Regulatory divergence is the prize of Brexit – but which sectors will pay the highest price for it?

David Frost, the UK Chief Brexit negotiator, gave a speech on Monday 17 February in which he threatened to walk away from negotiations over the future trade agreement unless Brussels drops its demand that Britain aligns with EU rules.

He called instead for the EU to offer the UK a deal along the lines of those struck with countries including Canada, Japan and South Korea.

Frost said that the ability to diverge – for the UK to set its own laws – was the fundamental point of Brexit. He said that thinking “that we might accept EU supervision on so-called level playing field issues simply fails to see the point of what we are doing”.

He was clear that the UK accepted that moving to a new trading basis would introduce greater trade friction, calling it a “one-off cost”, but expressed scepticism that the impact of this was “anything like the scale” some have suggested. He also noted that “we aim to manage it down as far as we can through modern customs facilitation arrangements – and I am convinced that other factors will outweigh it”.

This speech made explicit what has been clear for some time. Boris Johnson’s Government sees divergence as the prize of Brexit – and will not accept harmonisation with EU rules as the price of access. This is a fundamental shift from the position under Theresa May, where the starting point was as far as possible to eliminate friction at the border and therefore broadly align at least as far as goods are concerned.

In practice, it might be that the difference between the May Government and the Boris Johnson Government is not huge.

In a modern, commoditised, mass-produced society, many goods are manufactured to common standards which transcend national boundaries. This is not to say that Brexit doesn’t have the potential to introduce checks on goods at the border even if in practice they are manufactured to a common rule book– and food and drink could well see particular issues given regional variations. But from the Government’s point of view, the likely gain from divergence on goods is much less than on services.

This feeds through into the UK’s likely strategy. As the Government has set itself a target of concluding a deal by the end of the year, it will have to decide what sectors it will prioritise. The optics of starting January 2021 with any of tailbacks at the UK border, price rises or shortages of certain goods would be extremely problematic – so it is likely that the Government will prioritise deals on goods over services (anecdotally, we are hearing that this is where the Government are putting most of their resource).

On services, the area of most political interest is financial services.

50% of financing for the public and private capital requirements for Europe are funded in London; as Europe’s finance wholesaler, it is hard to see the logic of the UK becoming a rule-taker – and therefore surrendering regulation of Europe’s largest financial services sector to an entity over which the it no longer has any say. Sajid Javid when he was Chancellor said that the UK would be arguing for an equivalence deal based upon common outcomes, not a common rule book. The change in No11 will not have altered this approach. It is clear that the Government is starting from a position of accepting a very hard Brexit for financial services and arguing for equivalence in part on the basis that the EU are ultimately likely to need access.

Although this might work for the financial services sector, it potentially leaves other UK services out on a limb.

The City is not just financial services but also legal, audit and other offerings. The UK also exports architects, engineers and communications, among many other things. Not all of these benefit from or need formal access agreements. But for those which do (legal services, for example) the argument for the EU allowing them continued access or continued enforcement of commercial judgments is much less compelling to the EU – and in the UK Government, little understood outside of their sponsor departments.

First published in our weekly Political Capital newsletter
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