LONDON – When the United Kingdom eventually leaves the European Union – assuming it does – it will take Europe’s biggest capital market with it. The loss of the City of London could drive the EU’s 27 remaining members to pursue an inward-looking strategy for managing their capital markets. But, as we argue in a new policy brief for the Centre for European Reform, the EU27 would be far better off keeping those markets open to – and, indeed, integrated with – London and the rest of the world.
Greater capital market openness has been on the EU’s agenda for some time. Since 2014 – well before the Brexit vote – the EU has been aiming to build more integrated markets for cross-border investment within the bloc. But the creation of a capital markets union (CMU) requires politically tricky policy changes in a wide range of areas, including taxation, insolvency regimes, and financial regulation. As a result, progress has been slow.
Without the City of London, the EU can probably forget about creating a capital market that could compete with New York or Tokyo. But that does not mean it should abandon its ambition to build a CMU. After all, the fundamental issues that such a union is supposed to address endure.
For starters, the eurozone is still at risk of being destabilized by asymmetric shocks. A larger, cross-border capital market would mitigate this risk, by enabling the costs of economic shocks in one country or region to be shared among investors across the EU.
Moreover, European companies remain excessively reliant on banks, which, under pressure from regulators, have been lending less and raising more capital. A CMU would open up a wider range of funding sources, while reducing vulnerability to banking shocks.
But even integrated EU27 capital markets would be too small to meet the funding needs of European businesses, meaning that they will need to source financing from outside Europe. That is why global engagement is critical.
Such engagement will not come without challenges, beginning with a loss of regulatory control, because leading global capital markets would be outside the EU’s jurisdiction. This is a major reason for EU policymakers’ firm line on the UK’s post-Brexit access to EU markets: unless the UK remains in the single market, British firms that want to continue selling to the EU will have to rely on narrow equivalence provisions. The UK will not be considered a special case.
This approach reflects the (understandable) tendency in Brussels to look at EU-UK arrangements holistically and attempt to exploit negotiating levers wherever possible. EU27 leaders know that access to their consumers is a high priority for UK firms, so they will not grant it easily. Instead, they are likely to emulate their strategy for pressuring Switzerland to sign off on a stalled partnership treaty, which included threats not to extend the country’s stock-market equivalence.
The problem for the EU is that its own equivalence rules would make it extremely difficult actively to discriminate against UK businesses without applying corresponding measures to other foreign firms. Because the EU is, above all, a rules-based system, ignoring its own requirements is not really an option. As such, any politically motivated “raising of the drawbridge” would affect all international finance, not just the UK.
While concerns about loss of regulatory control are legitimate, they must not be allowed to curtail companies’ access to finance unnecessarily. The days of financial autarky are gone, and Europe cannot bring them back. What Europe can do is deepen its engagement in global financial markets – and strengthen its voice in their regulation.
To that end, the EU27’s relationship with the UK is crucial. Whatever legal form that relationship takes, the EU needs to make sure that it includes regular exchanges of information, deep supervisory cooperation, and joint policymaking on new issues that arise. The UK, for its part, could offer the EU a role in formulating and implementing capital-market regulations for the City of London, carried out through a joint policymaking forum that includes formal structures governing the supervision of institutions active in both markets.
The ideal post-Brexit financial relationship between the EU27 and the UK would be a mutual recognition arrangement. This is not it. But the EU will never accept legally binding mutual recognition in financial services, especially for a country that has chosen to leave its ranks. In lieu of such legally binding measures, supervisors and regulators on both sides must pursue formal, institutionalized cooperation.
When it comes to capital markets, Europe cannot go it alone. And it would regret trying.
Jonathan Faull, a former senior British official at the European Commission, is Chair of European Public Affairs at the Brunswick Group. Simon Gleeson is a financial regulation expert at Clifford Chance.
Jonathan Faull and Simon Gleeson