Eitan Urkowitz: Hi, this is Eitan Urkowitz at the Peterson Institute for International Economics. I'm joined here with Nicolas Véron to discuss his recent paper on Brexit, the British exit from the European Union and the effect that will have on banking and financial regulation in the EU. Thank you for joining me, Nicolas.

Nicolas Véron: Thanks for having me.

Eitan Urkowitz: London has been the biggest financial hub or center in the EU. So how is Brexit going to be affecting London?

Nicolas Véron: So, of course, it depends a bit on the scenarios of Brexit. But the key point is that the UK will leave the European single market. And that means that to serve their clients in the EU 27—28 minus the UK—single market, financial firms will need to relocate a bunch of activities from London to some country into a single market, which the UK is no longer a part of.

Eitan Urkowitz: Well when you say relocate, what numbers are we talking about?

Nicolas Véron: So with this paper, first it's co-authored with my two colleagues at Bruegel, André Sapir and Dirk Schoenmaker. And we have very rough ballpark estimates. These are not forecasts. There is too much uncertainty but just to sort of set the debate. The UK banking assets are about 10 trillion euros. We reckon that about half of that is wholesale banking assets. And about a third of that half would be so about 15, 17 percent of the total would have to be relocated from the UK to the continent to give an order of magnitude. So in absolute numbers, 10 trillion, 5 trillion of this is wholesale banking assets. You would have about 1.7 or 1.8 trillion that would move across the channel over the sea of Ireland.

Eitan Urkowitz: Pretty significant numbers. So where in the EU are they going to be going?

Nicolas Véron: So this we don’t know yet. And actually, we don’t have time to give a sense of that. Our impression is that Frankfurt is clearly the frontrunner, behind Frankfurt probably next too are Dublin and Paris. And then you have different centers probably with some specialization in Nice, Amsterdam, Luxembourg, or Madrid, or other places for different market segments.

But frankly, our focus in the paper is really on the policy framework for the EU 27 and what sort of policy architecture should be in place so that this competition between different financial centers to attract activity isn't something that in the end will be detrimental to financial stability or market integrity. And therefore, what we say is that the competition should be on all sorts of things; infrastructure, skills, English language proficiency, tax labor law, or whatever, but should not be on the basis of financial regulation because, otherwise, you have the risk of arbitrage race to the bottom and in the end a bad financial system.

Eitan Urkowitz: So, on that note, the European financial institution has been described as weak or having weak spots. So how is all this movement going to be affecting their financial system and the stability of it?

Nicolas Véron: This really depends on the architecture that is put in place. So if you have different national authorities defending their national champions vying for position on the European map, you will probably have a pretty lousy outcome in terms of, again, market integrity, behavior, conduct of business, and also with consequences for financial stability.

And this debate hasn’t really started in the EU because at this point everybody is focused on what is going to happen into bilateral relationship and negotiations between the EU 27 and the UK. But what we're talking about here is not about that. It's really about decisions that the EU 27 has to take for themselves forward-looking and looking ahead beyond the B-Day, the day when Brexit happens and when the UK is gone.

And here what we're saying is that the current architecture is not fit for our purpose. It needs significant reforms so that you can have this level playing field, this consistency of not only the rules that apply, but the ways they're implemented and enforced all across the single market.

Eitan Urkowitz: So what are the biggest dangers and risks?

Nicolas Véron: So I think there are two main risks. One is sheer market fragmentation that if you have 27 authorities vying for position you would have a fragmentation of the marketplace along national lines as contrasted to the current situation where most of it happens in London in one single place. And therefore, it’s very effective and efficient. So that's one risk.

And of course in the banking space, we have banking union and there is policy integration for prudential supervision of banks. But that doesn’t exist for market conduct behavior and market integrity which are typically to preserve national security authorities. There is this thing called the European Securities and Markets Authority (ESMA), which has been created in 2011. But at this point, it doesn’t have enough of a mandate to really ensure this level playing field.

The other risk is simply what I was alluding to. You have a race to the bottom, some national authorities just trying to cut a deal with low standards to attract activity. And therefore, you have bad behavior and financial stability risks.

Eitan Urkowitz: So what are your policy recommendations for the EU? How should they really prepare for this?

Nicolas Véron: So it's actually quite simple. We suggest beefing up ESMA (European Securities and Markets Authority). It exists. It’s a good base to build on. But at this point, it’s not strong enough. It needs more independent resources, following good international practice, having a small levy kept on market's activity instead of being captured by political interest in the yearly politicized budgetary discussion as is currently the case at the EU level. Better governance with more independence in the decision-making structure. And a stronger mandate to be able to enforce things that are really important in terms of equality or consistency of enforcement and implementation across the EU. For example, financial accounting, financial disclosure, enforcing international financial reporting standards that the EU has adopted; all these should be something on which ESMA is empowered.

So the second thing is on banks. We have a banking union, but it’s still very incomplete. So we suggest a number of things I'm not going in too many details here for lack of time. But to strengthen banking union and getting it closer to a point where banking sector policy would be really in European level thing and not in the hands of national authorities that, again, tend to support national champions than to take the banking sector as an instrument to give preferential funding to the state or to preferred industries et cetera so basically having a much more consistent framework again here.

And the third thing is in a way a consequence of the first two. But regarding the rest of the world including the UK, but also the US and other financial centers that are not in the EU going forward after Brexit, we need a better regime to make sure that European authorities have proper oversight of, say, critical infrastructure, for example, clearinghouses which play a significant role in the EU financial system but are outside of the EU. And there will be some of these in the UK in particular.

And here what we're saying is just that the European authorities should get the same sort of oversight as the US authorities actually have. For example, the CFTC (Commodity Futures Trading Commission) in the US can send inspectors to London-based clearinghouses to make sure that the conditions for the registration in the US are properly met. And we're just saying European authorities should have the same sort of extraterritorial ability to protect their supervisory and oversight capacity in order to ensure a smooth integration. No mercantilism. No protectionism. But oversight rights to ensure that everything is done all right.

Eitan Urkowitz: Very interesting. Thank you, Nicolas.

Nicolas Véron: Thank you, Eitan.