Summary: Theresa May’s speech on 17 January 2017 has been given a mixed reception. Financial services firms will be pleased to hear her recognise the disruption caused by a cliff edge exit. But the prospects of avoiding that cliff edge are now more uncertain than ever.

Theresa May’s speech on 17 January 2017 shows that she has understood the importance to financial institutions of certainty; but not that she is in a position to deliver it.

The three key statements from the speech for financial institutions are:

  1. That the UK will not remain a member of the EU single market following its secession from the EU;
  2. That the UK will aim for EU/UK trade in financial services to be governed by a single, comprehensive Free Trade Agreement, to be negotiated within the two-year Article 50 period and to cover financial services, as well as trade in everything else (both goods and services); and
  3. That the government intends to avoid a disruptive cliff-edge and instead negotiate a phased implementation period, during which there will be time to prepare for the future legal and regulatory framework for EU-UK trade in financial services.

Statement 1 has never been said explicitly by the Prime Minister before. However, it also is not news, since it is the logical consequence of the red lines that David Davis and Boris Johnson have been articulating since the very earliest days of this government (i.e. that Britain must regain control over its borders and its laws) and the Prime Minister herself said in her October 2016 speech to the Conservative Party Conference. As the Prime Minister explained in her speech, “membership [of the single market] means accepting the “4 freedoms” of goods, capital, services and people”, which in her view “would to all intents and purposes mean not leaving the EU at all”.

The government’s conclusion in Statement 2 that an FTA will be the vehicle for agreeing future EU-UK trade relations is also not unexpected. However, Mrs May’s statement that “I want us to have reached an agreement about our future partnership by the time the two-year Article 50 process has concluded” raises serious questions about how realistic the government is being about the timeframe for negotiating the EU-UK FTA. The most important fact that this statement ignores is that the government’s EU counterparts have repeatedly said that they will not even begin negotiations for an FTA until after the Article 50 process has been concluded. Even if we did not have that, absolutely fundamental problem, in achieving an FTA within the Article 50 period (which is likely to be nearer 18 months than two years, taking into account the impact of the French elections at one end and the time needed for ratification by the European Parliament at the other end), we must also remember that FTAs of much less political complexity have taken a great deal longer to negotiate. For example, the recently finalised Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada, took over 7 years, and even then almost fell at the final hurdle due to the protectionist position adopted by Wallonia. Given the high degree of political heat that will surround the EU-UK FTA negotiations and the limited number of experienced trade negotiators available to the UK, it is difficult to imagine that the government believes the EU-UK FTA will take less time to negotiate than the CETA. From a financial services perspective, the government’s desire to strike a quick FTA does not bode well. Whilst there are examples of FTAs that have been negotiated in a short timeframe, they typically relate almost exclusively to goods (i.e. reduced or zero tariff deals) and cover very little in the way of services.

Almost as strange, on the face of it, is Statement 3. The problem with this statement is that a disruptive cliff-edge in the financial services sector means a loss of passporting and an abrupt reversion to WTO terms in 2 years. The only way that an implementation period can prevent that is it if it preserves the status quo for a longer period (i.e. rights equivalent to passporting rights). Mrs May acknowledged in her speech that “the interim arrangements we rely upon are likely to be a matter of negotiation”. That seems to us to be a wild understatement of the scale of the political difficulties she will face in achieving this, given the EU27’s apparently settled intention to make sure that Brexit leaves the UK in a worse position than EU membership (pour decourager les autres). Even if the main players in the EU27 were to be swayed by their own financial institutions’ wish to avoid sudden loss of access to London’s financial markets in the event of a cliff-edge Brexit, Mrs May still has all of the minor players to persuade, who will rightly view this as an opportunity to get their voices heard.

A further consideration is that the FTA is likely to constitute a “mixed” agreement to be entered into jointly by the EU and the individual Member States. If it is a “mixed” agreement, then the agreement runs the risk that it could be held up or blocked by any EU Member State or region (in the same way that Wallonia held up the CETA). The precise definition of what makes something a “mixed” agreement is currently the subject of a case before the Court of Justice. We should have some clarity on this point by summer; but if the Advocate General’s opinion (issued just before Christmas) is followed, then there will be a substantial list of subject areas whose inclusion in the EU-UK FTA would turn it into a “mixed” agreement.

The upshot? If your business depends upon continued access to the single market post-March 2019, then you need to accelerate your contingency plans. Although the Prime Minister has said that she will “seek to avoid a disruptive cliff edge” and “do everything we can to phase in the new arrangements we require”, the cliff edge is still there – and the UK is utterly dependent on the goodwill of each member of the EU27 if we are not to go over it.