Since the Brexit referendum, the UK’s financial services sector has moved relatively quickly to close out the risks to its business and clients. In stark contrast there has been little, if any, progress (despite much debate) in clarifying what will happen to the EU legal structure in which UK financial institutions and FS regulation currently operate.
UK regulators have required firms to be ready for Brexit but cannot offer any guidance on what Brexit means or its timetable, so the worst case scenario (of a crash landing in late March 2019) has been the only basis for firms to model. Key restructuring often involves getting single market operating subsidiaries established, and applying for authorisation, in a continuing EU/EEA state and/or transferring operations to existing EU/EEA subsidiaries.
The benefits of a ‘smooth’ transition - or at least some reasonable prior notice of regulatory change - are widely acknowledged. The European Council’s negotiating mandate recognises the desirability of transitional arrangements (assuming Article 50 withdrawal terms can be agreed). The UK will ‘port across’ the EU rules into domestic requirements, and so could seek the continuance of current cross-border arrangements, but Article 50 requires some level of consensus on the ultimate EU/UK relationship, which is to be negotiated.
In our recent report with the Legatum Institute, we looked at the options in FS for a bespoke UK/EU relationship.
The WTO initially had great success in relation to trade in goods. In services it has made more limited progress, and progress in FS has been difficult. This means that ‘market access’ (in WTO/FTA terminology) is not the real or immediate priority for financial services. An agreement on dual regulation co-ordination (“DRC”) is required.
When FS firms seek to provide financial services from their home state into another country (the host state) or from within the host state, they face substantial barriers from the host state regulatory regime. In some cases, these barriers preclude cross-border modes of supply altogether. A firm may require host state authorisation, which in turn may require a local subsidiary to be used. In clearing, the EU is looking at legislation to enable it to penalise the use of central counterparties outside the EU. These are only examples of a wide array of barriers that may arise.
The current single market package of DRC is the start point and could continue through a transitional period. In the longer term the objective is to maintain and coordinate DRC arrangements on a bilateral basis. Most free trade agreements (“FTAs”) are about convergence and reducing barriers; Brexit involves the opposite - managing potential divergence and DRC barriers.
Future DRC should not be limited to those narrow (equivalence-based) third country arrangements provided for under pre-existing EU FS legislation. As we have seen with clearing and holding company requirements, the EU can easily restrict its unilateral third country concessions. There is a wide range of available DRC techniques; the common theme is that host state regulators should rely (to an agreed extent) on home state regulation. The amount of DRC may differ across sectors: for example, it may be easier to agree DRC measures for wholesale banking than for retail insurance, and across areas of regulation - DRC on prudential matters may be more achievable than conduct of business. What is clear, however, is that governments in the UK and EU should be seeking maximum DRC in order to reduce what would otherwise be substantial barriers to cross border trade.
The EU’s clearing proposals themselves include alternative powers which involve DRC, whereby UK CCPs would be subject to European institution oversight as well as regulation by the Bank of England. This new DRC approach has been welcomed by Mark Carney in his speech of 20 June at the Mansion House: “Elements of these proposals could therefore provide a foundation on which to build robust cross-border arrangements for the supervision of CCPs. This should be based on deep cooperation between jurisdictions and authorities who defer to each other’s regimes where they meet international standards and deliver similar outcomes.”