The UK has one of the largest financial systems in the world. Since Brexit, however, UK imports of financial services from the EU have declined, and hundreds of banking and finance organisations have left the UK and relocated to the EU. As a result, the government is doing all it can to make the UK, and the City in particular, look more competitive to international businesses. One key area of focus is remodelling the UK's financial regulatory framework: the government is planning to repeal EU rules in favour of giving the domestic regulators, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA), powers to regulate the sector.
In this article, we consider the post-Brexit regulatory landscape and explore what the UK's future relationship with the EU might look like for the financial services sector.
What's happened so far?
Pre-Brexit times were certainly simpler for the UK. With all EU member states being part of the EU single market, businesses were able to establish themselves freely and, over time, common standards of financial regulation and supervision were established across the EU. Today, where a bank or financial services firm is established and authorised in one EU country, it can apply for the right to provide certain defined services throughout the EU, with relatively few additional authorisation requirements. This pan-EU authorisation is known as its financial services ‘passport’.
At the start of the Brexit process, the UK had hoped to negotiate a bespoke agreement on financial services to retain some of the benefits of passporting. However, the EU was unwilling to offer this. As a result, the UK–EU Trade and Cooperation Agreement (TCA) was drawn up which, unhelpfully, contains only a few provisions on financial services, leaving trade to be managed through mutual unilateral 'equivalence' decisions.
Equivalence is a system which can be used to grant domestic market access to foreign firms in certain areas of financial services. It is based on the principle that the countries where these firms are based have regulatory regimes which are ‘equivalent’ in outcome. A country may therefore decide to grant a foreign financial services firm access to its domestic market on the basis that the foreign firm's country has equally robust regulations to the market it is trading with. Unlike passporting access, equivalence means either side can terminate access to each other's market with 30 days' notice.
By the end of the transition period, the UK had replicated much of the EU equivalence framework in domestic law. As of January 2021, the UK had granted the EU 27 equivalence decisionsallowing EU financial firms access to parts of the UK’s financial markets. However, despite the EU having recognised regulatory regimes of other non-EU countries as equivalent, it has yet to make any equivalence decisions for the UK (except for two temporary decisions granted at the end of the transition period, of which one has already expired). This means that UK firms’ access to EU markets now depends on the rules each member state applies to third country businesses.
Passporting was not perfect: despite supposedly common rules, there were differences between regulators in how to apply them, and some aspects of business were not addressed in EU law, leaving each individual member state free to make its own rules. However, its major advantage was, of course, the single authorisation requirement, now lost to UK firms wishing to do business in or into the EU, and to EU firms wishing to access the UK markets.
What are the government's plans?
Despite these challenges, the government's ambitions for the UK financial services sector post-Brexit have not been dampened. In July 2021, the Chancellor used his Mansion House speech (and accompanying paper – A new chapter for financial services) to set out a vision for the sector and what he hails as a "Big Bang 2.0" for the City of London post-Brexit. The Chancellor outlined the ambitious reforms the UK is undertaking so that the financial services industry can lead both domestically and internationally in the sector and focussed on the following key areas:
- Regulation – despite no decisions on equivalence having been reached between the UK and the EU, the Chancellor said the EU will not be able to deny the UK access indefinitely and that the intention now is for the UK to strengthen its existing regime
- Global ambition – the government intends for the UK to remain an ‘open and global financial hub’ and the Chancellor cited the UK's plans to forge new relationships with other third countries outside the EU, specifically Singapore, the United States and Switzerland
- Technology – the financial services sector in the UK will be supported by new technologies and the possibility of a new digital currency
- The environment – the Chancellor also discussed plans for the UK to focus on green finance and he challenged the UK to be the world's first net zero aligned financial centre.
Building on the plans outlined by the Chancellor, in November 2021, HM Treasury set out proposals for reforming the UK's financial services regulatory framework to ensure it is fit for the future by establishing the Future Regulatory Framework Review (FRF Review). The proposals largely involve the shedding of EU regulation in favour of a home-grown regulatory framework. The consultation looks at the overall approach to financial services built on the existing Financial Services and Markets Act 2000 (FSMA) model and concludes that the FSMA model remains the most appropriate way to regulate financial services in the UK. However, the proposals put forward by Treasury signal a change in the relationship between Treasury and the PRA and the FCA and include adding ‘new growth’ and ‘international competitiveness’ as secondary objectives that the regulators will have to pursue.
Other key points and proposals in the FRF Review include:
- Amendments to existing principles to ensure sustainable growth consistent with the commitment to a net zero economy by 2050
- A new "designated activities" regime to allow the regulation of certain activities outside FSMA and the FSMA 2000 (Regulated Activities) Order 2001, for example, to keep the current EU-derived controls on short selling
- Added controls and accountability for the regulators
- An easing of Solvency II capital requirements for the insurance industry in order to free up money for firms to invest
- A change to share-listing rules to make London a more attractive destination for tech start-ups to go public
- Regulations to ensure consumers and businesses continue to have access to cash in an increasingly cash-less society, within reasonable travel distances.
Read our full analysis of the FRF Review here.
What else is happening?
In January 2022, Brussels set out plans to consult on a potential extension of its current equivalence decision for UK clearing houses, allowing EU banks to clear trades through them for another 3 years until 2025. However, nothing has yet come of this. The longer the EU takes to grant equivalence decisions, the less value it will have and the more likely the UK's focus will turn to more emerging international markets.
Elsewhere, the European Affairs Committee has recently launched an inquiry into:
- The impact so far of the UK's departure from the EU single market on the UK financial services sector
- The impact of the absence of a functioning framework for UK-EU regulatory cooperation
- The future of cross-border UK-EU financial services trade in the absence of equivalence
- The impact of regulatory divergence and agreements with third countries on UK-EU financial services trade.
The Committee expects to deliver its report by May 2022.
The UK regulators are also working hard to maintain regulatory and supervisory co-operation, including data sharing, in order to effectively supervise international firms operating in the UK post-Brexit. The PRA has signed memoranda of understanding with almost all EU member states and with the European supervisory agencies, including the EBA, ESMA and EIOPA. The Bank of England is also in daily conversations with its counterparts in the United States, the EU and other jurisdictions to convince them that the UK's financial market infrastructure is of a standard they (and their financial institutions) can trust.
The world is waiting for the UK government to exercise its rule-making powers and give the UK a robust but reasonable regulatory environment to attract international business. The Treasury wrapped up the consultation stage of its FRF Review on 9 February 2022 and the Chancellor has confirmed that this package of measures will be included in the next Queen's Speech later this year.
Many see this departure from EU regulation as a positive step towards taking back control of the UK's regulatory regime, seizing new opportunities and enabling the domestic regulators to meet their regulatory objectives on their own terms. However, there are also concerns that such overhaul may bring pressure to lower standards and move towards a more light-touch form of regulation, although the FCA and PRA remain firmly of the view that long-term growth and competitiveness is not achieved by having low standards. And, even if high standards are maintained, will any departure from EU standards, regardless of whether it results in equal, or stronger, requirements, make it less likely that the EU will consider an equivalence decision?
While the world waits for "Big Bang 2.0", there is still uncertainty about the future and what any parting from EU financial services regulation will mean for the UK. Does the government's push for an overhaul of the UK's financial services regulation in fact signal an abandoning of the UK's equivalence hopes? It it worth that risk in order to remove some of the parts of UK regulation that stem from less popular EU requirements in favour of what the UK regulators view as equally high standards of regulation but better suited to UK financial institutions, markets and consumers? Whatever the developments will be, there is no doubt that they will shape the work of regulators and the UK's financial services landscape for years to come.