by Philip Whyte

When EU finance ministers met in Brussels on 18 May, many observers expected sparks to fly. The reason? This was the first EU meeting that Britain’s newly-elected government would attend. And a leading item on the agenda was the Commission’s proposed directive to regulate managers of ‘alternative investment funds’. France and Germany have pressed hard for the directive. Britain has deep reservations about it. The fear across the EU was that a hard-line British eurosceptic government ideologically resistant to regulating financial markets would come to Brussels seeking confrontation over the directive. In the event, the bust-up never happened. What lessons should one draw about the new, Conservative-led government’s attitude to the EU and to financial regulation?

The Conservative Party is more eurosceptic than it has ever been. Many of its members would like to withdraw from the EU altogether. The party’s leader, David Cameron, is no euro-enthusiast himself. But he is above all a pragmatist, not a rigid ideologue bent on confrontation. Recall that he enraged sections of his party when he decided not to hold a referendum on the Lisbon treaty once it had been ratified by all 27 member-states; and that he has formed a coalition with the UK’s most pro-European party, the Liberal Democrats. Besides, the government that he leads has more important things to do than pick needless fights in the EU. The focus of its attention over the next five years will be on consolidating the public finances and managing the inevitable social conflicts that will result.

What of financial regulation? A common view across Europe is that the financial crisis was the result of ‘unregulated Anglo-Saxon capitalism’; that the EU’s task is to cajole the reluctant British into clamping down on the City of London; and that the Conservatives may be particularly resistant to cooperating, given their ideological commitment to free markets and historical links to the City. Much of this account is inaccurate. Many of the regulatory failings exposed by the crisis were as much in evidence outside the Anglo-Saxon world as within it. The UK has pushed through many regulatory reforms before the EU. And the Conservative Party has distanced itself from the City and is considering measures – like breaking up large banks – that go far beyond what most EU countries are contemplating.

Does this mean that Britain and the EU will work harmoniously on the reform of financial regulation? The answer is: probably not. One problem is the populist undercurrent that is driving some reforms in the EU. The sad truth is that the alternative investment fund managers’ directive has been a poor advert for EU legislation. The Commission proposed it, under pressure from France and Germany, without carrying out the detailed impact assessment that its ‘better regulation’ agenda requires. The directive targets a rag-bag of disparate entities, mostly in the UK, that had nothing to do with the crisis and that will be saddled with inappropriate rules. And it is being imposed over the objections of the country that will be most affected by it by countries that will barely be affected by it at all.

Britain’s historical attitude to the EU – its enthusiasm for the single market, allied to its hostility to institutional integration – is another problem. Why? Because it is no longer clear that this Janus-faced position is tenable. As the UK’s Turner Review acknowledged, the financial crisis exposed fault-lines in the EU’s single market for banking that can only be solved in one of two ways. The first (the ‘less Europe’ option) is to return powers to host country authorities – a move that would mark a retreat from the single market. The second (the ‘more Europe’ option) is to beef up existing EU bodies so that a common rulebook can be developed and co-ordination between national supervisory authorities can be tightened. (This option does not currently envisage the creation of a pan-European supervisory authority.)

A key task facing the EU following the financial crisis is to rescue the single market in banking. If the EU is to succeed, Britain’s Conservative-led government and its EU partners must work together constructively. Britain’s EU partners need the Cameron government’s pragmatism to trump its euroscepticism. But European politicians would help if they showed cooler heads and more measured rhetoric than they are doing at present. Tirades against hedge funds, ‘speculators’ and Anglo-Saxons may play well in some EU countries. But in Britain, they increase the suspicion that European politicians are happier looking for scapegoats than learning the real lessons of the crisis. If it goes unchecked, European populism could become an obstacle to the Cameron government’s pragmatism.

Philip Whyte is senior research fellow at the Centre for European Reform