that took place and how that played out. Are you in a position to comment on that? Would you regard it as satisfactory to have a transcript?
Mark Hoban: My recollection of those processes from when I engaged with them varies. Certainly, when I attended ECOFIN to deputise for the then Chancellor, I cannot recollect if a vote even took place—it was done by consensus. A large number of those meetings were televised; I may have even been sufficiently anoraky to watch one or two of them. Other committees operate differently. At the EPSCO, the Employment and Social Affairs Council, there were votes around that table.
The heart of the challenge—Committee members will be as familiar with this as I am—is that you have the process in Council and in Parliament, but it is the trilogue where there is less transparency in the process. That is a challenge, but one that we would have to live with in future regardless of our relationship.
Q391 Chair: Mr Kent, do you have any thoughts on that?
Ronald Kent: I am not sufficiently familiar with the EU parliamentary process to answer that question, but I can answer the question about the long-term risk, if you would like me to.
Chair: By all means, yes.
Ronald Kent: To pick up on what Mr Hoban said, the existing cup is full of a programme coming from the EU on the financial services sector. Much of it is done. As you rightly allude to, there are a number of proposals that recently have been put on the table. They are controversial not merely here, but among EU member states. You have seen in the context of the CCP how, although it is not clear how this will ultimately play out, there has been some row-back already from the initial start proposal of a wholesale transfer of CCP activities in euro instruments from international markets.
Q392 Chair: For the benefit of those watching, was does CCP mean?
Ronald Kent: Forgive me, a central clearing party, such as LCH.Clearnet, which is the clearing house for London stock exchange activities and other activities.
Perhaps I can step back for a moment. After the financial crisis, one of the major risks identified by the Lehman crash was the counterparty risk that happens if you have many contracts in place with somebody else who has gone bankrupt. In order to address that risk, one of the many reforms that was put in place post the financial crisis was a mandatory requirement that many of the more risky financial contracts, particularly in the derivatives arena, were put into a central venue—like a stock market—and collateralised. That ensures that if there were to be a default because the other person you were dealing with, like Lehman, went bust, you were not exposed, because your exposure was to this central bank, in effect. That is what a CCP does.
Because of the success of the UK market, we now represent, in the UK, approximately 80% to 90% of the activity in certain complex hedging instruments—particularly euro-denominated ones. That is at the heart of the specific proposal that you alluded to, which is a desire by the EU to ensure that such a significant element of their currency is brought back within their supervision and jurisdiction. There has been a case that looked at that pre the UK’s departure, which reaffirmed the status quo, but that is what this legislation intended to do.
Q393 Chair: So it is a sort of “grab for power” thing, is it, in a way?
Ronald Kent: It is being positioned as a financial stability consideration.
Q394 Chair: They always use fancy words, but effectively it means that they want to get control over it. Is that it?
Ronald Kent: Certainly they want to get more control. In the context of your question about timing, there is a robust debate within the EU as to whether or not there should be wholesale control by them moving into the EU or whether there should be joint supervision. It has moved more towards the direction of a joint supervision approach. The Chancellor has, I think, acknowledged that that is a conversation to be had, but we will see where this plays out. From a timing standpoint—this is still at a relatively early stage—it seems entirely possible, picking up the point that Mr Hoban made, that that particular piece of legislation may play out of time with the existing Commission and may play into the new Commission. As Mr Hoban has alluded to, if that is the case, we are then at a point of time when transition is nearing its end. That is if the legislation is passed.
Just to finish off the point, you will appreciate, Mr Chair, that once legislation is passed there has to be a substantial implementation period to allow business to get ready for it. If you look back at MiFID, it was a regulatory reform that took about three to four years to put in place, and it took two years or so for businesses, once the new rules were made clear, to set up their IT systems and so on before the rules came into force earlier this year. If you look at the practicalities, the practicalities suggest that the risks you allude to, while they may be there, seem quite remote at this stage.
Q395 Chair: Have you got a comment on what we have heard so far, before I come on to the next question, Mr Reynolds?
Barnabas Reynolds: Yes, I have. I have a number of comments. First of all, I think that here, like elsewhere, we really need to get into the detail ourselves, check propositions about the need for the transition that have been raised and get some innovative ops and legal people into the room with the firms that identify those problems, to see if the Government can clear them away. The firms at the moment, given the EU has said there is no certainty of the transitional deal, are, in my belief, spending money on their contingencies anyway for March 2019. I think we need to get into the weeds of the extent to which it is genuinely necessary for everyone. I am not saying there are not issues that need clearing away.
In addition, yes, there are some very alarming developments in law coming down the pipe in the EU. In particular, the French non-paper of two weeks ago, where they, as I mentioned, were seeking to narrow the reverse solicitation. If that were applied to the City of London, which it would be if we were in the transitional period, it would effectively remove almost entirely our overseas persons open access to wholesale business around the world, where people can trade with us under their own regimes, not ours, which is key to a global financial centre. It does not matter to most of the other markets in Europe.
So there are points, and EMIR, which I think you alluded to on derivatives clearing, absolutely has some provisions which, when we are in the EU, would increase the powers of the ECB, the colleges of regulation, over central counterparties here, and would remove our access, potentially, if applied on its face at the moment, to US central counterparties from London. These are damaging things for London, so I think we need to get into this properly.
Q396 Chair: Just on that point, can I ask you, because, again, people watching will not know what reverse solicitation means, to briefly explain that?
Barnabas Reynolds: Yes. It is the way the EU refers to it. In London, we allow in the wholesale markets, in the context of large corporates and regulated firms, people to deal with those sorts of entities in the UK without being subject to UK regulation. We are open to the world. It is key to being the global financial centre that we are. In the EU they have got a version of that—that in fact we were involved in negotiating—and we were reassured that our approach wasn’t damaged by the EU’s wording, which is included in MiFID II. They call it reverse solicitation. The idea there is that anyone in the EU can reach outside Europe—a corporate or an authorised firm—and outside the ambit of EU law and regulation, so that they are no longer subject to the financial regulation of the EU. They would benefit purely from the protections of the jurisdiction of the seller.
If I may, I will make a couple of other points. On the euro location policy, I do not think it would be sensible for us to agree to something involving joint supervision. Regulating financial markets and central counterparties is very risky stuff. We know from experience that our taxpayers are at risk. The idea that we would give someone else a sort of veto over how we regulate these organisations is mistaken.
The reason why the EU27—in reality, it is coming from the Banque de France—are interested in regulating or having a hook into UK central counterparties is not, in my view, because of a problem of genuine systemic risk to the EU27. What it amounts to is that it results from events in 2011-12, when a clearing house here decided that southern European member state bonds were riskier than it had been previously thinking, and essentially it started to haircut or discount the value of those bonds. The Banque de France and perhaps some others in the EU—a couple of member states—did not agree with that; they do not like that and wish to control collateralisation and use of member state bonds. That is not in the interests of the global financial markets or UK taxpayers. It is not in the interests of the UK, and actually it does not happen elsewhere in the world.
The way that we and the Americans regulate central counterparties is that you agree a margining model with the central counterparty, and they call under that model, but you do not tell them on a minute basis, “You cannot discount this particular bond, because it suddenly appears more risky.” That is an alternative reality. It is Canute-like. It is trying to deny the truth. What happens in that situation with the financial markets is that they just move their risk.
I have one final point that I would like to clarify. I am in favour of a deal and have set out in the most detail of all a fully-fledged proposition that achieves all the things that Mark and Ronnie have mentioned. It tracks the wording of what the Chancellor said he wanted to achieve in his speech setting out the financial services deal.
Q397 Chair: This is the March one.
Barnabas Reynolds: Yes.
Q398 Mr Fysh: I want to elucidate a bit on what we have been talking about with some of the practicalities of different models for the sorts of deal we might do. On the mutual recognition front, how do you envisage we might 1go about collaborating with the other side on prudential matters, conduct within the markets and oversight? How would our Parliament and our own law-making here in the UK relate to that? How would that be different from enhanced equivalence, which is the alternative way of doing it?
Mark Hoban: Shall I kick off? We start from a point where on the date on which we leave the EU, our rules will be exactly the same and will deliver the same outcomes. Over time, however, as markets and regulation evolve, there will be some divergence. We know there is a regular flow of global initiatives on regulation. To facilitate that dialogue, we have proposed a form of regulatory alignment where there is discussion between the regulators in the UK and the EU27 about proposed changes for regulation on both sides and discussion about the implementation of global initiatives. That would mean there was some transparency, to go back to the point that Sir Bill made earlier, about the changes that are taking place. That should help ensure that where changes are made to the detail, so long as they deliver the same regulatory objectives, cross-border access will continue. We see that forum as being an important part of this process.
That is not a novel process; it is used in other free trade agreements. The novelty is in its application to financial services. There is not a substantial financial services chapter in any other trade agreement. It mirrors to an extent some of the conversations that happened between the UK and the US on TTIP. That forum will be there. It does not remove the right to materially diverge and therefore lose access. It is absolutely at the heart of the autonomy of the UK and the EU27 to develop their own rules, but it creates a framework for that conversation to happen.
The IRSG published a report late last year looking at the post-Brexit regulatory architecture. One of the points that we made, in the context of the rule-making powers resting with the regulator, was that where there was a proposal that led to material divergence, there had to be some policy oversight because it would be inappropriate for regulators to make such a big step without that oversight. Absolutely there is an important role for Parliament in monitoring how the regulatory alignment forum works and how our rules evolve over time and the impact that has on the degree of deliverability of the regulatory objectives and the outcomes.
Q399 Mr Fysh: In terms of the way that the different market players operate now, though, we wouldn’t have a role in the UK in, for example, setting the prudential arrangements for the foreign players who were operating in our markets.
Mark Hoban: If they are based in the EU27 and we have confidence that the prudential rules in the EU27 deliver the same regulatory outcomes as our own, we should be content to allow them to trade cross-border, in the same way that we would expect that banks based here in the UK could trade cross-border if there is the same degree of confidence in our prudential rules. Quite often, actually, prudential rules are set at a global level. So CRD IV and CRR 1, which I am sure have been before the Committee perhaps in the last Parliament, were a product of the Basel III negotiations. For this to work—to be able to trade cross-border—does require us to have confidence that the regulatory objectives delivered are the same in both jurisdictions, even if the rules differ. Otherwise, we wouldn’t be able to trade cross-border.
The other point you raised that I forgot to mention was about supervision. Clearly, there are now supervisory colleges for cross-border institutions. Our model proposes that there is a continuation of those colleges in a different legislative place, so that people can see how the others are being supervised so that there is an exchange of information on particular practices and how they are complying with the rules. To pick up on Mr Reynolds’ point, clearly where taxpayers’ money is at risk, the responsibility would rest with the home state regulator. I think that is an important part of the process, so that you are not having somebody else dictating how UK taxpayers’ money is used, or vice versa. We have indications of support from the Bank of England and others that there is a model there that can work. I think it is again about confidence. We have similar models of supervision with the US and others, for example.
Q400 Mr Fysh: Mr Reynolds, could you comment?
Barnabas Reynolds: As a legal matter, as I mentioned, in the wholesale market we don’t regulate entities elsewhere at all. It is a sort of caveat emptor system. It works for a global centre and we ensure that risk is managed in London by the institutions here on their own books. That wouldn’t change. It is more for how the retail markets, their equivalents or whatever term one wishes to use, would operate for us and for branches, for inbound business, in terms of its relevance to us.
Perhaps I could just unpack some of the terminology flying around, because it is very confusing and sometimes people write up differences that don’t exist and it is actually simpler than it might first appear. The thing that we are all seeking, I think, if doable on the right terms, which is an important qualification—
Q401 Chair: You are referring to whom here?
Barnabas Reynolds: The Government can speak for themselves in a moment, but I believe we are seeking the same thing: mutual access through mutual recognition—mutual access for businesses trading with each other across the channel and mutual recognition of standards. The Chancellor and I have used the term “enhanced equivalence.” Now the EU are using it, but they mean something different by it, because they don’t mean it to be binding and they mean it to be narrower—it is a question of what you mean by enhanced. The IRSG in October last year used the term “divergence.” The Government used the term “alignment” in its phase 1 contingent agreement.
None of these words means much without being defined. You have to define these terms in order for them to have substance, so how do you define them? You define them by reference to high-level outcomes. Where there are international outcomes, you look to international standards. That is the key bit—that is the bit that matters, if you like. That requires the EU and us to agree that we will peg ourselves to the Basel standards and whatever other standard is relevant. Where there are not those standards in certain areas, you would work technocratically to agree them.
There will be a treaty—an agreement—binding us both to enforce what we agree to. You can either have everything in the treaty, which some have proposed, or part of it in the treaty and part of it implemented through national law, but the treaty would provide the commitment. In the case of the EU, Danuta Hübner said this morning, “We could never accept this, because it affects our sovereignty.” That is not true. What the treaty would do—the version I have, at least—is commit the EU to apply its own law, as it says on the tin.
Equivalence in the EU is already pegged to outcomes, so we say, “Fine, let’s put that in the treaty, have an independent court above it to make sure that we both do vis-à-vis each other what we commit to do, fill in the relatively small gaps in equivalence and make it certain.” That is what we want to do. That would allow the UK to remove red tape and the EU to do what it wishes in its own way. The UK needs to be competitive, not in terms of low standards but in terms of operating on the tried and tested methods of regulation, which are safer, and we would depoliticise the application of the law.
This issue needed solving anyway prior to Brexit—it has been bubbling away for quite some years. As part of the Cameron deal, we tried to solve the position of the City’s regulation vis-à-vis the Eurozone. Brexit gives us the opportunity to ensure, on an expedited basis, that we are able to regulate the global markets that are hosted here in a way that works for the global markets, and that the EU27 can regulate their more domestic markets in a way that works for them, but mirroring at the high level international standards. That is absolutely key.
The one troubling little note I have heard from some Government representatives in the past few days is, “We wouldn’t accept automatic equivalence.” I am not quite sure what they mean by that. It may just be loose terminology, but if we by default accept all the EU laws and are not able to regulate in a more bespoke way, with more judgment-based regulation by our very good supervisors, and instead we are forced to take all sorts of detailed stuff that is not really directed at what we need here but in very extreme situations we can opt out, that might be an issue. But of course the devil is in the detail of what words mean.
One final point on equivalence that it is important to make is that it is not as black and white as us either getting this sort of a deal—whether you put it all in a treaty, partly in a treaty or whatever—or getting absolutely nothing. Obviously, if there were the possibility of no deal, we should be planning for it as a contingency, but I do not think it is realistic, or in fact likely, that we will end up with no so-called access to EU markets, because they need the liquidity of London sufficiently that they would unilaterally make declarations of equivalence on day one across most of, if not all, the existing equivalence areas of the EU. Given MiFID II, that covers the investment banking world, which is most of the cross-border business. In a no deal scenario, we would not have nothing; we would be in an ongoing negotiation, as it were, where your Committee constantly had to review proposals and rules, and decide for particular topics whether it was worth carrying on or whether we should walk away and not bother with equivalence.
Q402 Mr Fysh: Lastly on that, when it comes to the legislative side and the EU looking at us as a third country rather than a member state, are there any specific things that we should look out for, aside from what you have already mentioned in terms of being part of a free trade agreement? What are the legislative things that we should be looking at as a Committee?
Barnabas Reynolds: The reason I have taken the word “equivalence” and added the enhancements that I am proposing—as I say, do not mistake that for the EU’s or some spokespeople’s current version of enhancement; my version is binding and has an independent court and all these other things—is that it is in use in the EU already, vis-à-vis the US and elsewhere in the world, it is based on outcomes and it works. We do need to make some improvements, but it is there. Most importantly of all, it doesn’t seek to interfere with anyone else’s sovereignty or domestic law. That concept and precedent, which works for everyone else, needs to work for us to.
So I don’t think we should agree to something with strings attached. One sometimes sees suggestions being floated that we should agree to something where we fetter our ability to organise our own tax regime or how we do things. That is not required by equivalence, as it is now, and it shouldn’t be required by any deal. That is, effectively, why I have been using that term. Obviously, others are using it in a different context.
Q403 Geraint Davies: Mr Kent, do you agree that there would be some sort of business as usual if we had no deal? It seems to me highly unlikely. Secondly, in the event that the EU does a trade deal with Japan that includes financial services, which it is likely to, over the long run, do you think this is a major blow for the city of London, being outside the euro-yen axis, as it were?
Ronald Kent: I will take those in turn. First, backing up a little bit, on the issue of terminology, I agree entirely with Mr Hoban and Mr Reynolds; it is really important to be thoughtful about the way words are used, because they can be used in very different ways by people in the same meeting in Brussels and in the UK. We have been spending quite a lot of time with the Canadian trade team that negotiated CETA, which has invited us regularly to visit it in Ottawa. As they have pointed out, they know quite a lot about what it is like to negotiate and trade, including trade in financial services, with the EU.
To a trade expert—they are trade experts—the word “equivalence” means what we think of as mutual recognition. That is an interesting analogy to draw, because when you are in Brussels, the way they currently use the word “equivalence”—it is very different from the way Mr Reynolds has outlined his concept of enhanced equivalence—is very different from mutual recognition. The starting point is that Brussels’ “equivalence”, as it currently stands, is limited in scope, so it is available only for a limited number of services.
I will take a classic example. If I am a middle-market European exporter, whether in the UK or in an EU27 country—the champions we ought to want to support—I do not think of the world as directive A, CRR, MiFID or whatever. I think of it as, “I want to be able to sell things to my customers”—to use your example—“in Japan. What financial services do I need to sell those?” If I look at the things that I need in order to sell my products to Japan, I need some things that currently in Brussels equivalence is theoretically available for and others that it is not available for. That is why the passporting regime we have today is so valuable.
Issue No. 1 with the equivalence regime is that it is very limited in scope. Issue No. 2 is that it is unilateral. It is in the grant exclusively of the EU. That would remain the case. Issue No. 3 is that it can be withdrawn unilaterally at very short notice. A treaty would allow that to be addressed. That is one of the reasons why we think the mutual recognition approach addresses both the question that you, Mr Fysh, were asking about the importance of maintaining sovereignty and parliamentary oversight—whether by the UK Parliament or the EU equivalent—and at the same time allows many of these mechanisms to be liberalised and made available on a basis that is bilateral, but ultimately sovereign, so that if one side or the other felt that this goes too far, you have a mechanism for dealing with the divergence point that Mr Hoban was alluding to.
To your point about business as usual with Japan—
Q404 Geraint Davies: If there is no deal, will there be quite a lot of business as usual? You seem to be saying there will be.
Ronald Kent: If there is no deal, I pick up to the points Mr Reynolds was alluding to in terms of the mechanisms that you would try to use to compensate for the consequences of no deal. As we touched on in the earlier evidence, the challenge is that those are no more than mitigants—they would result in outcomes that were substantially diminished from the position today, and substantially diminished from the position that could be achieved if a mutual recognition arrangement were put in place along the lines of the model suggested by Mr Hoban and us.
Q405 Geraint Davies: So there would be a problem. On Japan?
Ronald Kent: On Japan—no, we don’t think that’s an issue. Certainly the UK is hoping and looking for its own long-term arrangements with Japan, and Japan has said that that is its hope as well. So far as our sector of financial services is concerned, the EU-Japan arrangement is only slightly more ambitious than the Canadian arrangement, and therefore falls far short of the type of close and broad relationship in financial services that we think would make sense under a mutual recognition arrangement and in a proper financial services chapter in a free trade agreement that was fit for the UK economy—and which its partners would benefit from—in the next 10, 20 or 30 years.
Q406 Chair: The EU is using a rules-based system in order to try—I used this expression before—to take a greater degree of control and, even when we will be outside the EU, effectively to hedge us in with the rules that it prescribes. Considering the scale of our financial services in relation to the rest of the world—including even America, I imagine—and the volume of activity that we engage in and have done historically, the idea that somehow the EU can dictate to us, and for that matter to the rest of the world, the basis on which Britain in the City of London operates vis-à-vis the rest of the world seems to be something of a fantasy world in itself. Despite the fact that the EU says this, it is actually it that is living in the fantasy world, not us. We obviously want to have arrangements, we obviously want to do deals, but the idea that it can come along and impose rules on us, the effect of which would be to inhibit our ability to trade throughout the world when other people want to trade with us, would seem to me to be something of an illusion.
Ronald Kent: There is a recognition even on the EU side that the concept of equivalence, as described previously, needs to be reformed. The challenge is that there are two very different schools of thought on what that reform might look like. One is to move in a more restrictive direction, which I think we all strongly resisted, and the other is somewhat more outward-looking and looks at ways in which equivalence can be addressed to touch on some, but not all, of the challenges that we have talked about. Ideally, the long-term model with the right sort of conversations and a headwind might even get to the point of the enhanced equivalence model that Mr Reynolds touched on. Mr Reynolds, I think I am right in remembering a footnote in your paper, which I read with great interest and which we have discussed many times, that points out that enhanced equivalence when it gets to the right point starts to look remarkably like mutual recognition.
Q407 Chair: Right. Moving on now to independent dispute resolution, we have had some evidence, and I ought to mention that in our last report we came down in favour of what I describe generally as the Martin Howe approach to the question of independent dispute resolution. You have obviously been giving a lot of thought to this, and I am going to ask you a question about alleged regulatory divergence in this context. Could an independent dispute resolution body overrule a decision by either the UK or the EU to restrict market access?
Mark Hoban: This gets to the heart of the challenge that we face. Certainly in explaining our proposals to our interlocutors in the 27, we are very clear that the scope of the dispute resolution mechanism—our proposal—is very narrow indeed. It simply seeks to say, “Do these rules, the changes in these rules, amount to material divergence when it comes to delivering the regulatory objectives—yes or no?” That is all it is. It does not seek to override the interpretation of EU rules by the ECJ or of UK rules by the UK court system; it is on a very narrow point of whether this diverges from delivering the regulatory objectives. If it does, then there are remedies, but it does not seek to do anything about the interpretation of law as it applies to business. That is something that we have been very clear about in our engagement with European institutions and to member states. It is very typical of the mechanisms we see in trade agreements.
The other thing I would say is that, in thinking about that mechanism, we are very clear that it should be independent. There should be effectively a UK representative, an EU representative and an independent to ensure there is some impartiality and balance in there. But it is very much on the narrow point of whether this leads to material divergence, and then people have to decide, depending on the answer, what they will seek to do as a consequence.
Barnabas Reynolds: I agree there should be a court that is truly independent—one from each side and the chairman maybe chosen by the two of them. In the model I have proposed, the EU does what it wants and we do what we want, but if you are seeking equivalence on a topic, you turn up and say, “Here are our laws that hit these international standards.”
The situation where a country or jurisdiction could be overruled in its decision would be if applying its own equivalence concept did not do what it said on the tin. If you turn up with rules that are objectively equivalent, in the sense that they hit the same international standards, and your regulatory authority is saying, “No, that’s not good enough,” that would be overridden by this court, subject to one qualification, which is systemic risk. If you could demonstrate that the system was polluting your market in some very dangerous way, there would be a carve-out, but that would have to be objectively demonstrated by evidence in front of the court, with damages paid if someone wrongly barred access.
I think that is perfectly reasonable; and actually, what I would say on the proposal I have set out is that the rules themselves that need to be equivalent—the ones that matter—are the ones that hit the point about systemic risk, so you would not be able to turn up with rules that do not deal with and address systemic risk, which is something the UK is very good at doing anyway.
Ronald Kent: To add a little to what has already been said and perhaps to fill in some of the themes that you touched on, Chair, ultimately, what the independent dispute resolution mechanism had as a matter of jurisdictional authority would be a matter for the parties to agree and determine. Looking at it objectively, it feels like the sorts of things that you ought to contemplate that dispute resolution body determining are, first of all, mechanisms that do not in any way override the independent sovereignty and parliamentary rights of either party to make law, interpret law and apply law. That is principle No. 1, which I think we would all agree with.
Therefore, you are looking at more administrative law concepts of fairness, transparency and appropriate process to ensure that if things are withdrawn or looked at by the dispute resolution mechanism, it is done in a proper way. The most simple example of that is to ask yourselves the question whether, if an issue was “politicised” and if a decision was made on a politicised basis rather than an objective basis, that was a reason to object and to override it. The view of the parties may be that each side should retain the political right to make it a political decision and therefore it should not be a matter for the dispute resolution body to have power over. It could equally be the view that certain matters should be looked at on the basis of objective criteria, properly laid out standards and transparent processes, where the politicisation—with a small p; not the process of politics—of the issue ought not to be supported and therefore ought to be a reason to question and look at that particular determination.
Those are all matters to be determined by the parties to the treaty, because if you look at how international treaties have considered dispute resolution mechanisms or what their jurisdiction should be, those are the sorts of things that have been looked at. In this context, we are suggesting nothing different from that, but the most important thing to focus on is, from a sovereignty standpoint and from an authority of Parliament standpoint, those remain inviolate and sovereign to the UK and to the EU.
Chair: I find that very interesting, not least in relation to the European Court of Justice. What if it was to be given exclusive or predominant influence in the determining of these questions, which are of huge importance to the City of London, our financial services and, for that matter, the European Union as a whole? The problem is that, because of the purposive approach that it adopts and the manner in which it tends to exercise its jurisdiction, it is and often becomes a highly politicised operation. It does not do the kind of analysis for which the City of London arbitration jurisdiction system has become internationally renowned. Many people want to come and listen to the judgments made in the arbitrations that are done by UK judicial experts, particularly in the field of trade and things like that.
What troubles me is this constant presumption—arrogant, I would say—by some parts of the legal service of the Commission and by the negotiators on the EU side that somehow or other they can continue to assert that when we are outside the EU, we will have to be subject to their system of jurisdiction. That greater degree of objectivity and interpretive skill that happens to reside in this country and has done for a very long time would benefit everybody. I say that not in a presumptuous fashion; it is just a matter of fact, otherwise why would people come here to such an extent to listen to the judgments that are made? There is a degree of objectivity that is brought to bear. I think what you have said on this has been very interesting, including your constant reference to sovereignty carrying with it the capacity to be able to exercise that degree of impartial jurisdiction.
I would now like to ask David Jones whether he will be good enough to ask the next question.
Q408 Mr David Jones: May I first apologise for not being here earlier in the session? I was required in a Committee meeting next door. What would your response be to the dismissal by the EU of your proposals thus far? Why are you confident that they are acceptable to a majority of the EU27 member states and the European Parliament?
Mark Hoban: One of the challenges is to think about what sort of relationship the UK and the EU27 want going forward. It strikes me that there is a suite of options that will enable high levels of trade to continue across a number of areas, and that could be underpinned by the mutual recognition deal. The other deals on offer are sub-optimal. They will lead to worse outcomes for consumers, less trade happening and lower volumes of business being done. I think it is in the economic interests of member states to adopt the mutual recognition model that we propose, because it is in their interest and that of their consumers. Absent the access to the pool of liquidity there is in London, you will see interest rates for debt in EU member states increase. That will be paid by consumers. They will lose access to the innovation and expertise that has made London a successful global financial centre. If you can find a mechanism, which mutual recognition is, that enables those benefits to continue to flow, albeit on a different legal basis, it is in the economic interests of member states to adopt our proposal.
As I referred to earlier, I think there is a difference in view on this. You hear in so many areas the Commission articulating the status quo—the existing third-country regime—and not just in financial services. I think member states are much more interested in how we can find a better relationship to move forward together in a comprehensive, deep and broad free trade agreement. Mutual recognition would help underpin that.
Q409 Mr David Jones: But the Commission has been very obdurate so far. It has flatly rejected this so far. What makes you think that the individual member states will be able to speak with a sufficiently common voice to persuade the Commission to change its stance?
Mark Hoban: It is interesting. The mandate for the Commission is given by the Council of Ministers. One reason why the trade associations have been active in this field—the principal trade association has done 50 visits to 25 member states in the first quarter of this year—is to seek to influence member states to ensure that they understand the proposals we are making and to see the economic costs and benefits of going for a sub-optimal solution. That is ongoing work. I know that Government Ministers are doing exactly the same thing. We need to continue to engage with member states to persuade them that this is the right model and that they should therefore instruct the Commission to act.
I would point to a couple of things: the minute annex to the last General Affairs Council proposed by France and Luxembourg got financial services on the agenda. That is a very different position from where we were a few months ago, when it was very much off the agenda. We are taking steps. Talk to member states that have sophisticated financial needs but relatively underdeveloped financial markets; they look to London to provide those services rather than anywhere else. There is work to be done—none of us is complacent about that—but we need to persuade member states that this is the right way forward.
Q410 Mr Jones: Have you made any assessment so far of which member states are more likely to be receptive and which are more likely to be problematic?
Mark Hoban: You will find that there are member states that broadly share our view of being internationalist, pro-trade and who want proportionate regulation, who are more interesting as allies than others.
Q411 Mr Jones: Would you like to name them?
Mark Hoban: You can guess the like-minded states—Luxembourg and all the countries that pushed for the statement in the minute. You see that happening. Finance Ministers in several member states have suggested that the UK will remain Europe’s global financial centre. Wolfgang Schäuble, who was Finance Minister in Germany—we have not heard from the Finance Minister—was very clear that London will remain Europe’s global financial centre.
Q412 Chair: A few weeks ago, some Italian—I forget which one but quite a substantial figure by all accounts—said it is essential that London is providing the kinds of facilities that are needed for the rest of Europe, or words to that effect.
I have come back to this a number of times because it really troubles me. There seems to be quite a difference between the obdurate acquis communautaire status quo position adopted by the rather obsolete European Commission and its legal service, and the more understanding, flexible approach that seems to come from some member states.
You have been dealing with these people directly a lot. Do you think, as David Jones just suggested, that underneath all the obduracy from Mr Barnier, which often seems to be grandstanding, if they want a proper relationship with the United Kingdom, particularly in financial services where it is so important to them and us, the member states are more likely to move towards a sensible outcome than an obdurate dismissal of the kind that we have heard from Mr Barnier and co.?
Mark Hoban: Member states have a range of interests. This is a negotiation on a multi-sector deal. Other people will have priorities in determining what the future relationship looks like. There is a trade here—that is articulated from Finance Ministers from different member states. We continue to push this.
Q413 Mr Jones: If EU member states and all the Commission were to remain obdurate, where would EU member states get access to the sort of capital that they access at the moment through the City of London?
Mark Hoban: That is one of our arguments. The capital flows that come into and out of London are an important way of financing European development.
Q414 Mr Jones: Are there any European rivals?
Mark Hoban: TheCityUK published a report last year that looked at the relative strengths of a range of financial centres. It was only the UK that consistently was in the top two or three across Europe.
Q415 Mr Jones: Do you think any changes could be made to the current negotiating stance to facilitate progress?
Mark Hoban: A comment that comes back often from our European interlocutors is an appetite for more detail. We would welcome the publication of a White Paper in due course. That will help the debate.
Q416 Mr Jones: Is it a concern to you that the White Paper is not published?
Mark Hoban: The ways we do politics differ. You will have seen in your roles that in the UK it is quite normal to conduct politics by speeches. When I talk to EU counterparts, their view is that a member state that seeks to make changes has to put down the text of what those changes are. Politics by text—I mean legal texts, rather than what we do on our phones—is their way of doing things. There is just a culture gap there.
To be fair, I think the Government have set out in quite significant detail the way in which they seek to proceed. There was the Prime Minister’s Mansion House speech and the Chancellor’s speech at HSBC, and you don’t have to look very far on the internet to see the presentations given by UK Government officials to the EU27 about the economic relationship. There is plenty of material out there.
Q417 Mr David Jones: But culturally they don’t accept the speech as a position?
Mark Hoban: It is one of the depths of the continental mindset that I have yet to be able to plumb and to understand.
Q418 Mr David Jones: Is that why you think the White Paper is essential?
Mark Hoban: It is very helpful. It would also give some comfort to businesses about the direction of travel of the UK Government. They understand the position the Prime Minister took in the Mansion House speech and they understand the demand, but there is an insatiable thirst for detail on both sides.
Q419 Darren Jones: Mr Reynolds, I am conscious that you didn’t have the opportunity at the beginning of the session to confirm who you are representing. Would you mind doing so now, so that it is on the record?
Barnabas Reynolds: No one. I have just published some proposals or suggestions on a template for an enhanced equivalence blueprint for Brexit and for fall-back scenarios if there is no deal. As Sir Bill mentioned, they have been widely discussed, which I presume is why I have been invited here.
Q420 Darren Jones: How many banks, institutions and insurers have signed up to your version of the deal?
Barnabas Reynolds: I am not collating or lobbying. If we are to do this, I think it might be helpful for me to set out how I think it could be executed successfully. I have not done more than that.
Q421 Darren Jones: I just want to be clear, because I am new to financial regulation. It sounds like you have an easy win here, Mr Reynolds, but I just need to understand what the industry buy-in for this is. To go to my substantive question, thinking about the implementation of either your model, Mr Reynolds, or those proposed by others, do you think the transition period is long enough?
Barnabas Reynolds: Going back to the earlier question, I think we need to start testing in detail the thinking of everyone and what the Government can do to assist on transition, and whether it is needed, and if so how long it needs to be. I don’t think you can make an abstract proposition from 10,000 feet across the entire City on that.
Q422 Darren Jones: Did you say that you think that there potentially doesn’t need to be a transition period?
Barnabas Reynolds: For certain bits of the industry there may not need to be one. I don’t know. We need to test this. I don’t think we can just do it from 10,000 feet and say that people need more time. We need to get very granular on this. It is a very fiddly thing that we are executing upon, and I think it involves getting into the weeds on it.
Q423 Darren Jones: So we don’t yet know the answer to the question of whether the transition period is long enough.
Barnabas Reynolds: I don’t think that there is a consensus understanding of the answer, because I don’t think it is in the public domain and I don’t think it has been tested fully. We are getting inputs from all sorts of people, but the next level up from that is testing things and seeing what can be done to cure it.
Q424 Darren Jones: I think you are saying that we don’t know the answer, which is perfectly acceptable. On the model that you have been promoting from a transition period, how long do you think it would take to implement the measures you propose, and do you therefore think that the proposed transition period is long enough to deliver that model?
Mark Hoban: The transition period is there, in part, to help deal with some of the cliff-edge issues we referred to, such as how businesses make the necessary adjustments to the deployment of their people, capital, innovations and contracts and so on to facilitate Brexit. If a declaration on the nature of the future relationship is made at the October council, as people expect, one of the challenges will be how much comfort that will give people about how they can then operate in the future.
Clearly, the more content and depth there is in the October statement, the easier it will be for people to continue to trade as they are at the moment, and therefore not to have to make any adjustments. My encouragement would be that there is sufficient weight behind that statement to give businesses the confidence that they can continue to trade cross-border while the detailed negotiations are happening.
Q425 Darren Jones: So business as usual after hopefully avoiding a cliff edge, but I am still trying to understand what next. On the assumption that one of these models is agreed with the European Union, which I appreciate is an enormous assumption to make at this stage, how long do you think it will take us? Do we have any sense? Do we have a pipeline of things we are proposing that need to happen, and how long will that take? Is there an example of this happening anywhere in the world, or is it just the case that we will have to go on with business as usual for a transition period and then hope for the best?
Mark Hoban: There is something that is new about this. There has been a financial services chapter in a free trade agreement before, and free trade agreements can be lengthy to negotiate, but the advantage we start with, compared with other agreements, is that we start off at the point of having the same rules; we are not seeking to manage a process of convergence. If there is the right political will, the technical requirements are relatively straightforward to implement, because people have been engaging on what they are now. A lot of the conversations we are having have been at a very technical level. The statement people send about what the future relationship looks like is important, because that can give sufficient incentive for business as usual to continue beyond the transition period while the detail is being worked out. It depends on the robustness of that October statement.
Q426 Darren Jones: So we wait in anticipation for the White Paper and then see where we get to in October?
Mark Hoban: Absolutely.
Q427 Darren Jones: Mr Kent, do you have any views on the question of the transition period?
Ronald Kent: Yes. May I try to add a little bit, to complement rather than repeat what others have said? With your permission, I will tie it back to Mr David Jones’s proposition as well. It is important to look at what we call the transition period in two components. The first component is buying time to get the details in place and understand what the details are. The way we and our members look at it is that you are extending the existing runway from the existing two-year period that expires at the end of March next year to the currently proposed end of December 2020. In order for that runway extension to be useful, you want to move that transition phase into an adaptation phase.
What do I mean by an adaptation phase? Adaptation is what you do once you know what the endgame looks like. It is very difficult to build your IT systems, to understand what capital or what warehouse space you need, what customs officers you need to have, and all the things you need to do technically until you know what the endgame looks like.
That goes back to the question Mr David Jones asked earlier, because what we hear from both our members and our customers on both sides of the channel is a strong plea for more detail, more specificity and more decisions to be taken more quickly, so we can move from that transition phase into that adaptation phase, which will be long and complex. Of course, as you have touched on, the challenge is the political reality. You know much more about that than I do. The political reality is that the politics might not always permit those things to happen as quickly as business, customers and end users would like, to give them sufficient time to adapt.
There have been studies looking at how long it takes once you know what the end looks like, particularly if the end is dramatically different. If it is not very different, that is much easier. The fair answer to your question has to be, “Potentially not.” Obviously, it will depend on the individual firm, business or customer and the extent to which they need to reorganise themselves to adapt to whatever the endgame looks like, but the realpolitik answer is that it may have to be enough, because that is all there is.
Q428 Darren Jones: Therefore, the best outcome is to remain close to what we have today, to reduce the adaptation required during that implementation period?
Chair: I would think carefully before answering that question.
Ronald Kent: From a practical standpoint, if you are a customer or a provider of services to a customer, you would like to be able to do as much as is possible in as unrestricted a way as possible. Whether that is the way it is done today or a way that it is done tomorrow—our mutual recognition model and Mr Reynolds’s enhanced equivalence model give us other tools to provide services in a similar way in a completely different political and sovereign environment—there is more than one way to skin the cat.
Chair: Could I just comment on that before Mr Jones comes back? It seems to me that we are encapsulated within a silo that began somewhere around 1973, which gradually moved us, after the Single European Act, into the field of financial services. Historically, for 400 years, for some reason that people have not been able to entirely work out, the United Kingdom, or certainly the City of London, has been uniquely well established in achieving degrees of pre-eminence in these matters. New York, obviously, has a powerful influence as well, but in comparison with other countries, for reasons we do not have time to go into, the City of London has been enormously successful.
But what we are now talking about is within a framework of having to conform to a regulatory regime that came in as a result of our being part of the European Union. What benefit that did to us or to anybody else is perhaps for another occasion, but basically what I think you are saying is that it would be highly desirable to have a greater degree of liberalisation, as a result of which new products and new ideas could then be stimulated and developed. But, of course, you run into the rulebook, and that rulebook has largely been prescribed by the European rulebook, which we absorbed through the European Communities Act 1972.
I suppose the question—if I may suggest this to Darren Jones as a supplementary—is whether the advantages that might accrue from our being able to have a greater degree of opportunity to develop our own initial and indigenous skills would be something that we would prefer. Mr Sarkozy said—I think he said this, but I do not want to misquote him, particularly in his present travails—that he wanted effectively to take over the City of London, or words to that effect. There is an ambition out there, and in Germany too, but the practical point that I am trying to make, in a nutshell, is that we are pretty good at doing what we do in the City of London and it would be to our advantage to be able to increase the degree of opportunity to evolve in a sovereign context. But Darren, you may well want to come back on that.
Q429 Darren Jones: The Chair has very skilfully answered my question, posed his own question and answered it in the form of a question. Maybe I will have such skill in a number of years’ time.
My penultimate question to the panel is further on this EU27 conversation. When we were in Brussels, Monsieur Barnier made it very clear to us that it was, in his words, a “waste of time” for UK officials to keep travelling around the 27 member states, because he has a clear mandate from the European Council, in terms of the negotiation with him and his team. You have spoken today about liaising with equivalents and Financial Ministers in member states. Do you have any sense of optimism about your equivalents, or Financial Ministers, being able to persuade the leaders of the EU27 to ask Barnier to perhaps take a different position?
Mark Hoban: Can I just respond to Sir Bill’s comment? He and I had this discussion when I was in a previous incarnation and he was in this incarnation. We should not portray Britain as a victim of the European legislative process. The reality is that, particularly on the oversight of financial services, UK Governments and regulators have been very influential in shaping the regulatory framework. You occasionally have the comment, “Oh well, when we’re free, we’ll scrap all this regulation,” and people point to MiFID II. Much of MiFID II was inspired by the FCA. We should not lose sight of the fact that we have been very influential in European debates, and one of the things that comes across from conversations with our counterparts is a regret that our voice is no longer there to shape that debate, and a concern that we are no longer in the room. I would not want anyone to feel that we have been victims in this process. We have been highly influential.
To go back to Mr Darren Jones’s question, this is about politics. It is about how member states respond and how they set the mandate they give to Michel Barnier. This may not be a very helpful example to use, but it is interesting that in the discussions about the multi-annual financial framework, the 27 sought out the UK to participate in those debates because of the UK’s ability to influence thinking about the EU framework. That was against the advice and wishes of the Commission, but member states did it.
It is very interesting that the way in which the negotiations have been structured has sought to maximise unity on phase 1—on money and on the rights of citizens—and all the areas where there are likely to be disputes are in phase 2, when we talk about the future relationship. I think we should hold our nerve on this. There are different views within the 27. There are different sectors of the economy that will be debated, and this is a negotiation—it is a trade-off.
When I talk to the practitioners of trade negotiations, that is the point that they make. There will be a bargain at the end. It is important for the UK financial services sector to ensure that we continue to push for mutual recognition, not just with our own Government but with other member states. Then, let us see what happens.
Chair: Before coming to Philippa Whitford, I should say that I think this exchange is quite relevant. I would challenge your response to me on this basis: it seems to me that you are perhaps underestimating the extent to which the legal framework is initiated by the European Commission itself, because it is the European Commission that introduces the legislative framework to which we respond.
Mark Hoban: Ah!
Chair: Just a moment, Mr Hoban. I am not going to dispute, although we have had our discussions and disagreements about this over the years, that we have had a degree of influence—very significant in certain cases—in mitigating some of the more absurd ideas that have come out of the European Union. What I am saying, however, is that now that we are leaving the European Union, subject only to the problems of the ECJ, which we have already discussed, the opportunity for us to do things on our own terms will increase, but I do agree that we will also have to work within the framework of international decision making—Basel would be a good example of that. I think we can leave it at that, because I would never want you to get the advantage of being able to have the last word on the subject.
Q430 Geraint Davies: In terms of regulators, the FCA had 3,000 regulators and the Bank of England had 2,000—so that is 5,000 that we had—compared with the European Banking Authority with 150 and the European Securities and Markets Authority with 150. They had 300 regulators and we had 5,000. That is why we did all the heavy lifting on financial services regulation and why we have such a successful single market in finances. Do you accept that, as we withdraw, the problem will be that our mass of regulators are out of the room and other people will be making the decisions? Those decisions will be made in a single-minded way in the negotiations with Barnier—we simply cannot pick people off. The answer, therefore, is to try to be as close to the single market as we can be, if not in it.
Mark Hoban: We should not forget that the European regulatory process includes the national competent authorities—the regulators at each member state. It is true that when you talk to many of them, they respect the expertise of our regulators because we are the largest financial market in Europe. Our expertise is very valued. They have said that they will miss that input. However, the reality is that the debate about whether we are in or out of the single market is gone.
Geraint Davies: Well, we can vote for it still.
Mark Hoban: That decision was taken in the referendum.
Geraint Davies: It wasn’t.
Mark Hoban: It is a natural consequence. I was a remainer and I made the point that, based on the arguments of the leave side, we would no longer be in the single market as a consequence of issues such as the jurisdiction of the ECJ and the ending of freedom of movement.
The challenge for me and others in the sector has been, on what basis can we construct the future relationship to enable high levels of cross-border trade in financial services to continue, to the benefit of the consumers of financial services across the whole of Europe, including in the UK? That is what our proposals are about. Mr Kent and I have talked about mutual recognition. Mr Reynolds talks about enhanced equivalence. We have differences in our views about how you get there, but the outcome for us is the same. We want to ensure that people still continue to benefit from UK financial services, in the same way that UK citizens benefit from services provided by EU financial services firms. We are trying to find an alternative basis to the single market—one that will necessarily be suboptimal, but one that will continue to deliver benefits to people throughout the 28 countries.
Q431 Mr Fysh: Just to confirm this very quickly, does any of you think that being a member of the EEA is the appropriate mechanism to regulate the UK’s financial services industry?
Barnabas Reynolds: Not me.
Mark Hoban: The problem with being a member of the EEA is that you are an automatic rule taker, and I do not think that is in our interests.
Barnabas Reynolds: Perhaps I can add to that. This idea of automatic rule taking is at the heart of why the deals we are suggesting have been constructed in the way they have. As I said, it was an issue the UK was having to grapple with anyway under the David Cameron deal, which I regarded as almost a right to negotiate—it was a starting point of exactly this discussion.
The issue is that the City supervisors need to use rules that they are comfortable with and that are appropriate for the global markets hosted here. We cannot just apply any rules that someone makes up and that may or may not coincide with what we need to do. It is absolutely critical that this market is safe for the benefit of UK taxpayers and the global markets.
Chair: Also, may I suggest that it needs to be highly competitive, which is crucial in a global marketplace and may mean that you have to have some divergence in the rules?
Just to put this on the record for those who had not noticed, there was a very interesting article by the Prime Minister of Norway yesterday, and again today, about the whole question of the EEA, EFTA and so on, which is not on our agenda today. Her conclusion was that although she had been quoted as saying that Norway would now be happy for the United Kingdom to join in the EFTA/EEA arrangements, she did not think it was suitable for the UK. I think that is worth considering—it was in the Times review yesterday.
Philippa, I am so sorry to have kept you so long.
Q432 Dr Whitford: That is okay; thank you, Chair.
Can I start with Mr Hoban? You talked about mutual recognition, but what is your view of recognition of equivalence as a backstop if that is not achieved? It clearly does not give you all the same opportunities, particularly in some of the large markets within the London financial market. Could we end up effectively as a rule taker purely to stay in those markets?
Mark Hoban: I think the current model of equivalence is problematic, and indeed that was the starting point for our work. It is not just me saying that; it was the product of the work that the IRSG did.
Just to echo the comments that Mr Reynolds made earlier in response to Mr Fysh, if you read the remarks of Andrew Bailey, the CEO of the FCA, and if you listen to the words of the Governor of the Bank of England and the Chancellor, they are all deeply critical of the concept of being an automatic rule taker. There is a consensus here, and why? It is a unilateral process—the EU decides whether our rules are equivalent. The process is, frankly, opaque. There was a very good example in December last year, when a Swiss equivalence decision was wrapped up with a broader political issue. There is a lack of transparency around the process.
There is not a dispute resolution mechanism, so if you disagree with the Commission’s interpretation there is not a lot you can do about it. It can also be withdrawn at 30 days’ notice. To add to the point that Mr Jones made earlier about the transition, we are already seeing some of the challenges if you start to move outside the EU. Those challenges would continue if equivalence was withdrawn with 30 days’ notice, so that notice period is problematic.
For all those reasons, we very clearly identified in phase 1 of our work that the equivalence mechanism simply did not work.
Q433 Dr Whitford: So if mutual recognition is not accepted or does not develop, what would be your alternative backstop? That is what we are talking about—a backstop.
Mark Hoban: Absolutely, and I do not see the existing equivalence mechanism as being that backstop. It is interesting that the critique we have of equivalence is shared by, for example, people like Brian Hayes MEP, who produced an own-initiative report recently that clearly shared our analysis. People say we must reform equivalence. What we have not seen from the EU is what those reforms might look like, whether it is in the scope of equivalence—does it need to cover all products and services—or the process. At the moment, to those saying there is improved equivalence—as distinguished from Mr Reynolds’s proposal—my challenge would be that we have not seen what that is, so what is the backstop they are proposing if they do not want mutual recognition, but want to continue to benefit from cross-border trade?
Q434 Dr Whitford: But what would your proposal be—to simply function as a third country in the way of others?
Mark Hoban: Increasingly, what we are seeing, in the absence of legal certainty around transition and the future relationship, is businesses starting to adjust and move operations into the 27, as needed, to service their EU clients. It is a real challenge as to what appropriate backstop there would be, and it would depend on what the trading relationship looks like at the time we leave.
Q435 Dr Whitford: Obviously that is what we were trying to have not happen—jobs moving.
Barnabas Reynolds: I think we are agreed about what is desirable. If we are in a world where there is not a deal and there is this sort of unilateral equivalence regime that the EU can construct and apply in their own fashion, then—and this is why we should be doing our contingency planning overtly now—all the 10 points that I have advocated, although I did not get through them all, are key for us to adopt, which is basically reinstating the things that make the City safe, competitive and attractive and so on. I think we should operate on that basis.
We should then not worry too much about the EU equivalence regime as a starting point: we should do what we think is right for the global markets located here, and ensure that this market remains safe and attractive. If, the EU says, “Well, if you make this small tweak, we will give equivalence”, we can consider that point. But the starting point should be what is right for London, and then we can engage in any particular discussions on topics if the EU asks us to change them. That is one of the reasons why I think, actually, they will end up wanting a deal—because it gives them more of an ongoing dialogue as to what the shape is of global regulation, rather than us just deciding, especially if we take these mitigating steps to facilitate business with EU customers from here. I am not advocating that as plan A: that is my plan B.
Q436 Dr Whitford: So there are not aspects of equivalence that you see as likely to be reformed or changed that would make it more desirable? It is just a non-starter as far as you are concerned?
Barnabas Reynolds: The EU is in discussion about reforming and improving equivalence. They even use the term “enhanced equivalence”. They are looking at enhancing equivalence themselves; they recognise that it is not ideal. But some of the things being thrown around in terms of enhancing equivalence involve trying to clamp down more on what others do, and obviously that is not something that is likely to be attractive.
The trouble is that we need to look at every situation on the facts, but I would suspect that if they went down that route, they would have to flex in order to get access to global liquidity pools on the easiest possible basis here. When it goes back to the member state point, and the numbers and the cost of not having access to global financial pools in a global financial service centre on their doorstep become apparent—and anything they do will affect the US as well, by the way, which is a very big point—it will be a big drag on playing games on this, were they minded to do so. The cost of not having that access will be very significant and, as part of the negotiations, we should be assisting member states in understanding those numbers.
Q437 Dr Whitford: Obviously the proposals they are looking at are not loosening—they are very much about making equivalence stricter.
Barnabas Reynolds: Some of them. This is a negotiation, and they are negotiating in parallel with the Brexit negotiations in relation to the refining—as they would see it perhaps—of equivalence. Their desired outcome, I am sure, is to control the global centre here. I do not think that is in the interests of the global markets or of the UK. I do not think it is safe for the UK, and therefore it is unacceptable. But clearly they are trying that. What we are proposing is a step back for the EU machinery from where we are now, in a way, because they have less to control. I think it is safer. I think it is in their interests—I think it is massively in the interests of the EU27 systems and so on. And I think it is the rational outcome that will prevail. But, of course, the EU would, I am sure, like to see if they can control this and not have to enter into a deal.
Q438 Dr Whitford: Basically, access to capital is the key card that London would have to play.
Barnabas Reynolds: Absolutely.
Chair: I think we have to bring this to a close now, because we have been doing this for some time.
Q439 Dr Whitford: I just want to let Mr Kent add his comments.
Ronald Kent: To complement rather than to repeat, no, I do not think equivalence would be a satisfactory alternative, for all the reasons we touched on—if we are talking about Brussels equivalence as it exists today, and we have touched on what that means. You are quite right to allude to the fact that it talks about improving, enhancing, changing—whatever. There are, as we touched on earlier, two schools of thought: some would perhaps make it more restrictive, and some would make it more rational. All of those, as currently expressed, are compromises. You may remember my remark earlier about the advice from the Canadian trade experts. If you choose to use equivalence as a trade expert would understand it, they would think about it as meaning mutual recognition, which is the danger of language.
There are other tools that are available to us, in addition to the 10 that Barney alludes to. For example, it is often forgotten that, underneath the passport and the equivalence, which are EU-level requirements, the EU principle of subsidiarity still gives individual member states—the UK included—a great deal of right in relation to legal matters, including financial service provision. If you look at the position of individual countries, such as Germany, France, Spain, Portugal and so on, each of those has got very much a patchwork—we have done a study of this—of things that you can do to continue to provide financial services cross-border at the member-state level, notwithstanding the EU-level restrictions. The problem is they are a patchwork, and they mean that, for example, a bit like equivalence, you can provide financial service A in country X, under their domestic rules, but not financial service B. So if you are a customer in that country, you have a mixed bag.
Some countries are much more open. The UK, as Mr Reynolds has touched on, has one of the most open regimes for wholesale markets of all the member states. So that provides you with an additional backstop tool in the event that you find yourself in that position. But to come back to the point we talked about before, all of those are mitigants and are dramatically reduced from where we are today.
I have one last comment, if I may. It is important, as we reflect on our concerns in the UK, and as others have touched on, to recollect that this is ultimately a negotiation, and we need to think about how this also plays into, and takes into account, the concerns on the EU side, because, ultimately, I hope there is a deal to be done. In that context, one of the things we hear repeatedly in our member state meetings, as I am sure you hear as well, is the importance of ensuring that, whatever the outcome is, there is a difference—there is clear blue sea—between being inside the single market, as we are today, and whatever the end state is. My personal view is that that will ultimately be determined across the entirety of the piste—all the economic sectors, including security, aviation and so forth. That will mean a determination that, for sector A, you can be a bit closer because it is really important—security, I would hope, is going to be very, very close for all of us—while, for sector B, you can be more divergent. We need to think that through as we reflect on the evolving interests of the member states, who, I think, will be an important voice here, and try to ensure that that is reflected in a successful negotiation and, hopefully, a trade agreement that we all feel works.
Q440 Chair: Just in conclusion, I simply say that the other thing we have not talked about, although we have heard of certainty, security, the necessity for stability and all those sorts of things, is that if you looked at MiFID II, you would see an enormous amount of opaque complexity. As a lawyer myself, and having seen a lot of the City activities in the past before I entered this House of Commons, I would say that the degree of complexity, although obviously attractive to some lawyers, is extremely damaging to the practitioners when they are trying to provide a good service for the customer, because it gets so opaque.
I will leave you with a thought and hopefully you will respond. It would be highly desirable if, with all the necessity for security and dealing with fraud and all the other things, we could at the same time simplify a lot of the lawmaking. I remember reports that we got when MiFID II was going through. The stuff that we got from the representative bodies that you are now involved in was very critical of the degree of complexity. It may be that we influenced it, Mr Hoban, but we ended up with something that, by all accounts, was extremely complicated for the practitioners and the customers. Would you disagree with that thought—that somehow or other we might get a degree of greater transparency and simplicity, because the rulebook is not an end in itself?
Geraint Davies: You would have two sets of rules instead of one.
Barnabas Reynolds: You wouldn’t, actually, in London, because of how we operate. There is one set. In the wholesale market, we apply ours, but then we defer to others for people trading cross-border. I completely agree that it is one of those things that is risky in regulation, not least because it diverts everyone’s attention to all sorts of micro-points. There are armies of people checking micro-points, rather than focusing on the things that really matter and applying judgment-based supervision, which is the traditional way in which we have done it successfully.
We were not subjected to the full effects of the Wall Street crash in London. The last financial crisis happened against the backdrop of the EU regulatory architecture, where there were some countries trying to solicit business by not applying rules at all. That made it very risky, and the UK had to respond to that. It is very dangerous to play around with these rules in the wrong ways.
Mark Hoban: I do not necessarily disagree with what you are saying, but I think there is an approach to regulation in the EU that differs from the approach that would be adopted in the UK. EU laws tend to be much more prescriptive. It is partly a cultural thing; it is partly the way in which the rules are made. The standards in the UK are very, very high. I do not think anyone is saying that we ought to water down those standards at all. I think a less prescriptive and more principles-based approach is used in UK regulation than is used under the EU rules.
Ronald Kent: Without wishing to repeat what has been said, perhaps one thing that can be looked at is that, as has been touched on before, the UK has in many cases gold-plated things that have come across from the EU or from global standards. That is perhaps worth taking a look at.
Chair: Thank you all very much. It has been a very long session, but a very interesting one. Thank you very much for coming along.