The City of London Needs Equivalence — With New York

(Bloomberg Opinion) -- The eminent economist Bob Solow once said his profession “requires three qualities: faith, hope and clarity; and the greatest of these is clarity.” For the past four years the British view of its future trading relationship with the European Union has reflected much more of the first two virtues than the latter. Thankfully, we’re now seeing signs of lucidity. A speech last month by the U.K. trade negotiator, David Frost, was admirably clear on the subject.

Reasonable people can disagree about whether remaining in or leaving the EU is a good thing. But, as Frost said, there’s little point in giving up the advantages of membership without getting the benefits of leaving. The previous U.K. government, under Theresa May, started by arguing that a no-deal Brexit was better than a bad deal and ended up by arguing that a bad deal was better than no deal. She was prepared to sacrifice the good things about being an EU member without reaping the dividends of separating.

As we move into the next stage of Brussels negotiations, it’s important to recognize that while a free trade agreement is desirable it can’t mean having to follow rules and regulations that are created and monitored by the EU, with no British input. I’d also argue that it’s far more important for the City of London to be “aligned” with the U.S. than it is with Europe.

This week the EU General Affairs Council, which is overseeing the talks with the U.K., approved the bloc’s negotiating mandate for the discussion on a possible free trade deal. As the Financial Times remarked, “one of the EU’s aims from the talks is to ensure that it does not allow an economic threat to emerge on its doorstep.” It will do this by insisting on the U.K. sticking to a “level playing field” on its rules and regulations.

Such a view speaks volumes about the EU’s mercantilist ambitions. Since when did the case for free trade rest on the need to impose restrictive laws and regulations on trading partners, as opposed to the opportunity to exploit comparative advantages? David Ricardo, the political economist who dismantled the case for mercantilism, must be turning in his grave.

There is no logic in the argument that a trade agreement requires countries to align their regulatory and legal systems. And the EU is attempting to impose conditions on the U.K. that it does not on other trading partners. As things stand, Britain would be better off leaving and trading under World Trade Organization terms than agreeing to abide by EU regulations. A deal at any cost makes no sense for the U.K. In my experience the attitude of EU politicians is driven by a combination of dislike of “Anglo-Saxon” markets, which are seen as outside political control, and envy of the global role of the City.

The U.K. should be most wary of aligning with the EU in financial services. This was brought home to me in the immediate aftermath of the financial crisis a decade ago when I was chairman of the Governors and Heads of Supervisors in Basel. I met with Michel Barnier (then the relevant EU Commissioner, now the Brussels Brexit negotiator) to discuss the adoption of the new Basel III capital adequacy regulations into EU law. The aim was to raise the amount of equity capital that banks had to issue to improve their ability to absorb losses.

From the start of the Basel process these requirements were always seen as a minimum — individual governments were free to go further to make their banking systems safer. And the U.S., Switzerland, Sweden, as well as the U.K., were indeed keen to set a higher bar. 

Those countries didn’t insist in turn that the EU should impose tougher regulation on its banks, as it was unwilling to do. But Barnier, strongly encouraged by his staff, wanted complete EU harmonization and opposed the U.K.’s wish to enforce stricter rules on its own lenders. His guiding principle was that there should be a single regime in Europe determined by the Brussels machinery. He was left in no doubt that the U.K. wouldn’t accept this.

Since then EU regulation of financial services has gone down a road of increasingly detailed and often pointless directives that offer little protection to retail investors but add to the costs of the system. MIFID II is a classic example that has created unnecessary problems for the U.K.’s Financial Conduct Authority, such as the calculation of future returns that fund managers must provide to their investors. Banking’s culture needed to improve, but you don’t do this by setting up an expensive and incomprehensible burden of compliance.

Equivalence with EU regulation is not, therefore, an attractive path for British officials to follow. Recent comments by the outgoing and incoming governors of the Bank of England suggest they understand that. As a global financial center, any threat to the City will come not from various European hubs that would like to take business from London but from New York. That’s why equivalence with the U.S. should take precedence.

The first reason for prioritizing the Americans over the Europeans is that much of the U.K. financial sector’s business in Europe is already being done through separate subsidiaries or branches in the EU. Obviously, those companies will have to abide by EU regulations when selling within the bloc. But there’s no reason why Britain would wish to force those rules on firms operating in the U.K. when they’re selling either domestically or to the rest of the world, including to the U.S.

Second, New York is the real rival to the City, not Frankfurt, Paris or other would-be EU financial centers. As such, any regulatory alignment should be determined by the U.K.’s interest in remaining the pre-eminent financial hub in the European time zone. Why align with Europe when the real game is elsewhere?

Third, whatever the disagreements between London and Washington over Huawei, Iran or chlorinated chicken, it would be foolish of the U.K. to ignore the benefits from cooperation between the two countries on financial regulation. In the post-crisis debates on regulatory reform, the Americans and the Brits worked together well to toughen capital requirements on banks. This was often opposed by continental regulators more interested in protecting their national banks, which remain financially weak to this day. 

The transatlantic partnership offers a better hope for future regulation than tying London to a EU model. If equivalence must be the aim, then it’s with the U.S. rather than the EU that the future lies.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Mervyn King is a Bloomberg Opinion columnist. He is a member of the U.K. House of Lords, and a professor of economics and law at New York University. He was governor of the Bank of England from 2003 to 2013.

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