What Brexit would really mean for financial services
TWO fallacies are common in the EU debate. One is the “nirvana fallacy”, the idea that, if we leave the EU, we will have optimal policy at home. In financial services, for instance, while many are rightly angry about the European Court of Justice’s rejection of the UK challenge to a EU financial transaction tax (FTT), some of the worst developments in regulation have been home-grown. Recent regulation of the mortgage market is a prime example.
The second fallacy is common on the pro-EU side. Business models are often built around the EU regulatory system, with the implicit assumption that, if we leave the EU, everything will stay the same – except that we will have no seat at the table to influence its regulation.
However, if we leave the EU, everything changes. The Single Market is not a free trade area, but a system of uniform regulation – though there are still some last vestiges of mutual recognition. That regulatory system restricts the way businesses operate, both when they are trading across borders and within their own countries.
Solvency II for the insurance industry (which has not yet been implemented), the Alternative Investment Fund Managers Directive, and a range of other regulations, with many still to come, raise costs, and limit innovation and competition. If we are not in the EU, we do not have to adopt that regulation in the UK, although UK firms would, of course, have to abide by it when operating within the EU.
But there would be nothing to stop financial services companies operating through subsidiaries in an EU country and procuring the actual services provided from their UK subsidiaries: trade can happen without the UK subscribing to the Single Market. That is how, for example, offshore financial institutions operate. UK companies would then also avoid the dreaded FTT for most of their global business.
Secondly, the EU is becoming an increasingly small share of the global market. The EU distorts trade as well as promotes it. Outside the EU, many financial services firms can look elsewhere for business. And our government can promote trade both by free trade agreements and through multi-lateral agreements on regulation. For example, it might have made more sense in the early 1990s for the UK to agree trade and mutual recognition of regulatory arrangements relating to insurance with the US, Canada, New Zealand and South Africa rather than try to ram Solvency II through the EU.
Finally, we can reduce more general regulation applying to UK business, such as labour market regulation. Paradoxically, exit from the EU may also allow politicians to liberalise immigration rules that apply to skilled labour from non-EU countries.
But this takes us back to the beginning. Exit from the EU would take those who benefit from the established order out of their comfort zone and many benefits could flow from Brexit. However, the British government has shown itself just as inclined to deal with every problem it meets by increasing regulation as the EU. We need a return to the liberal culture of the late nineteenth century. That is possible if we leave the EU, but impossible if we remain in.
Philip Booth is editorial and programme director at the Institute of Economic Affairs, and professor of insurance and risk management at Cass Business School.