Until recently, the EU and the UK were in disagreement over one part of the EU-UK Trade and Cooperation Agreement, the bit that dealt with Northern Ireland. This seems to have been settled by the so-called “Windsor Protocol”. But what’s striking is what has never been discussed, and what is not agreed at all. The Agreement said nothing about financial services or about economic and monetary policy. This gaping hole meant new uncertainties for the world economic system, for financial system regulation, for currency markets, and for the international financial institutions.
The UK had never joined the euro, but it had agreed to the treaty provision that non-euro countries would treat their economic policies as a matter of common concern. And likewise, it had agreed that it would treat its exchange-rate policy as a matter of common interest. By leaving the EU, the UK withdrew from these obligations. And the UK is now no longer a member of the EU’s Economic and Financial Affairs Council (Ecofin) which coordinates economic policies, and which also coordinates EU positions for the G20, the IMF and the World Bank.
The UK has also left three significant EU bodies concerned with financial market regulation. The EU has agencies to deal with banking, with securities markets, and with the pensions and insurance industry. The UK membership of these is being replaced by a series of bilateral agreements for information exchange and cooperation.
Above and beyond these three EU sub-sectoral bodies there is the European Systemic Risk Board. This is a crucial component of the policy architecture built up since the last financial crisis. The Board itself is accompanied by a wide range of technical committees, working groups, etc., looking at how the financial sector interacts with wider economic issues. The catch-all name for all this is “macro-prudential”. The structure is maintained and supported by the European Central Bank. The ECB’s Christine Lagarde is the chair of the General Board and of the Steering Committee. The Board includes the agencies mentioned already, and also (without a vote)the EU member states and the other EEA states (Norway, Iceland, and Liechtenstein). This means there is high-level policy overview of how financial crises can occur and what to do about them. But the UK is no longer part of this crucial analysis and problem-solving. Both the EU and the UK have lost a part of the bigger picture, and common positions could be rather uncommon in the future.
London is still a key financial centre for Europe but no longer subject to European regulation. Separate development in the EU and the UK will sharpen the differences. It will weaken relationships, and it will widen the gaps.
And things would be even worse if the UK were to pursue a maverick course in the world economy. Disagreements about regulation could make it less likely that a comprehensive view will be taken of the financial sector. There are many challenges, including the role of Internet banking, artificial intelligence, virtual currencies, data protection, and cybercrime. Different responses from the EU and the UK to the challenges will create the potential for confusion and worse. A disappointing Brexit experience for the UK will increase the temptation to pursue a policy of devaluation of sterling. This would require conscious non-cooperation with other parts of the world.
Moreover, lack of agreement on financial sector regulation may lead the UK to pursue a more adventurous role in this field. A more tolerant approach to capital inflows, with less questioning as to their ultimate origins and destinations, could endanger stability. New approaches to financial regulation, such as further liberalisation of derivative markets, are also a danger, perhaps with different perceptions of sustainability and risk are another
At a technical level, we can be sure that officials will do their best to continue to cooperate. And there are still international bodies such as the Financial Stability Board, although this has a much wider membership. But the UK is no longer part of the explicit political commitment and common European purpose. It is not hard to imagine a perilous outcome if the UK tries to be too clever, or even if it just tries too hard to be different. Also, the EU has lost an important and very sceptical member, and there will thus be fewer constraints on EU policy development in the future. The risks of misjudgements have increased on this side also, if not to the same extent.
A new Labour government in the UK will want to take a different approach to the EU. Unfortunately, this seems likely to focus on issues such as trade procedures, migration and defence. Economic and financial policy is unlikely to be a priority.
Commentators sometimes make a distinction between the financial economy and the “real” economy. In the case of Brexit, however, the real story may be the financial story: it has yet to be told and the ending may not be a happy one. When the next financial crisis arrives, Brexit will have made it a bit more difficult to deal with. And Brexit may have made the next crisis a bit more likely to happen.