Brexit – On to the Next Course

With “sufficient progress” made on initial Brexit negotiations, the next phase of talks between the EU and UK will focus on their future relationship. After months of deliberation, it’s still unclear whether we will ultimately see a soft, medium, or hard Brexit.  

In the video below, we explore those three options and what that could mean for the asset management industry.

Breggsit served play

In the last few weeks of 2017, the EU and UK made welcome progress on red line Brexit issues such as citizens’ rights, the financial settlement, and the Northern Ireland border issue. The next round of talks (Phase Two) will focus primarily on the transition period and framework for their future relationship. Phase Two is also likely to shape the terms of any reciprocal market access agreement, which will likely include an extended transition period in which the UK will continue to follow European regulations.

No Exceptional Cases

Given the extensive relationship between the UK and the EU financial market, many hope and expect that the role of UK banks and asset managers would be given particular attention during future discussions. However, based on recent comments from senior EU policy maker Stefaan De Rynck, this may not be the case. “There can be no sector-by-sector participation in the single market,” he said, since any such arrangement risks the “end of the correct functioning and integrity of the single market and is therefore something the EU would want to avoid.”

Like all things Brexit, the future is uncertain, however for now it seems that all industries, including financial services will be afforded the same terms and conditions. This means a bespoke negotiated arrangement – or a “medium” Brexit – is still a viable option. However, a general trade agreement may not adequately address the specifics of financial regulations. For example, regulatory equivalence and cross border passporting do not play as large a role in the functioning of other industries but they are critical to the functioning of asset management in Europe.

Political Red Lines

The burden of ironing out the wrinkles within the Brexit process do not solely lie at the door of the EU. As politics dictate, hard-liner Brexiteers may never accept the four EU freedoms of good, services, people, and capital; or the jurisdiction of the European Court of Justice. These elements are needed to form the cornerstones of any reciprocal market access agreement from the EU perspective.

Another camp has coined the term “Brexitino,” meaning agreement with a “Brexit In Name Only.” This would mean that the UK leaves the EU, but commits fully to EU regulatory alignment in perpetuity. While theoretically possible, this option would be politically impossible. Political divides will remain a major influence as negotiations continue.

Predicting the Unpredictable

Despite months of detailed negotiation, it is still difficult to predict what form of Brexit will ultimately come to be. However, there are some things that now appear clear. Moving to Phase Two dialogue indicates that “no deal” or “no Brexit” options are low probabilities. It also seems unlikely negotiations will lead to a bespoke financial services arrangement. We expect the outcome to look more like a single all-encompassing trade agreement and all three types of Brexit remain on the menu:

SoftLargely a retention of the status quo. The champions of Brexitino hope for this but the politics on both sides of the negotiating table make it a lower probability event. A soft Brexit would largely replicate Norway’s current relationship with the European Union. But it would be a resolution that displeases many who voted in support of Brexit in the first place. European Court of Justice jurisdiction over certain UK affairs would remain intact, the UK would likely continue to contribute to the EU’s budget, and the EU and UK would remain aligned on regulation.

MediumA bespoke negotiated arrangement. For financial services, this means EU access through third-country equivalence rather than passports. This is the most complex to work out, and as such, the agreed length of the transition period will be key. By definition, there is a wide spectrum of possibilities within a medium Brexit. Many look to Canada as an example of the relationship, but the EU-Canada agreement has a limited scope. After nine years of debate, it only applies to trade tariffs on goods.

HardA hard Brexit means the UK would be separate from the EU, with no negotiated access to the EU market. A hard Brexit is the toughest possible outcome for asset managers. A hard Brexit scenario, particularly if trade negotiations were to promptly fall apart, would necessitate defaulting to use of the template World Trade Organization agreement. This is an outcome that all stakeholders are probably now keen to avoid.

The Updated Menu

While all three options remain on the menu, it does not appear that anyone has a strong appetite for a soft Brexit. A medium Brexit appears to be the most popular serving, although it takes the most time and expertise to prepare and the collective cooperation needed to serve a medium Brexit has not been present to date. A hard Brexit also has a loyal support base especially for those who like clear, hard and fast rules that leave no room for interpretation. Although a hard Brexit takes longer to prepare, it does satisfy those who like to know exactly what they are ordering.