Cameron’s UK and EU Economic Governance Agreement

Within the rules of the club, Prime Minister Cameron achieved as much as could be expected on Economic Governance from the European Council negotiations. But the gain in flexibility may turn out to be rather less significant in practice.

The agreement recognises two quite different visions for the European Union. Eurozone nations seek closer economic and political union, while UK negotiators wish to safeguard its current economic and political sovereignty.

Leaders have fashioned an agreement which accommodates both visions. The UK will remain responsible for its own monetary and fiscal policies. And the UK cannot veto or obstruct Eurozone countries move towards ever closer union.

It is in the realm of financial regulation, dominated by EU law, where a compromise has been struck. But because compromise in financial markets can lead to incoherence and exploited by financial flows, it is unlikely that this will lead to much flexibility in practice.

The compromise comes where the agreement recognises the rights and competencies of nations not in the Eurozone. This means authorities, such as the Bank of England, has authority for monetary policy and financial stability. But on the other hand, the agreement recognises the legal authority of the single rulebook for financial regulation for all member states with the aim of preserving a level-playing field and contributing to financial stability.

The two principles are upheld by a compromise. The agreement states that the single rulebook “is to be applied by all credit institutions and other financial institutions in order to ensure the level-playing within the internal market.” Yet prudential requirements may need to be “conceived in a more uniform manner” than for nations outside of the banking union.

The translation is that the UK may have some flexibility in setting prudential regulations relative to the uniformity for those nations within the banking union.

This matters because the UK does not just host its own financial market. It is by far the largest financial centre in Europe, dealing with around one-third of Euro denominated wholesale financial transactions (foreign exchange, derivatives, cross border lending). What happens in the UK matters very much for the Eurozone.

To see how much flexibility may be permitted, it is worth remembering why we have a single rulebook at all. It consists of capital regulations and directives, which include important prudential requirements relating to capital, liquidity and leverage of financial institutions. Before the crisis, there were all sorts of differences in national prudential regulations which encouraged cross-birder money flows and added to the fragility of the system.

So how much flexibility is likely to be tolerated for the UK? Given the importance of the UK financial system to the Eurozone and the enormous political commitment to the banking union to deliver financial stability it is hard to imagine much leeway being granted in practice.

The second new concession in the agreement is that the UK, along with other non-Eurozone nations, can attend the Euro Group. (an informal group of Eurozone finance ministers). While non-Eurozone nations cannot vote at this Group, any nation can raise an issue to the Council which has the greater authority. But under new voting rules which come into force next March the Eurozone group of nations will have a built-in majority. In effect the UK would have a right of appeal, but in practice this may be less of an assurance in future.