Be Careful What You Wish For!

This is the second scenario for the Brexit process: The core argument put forward by the government is for “managed divergence” as the basis of the post-Brexit relationship with the EU27.

So far, the EU27 have stated consistently that there can be no cherry picking with the single market and customs union. Either we are in or we are out. The Italians have recently stated that the Canada +++ model sounds like the single market without the obligations. Yet this is what the government wants. The basic argument is that there will be some areas where we wish to be fully aligned, some where we wish to diverge and a middle where we can have regulatory equivalence and mutual recognition.

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Boris Johnson has suggested that the EU GDPR, updating the data protection frameworks, which comes into force in May 2018 is one area where we may wish to diverge. David Davis has said that new areas such as Artificial Intelligence which will need new frameworks is an area where we may wish to go alone.

I find it interesting that both Ministers have chosen Technology areas. The challenge is whether the UK market is large enough to support what are global sectors through UK standardisation. Vodafone grew to global status off the back of European cooperation on 2nd generation mobile standards. The Post Office (now BT) developed the System X capability in the late 1970s. It has proven remarkably reliable but achieved little International foothold, and is now gone.

As I argued in the earlier scenario, some sort of fudge will undoubtedly be made so that both sides can claim some sort of victory. My question about this proposition is what are its implications not on day 1, but over the next decade.

The first thing to say is that organisations working in the UK and EU27 will have to comply with GDPR for business within the EU27. This means, potentially, 2 sets of IT infrastructure, raising costs. The question is to what benefit?

Now, let us consider an example in FINTECH. For the purposes of this example consider the following:

  1. The UK Fully aligns with Financial Services
  2. The UK achieves regulatory equivalence with GDPR and mutual recognition
  3. The UK establishes its own regime for AI.

The first thing to say is that the second point means that if the EU27 modify GDPR then the UK risks losing equivalence unless it follows suit. For the purposes of long-term investment, this creates ongoing uncertainty for any City Firm. Regulatory equivalence is recognised as a step towards integration and its use for managing divergence remains largely untested.

Now consider a UK Fintech start up that wishes to use AI and blockchain on large volumes of Financial data.

We could find ourselves in a position where the regulatory framework for blockchain could be different within the EU27 and the UK. This could mean that the AI algorithms may need to be distinct to handle UK data and EU27 data according to different regimes.

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In the event of another downturn, maintaining alignment in these regimes would add a layer of complexity for the users. For the suppliers, the costs of maintaining multiple systems could be problematic.
Now look beyond Financial Services into say manufacturing. If the UK diverges from the EU regimes unlike in Finance, then the AI, blockchain and GDPR impacts may be different.

For companies trying to build platforms across multiple sectors, it is hard to see what the benefit of this additional complexity could be.

So, for me, the principle problem with the UK’s preferred solution is that it does not end the uncertainty post the transition period, but actually bakes it permanently into the new relationship.

There is a salutary lesson from 1973, the year the UK joined the EEC, as it then was: The first Arpanet node outside the USA, the predecessor of the Internet, came to the UK shortly after we joined. It was held up in Customs by VAT as we couldn’t get an agreement what an Arpanet node was for tax purposes.

So, here’s the challenge for 2018 on this scenario. Business wants certainty to support investment during the transition and beyond. If the EU27 refuses to budge on managed divergence, what should the UK do? If the UK does achieve concessions, how do you build a capacity to evolve over time that limits the uncertainty I have described above?

If you are a UK-based FINTECH company looking to raise funding this year, how do you protect yourself against the multiple uncertainties both in the short term and the long-term?

I think that I can safely predict that if this scenario comes to pass, the big winners will be the lawyers, unless they are replaced by AI. That’s a story for another day.