It is becoming increasingly clear that while Theresa May’s Mansion House speech may have applied some sticking plaster on the gaping wounds within the Conservative government, it fails to address vital issues on which it simply offers more unrealistic fudge.
The latest wheeze is to say that the UK and the EU should go for “mutual recognition” of each others’ norms and standards for goods and should accept the rules governing services, in particular financial services, as “equivalent”.
This doesn’t bear scrutiny.
Goods: Hidden hurdles of mutual recognition
May set out a vision of a “comprehensive system of mutual recognition”, in which “products only need to undergo one series of approvals, in one country, to show that they meet the required regulatory standards.”
Let’s start by recalling that she wants Britain to leave the system that actually secures this by agreeing common standards and redress mechanisms, thereby allowing goods to circulate freely without needing further checks. Leaving the EU single market puts us outside this comprehensive system.
Instead we will be asking the EU to recognise a new set of separate British standards that could, and in due course will, diverge from the previously agreed common standards. Such a system has never been established on a comprehensive basis with a third country before.
Existing systems of Mutual Recognition Agreements (MRAs) with third countries work sector by sector. For each one, they set out the conditions under which one country will accept the testing, certification and conformity assessment carried out in another country. They have to be reviewed if the rules on either side change, and this can take years to negotiate.
When there is no such mutual recognition of certification processes, products have to be inspected before they are allowed onto the market. In January, the European Commission published a notice to stakeholders pointing out the limitations of current systems of mutual recognition of regulations for industrial products, such as those for machinery, radio equipment, medical devices, cosmetics, construction products, batteries and toys, to name but a few.
The first hurdle for such British products to enter the EU single market if the UK is no longer a member will be the need for conformity assessments, certifying that they meet the relevant EU standards. In some product areas, this assessment needs to be done by a ‘Notified Body‘. Up until now, UK Notified Bodies have been able perform conformity assessments on behalf of the EU. After Brexit, UK Notified Bodies will lose their status as EU Notified Bodies. This means that UK manufacturers who wish to continue to export their products to the EU post-Brexit will need to apply for certification by a Notified Body in one of the EU-27 states. This is likely to incur greater costs and take longer for the firms needing them.
(It is also a loss of income for UK Notified bodies, who currently gain trade not just from UK firms but from firms across Europe when they have specialised expertise, often for high value products, or when offering certification services for imports from third countries.)
Another hurdle, for certain products, will be the need to have either an authorised representative or a responsible person established in the Union on the territory of the EU market. This applies, for instance, to medical devices, cosmetics, transportable pressure equipment or marine equipment. Another extra cost that was not needed as an EU member.
If regulatory divergence is the Brexiters’ hidden goal behind leaving the EU, then it is one that comes with a significant price tag.
And let us not forget that EU rules with which exporters need to comply will be set in future without the UK government or MEPs having a say on them.
Services: Not so equivalent after all
There are similar noises from Brexiters trying to reassure us that the UK’s financial services industry – a very significant sector of the economy, and in turn of government tax receipts – will still be able to access the EU Single Market for services post-Brexit. This can be achieved, they argue, through seeking recognition of ‘equivalence’ (of UK financial services rules and supervision mechanisms) from the European Commission.
In reality, the process by which the EU grants access is much more complex, limited in scope and risky than the Brexiters pretend. Theresa May has begun to admit this by abandoning her aim of continued passporting for the financial industry for the financial industry post-Brexit – a sector of the UK economy which is worth billions of pounds.
Finance is one of the few service sectors with a set of rules allowing firms in non-EU countries to operate within and trade with the EU. This is done after a detailed assessment of the third country’s rules by the European Commission, following by approval by a qualified majority of EU Member States. Seeking equivalence is one of the main incentives for regulators in third countries to develop, adhere to, implement and enforce the same standards as the EU.
However, there are several reasons why equivalence cannot be seen as an easy solution for the UK.
The Commission’s assessment process involves evaluating how much risk the EU financial system is exposing itself to through granting equivalence to a non-EU member state. These risks include the size of the country’s financial services market (and London’s financial economy is disproportionately large, so there will be a natural wariness about it), its policy priorities, tax and anti-money-laundering considerations and whether there is a risk that EU rules are going to be circumvented.
In order for equivalence to be granted, the UK needs to follow the same regulatory goals as the EU. If granted, it is then not compatible for the UK to radically changing its rules.
However, Theresa May said in her Mansion House speech:
The UK has responsibility for the financial stability of the world’s most significant financial centre, and our taxpayers bear the risk, so it would be unrealistic for us to implement new EU legislation automatically and in its entirety.”
thereby at a stroke diminishing the prospects for securing equivalence recognition.
Another important point is that different EU acts have varying equivalence provisions, some having explicit provisions and procedures to allow equivalence to be recognised, and some not. Some EU rules, such as in the payments area, retail banking and reinsurance do not even have equivalence provisions.
And even when there is a provision for equivalence to be recognised, the UK would need to seek a separate decision in each case, resulting in numerous Commission assessments that require both time and money.
Furthermore, equivalence is unpopular among some in the City because of the unpredictability of both its granting and withdrawal. The Commission makes every assessment on a case-by-case basis, which, given the risk based approach in each and every case, makes it unpredictable. One thing is certain, however: not a single equivalence decision has been granted to a third country whose laws diverged significantly from the EU’s rules.
Investors will also be worried by the fact that equivalence can be very easily withdrawn. The Commission’s Staff Working Document on the issue is crystal clear: “as a unilateral and discretionary EU act, an equivalence decision may be changed or even withdrawn from the EU, as necessary, at any moment”.
All in all, neither mutual recognition in goods nor equivalence in financial services are helpful solutions to the UK government’s Brexit dilemma. Both would mean that UK businesses will be affected by current and future EU rules – without any longer having any say in what they are – and both would entail additional costs and regulation for businesses, and uncertainty for all.
The fudge offered by May is an attempt to bridge the gap of the central dilemma of Brexit:
- leave not just the EU but its single market rules and face a big economic hit
- or still follow those rules and become a rule taker, not a rule maker, with no say on the rules.
Neither solution is good for Britain. And the attempts to fudge this by finding ways of having separate rules but still having full and easy access to the single market are illusory.