The European Union (EU) is threatening sanctions if the UK follows through with plans to cut tax and deregulate some industries, thereby undercutting the bloc's economy, according to a leaked strategy paper.
Unprecedented safeguards such as "tax blacklists" penalties against state-subsidised companies could be used by the EU in in efforts to preserve a "level-playing field" and minimise the "clear risks" of such measures, a presentation to EU27 member states seen by the FT reveals.
The slides describe the UK economy as too big and too close to enable normal trade partner relations, and the EU therefore wants to define new ways to enforce restrictions on taxation, state aid, environmental standards and employment rights.
EU negotiators said any deal on post-Brexit relations had to "cater to the specificities" of the relationship — implying the "depth and breadth" of relations warrants tighter controls than those seen in the bloc's relations with the US, Japan or Canada.
Noting such strict curbs do not feature in standard trade deals, the EU paper argues innovative mechanisms will be needed to keep the UK in check, either through conditions in a trade agreement or separate retaliatory measures.
"International rules do not adequately address the [potential] distortive effects of subsidies on investment, trade and competition," the paper stated "The EU-UK agreement will have to include robust provisions on state aid to ensure a level-playing field."
While UK negotiators will have expected the EU to take a hard stance against "unfair" competition, officials said the EU would need to allow for "special" levels of trade access to justify such "special" restraints on the UK.
The presentations added the UK is "likely to use tax to gain competitiveness" and is already a low-tax economy with a "large number of offshore entities", but acknowledges the bloc has "very limited legal/political restrictions to prevent this".
Outlining their approach to ensure tax standards are upheld, the EU negotiators call for "binding requirements" on anti-tax avoidance measures, information sharing and transparency.
Should the UK refuse to accept such agreements, the EU warns it "has its unilateral listing process for uncooperative tax jurisdictions".
UK plans own regulatory path
It follows the UK government's plans revealed in September 2017, which would see the country develop a new regulatory framework for financial services, distinct from that of the EU, to secure a long-term competitive advantage for the industry when the country leaves the bloc.
Brexit secretary David Davis told senior industry figures last the government is working towards a transitional period immediately after leaving the EU, in which the sector would benefit from a "standstill" deal, maintaining all existing cross-border agreements, according to the Financial Times.
Davis believes if the UK maintains its existing regulatory framework for financial services after Brexit, in the long term the country would lose any competitive advantage the UK-based industry would gain from being outside the bloc.
Since the UK's referendum on EU membership in June last year, many have argued that maintaining equivalence with the bloc would help to ensure key aspects of the UK's financial services activities were not lost to other countries within the bloc.
According to FT sources, Davis now agrees with Chancellor Philip Hammond in the proposition of a standstill period of up to three years after March 2019, during which the existing UK-EU relationship would broadly remain the same.
Former European commissioner Jonathan Hill, RBS chairman Howard Davies, Morgan Stanley head of Europe Rob Rooney, EY UK chairman Steve Varley, founder of hedge fund Marshall Wace Paul Marshall, London Stock Exchange chief executive Xavier Rolet, and Legal & General Investment Management head of personal investing Helena Morrissey were among those in attendance at the meeting.
From the government, Davis was joined by business secretary Greg Clark and City minister Stephen Barclay.
Ministers reportedly gave the impression to industry figures present that the government was committed to a standstill transition period.
However, Lord Hill is understood to have argued that, although the UK should remain aligned to global financial regulation, it would be wrong to permanently tie the country to European standards it could not alter, after the transition period.
Lord Hill received a mixed reaction to his position from those in attendance, with banks conscious of global convergence on sector regulation and reluctant to see the UK engage in a "race to the bottom" by abandoning equivalent standards, the FT reports.
Prime Minister Theresa May and the Chancellor have previously warned that if the UK could not secure a good future trade deal with the EU it had "another option". The UK could conceivably walk away from a "bad deal" and compete with the bloc as a Singapore-style low-regulation, low-tax economy.
Since the election, however, May has backed away from that threat, but Hammond said at a City event last week that the UK would not be forced to accept EU regulation that sought to damage UK-based financial services.
"We will not accept protectionist agendas, disguised as arguments about financial stability," he said.