A crucial phase in the Brexit talks will soon get underway when UK and EU negotiators meet to discuss trade. Leading the EU side, Michel Barnier has categorically said City firms will lose their passporting rights when the UK exits the Single Market and EU leaders have held firm on the reduced level of market access that the UK can expect.

But might it be possible for Brexit secretary David Davis to negotiate a trade deal which includes financial services with the EU27?

Read more: Verhofstadt: Did Barnier put something in Farage's tea?

Policy experts in London are convinced the UK can secure licence-free access to the EU market. Rachel Kent, global head of financial institutions at Hogan Lovells, has conducted extensive research for a report describing such a deal. She points to the trade agreement between Canada and the EU, Ceta, as a springboard for talks.

“I am something of an optimist, because if you look at trade agreements such as Ceta, they seem to envisage access might be possible down the line,” she said. “But we are different from every other country in the world, that for me is absolutely key.”

EU leaders are holding firm on their commitment to the Single Market's four freedoms (Source: Getty)

In her report for the International Regulatory Strategy Group (IRSG), Kent argues financial services could be part of a free trade agreement (FTA) with the EU because the UK is already aligned with EU rules.

Normally, financial services firms are excluded from FTAs as part of a prudential carve-out. Financial services are treated as sensitive aspects of an economy because financial stability is non-negotiable, and governments naturally want to protect consumers. For example, if one jurisdiction has low capital requirements, it poses a risk to potential trade partners. But this would not be true of any UK-EU co-operation on financial services as currently the UK has the same capital requirements as its EU partners.

Read more: Red alert on Brexit risks to financial services given by City lobbyists

The UK-EU FTA can bypass the prudential carve-out because the UK’s regulatory framework means it is not a risk to financial stability in the EU27; the deal could be set up using the language of the Single Market.

So, according to the IRSG analysis, it is technically possible for financial services to be included in an FTA. But there’s another problem, articulated by trade expert Christophe Bondy, senior counsel to Canada in Ceta talks, when he gave evidence to the Brexit select committee last week.

“I’ve heard many people say: Well it’s going to be easy because we’re harmonised,” he said. “Well, that’s day one. What about day two, day 10 — that’s where the real issue is.”

Negotiators must, therefore, create a framework which allows the UK to diverge from the EU, without it becoming a liability to the bloc. Allie Renison, head of Europe and trade policy at the Institute of Directors, describes such a deal as a “living agreement”, with joint committees of regulators meeting on a weekly basis.

Davis will have to convince the EU that access for financial services can be part of the deal (Source: Getty)

Ruth Lea, economic adviser to the Arbuthnot Banking Group, says the UK and the EU could agree areas where they must remain aligned, and areas where they can move apart. It is unlikely the EU would allow product regulations to diverge, for example. But, Lea says the EU may allow for differences in labour market regulations, such as the working time directive, an EU rule which restricts the working week to 48 hours.

Separately, the deal must outline an approach to new regulation. Given its outperformance in Fintech, the UK will likely lead the way in regulating this sector. The EU would, therefore, benefit from ongoing communication with UK regulators on this area of financial services.

Read more: Hammond and Davis fly out for charm offensive with German business

Co-operating on trade means disputes between the EU and the UK won’t end with Brexit. Trade disputes will flare up in the future, and the IRSG has proposed a new judicial structure to provide resolutions. But the remit of the new body should be limited to whether both sides are complying with the trade agreement.

Ultimately, both sides will benefit from drawing up a deal that allows licence-free access for financial services, Kent adds. Opting for no deal shuts European consumers out of a global financial centre, and increases the capital requirements for London-based banks looking to do business in Europe. Kent says institutions would start to question whether to do business in Europe, or pass on the extra costs to consumers.

Sam Woods, deputy governor at the Bank of England, says a trade deal which recognises the City of London is technically feasible and could be completed within three years. So, it appears barriers to forging a deal are political, rather than technical. Firms will be hoping Whitehall is ready to do what it can to protect the City’s interests.

A crucial phase in the Brexit talks will soon get underway when UK and EU negotiators meet to discuss trade. Leading the EU side, Michel Barnier has categorically said City firms will lose their passporting rights when the UK exits the Single Market and EU leaders have held firm on the reduced level of market access that the UK can expect.

But might it be possible for Brexit secretary David Davis to negotiate a trade deal which includes financial services with the EU27?

Read more: Verhofstadt: Did Barnier put something in Farage's tea?

Policy experts in London are convinced the UK can secure licence-free access to the EU market. Rachel Kent, global head of financial institutions at Hogan Lovells, has conducted extensive research for a report describing such a deal. She points to the trade agreement between Canada and the EU, Ceta, as a springboard for talks.

“I am something of an optimist, because if you look at trade agreements such as Ceta, they seem to envisage access might be possible down the line,” she said. “But we are different from every other country in the world, that for me is absolutely key.”

EU leaders are holding firm on their commitment to the Single Market's four freedoms (Source: Getty)

In her report for the International Regulatory Strategy Group (IRSG), Kent argues financial services could be part of a free trade agreement (FTA) with the EU because the UK is already aligned with EU rules.

Normally, financial services firms are excluded from FTAs as part of a prudential carve-out. Financial services are treated as sensitive aspects of an economy because financial stability is non-negotiable, and governments naturally want to protect consumers. For example, if one jurisdiction has low capital requirements, it poses a risk to potential trade partners. But this would not be true of any UK-EU co-operation on financial services as currently the UK has the same capital requirements as its EU partners.

Read more: Red alert on Brexit risks to financial services given by City lobbyists

The UK-EU FTA can bypass the prudential carve-out because the UK’s regulatory framework means it is not a risk to financial stability in the EU27; the deal could be set up using the language of the Single Market.

So, according to the IRSG analysis, it is technically possible for financial services to be included in an FTA. But there’s another problem, articulated by trade expert Christophe Bondy, senior counsel to Canada in Ceta talks, when he gave evidence to the Brexit select committee last week.

“I’ve heard many people say: Well it’s going to be easy because we’re harmonised,” he said. “Well, that’s day one. What about day two, day 10 — that’s where the real issue is.”

Negotiators must, therefore, create a framework which allows the UK to diverge from the EU, without it becoming a liability to the bloc. Allie Renison, head of Europe and trade policy at the Institute of Directors, describes such a deal as a “living agreement”, with joint committees of regulators meeting on a weekly basis.

Davis will have to convince the EU that access for financial services can be part of the deal (Source: Getty)

Ruth Lea, economic adviser to the Arbuthnot Banking Group, says the UK and the EU could agree areas where they must remain aligned, and areas where they can move apart. It is unlikely the EU would allow product regulations to diverge, for example. But, Lea says the EU may allow for differences in labour market regulations, such as the working time directive, an EU rule which restricts the working week to 48 hours.

Separately, the deal must outline an approach to new regulation. Given its outperformance in Fintech, the UK will likely lead the way in regulating this sector. The EU would, therefore, benefit from ongoing communication with UK regulators on this area of financial services.

Read more: Hammond and Davis fly out for charm offensive with German business

Co-operating on trade means disputes between the EU and the UK won’t end with Brexit. Trade disputes will flare up in the future, and the IRSG has proposed a new judicial structure to provide resolutions. But the remit of the new body should be limited to whether both sides are complying with the trade agreement.

Ultimately, both sides will benefit from drawing up a deal that allows licence-free access for financial services, Kent adds. Opting for no deal shuts European consumers out of a global financial centre, and increases the capital requirements for London-based banks looking to do business in Europe. Kent says institutions would start to question whether to do business in Europe, or pass on the extra costs to consumers.

Sam Woods, deputy governor at the Bank of England, says a trade deal which recognises the City of London is technically feasible and could be completed within three years. So, it appears barriers to forging a deal are political, rather than technical. Firms will be hoping Whitehall is ready to do what it can to protect the City’s interests.