The Brexit Stalemate: Are We Headed for a No Deal?

Brexit. Remember That?

A Soft Brexit or a Hard Brexit. ‘Remoaners’ vs. ‘Brexiteers’. The Irish backstop and the cliff edge. Even the linguistic impact of the UK’s shock decision to quit the European Union on June 23, 2016 generated a level of anguish and controversy that few had foreseen. Brexit, which had dominated headlines for four vertiginous years, almost became an afterthought when the UK finally left the European Union on 31st January, 2020. With the world reeling from the devastating impact of COVID-19, Brexit negotiations had to be continued via video link in an attempt to forge a path forward. The UK’s official departure in January triggered an 11-month transition period. The transition period was intended to provide a temporary status quo that offered some breathing room to get back to the negotiating table. July 1st, 2020 was the deadline by which negotiators had to decide whether an extension to the transition period was necessary. That deadline passed without any further extension requests. The race is now on for the UK and EU to strike a deal on their future relationship and avoid the very real prospect of the UK walking away without a deal (the so-called “cliff edge” scenario) on December 31st, 2020. With a little under five months remaining, perhaps unsurprisingly, London and Brussels are struggling to find a compromise to negotiate a trade deal. Are we back in another cycle of Brexit brinkmanship? Is the UK headed for a no-deal Brexit? What are the implications for the Financial Services industry? How will COVID-19 affect current negotiations and can both sides find a breakthrough that leaves neither feeling short-changed? Exploring the interaction between the negotiations’ key sticking points, the tight timeline and the impact of external factors will shed further light on why “get[ing] Brexit done”[1] is such a colossal task.

The Schedule and October’s “Moment of Truth”

Michel Barnier, the EU’s lead Brexit negotiator, has designated October’s European summit as a “moment of truth”[2].  Practically speaking, the months between October and December are critical to draft the required legal agreements and achieve full ratification by EU member states. In the meantime, Boris Johnson, the UK Prime Minister, continues in his push to strike a deal by the end of summer. An optimistic and ambitious aspiration, even before one considers the fact that COVID-19 has drawn political attention away from Brexit. In a joint effort to intensify talks on future relationships, face-to-face negotiations resumed in early July. Unfortunately, negotiations conducted in person have not yet delivered the tangible results that negotiators on both sides had hoped for. Talks in Brussels in early July ominously ended a day earlier than scheduled and a Downing Street private dinner the following week between Barnier and David Frost, the UK’s chief Brexit negotiator, showed that “significant divergences” remain[3]. What are the key stumbling blocks and how can the stalemate be broken amidst waning patience and against the backdrop of a global pandemic?

The Key Stumbling Blocks

No doubt, the irony of Downing Street’s decision to serve halibut at a recent Brexit negotiation dinner, were not lost on Michel Barnier. Fishing rights, in particular access to UK waters for EU fishing fleets, remains a fundamental sticking point in the Brexit impasse. Police and judicial co-operation and governance procedures for resolving future disputes and achieving a “level playing field” are other pressing items on the Brexit negotiation agenda. The UK’s red line that there be no role for the European Court of Justice (ECJ) in the UK represents a Boris Johnson promise to “take back control.”[4] Brexit is at its very core about asserting UK sovereignty and the idea that a group of mostly non-UK judges will have a say on matters pertaining to UK law is anathematic to Mr. Johnson and his allies. The EU wants to establish a level playing field to avoid the UK undercutting the EU bloc’s workers’ rights, environmental standards, and state-aid rules. The UK wants access to EU-databases (fingerprints, DNA, license plates) for the purposes of national security and both sides want a free-trade deal that includes an agreement on a dispute-resolution system. Each of these significant requests brings the oversight and enforcement responsibility of the ECJ into play, leaving both parties scratching their heads as to how they might reconcile their publicly declared “red lines.”[5]  However, in an indication that “compromise” may no longer be such a dirty word in Brussels, sources close to EU negotiators have suggested that they are “mentally preparing” for a compromise on the role of the ECJ.[6] Good news for those hoping that a deal can be struck and a chaotic no-deal departure can be avoided.   

Financial Services Implications and Regulatory Equivalence

The tug of war over a level playing field has inevitably extended to the financial services sector. Both sides are looking to preserve financial stability but are wary of being left short-changed by post-Brexit arrangements. The UK had proposed that the City of London continue to be given access to European Union markets, but at the same time set their own rules regarding financial regulation. Unsurprisingly, that was rejected as “unacceptable”[7] by the EU’s chief negotiator. Barnier refuses to let the UK enjoy the benefits of the single market without an equivalence guarantee on UK/EU regulatory standards. In a bid to prove that it will not undercut the EU if it were to maintain access to their markets, the UK agreed to complete an EU-imposed “equivalence assessment.” To date, the EU has submitted 28 questionnaires which would provide the EU commissioners with the confidence that the UK would be, quite literally, playing by the same rules. Assuming a positive outcome of the equivalence assessment, UK financial institutions, and financial market infrastructures (FMI) would likely be granted continued access to EU markets. Characteristic of the delays that have plagued the Brexit process, only four of the 28 questionnaires have been completed by the initial June deadline.

One of the most pressing components of the equivalence discussion relates to derivatives clearing and the potential impact of EU counterparties losing access to UK central counterparties (CCP).  If UK negotiators fail to convince the EU that future regulations are equivalent to those applying to the remaining member states, UK CCPs would not be recognized as Qualified CCPs (QCCP). By law, UK based CCPs, including the London Clearing House (LCH) would be forced to terminate the memberships of EU based legal entities, resulting in a collapse of current clearing practices. Emma Dwyer, a partner in Allen and Overy’s derivatives and structured finance practice, stressed the importance of clarifying this long-term access to UK clearinghouses for EU clients by September.[8] This would leave the required time to make necessary arrangements for a no-deal scenario before the transition period expires on December 31st, 2020. The tight timeline to have this all wrapped up before a September “cliff edge,”[9] or risk financial instability, may convince the European Commission to agree on a “time-limited” equivalence measure. This would grant continued access to UK clearinghouses for EU counterparties from January 1, 2021, and offer some breathing room until the long-term equivalence framework for a third country[10] such as the UK is formalized under EMIR 2.2. How long this time-limited reprieve will last is unknown but EU clearing members would do well to put the necessary steps in place to safeguard against a chaotic departure in the event equivalence cannot be established.

Final Thoughts & Next Steps

Now that the Brexit rhetoric has shifted from one of “good deal vs bad deal” to simply “deal vs no deal,” it would be an understatement to say that a deal hangs in the balance. In reality, it is weeks rather than months that remain for David Frost and his opposite number to unpick the stubborn knots that persist in their socially distanced negotiations. Time is simply running out to reach a deal that works for both parties. Compromises will have to be made on issues as emotional as fishing rights, as delicate as the role of the ECJ, and as technical as regulatory equivalence. Britain has struggled with its relationship with the EU ever since it joined the European project in 1973. When Prime Minister David Cameron put the famous “In or Out” question to the country in 2016, this complex and emotive issue took center stage once again and began to ruthlessly chew up and spit out political careers. Can Mr. Johnson succeed where others have failed and strike an elusive trade deal with his EU counterparts or, with Brexit playing second fiddle to a global pandemic, will Britain unceremoniously crash out of the bloc in the new year? One thing is for certain, for better or worse, Brexit is happening.

About Monticello

Monticello Consulting Group is a management consulting firm supporting the financial services industry through deep knowledge and expertise in regulatory change management and risk and resiliency planning within its Financial Services Practice. Our deep knowledge of capital markets instruments, legal agreements, and operational processes, has us uniquely positioned to help our clients fully adapt to and exploit an ever-changing regulatory framework. Additionally, Monticello teams are dynamic, flexible, and highly motivated to ensure our clients effectively navigate the operational implementation of post-Brexit regulations.

[1] https://time.com/5749478/get-brexit-done-slogan-uk-election/

[2] https://www.bloomberg.com/news/articles/2020-06-24/october-will-be-moment-of-truth-for-u-k-deal-eu-s-barnier-says

[3] https://www.bbc.com/news/uk-politics-53354493

[4] http://www.voteleavetakecontrol.org/why_vote_leave.html

[5] https://ec.europa.eu/commission/presscorner/detail/en/speech_20_1262

[6] https://financial-press.uk/2020/07/11/brexit-news-boris-johnson-secures-breakthrough-as-barnier-backs-down-on-ecj-role-demand-uk-news/

[7] https://www.reuters.com/article/us-britain-eu/eus-barnier-calls-british-financial-market-proposals-unacceptable-idUSKBN241310

[8] https://www.marketsmedia.com/clearing-cliff-edge-looming-in-september/

[9] https://www.fia.org/articles/ccp-equivalence-clarity-needed-september-avoid-cliff-edge-say-panellists

[10] https://ec.europa.eu/home-affairs/what-we-do/networks/european_migration_network/glossary_search/third-country_en