Brexit: The Future of Financial Regulation and Supervision (European Union Committee Report)

Baroness Kramer Excerpts

Wednesday 6th June 2018 Lords Chamber

[Baroness Kramer (LD)]

My Lords, I start by congratulating the committee and my noble friend Lady Falkner on what is a very meaty report—I fully accept that. But I am afraid that I find myself in the camp of the noble Lords, Lord Davies, Lord Liddle and Lord Desai, and my noble friend Lord Bruce in this debate.

I start by trying to find at least a little bit of common ground. We can all agree that the financial services industry is absolutely crucial to this country. My noble friend Lord Bruce quoted the number of employees and the tax that it generates, and 30% of that is generated from an EU client base—the client base within the 27. A very significant part of the financial services industry that we have here and which underpins so much of our economy is essentially generated out of the 27. We access that, as others have described, through a very diverse set of regulations and directives, from direct passporting for the banking industry and much of the insurance industry, and rights of delegation for asset management. The reason why we can have the London Stock Exchange acting as the global foremost CCP which clears virtually all euro-denominated derivatives as well as many in other currencies is because of liquidity provided by the European Central Bank and underpinned by a location policy. Many of the fintechs that the noble Baroness, Lady Neville-Rolfe, talked about survive because they were pan-European from the day when they were born and function across borders through the e-commerce directive. Many of them have based their future plans and what they expect and hope for on the single digital market. So we are deeply embedded in this process.

There are two other big issues for our financial services industry. I am not going to address them here, but let me mention them by title. There is freedom of movement. So many of the staff—one-third of all those in our fintech operations, for example—come from continental Europe. They are not going to come here under visa terms, because why should they live with those restrictions when they can live without them elsewhere. Then there is the whole issue of data exchange.

I want to go back and pick up the point that the noble Lord, Lord Desai, made. The British-to-British conversation that takes place all the time, about how we manage to keep financial services thriving at the current level and growing in a post-Brexit world, comes without any recognition of where the European Union is coming from—and positions that we ourselves would take if we were in its position. I hear so often, “They need us more than we need them”. You hear that almost on a continuous basis. But there is a lack of capacity in the rest of Europe. Over the last 10 or 20 years, nearly all financial services capacity has been sucked into London. It has thrived in London and has come to this financial centre, particularly with regard to the wholesale markets. That is where things are today. If you are sitting in the EU, you recognise that as a reality, but it is a reality for now. Five years or 10 years from now, why should that continue to be so? Surely, you look for an arrangement, when the UK decides that it is going to step out of the club, leave the EU and become a third country, and you look for an opportunity to bring that business back into the EU, perhaps salami slice by salami slice, and build capacity gradually.

We often hear from the British the threat that, “If the business doesn’t thrive in London, it will move to New York”. That is just from one third country to another third country—perhaps a less attractive third country, and perhaps one where the time difference is more of a problem. But it is frankly not a major issue, if you are sitting within the EU and what you are looking to do is to over time build that capacity. To think that the EU 27, which by purchasing power is the second largest economic bloc on the globe, would allow its crucial financial centre to be outside its supervision and control, is fairly extraordinary. We would have to make an exceptional case to argue that that should happen. I do not think that any of that is recognised in the discussions that we constantly have about the solution that we would like.

That leads me to the issue of what is often called bespoke dynamic mutual recognition. We will have mechanisms where we recognise them as acceptable players and they recognise us as acceptable players, but when we dig beneath that we find that it requires fundamental change in the EU to achieve it. This is an organisation that lives in a rules-based society and has a legal framework structured through the ECJ, and all that would have to be reconfigured to meet the requirements of mutual recognition. New institutions would have to be created, staffed and funded, and the EU would fundamentally have to change how it operates. Why would it do that?

I am afraid that the very unsatisfactory third-country equivalence that is on offer—and I agree that it is very unsatisfactory—works perfectly well for the EU. Nobody in the UK is going to stop them coming to use London markets and say, “No, you can’t come here and have access, we’re going to take it away from you”. We need their business. It is perfectly acceptable for them to work on a basis whereby, essentially, on 29 days’ notice the European authorities can simply remove the business or set in place new requirements or new rules—and it works very well with that strategy of moving attractive pieces of business salami slice by salami slice back to continental Europe as the capacity develops and as it is capable. We delude ourselves in thinking that the EU is going to go through extraordinary contortions and change its fundamental way of working to accommodate a mutual recognition framework, even though we think that for us that would be ideal.

The same thing could be said of a free trade agreement. I would love to see a free trade agreement that contained services. I was at an event today at the City of London where the speaker said, “If the EU wishes to prove itself to be the leading free trader in the world, it would be an excellent opportunity to create the template to include financial services in a free trade agreement”. I just do not see that that is where the EU is at this moment in time. It is not on its priority list to identify itself as the leading free trader and start to create a framework that redefines global trade and WTO rules. If it does have that ambition, it is certainly not going to be doing it in the next 12 months or two years. That is the kind of thing that you might develop over five or 10 years. It would be long and tough and, obviously, it would have to be framed as an arrangement that has served not just an arrangement with the UK but with all the other various financial centres around the globe. So it is not something that is going to be immediately available, which drives us back to this very unsatisfactory arrangement of—I am now losing the terminology. What is the word that I want? It begins with “e”.

[Lord Bruce of Bennachie]

Equivalence.

[Baroness Kramer]

Equivalence. I do have this problem.

The other issue that I have heard discussed here and which bothers me hugely is the discussion about how, after we leave, we can reframe our rules to allow more risk-taking. To pick up exactly the point that the noble Lord, Lord Davies, picked up, if you were sitting in the European Union and looking at the UK in 2008, you saw a financial crisis to some significant degree attributable to light-touch regulation—and how we touted light-touch regulation and told everyone that it was the way to go. It is exactly a return to that language of light-touch regulation. We have mistrust within our own country—people mistrust the industry and the regulators, so it is wrong to suggest that in the European Union they are going to say, “No, no, no—these people have changed completely. When they talk about reducing regulation it will be in the context of being absolutely safe”. It is not—it is in order to create competitive advantage.

As noble Lords know, Barney Reynolds is a great promoter of that particular approach. I took some quotes from the report that he submitted, where he talks about a “market-friendly” financial services framework. That sounds very good, if you believe that market forces are the answer, but not if you believe that market forces ran rampant and out of control in 2008. International competitiveness should be a “statutory objective” for all our UK financial service regulators—that is the kind of language. That is a race to the bottom. This is precisely the accusation that is being levied: international competitiveness means that you always have the least-regulated structure. We are seeing in the United States, again, that a lot of the regulation that was put in place following the 2008 crisis is now being pulled back. That creates an added level of discomfort with this kind of Anglo-Saxon approach and framework. I do not think that we should underestimate how much we are caught in that particular view.

I also have to say that, when I ask those at any financial services entity, “Where are you looking for a change in regulation?”—the noble Lord, Lord De Mauley, hit on it exactly—they say that it is on remuneration: lifting the cap on bankers’ bonuses. If ever there were an example that inspires mistrust and a sense that we are returning to the bad old days, it is that. It is always represented as the key and most important regulation that the financial service industry would like to see lifted.

I am desperate to keep the financial services industry here to the extent that we can, but I think we have to be realistic. A lot of it has already left. As my noble friend Lord Bruce said, this is not done with press releases and open discussion; no company wants to create concern among its customers, suppliers or regulators by saying, “We are at risk if we stay within the UK”, but these companies are very quietly moving and we are beginning to see a series of announcements. It was also an iconic moment when Lloyd’s of London dropped “London” from its title. It is now established in Brussels. It has 600 staff in London; 100 of them are moving to the Brussels office—it is just the beginning. Insurance companies, because of the reasons of contractual continuance that have been raised here, have all been moving over the last 24 months. I just say to the noble Baroness, Lady Neville-Rolfe, that the fintechs are moving as well. I have talked to so many of them that are applying or have applied for a licence in Dublin—but the real risk is Paris. She spoke about the innovative approach that we have to regulation of the fintech industry, and I agree, but it has spread rapidly and she perhaps does not know that the Paris equivalent has an MoU with the FCA to make sure that it takes an equivalent approach to regulation and sandbox to Paris. It is to Paris that a lot of the fintechs are moving; it is an attractive lifestyle and many of them are fans of Macron. They see a future there and there is real competition for that particular industry.

What do we do under these circumstances? I, like others, think that the only route we can take that leaves us with something other than this unsatisfactory third-country equivalence is, frankly, to stay within the single market one way or another. Without that, it seems to me that we will be on the outside. If we are going to be on the outside and trapped within just equivalence, our whole negotiation has to be focused on trying to make sure we have a voice at the table. I do not see the Government doing that; I see them going down the mutual recognition route, basically with pages of demands that require the European Union to restructure the way that it works, to change everything that it does, to shift its principles and to have 27 countries operate under a rules-based system and the 28th without that. If we can get the Government to pull back from that and to pursue an opportunity—I would prefer it to be in the single market but it has to be an equivalent to try to get us a voice at the table through some mechanism or other—we might have some possibility and some hope. The complexity around this industry more than illustrates the fact that there are only downsides to Brexit. One can find a few upsides but, my goodness, weigh them on the scale and they are very small.