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Photographer: Simon Dawson/Bloomberg Photographer: Simon Dawson/Bloomberg

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With Brexit talks back from the summer holidays, it’s worth considering one way in which failure to reach a deal before the U.K.’s departure in March would also be bad for the European Union.

Such an outcome would unsettle the City of London, the motor of the British economy. But the danger for the EU is that Britain responds by emulating the U.S. in cutting taxes and deregulating. A low-regulation nirvana would go against the EU’s desire for a “level playing field” after Brexit, while also threatening financial stability in the other 27 member states -- just as the bloc is being sucked into a trade war with Donald Trump.

“The harder Brussels makes it for London firms to do business with EU firms under EU rules, the more likely it becomes that London remains the EU’s financial center and the place where EU firms have to go to raise capital and manage risk, whilst remaining entirely outside the EU’s regulatory ambit,” said Simon Gleeson, a regulatory partner at Clifford Chance LLP in London.

Absent a deal, Brexit means Britain will become a “third country,” with its insurers, banks and fund managers on a par with their peers from the U.S., or Japan, or indeed Kazakhstan.

That’s a problem given how closely intertwined the U.K.’s financial services industry is to the EU, even though British regulators have said they’re more likely to strengthen, not weaken, rules after Brexit.

Revenue generated by the U.K.’s financial services is about 200 billion pounds ($255 billion) a year, of which about half comes from domestic clients. The rest is split between EU-related business and international, non-EU business.

That explains why Brexit Secretary Dominic Raab is likely to argue to the EU that a closer relationship on financial services is in everyone’s interests -- even if British banks have to forgo so-called passporting rights that allow them to sell products and services throughout the EU single market.

‘Equivalence’

The U.K. is proposing some form of “enhanced equivalence,” an expanded version of a system that exists between the EU and some non-members.

An equivalent country is one whose rules the European Commission deems at least as tough as its own, allowing its firms to use provisions in some EU laws to do business in the bloc. The U.S., for example, has equivalence under the EU’s financial infrastructure regulations.

What is “equivalence” exactly, and what does that mean for banks?

But the system is under review, with critics pointing out that the European Commission can remove recognition at 30 days’ notice. The U.K., among other things, wants to ensure that equivalence is assessed transparently and could only be withdrawn at the end of an agreed process.

It’s a significant dilemma for the EU, which wants to avoid a financial hub just off its shores that is outside of its direct jurisdiction and control.

That means there’s scope for a deal.

“The EU is already talking about how it needs to amend equivalence rules,” said Brian Polk, a director at PwC in London. “It is hard to understand why they would not engage with the U.K.’s suggestions. It feels like there is plenty of room to cut a deal.”