Christopher Howarth: Why David Cameron should seek a UK emergency brake over EU financial laws

Christopher Howarth is a Researcher at the think tank Open Europe.

It now seems likely that France and Germany will push for an EU Treaty change at this Friday’s EU Summit. This is likely to give the EU further oversight of eurozone states’ public spending. Although this oversight would not apply to the UK, we are starting to see an EU where the balance of decision-making power is shifting towards the eurozone and, arguably, nowhere is this more important than in the area of financial regulation. Fortunately, however, Treaty change gives David Cameron an opportunity. If it is a Treaty within the EU-27 framework of all member states, he has a veto and therefore some influence. So what should he ask for in return?

Open Europe has this week published a new report, ‘Continental shift’, arguing that the UK is increasingly losing its influence on EU financial services regulation with the result that regulations are becoming restrictive and growth inhibiting. We argue that David Cameron should use the UK’s veto to gain safeguards over this vital UK industry.

Firstly, it is important to appreciate how much influence the UK veto provides. It is significant but not unlimited. Germany, in particular, wants to use the European Court of Justice (ECJ) to police eurozone states’ budgets and impose fines and sanctions on those running up deficits. To use the ECJ they need an EU Treaty change at the level of the EU-27, a eurozone-only treaty will not give them the right to use the Court and therefore no legal sanctions. However, UK bargaining power is not unlimited. If it pushes too far, the eurozone may decide to go ahead with its own treaty outside the EU structure, circumventing a UK veto.

Secondly, should the UK have a referendum on this new Treaty change – would that not give Cameron maximum influence? Well, leaving aside the legalistic argument that this Treaty does not affect the UK, a referendum ending in a UK no vote would risk forcing the eurozone to go ahead as 17 and without the opportunity to gain any UK concessions. What we need now is a plan, an analysis of the UK’s priorities and a way to safeguard them.

If we have some influence why use it on finance? There are a number of areas the UK should wish to reform, the Common Agricultural Policy or fishing are important but when compared to the UK’s financial services industry they are relatively small beer.

Our financial services accounted for a £35.2bn trade surplus in 2010 - the only industry sector in Britain that generated a substantial surplus and without which our overall trade deficit would be over £70bn rather than the already high £39bn. In addition to this, in the 2009/10 tax year, the UK financial services sector as a whole made a total tax contribution of £53.4bn, 11.2% of the Government's total tax receipts for that year. Financial services furthermore make up 10% of the UK economy, by contrast agriculture and fishing, although hugely important to some communities, account for only 0.7%. It is clear where the UK’s priorities should lie. Financial services are to the UK what agriculture is to France and fishing to Spain – two countries not shy of defending their national interests.

But is there actually a threat to our financial services industry? In the past the UK’s financial services industry has generally been a beneficiary of the single market.  In the 1990s and 2000s this benefit rested on two premises. Firstly, while EU-wide financial rules may have increased compliance costs for firms in Britain, they generally (due to UK influence), reduced barriers to trade and created opportunities for UK-based firms. Secondly, London was and is an entry point to the EU's Single Market in financial services – in the 2000s an attractive market, experiencing significant growth as financial services developed rapidly.

However, as a result of institutional changes in the EU, the financial crash and the continuing Eurozone crisis, the economic and political weather has changed. The underlying assumptions regarding the benefits of EU financial regulation to the UK are changing fundamentally:

Firstly, the UK's level of influence on new European financial rules has decreased; regulation is now less geared to financial services growth but more towards curtailing financial market activity, irrespective of whether such activity is good or bad. 

In addition, the Eurozone crisis is creating exceptional needs and political incentives for the euro countries to act in the interests of the Eurozone 17 rather than the EU-27, with UK concerns seen as peripheral at best. This new dynamic has already been expressed in a series of new proposals, including an EU-wide financial transaction tax, possible short-selling bans and the European Central Bank's insistence that transactions in euro-denominated financial products are cleared by central counterparties within the Eurozone rather than in London. These proposals represent a challenge to UK concepts of financial regulation but also UK access to the Single Market.

There is also, due to the financial crisis, a perception in many Continental capitals and in the European Parliament that 'Anglo-Saxon' light-touch capitalism needs to be reined in. Whereas in the 1990s and early 2000s, EU politicians and policymakers generally (but not always) felt constrained from imposing financial regulation on the UK with which it disagreed, they no longer feel inhibited – often far from it.  There are now at least 49 new EU regulatory proposals potentially affecting the City either in the pipeline or being discussed at the EU-level – while some are justified, very few of these are aimed at promoting financial services trade.

Equally important, over the next decade, growth opportunities for financial services within the EU are likely to be limited while they explode elsewhere in the world. Many European countries are likely to undergo economic stagnation and deleveraging. In 2005, the five largest EU economies accounted for 27% of global banking assets. In 2050, that will have decreased to 12.5%. Meanwhile, the BRIC countries' share of these assets will have increased from 7.9% in 2005 to 32.9% in 2050. Therefore, the benefits to London of acting as the gateway to Europe are becoming less convincing and the need to keep the door open to emerging markets elsewhere across the globe far more important.

David Cameron has two broad strategies he can pursue in response to the UK’s decreasing influence over EU financial regulation and the need to keep the City open for business in the global marketplace:

Work with likeminded countries to seek assurances that Britain's influence over EU financial services law will be safeguarded. This could be codified in a new 'Single Market protocol', inserted via EU Treaty change. Such a protocol could commit the EU to a pro-growth, outward looking and proportionate regulatory regime while safeguarding the UK from decisions taken solely by the Eurozone for all 27 member states.

However, this would provide no guarantee against the UK finding itself outvoted on future financial rules. Though it will be a tough to sell to other member states, the answer to this would be to seek a UK-specific, legally watertight ‘emergency brake’ that would ensure that the UK cannot be overruled on vital EU financial legislation and cement London's ability to do business and compete in global markets. This could include a 'double lock', acknowledging Britain's prominence in this sector and giving the Government the right to refer any disproportionate or discriminatory laws to the European Council, where it has an effective veto over regulatory proposals.

The financial services industry, for all its past faults, is vital to the UK and our only substantial export sector. In short, without it our economy could not pay its way. If French agriculture was at stake France would not be shy in making its case. Cameron needs to show the same sense of purpose and resolve to secure a vital UK interest.