As the end of the Brexit transitional period looms, Sir Jonathan Faull – Partner and Chair of European Public Affairs, Brunswick, Brussels – looks at the question of trade in Europe and how countries with different laws trade with each other.
Tension is rising as the end of the Brexit transitional period on 31 December 2020 looms and negotiations take place over an agreement to replace the pre-existing intricate web of rules governing trade between the UK and the EU. A withdrawal agreement is in force, but a Bill (draft law) has been published in London making it clear that the UK reserves the right to ignore some of its provisions, particularly in respect of the delicate issue of trade with Northern Ireland. A British Minister has gone so far as to confirm that the UK will knowingly breach international law commitments made only a few months ago. We live in extraordinary times indeed.
The question the EU will ask is how the UK intends to implement the withdrawal agreement notwithstanding the powers it wishes to have to disregard it. The UK has entered into international law obligations, approved by Parliament after a general election in which those obligations were a central issue. How does Her Majesty’s Government intend to fulfil them? Unless it can reassure the world on that, people will ask why anyone should agree anything with the UK again. It is an odd way to promote “global Britain”.
But let’s step back and ask a fundamental question. How do countries with different laws trade with each other?
This question has preoccupied politicians and lawyers since time immemorial. In today’s world, unitary states have largely codified national laws regulating internal commerce, while more complex confederations, federations and unions of various sorts have rules governing relations between their component parts. States have created regional or international trade laws between them by treaty and sitting precariously on top of the world is the WTO.
The European Union has spent the last sixty years creating what has successively been called a common, internal and single market among at first six, now twenty-seven, countries. It is very much a work in progress, still in many respects different from the arrangements within a single country. To understand how it sees the rest of the world, it is worth looking at the techniques it has used to unify its market internally and to regulate imports into its territory from abroad. These are not merely academic issues. They are at the heart of the debate about the relationship between the EU and first ex-member, the United Kingdom.
In essence, from the British perspective the question is whether the EU should accept that the UK is free to regulate goods and services as it wishes, acknowledging that it is a European country with broadly similar challenges and policies to its own and thus welcome without further ado its goods and services. From the EU’s perspective, the question is whether an ex-member should continue to trade with the EU’s single market on terms not very different from those which it enjoyed previously without complying with similar rules.
A related question is how granular any commitment to continued alignment should be. Can there be mutual recognition of regulatory systems based on their outcomes, rather than on their detailed ways of securing those outcomes? After all, don’t we all want health and safety, consumer protection, financial stability and a clean environment? Among friends, can’t there be a presumption that the devil is not in the detail after all?
This approach appears doomed to failure if one understands the way the EU operates.
Even the EU itself, a remarkably intimate set of trading relationships between sovereign states which have inflicted wars, occupation and dictatorship on each other (and many other parts of the world besides) in recent years, could not manage to go that far in relying on mutual confidence and shared values.
Romance and stirring speeches aside, the European Union is built on law, not love. Member states gradually come to trust each other by adopting common rules and an agreed system of interpretation and adjudication. Many adjectives and nouns are used to characterise advanced inter-state regulatory cooperation: mutual, dynamic, recognition, equivalence, adequacy, alignment. The rather lame sporting metaphor encapsulating all of this is the level playing field[1].
Once upon a time, Brussels applauded a European Court of Justice judgment[2] which seemed to cut through all these layers of complication and establish a simple principle: if it’s good enough for me, it’s good enough for you. If the French could buy and drink a blackcurrant liqueur known as Cassis de Dijon, German law should not stop it reaching German shops and lips.
Did the Cassis de Dijon judgment give rise to a free-for-all in which it was sufficient for a product to be lawfully marketed in one country to be sold freely in all the others? No, it gave rise to decades of painstaking rule-making to create common standards and mutual confidence. On fruit-based liqueurs themselves, for example, there is now very detailed legislation[3]. In the words of one of its recitals, “in the interests of consumers, this Regulation should apply to all spirit drinks placed on the Union market, whether produced in the Member States or in third countries. In order to maintain and improve the reputation on the world market of spirit drinks produced in the Union, this Regulation should also apply to spirit drinks produced in the Union for export.”
So, the detailed rules apply to internal trade, imports and exports.
In the field of services arriving from abroad, things are even more complicated. They are not subject to borders, customs, excise and tariffs. They are either allowed or not. When they are allowed, conditions are usually attached. In fact, the regulation of services and those who would provide them are among the most stubborn and effective trade barriers. Of the EU’s “four fundamental freedoms” (goods, people, capital and services), it has often been services which lagged behind the others in the creation of the “single” market.
Can I sell banking services, give legal advice, cut hair or sweep chimneys in another EU member state from my own? Usually the answer is yes, but only if I meet stringent local conditions, some but not all of which have been fully or partially harmonised by the EU. Rules, sometimes with roots in medieval guilds, will often get in my way.
Financial services are no different from other services. Since the financial crisis which began in 2007, a large body of rules has been enacted regulating the providers and provision of financial services in the EU. How do these rules interact with services from foreign countries? As usual, trust is essential but lacking, so the EU generally checks the “equivalence” of foreign rules in considerable detail before admitting services from the countries concerned.
So, an awkward question here is whether the EU and the UK really trust each other when it comes to the regulation of financial services. I can think of two reasons why they might not. Some EU folk believe, however unfairly and self-servingly, that the financial crisis, born in sub-prime mortgages in the American heartland, sliced and diced into barely understood and poorly regulated products in Wall Street and the City of London, created an Anglo-Saxon pandemic which infected naively unprepared Europe. This was seen to justify wariness and detailed regulation to make sure it could never happen again.
Some City of London ladies and gents, on the other hand, have long suspected that there is a dastardly plot hatched in the inefficient, over-regulated EU to dismantle the City and move its activities to some combination of European cities such as Paris, Frankfurt, Amsterdam, Luxembourg and Dublin. The so-called precautionary principle underlying much of the EU’s attitude is, goes the argument, either genuine but paranoid or insincere and designed to defend, protect and champion local businesses.
With conspiracy theories of this sort heard in ministerial offices and boardrooms, how can the mutual confidence be found to underpin mutual recognition based on shared values and aspirations?
Recently attention has been paid to a statement issued by the UK and Switzerland about the future relationship between the two countries in respect of financial services regulation, to be based on outcome-based mutual recognition[4]. Voices in London are heard asking why the EU and the UK can’t do something similar.
Switzerland is an important country in some financial services, but the UK is much bigger. The UK is the world’s largest net exporter of financial services (USD82.67bn), followed by the US (USD63.18bn) and Switzerland (USD23.37bn)[5]. The UK is a paramount world power in this field and its “global Britain” ambitions are far greater than simply emulating Switzerland in its relations with the EU.
So, what can be done to respect the sovereignty, interests and ambitions of both sides, while giving the European continent as a whole the financial stability and resources it needs to recover sustainably from the multiple crises of these early years of the twenty-first century?
Some degree of regulatory alignment is needed to allay fears of competitive under-regulation on the British side and aggressive use of regulation on the EU side to force relocation of activities. Regular meetings and dialogues should take place about what is after all often domestic implementation of already agreed international standards in the Basel constellation of committees in which, if one listens to complaints from Washington, Beijing and elsewhere, Europeans as a whole are too influential anyway. The British and the EU (and the Swiss) should work together internationally and undertake to implement what they have agreed in a way which preserves harmony and stability between their interconnected markets. Yes, there will have to be provisions for adjudication and sanctions if things go wrong but let them deter wilful or inadvertent divergence long before they need to be invoked.
Of course, there are those who advocate wilful divergence and will not want to see it deterred in any way. They need to be honest with themselves and, if they are politicians, with their constituents about the more difficult access to important and lucrative neighbouring markets that regulatory divergence entails. Proximity is an underestimated factor in international trade. Most countries trade more with their neighbours than with the rest of the world and that is true for services as well as goods. Whatever the rhetoric about Australia and Canada, it is not surprising that the EU/UK political declaration accompanying the withdrawal agreement lays stress on proximity. It is in the interest of both parties to agree to stay close to each other in regulating services, including finance, and to set up a mechanism for dealing with divergence when it happens.
Sir Jonathan Faull is a Brunswick Partner and Chairman of European Public Affairs, having been with the European Commission previously. Jonathan’s most recent roles at the Commission included Director-General Financial Stability, Financial Services and Capital Markets Union, as well as Director-General of the Task Force for strategic issues related to the UK Referendum. These notes are his personal views.