A new relationship - UK regulation for Financial Services after Brexit
This article considers the implications of Brexit on the UK's financial services regime. In particular, we look at the negotiations which have taken place to date, the implications of the exit deal agreed in 2020, the impact of Brexit on the financial services sector which we have seen so far, measures taken by the UK which have sought to soften the transition, areas where the UK may look to diverge from the EU going forward and the future vision for UK financial services in a post-Brexit context.
"If the price of this [equivalence] is too high then we can't just go for it whatever. I strongly recommend that we don't become a rule-taker. If the price of that is no equivalence ... then I am afraid that will follow."1
1.1 This statement was made by Andrew Bailey, the Governor of the Bank of England, in January 2021. In many respects, this reflects the ongoing dilemma and growing frustration felt among UK policymakers since exit negotiations began with the EU following the Brexit vote in June 2016. That is, whether the UK should seek to reflect the EU's regulatory framework in exchange for market access or use the split to shape UK regulation in a more bespoke fashion going forward (even where that comes at the expense of access to EU markets).
1.2 Following the apparent breakdown of equivalence negotiations2, this article seeks to set out some of the context behind those discussions and dives more deeply into what shape we expect future UK regulation to take in a post-Brexit world and those areas where UK policymakers might look to diverge from EU requirements going forward.
2 Brexit - the story so far
2.1 Following the referendum, the UK triggered art.50 of the Treaty for the Functioning of the EU (TFEU), thereby signalling its intention to leave the EU. That set in train a two-year timetable within which to negotiate a withdrawal agreement.
2.2 Following several votes of confidence, political summits, extensions and much brinkmanship, a draft withdrawal agreement was agreed between the parties in November 2018. After further extensions, this resulted in the UK formally leaving the EU on 31 January 2020. However, under the terms of the withdrawal agreement the UK remained subject to EU rules until 31 December 2020 (the so-called transition period) whilst both parties sought to negotiate a free-trade deal.
2.3 The EU-UK Trade and Cooperation Agreement (TCA) was ultimately signed on 30 December 2020 after eight months of negotiations. At this point the UK formally became a "third country" (ie a non-EU state) and the EU principles of free movement of capital, goods, workers and services no longer applied.
3 The TCA - what was agreed?
3.1 Since the UK's vote to leave the EU in June 2016, commentators and industry stakeholders have been clear about the potential negative consequences of the UK firms leaving the EU's single market without appropriate provisions in place for financial services. Many of these individuals were therefore concerned when they saw that the TCA, which has applied from 1 January 2021, had limited application to the financial services sector.
3.2 Instead, the TCA was fundamentally designed to smooth customs formalities and controls which would otherwise have applied to trade between the UK and the EU.3 Specifically, the TCA set out the basis of a free-trade agreement which provided for zero tariffs or quotas on traded goods, targeted support for assisting businesses in complying with rule of origin requirements and protocols relating to customs fraud and VAT co-operation.
3.3 In addition, the TCA contained provisions on the coordination of citizens' social security benefits and a good governance clause under which both the EU and UK agreed to uphold standards in relation to anti-tax avoidance, public tax transparency and exchange of information. The TCA also contained more high-level provisions for managing future divergences on state aid and subsidy control in order to ensure open and fair competition going forward.
3.4 Therefore, the TCA was very much focused on trade on goods and preventing unfair and counterproductive tax competition between the UK and EU. Whilst the TCA did contain non-discrimination clauses which would enable UK service suppliers and investors to be treated no less favourably than EU operators by the EU (and vice versa) as well as a "most favoured nation" clause which would allow UK and EU firms to claim more favourable treatment granted by the other in future trade agreements with third countries, this did not apply to financial services.
3.5 Importantly, the TCA did not extend firms' automatic right, whilst within the EU, to offer services on a pan-EU basis (so-called "passporting"). Therefore, following the end of the transition period on 31 December 2020, UK firms would no longer benefit from automatic access to the EU single market and would need to comply with applicable host country rules in each Member State.
4 What was "passporting" and why were UK firms so keen to retain it?
4.1 Passporting is the exercise of the right available to a firm authorised in one European Economic Area (EEA) Member State to carry on activities in another EEA Member State on the basis of its home state authorisation.
4.2 Prior to 1 January 2021, this right allowed UK firms to conduct regulated business in other EU Member States on the basis of their UK regulatory permissions, whether through a branch in the host Member State (right of establishment) or from the UK on a cross-border basis (services passport).
4.3 A firm wishing to passport to another Member State would need to make a notification to their home state regulator before commencing operations and comply with any local legislation and regulation relating to its activities in the host state.
4.4 The following EU directives were primarily relevant to UK firms seeking to exercise passporting rights:
(a) the fourth Capital Requirements Directive (2013/36) (CRD IV)4;
(b) the second Markets in Financial instruments Directive (2014/65) (MiFID II)5;
(c) the Mortgage Credit Directive (2014/17) (MCD)6;
(d) the Solvency II Directive (2009/138) (Solvency II)7;
(e) the Undertakings for Collective Investments in Transferable Securities Directive (2009/65) (UCITS Directive)8;
(f) the second Payment Services Directive (Directive 2015/2366) (PSD II)9;
(g) the Insurance Distribution Directive (2016/97) (IDD)10; and
(h) the Alternative Investment Fund Managers Directive (2011/61) (AIFMD).11
4.5 Therefore, the potential loss of such rights following Brexit was a widely documented concern among industry participants and policymakers in both the run-up to and aftermath of the Brexit vote.12 It was felt that the loss of those passporting rights could damage the UK's reputation as a global hub for financial services and as a base from which many international firms chose to conduct their European business. Indeed, research shows that prior to Brexit UK-based firms were responsible for approximately 76% of all passporting under MiFID II, with 78% of EU27 capital markets activity conducted in the UK.13
4.6 Firms which had relied on these passporting rights to conduct pan-European business have therefore needed to implement alternative measures since the Brexit vote to ensure the continuation of their European business going forward. These include alternative investment fund managers (AIFMs) (who relied on passporting provisions under the AIFMD), credit institutions (who relied on passporting provisions under CRD IV), investment firms (who relied on passporting provisions under MiFID II), mortgage firms (who conducted pan-EU business under the MCD), management companies (who managed EU UCITS funds under the UCITS Directive) and insurance undertakings and intermediaries (who relied on passporting permissions under Solvency II and IDD respectively). Typically, these firms have either ceased their European operations or set up separately authorised subsidiaries.
4.7 The initial concern around the removal of passporting rights was expressed equally by EU-based firms conducting business in the UK. However, in response to those concerns the UK implemented a number of measures which were intended to smooth the Brexit transition process.
5 What measures did the UK undertake to smooth the transition process?
EU (Withdrawal) Act 2018
5.1 These measures were designed to provide continuity and legal certainty in UK law following the transition period. They included passing the EU (Withdrawal) Act 2018 (EUWA), which sought to retain existing EU law into the UK's legislative framework through "onshored" EU legislative provisions. This legislation also confirmed that principles and decisions from the Court of Justice of the European Union (CJEU) would be persuasive, but not binding, on UK courts following the transition period and provided that UK courts would need to follow retained EU case law and general EU law principles until a relevant UK court departed from that or UK legislation modified the relevant retained EU law.
5.2 The retention of EU law into the UK legislative framework through ss.2-4 of the EUWA has resulted in existing EU regulations and directives being copied into the UK statute book as "retained EU law". As a general rule, this legislation retains the core provisions from the original EU legislation, substituting, where required, "EU' or 'EEA" references to "UK" and relevant EU regulatory bodies to their applicable UK counterparts. Therefore, the core provisions of EU law have generally been retained in the UK law as a consequence of the EUWA.
Temporary Permissions Regimes
5.3 The Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) also established a Temporary Permissions Regime (TPR) for EEA firms and funds which were passporting into the UK when the transition period ended in order to allow these firms to continue operating temporarily in the UK once the passporting regime had fallen away. Through this process, UK regulators effectively granted these firms 'deemed Part 4A authorisation' to enable them to continue conducting regulated activities in the UK for a maximum of three years following the cessation of passporting rights.
5.4 During this period, firms within the TPR will be allocated "landing slots", within which they will need to apply for full authorisation within the UK. Where firms choose not to submit applications before the closing date specified by the FCA then the regulator will be able to cancel the firm's temporary permission leaving it unauthorised. It is hoped that the TPR will prevent a wholesale exodus of EEA firms from the UK market, thereby protecting both UK consumers and market participants that rely on services provided by those firms, as well as the UK's position as a global hub for financial services firms.
5.5 In addition to the TPR, UK regulators established the Temporary Marketing Permissions Regime (TMPR) for EEA-based investment funds that had passported into the UK to continue marketing their funds in the UK following the end of the Brexit transition period. The PRA and FCA were also granted new powers to make transitional provisions in relation to financial services legislation for a temporary period until 31 March 2022. This is known as the Temporary Transitional Power (TTP) and allowed UK regulators to make alterations to their rulebook where required to smooth the Brexit transition process.
5.6 To date, EU Member State regulators have generally refrained from implementing similar temporary permission regimes in their own countries which would benefit UK firms conducting business in the EU, and such regimes are not likely to be implemented now.
5.7 Another measure implemented by UK policymakers to smooth the Brexit transition process was the package of equivalence recognitions granted to EEA states in relation to EU rules and their compatibility or "equivalence" with related UK requirements.
5.8 Equivalence decisions granted by the UK Government so far include14:
(a) confirmation that the intragroup exemption under the retained UK European Market Infrastructure Regulation (UK EMIR)15 could be applied with respect to trades between a UK firm and EEA group entities;
(b) a number of equivalence decisions under the retained UK Capital Requirements Regulation (UK CRR)16 which prevent UK firms being subject to increased capital requirements under UK law as a consequence of their EEA state exposures;
(c) applicability of the onshored market making exemption to EEA market makers under the UK Short Selling Regulation (UK SSR)17;
(d) the treatment of ratings from EEA credit rating agencies under the UK Credit Rating Agencies Regulation (UK CRAR)18; and
(e) recognition of central securities depositories in EEA states under the UK Central Securities Depositories Regulation (UK CSDR).19
5.9 It was hoped that granting these equivalence decisions would provide a range of benefits to market participants, including supporting well-regulated open markets, facilitating effective pooling and management of risk, and supporting UK and EEA clients' access to financial services and market liquidity.
5.10 However, despite concerted lobbying by the UK Government (as well as UK and EEA market participants), the EU has not been willing to grant similar equivalence decisions in relation to the UK's regulatory regime.
What is equivalence and why was it considered important?
5.11 Equivalence, in this respect, is a process under EU law whereby the Commission determines that a particular third country's regulatory framework in a particular area is sufficiently equivalent to EEA standards and that, consequently, firms from that third country should be granted access to the EEA market.
5.12 It had initially been hoped by UK policymakers that, given the general retention of EU law in the UK following Brexit and the close links between the UK and EU financial systems, a permanent scheme of equivalence could be granted by the EU following the transition period.
5.13 However, it is important to emphasise at this point that equivalence is not a two-way or objective process. Rather, the granting of equivalence is at the discretion of the Commission (based on input given by the European supervisory authorities - the European Banking Authority, the European Securities and Markets Authority, or the European Insurance and Occupational Pensions Authority, as applicable) and has a significant political dimension. Indeed, EU policymakers have cautioned that the UK is only likely to be granted limited access to European markets and that, where such access is agreed, it is likely to be for "low hanging fruit" and 'stuff [the EU] can afford to lose'.20The European Commission have also been keen to stress that the EU "must consider our own interests"21 relation to equivalence decisions.
5.14 It is interesting in this respect that the limited equivalence and transitionary provisions the EU have granted to date, in particular permitting EEA firms to continue relying on UK firms for settlement services (which expired in June 2021) and clearing services (which will expire in June 2022) have been primarily targeted at minimising disruption for EEA entities (given London's preeminent position in the market and lack of EEA-based alternatives), rather than facilitating market access for UK providers.
5.15 It is also important to highlight that equivalence is not the same as passporting. While passporting provides a legally assured guarantee of market access, equivalence decisions can be reversed, changed or unmade by the Commission at any time and are only available in relation to around a quarter of all EU financial services legislation.22
5.16 Therefore, while UK policymakers have been keen to secure market access to firms through equivalence, it is not generally practicable for firms to base business models on the granting of equivalence decisions (with most UK firms to date either choosing to cease EEA operations or establish separately authorised EEA subsidiaries).
5.17 To illustrate this, we have included the table below, which illustrates some of the differences between equivalence and passporting under respective EU Directives:
|Market access via passporting
|Market access via equivalence
|Yes (although only for MiFID II services)
|No (while third countries can be recognised as equivalent for prudential matters there is no market access right for third country banks)
5.18 Therefore, even if the UK and EU were able to agree some form of partial equivalence (which at this stage looks increasingly unlikely),23 this would fall significantly short of the market access rights previously enjoyed by UK firms under the EU's passporting framework.
What has been the impact of Brexit to date?
5.19 Given the difficulties obtaining equivalence and the limited application of the TCA to financial services, it is instructive to consider what impact Brexit has had on UK firms to date.
5.20 Broadly speaking, the impact has been felt in the following areas:
(a) the shift of certain trading operations and staff from the UK to the EEA;
(b) the loss of passporting permissions and subsequent restructuring of UK firms' European business;
(c) the transfer of clearing and settlement functions; and
(d) the bifurcation of UK and EU regulatory reporting regimes,
each of which is considered further below.
6 Shift of trading operations/staff
6.1 It is well known that financial services is one of the most important sectors in the UK economy, responsible for approximately 12% of UK GDP and over a million jobs.24 It was therefore feared that Brexit and, in particular, a no-deal Brexit, could threaten London's pre-eminent position as Europe's leading financial centre and result in a significant shift of both business and employment to competing EU financial centres.
6.2 In this regard, there has undoubtedly been a shift in trading volume from the UK to other EEA markets (most notably Dublin, Amsterdam, Luxembourg, Paris and Frankfurt) since the Brexit transition period. This has been most notable in the case of share trading, euro-denominated derivatives and asset management. Although fortunately the scale of business and employment lost is lower than some experts had predicted.25
6.3 With regards to share trading, London was replaced by Amsterdam as Europe's largest share trading centre in August 2021, with an average of EUR8.23 billion being traded on various Dutch exchanges during August compared to EUR7.63 billion in London.26 This shift to Amsterdam, the world's oldest stock exchange, reflects the fact that EU rules do not permit European investors to trade shares in EU companies from the UK. This excludes European juggernauts like Airbus SE and BNP Paribas SA from UK exchanges. While the EU could reopen access to UK exchanges by granting an equivalence decision there is little sign this is likely at this stage.
6.4 It is important to note, however, that the UK has sought to respond to the challenges demanded by Brexit in the share trading space in order to protect the position of the UK exchanges. Amsterdam had initially overtaken London in January 2021 when more than EUR6.4 billion of transactions left the City overnight following the end of the Brexit transition period.27 The UK responded to this challenge by negotiating an equivalence deal with Switzerland which allowed each country to list the other's shares on their exchanges. As a result of this London briefly overtook Amsterdam for trading volume in July 2021, as Swiss companies such as Novartis and Nestle became available on UK exchanges, before being overtaken again by Amsterdam the following month.
6.5 The UK Government is also seeking to protect London's position as a share trading centre through adopting various recommendations set out in Lord Hill's 2020/21 review of the UK listing regime (considered further below). One of the motivations behind this review was to make London a more attractive centre for global listings going forward.
6.6 The UK is also planning reforms to allow investors greater flexibility to trade "off exchange" in future. This includes, for example, reforming and permitting so-called "dark pools" where fund managers can trade large volumes of shares while minimising the visible impact on market price and more lightly regulated trading venues run by banks and high frequency traders. These are areas which the EU have been seeking to clamp down on and where the UK could potentially seek an advantage in regulatory divergence.28
6.7 Therefore, rather than Brexit resulting in EU exchanges replacing UK exchanges in their entirety, it is perhaps more appropriate to see it as signalling a move to a multipolar European exchange world. While it is true that the vast majority of European share trading will no longer be funnelled through London and that other players, such as Amsterdam and Paris, will be more important going forward, London remains an important destination for share trading. Indeed, we anticipate that, while London has undoubtedly conceded trading volume in EU shares to European exchanges (in January 2021 it was estimated that London lost an average of EUR8 billion a day to EU exchanges, while Amsterdam exchanges saw a 400% increase since 2020),29 the UK will remain an important share trading hub and will no doubt redouble efforts to make itself an attractive listing destination for non-EU companies going forward (eg by permitting greater off-exchange trading).
6.8 The euro derivatives market is worth approximately EUR100 trillion and is a market of which EU politicians are keen to gain a greater share. Brussels' primary concern relates to clearing arrangements, which are designed to guarantee completion of a transaction even where one counterparty is unable to fulfil their end of a trade. In particular, European policymakers have expressed discomfort at the fact that a non-EU clearing house, the London Clearing House (LCH), now accounts for approximately 80% of global clearing in euro denominated interest rate swaps (although only around 25% of these swaps have an EU counterparty).30 As EU financial services chief Mairead McGuinness told an International Swaps and Derivatives Industry Association (ISDA) event in May 2021,
"A significant amount of risk to the EU financial systems is (still) in London. This ... is simply not sustainable to us in the long run".31
6.9 Currently, LCH can serve EU customers until June 2022 and it is felt that volume will continue to move from LCH to EU competitors up to and beyond that date (with Eurex in Germany and clearing providers in New York being the main beneficiaries). To illustrate this, in the six months to January 2021, London's share of the euro swaps market fell from 40% to 10% while US exchanges (which unlike their UK counterparts are deemed "equivalent" by the EU) saw their share double to 20%.
6.10 However, certain commentators have expressed scepticism about the ability of EU clearing houses to process the volume of euro-denominated derivatives after June 2022, with Andrew Bailey observing in February 2021 that such a trading volume was, "not a viable amount for the EU to process",32 given the efficiencies inherent in London's large liquidity pool. Therefore, we expect that London will remain an important euro derivatives market for the time being.
6.11 The other key factor driving derivatives business from the UK to the EU following Brexit is the approach the European Securities and Markets Authority (ESMA) is taking with regards to the Derivatives Trading Obligation (DTO) under the Markets in Financial Instruments Regulation (MiFIR).33 This imposes an obligation on a wide range of counterparties to only trade certain derivative contracts on specified trading venues. In November 2020, ESMA issued a public statement noting that the DTO will continue applying without changes (ie there would be no special regime for UK trading venues). ESMA observed in this respect that most UK trading venues who offered trading in derivatives subject to the DTO had established new trading venues in the EU, that participants could meet the requirements by trading on EU venues or eligible trading venues in third countries and that the dispute was "primarily a consequence of the way the UK has chosen to implement [the DTO]".34 Therefore, it considered any market disruption caused by its approach to be manageable.
6.12 Trading under the DTO accounts for approximately EUR50 trillion of the EUR681 trillion35 European derivatives market. As most of this is currently concentrated in London, there has been concern that ESMA's approach would create challenges for some EU counterparties (especially UK branches of EU investment firms who, in the absence of an equivalence decision, would be subject to the DTO in both the EU and the UK). The approach has also been criticised by the French regulator and banking federation.
6.13 It remains to be seen whether the parties can come to an agreement. As our own Michael McKee observed at the time, ESMA's decision was a "starting gun for a fight between the UK and the EU for the location of international derivatives trading in Europe".36 Therefore, we anticipate that the horse trading around the European derivatives market still has some way to run.
6.14 Brexit has impacted UK asset management firms in the following ways:
(a) the lack of equivalence judgement means that some EU regulated funds and investors are no longer able to delegate portfolio management services to UK asset managers;
(b) UK UCITS funds can no longer be sold to retail investors in the EU and are no longer eligible assets for EU UCITS;
(c) UK firms are no longer able to be management companies of EU UCITS;
(d) UK AIFs operating in the EU will now be subject to the third-country annual reporting and disclosure requirements set out under art.42 of AIFMD; and
(e) UK AIFMs have lost their EU passporting rights meaning that they currently need to rely on a patchwork of national private placement regimes to market to EU investors.
6.15 As a consequence of these challenges, a number of UK asset managers have moved operations to EEA jurisdictions since the Brexit vote (most commonly Dublin or Luxembourg). In our view, this trend is likely to continue unless the EU grants equivalence under art.37 of the AIFMD. This allows third-country firms to conduct business in the EU where their jurisdiction is deemed to present no significant obstacles to investor protection, market distortion, systemic risk monitoring or competition. Although the UK has made recent tax changes to improve the position of the funds industry (discussed later) we do not consider that these are sufficient to alter the general trend.
6.16 ESMA's record on this issue and the political climate to date suggests that such a decision will be difficult to achieve. Indeed, it is noticeable that, even in circumstances where ESMA has considered there to be "no present obstacles" to third-country passporting (eg Canada, Guernsey, Japan, Jersey and Switzerland) it has not yet chosen to activate those third-country passports.
6.17 In January 2017, the chief executive of the London Stock Exchange speculated that a no-deal Brexit could cost the UK 232,000 financial services jobs.37 Thankfully such pessimism has not been reflected in the employment figures to date, with the most recent estimates suggesting that between 4,000 and 7,000 roles have been lost to the continent since the UK's vote to leave. While this may increase in future, and the EU has been keen to stress its "substance requirements for EU subsidiaries and opposition to "post-box" European operations set up by previously passporting UK firms, it is likely that the real issue will be new jobs being created in the EU in future that might otherwise have been created in the UK.
7 Loss of passporting permissions and restructuring of UK firms' EU business
7.1 As outlined above, following the end of the transition period UK firms lost the right to passport into the EU on the basis of their existing UK regulatorypermissions. Accordingly, and in the absence of any EU equivalence decision, UK firms have either:
(a) ceased conducting regulated business in the EU;
(b) opened up separately authorised European subsidiaries; or
(c) restructured their European business to ensure that they remain outside of the relevant Member State's regulatory perimeter (eg by only targeting high-net-worth clients or relying on reverse solicitation, where available).
7.2 It is instructive, in this respect, that different European jurisdictions have been attractive to specific parts of London's financial services industry, with a third of all asset management firms who have moved following Brexit choosing Dublin; 60% of firms that chose Frankfurt as their main EU base being banks and nearly two-thirds of firms moving to Amsterdam being trading platforms, exchanges or broking firms.38
7.3 Due to the strict deadline imposed by the end of the transition period and the time elapsed since the Brexit vote, most firms have had these arrangements in place for some time. Although we do expect the number of staff at European authorised subsidiaries to increase over time, particularly in the case of banks with larger European operations and deposit bases.
8 Clearing and settlement functions
8.1 In addition to the ongoing tug-of-war surrounding the clearing of euro-denominated derivatives referenced above, Brexit has also resulted in a diverging approach between the UK and EU on the Settlement Discipline Regime (SDR) imposed under the Central Securities Depositories Regulation (CSDR). The CSDR aims to ensure that transactions between buyers and sellers of securities are settled in a safe and timely manner by introducing common securities settlement standards across the EU. Under this legislation, the SDR includes measures which aim to prevent and address settlement fails by imposing (in particular) mandatory buy-in requirements and cash penalties for settlement fails.
8.2 While the EU has now postponed the implementation of the SDR on two occasions to February 2022, the UK announced in June 2020 that it would not be implementing the SDR component of the UK CSDR at all. While this approach has generally been welcomed by firms in the UK and the EU's approach to the proposed buy-in under the SDR may evolve before the February 2022 implementation date, it does mean that there will be multiple settlement regimes for cross-listed shares going forward, thereby adding to cost and complexity to firms which will need to comply with both regimes.
9 Bifurcation of UK and EU reporting regimes
9.1 The implementation of existing EU law into the UK legislative framework following the end of the Brexit transition period has now resulted in separate UK and EU transaction reporting regimes under MiFIR and EMIR, thereby adding to firms' regulatory compliance costs and creating complexity for firms with significant UK and EU trading operations.
9.2 To manage the UK's transaction reporting regime under UK MiFIR, the FCA has built the Financial Instruments Reference Data System and Financial Instruments Transparency System to replace the EU systems under ESMA. While this has been built to mirror the processes in place within the EU, certain differences exist (eg under the UK system, master data will be UK focused and not pan European) and for certain entities, most notably EU investment firms who execute transactions via a UK branch or UK investment firms who execute transactions via an EU branch, dual reporting obligations will apply.
9.3 In the derivatives space, the UK EMIR reporting regime will only apply to UK firms and their branches (and not, for example, to third country firms with UK branches). The FCA will expect in scope firms to report their derivative trades to a FCA registered or recognised trade repository in accordance with the new requirements. This means that a UK firm trading a derivative transaction with an EU counterparty could give rise to reporting obligations under both regimes, thereby further complicating the pre-Brexit EMIR regime.
10 Future vision for UK financial services post-Brexit
10.1 While all of the above factors arising from Brexit have impacted financial service providers, perhaps the most interesting area to consider is how the UK regulatory regime more broadly might diverge from the EU going forward.
10.2 The clearest indication that the UK intends to strike its own way in the world was given in July 2021 by Rishi Sunak, the Chancellor of the Exchequer in his annual Mansion House speech to the UK finance industry. Sunak observed that, while the UK's ambition had been to "reach a comprehensive set of mutual decisions on financial services equivalence", this "had not happened".39
10.3 As a consequence, Sunak noted that the UK now has the "freedom to do things differently and better" and that the Government intends to use that fully.40 Although Sunak was keen to stress that he was not, in this case, referring to any intention to weaken the UK's robust regulatory standards. Rather the UK would instead:
(a) seek closer links with advanced and emerging financial centres around the world;
(b) boost its competitiveness in regulation and tax; and
(c) aim to retain and enhance its position at the forefront of technology and innovation in the 21st century.10.4 Therefore, the UK's intention was not to become "Singapore-on-Thames'"or push deregulation, but rather to increase global convergence in regulatory standards through participation in global bodies such as the International Organisation of Securities Commissions (IOSCO), the Basel Committee and the Financial Stability Board. The UK would use this "regulatory diplomacy"41 to enhance market access to other, non-EU markets (eg through mutual recognition and equivalence agreements). It is hoped that such an approach will see the UK adopt a new, global role which would then offset some of the financial services business lost to the EU as a consequence of
Brexit and any such regulatory divergence.
11 Links with advanced and emerging financial centres
11.1 In recent months, the UK has been exercising this regulatory diplomacy to negotiate agreements with Singapore and Switzerland. In June 2021, the UK and Singapore agreed a landmark Financial Partnership for financial services.42 This is backed by a memorandum of understanding between the two countries which aims to reduce frictions for firms serving the UK and Singapore markets by recognising the similarities between each other's financial services regulatory regimes. Both parties have also agreed to cooperate on Fintech and new developments such as e-wallets and digital finance and put in place a separate memorandum of understanding on cybersecurity.
11.2 Similarly, through its ongoing negotiations with Switzerland, the UK is hoping to obtain a mutual recognition agreement which reduces costs and regulatory barriers for UK firms accessing the Swiss market (and vice versa). These negotiations have been given further impetus by the recent difficulties both countries have faced negotiating directly with the EU (during 2019 Brussels had blocked EU investors from trading on Swiss bourses with Switzerland responding by banning EU exchanges from trading Swiss shares).
12 Boosting the UK's competitiveness in regulation and tax
In addition to its decision not to implement the SDR under the UK CSDR and the increased acceptance of dark pools and off exchange trading outlined above, the UK has also signalled its intention to diverge from EU regulations in other key areas in order to boost its competitiveness and make it a more attractive destination for international business going forward.
Approach to divergence
12.1 Before providing an overview of these, it is important to emphasise that the UK is being selective in the areas in which it is seeking to pursue regulatory change, given it does not wish to unnecessarily disrupt existing UK/EU trade in financial services and having broadly on-shored existing EU requirements into UK law following the end of the transition period. Although there is undoubtedly a feeling among some figures in the UK Government that Brexit, while challenging presents an opportunity for a substantive overhaul of the UK's current financial services regulatory framework. As John Glen, MP, economic secretary to HM Treasury, has noted: "We can now be guided by what is right for the UK, regulate differently where we need to, and regulate better".43
12.2 Any future separation from EU rules will either take the form of both active divergence (where UK legislators choose to amend retained EU rules on its statute book or diverge from previously established EU regulatory practice) or passive divergence (where UK policymakers simply choose not to implement new legislative or judicial initiatives from the EU).44
12.3 One high-profile example of such divergence relates to the implementation of Solvency II, an EU directive that seeks to harmonise insurance regulation across the EU and came into force shortly before the Brexit vote in 2016. It is felt by some industry insiders that concerns expressed by the UK industry have not been taken into consideration by the Commission in the drafting of that legislation, in particular the imposition of high-risk margin requirements which many participants feel will not work in the UK given the low interest rate environment and the large volume of long-term business written with guarantees.
12.4 As the head of prudential regulation at the Association of British Insurers (ABI) noted:
"The EU Solvency II regime is necessarily highly prescriptive, given it is attempting to harmonise regulation across a multitude of member states. By contrast, regulation in the UK is less prescriptive and more principles-based, so returning to a more principles-based regime is key".45
12.5 Another area where the UK is hoping to boost its competitiveness is in relation to the companies listing regime. In November 2020, the Government announced that a review of the UK Listings Regime would be chaired by Lord Hill "as part of a plan to strengthen the UK's position as a leading global financial centre". 46 Recommendations made under the review include:
(a) changes to listing rules, including around dual class share structures, free float requirements and special purpose acquisition vehicles;
(b) the rebranding and repositioning of the standard listing segment;
(c) a fundamental review of the prospectus regime;
(d) for government to consider how technology can increase the involvement of retail investors and the efficiency of capital raising; and
(e) a review of the FCA's statutory objectives as part of the Future Regulatory Framework Review to add a duty to take into account the UK's attractiveness as a place to do business.
12.6 In April 2021, the Chancellor announced the Government's intentions in response to Lord Hill's review. Their commitment, in particular, to reviewing the UK's prospectus regime, considering whether prospectuses drawn up under other jurisdictions' rules could be used to facilitate secondary listings in the UK and facilitating the provision of forward-looking information by issuers in prospectuses could lead to future divergence with the current EU regime under the Prospectus Regulation.
12.7 Prudential requirements applicable to investment firms is another area where we will see divergence in future, given the UK is not following the EU's ongoing implementation of the Investment Firms Regulation and Investment Firms Directive (collectively, IFR/D).47 Instead, the FCA will shortly be implementing its own Investment Firms Prudential Regime (IFPR), the consultation for which closed on 17 September 2021. The aim of the IFPR is to "streamline and simplify"48 the prudential requirements for MiFID investment firms regulated by the FCA in the UK. It is expected that many firms will welcome the more user-friendly approach resulting from the IFPR and capital requirements being more readily available through the FCA Handbook.
12.8 Among other requirements, the EU's IFR/D requires systemic investment firms to be re-authorised as non-deposit taking credit institutions under the CRR. The UK, in contrast, will not require systemic investment firms regulated by the PRA to go through this process. Another area where we are expecting regulatory divergence in future is in relation to the prudential requirements applicable to smaller banks and building societies, with the UK keen to adopt a more "proportionate" approach.49 Support for a more proportionate approach has been voiced by, among others, Sarah Breeden, executive director of Supervision for UK deposit takers at the PRA and Sam Woods, the PRA's CEO. Linked to this is the Government's announcement that the UK will not be implementing future EU changes imposed under CRD V or CRR II.
12.9 In the asset management space, the UK is also seeking to improve its attractiveness as a location to set up, manage and administer investment funds. Consequently, in January 2021, the Government50 published a call for input with various proposals relating to:
(a) funds regulation (eg refining and speeding up the FCA authorisation process and improving the attractiveness of the UK's Qualified Investor Scheme); and
(b) taxation (eg the tax treatment of asset holding companies, low rates of tax to be applied to authorised funds and deemed deductions for distributions at fund level). These proposals are intended to make the UK a more attractive destination relative to its competitors in Luxembourg and Ireland going forward.
Future Regulatory Framework Review
12.10 In addition to these specific plans for regulatory divergence from the EU, the UK is also looking to boost its regulatory competitiveness by reforming the model of regulation in the UK under the Future Regulatory Framework Review (FRF Review).51 This is an ongoing review of UK financial services regulation led by the Treasury which is aiming to establish a fit-for-purpose, future-proof UK regime. The FRF Review was commissioned in June 2019 and aims to build on the strengths of the UK's existing framework under the Financial Services and Markets Act 2000, as opposed to designing a new regulatory model from scratch.
12.11 Among other recommendations, the FRF Review envisages a clear allocation of responsibilities between Parliament, HM Treasury, the FCA and PRA with more policy discretion being granted to the FCA and the PRA in relation to how regulatory requirements should be designed to meet Parliament's policy objectives. The Government is confident that this approach will allow the UK to remain flexible and agile in the face of changing market conditions. The Phase II Consultation closed on 21 February 2021, with the Government currently analysing the feedback received.
13 Retain and enhance its position at the forefront of technology and innovation
13.1 While the UK already has various initiatives in place which are designed to encourage the development of growth sectors in the financial services space (eg the FCA's Regulatory Sandbox), it is likely that Brexit will see the UK redouble its efforts in this space.
13.2 The most notable development is the 'Kalifa Review of UK Fintech' which was published in April 2021. Among other recommendations, the report advises that52:
(a) amendments are made to the UK listing rules to make it a more attractive location for initial public offerings;
(b) the Government works to improve the availability of technology visas to attract global talent and boost the Fintech workforce;
(c) the UK creates a regulatory Fintech "scalebox" to provide additional support to growth stage Fintechs; and
(d) a Centre for Finance, Innovation, and Technology is created in order to strengthen national coordination across the Fintech ecosystem and boost growth.
13.3 Lord Kalifa acknowledged that Brexit had created challenges for the UK Fintech sector, particularly the fact that firms would need to navigate a more complex immigration system for EU talent for the first time (a barrier which rival jurisdictions have been exploiting in an effort to lure European talent).
13.4 The UK has also, in the Fintech space, agreed "Fintech Bridges" with Australia, China, Hong Kong, Singapore and South Korea. Each Fintech bridge is unique, but they typically allow access to events, meetings and networking opportunities, referrals to streamline regulatory approval, to buyers, investors, trade associations and institutions, advice and one-to-one mentoring from Fintech specialists and discounted "soft-landing pads", grants or subsidies.
13.5 Another future area of growth which the UK is seeking to exploit is green finance.53 Boris Johnson, in November 2020's Ten Point Plan for a Green Industrial Revolution54 had announced his intention to "turn the UK into the world's number one centre for green technology and finance". Initiatives in this space include the UK taxonomy (an attempt to require investment managers to disclose the proportion of their investments directed at economic activities which are aligned with environmental objectives) and the Task Force on Climate-Related Financial Disclosures (TCFD) as well as the recent issuance of the UK's first sovereign green bond.
13.6 Brexit, in this regard, is seen by some as an opportunity for the UK given the difficulty the EU have encountered in agreeing their own taxonomy (a process which requires the agreement of multiple Member States and has been subject to intense lobbying). Although critics have countered that the UK's approach is likely to replicate much of the work already done by the EU. It is anticipated, however, that the UK approach will probably be less detailed and bureaucratic than the EU approach and one possibility is that the UK may seek to work with the US, Asian and Commonwealth country regulators to develop a less rigid taxonomy that can be more readily used globally.
14.1 Brexit remains the most significant constitutional change the UK has experienced in living memory. In this article we have covered some of the key impacts of that change on the UK's financial services sector. In particular, the shift of certain trading operations and staff from the UK
14.2 to the EEA, the loss of passporting permissions and subsequent restructuring of UK firms' European business, the transfer of clearing and settlement functions and the bifurcation of UK and EU regulatory reporting regimes.
14.3 We have also considered how UK firms and policymakers are responding to the challenges presented by Brexit, namely by seek closer links with advanced and emerging financial centres around the world through "regulatory diplomacy", boosting the UK's competitiveness in regulation and tax and aiming to retain and enhance the UK's leading position in technology and future growth sectors.
14.4 Whether these measures will compensate for the loss of access to EU markets and its £26 billion trade surplus in financial services with the EU will depend on how quickly the UK can translate its positive messaging into real-world business opportunities. With regards to the longer-term impact of Brexit on the UK's financial services sector, it is perhaps best to reiterate Chinese premier Zhou Enlai's comments on the French revolution: 'It's a little too soon to say'.
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4Directive 2013/36 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms  OJ L176/338.
5Directive 2014/65 on markets in financial instruments  OJ L173/349.
6Directive 2014/17 on credit agreements for consumers relating to residential immovable property  OJ L60/34.
7Directive 2009/138 on the taking-up and pursuit of the business of Insurance and Reinsurance  OJ L335/1.
8Directive 2009/65 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities  OJ L302/32.
9Directive 2015/2366 on payment services in the internal market  OJ L337/35.
10Directive 2016/97 on insurance distribution  OJ L26/19.
11Directive 2011/61 on Alternative Investment Fund Managers  OJ L174/1.
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15Regulation 648/2012 on OTC derivatives, central counterparties and trade repositories  OJ L201/1.
16Regulation 575/2013 on prudential requirements for credit institutions and investment firms  OJ L176/1.
17Regulation 236/2012 on short selling and certain aspects of credit default swaps  OJ L86/1.
18Regulation 1060/2009 on credit rating agencies  OJ L302/1.
19Regulation 909/2014 on improving securities settlement in the European Union and on central securities depositories  OJ L257/1.
20TodayUKNews (quoting an unnamed senior EU adviser), 'Will the EU grant the City post-Brexit equivalence?' (18 June 2021) available at: https://todayuknews.com /finance/will-the-eu-grant-the-city-post-brexit-equivalence/ [Accessed 12 October 2021].
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33Regulation 600/2014 on markets in financial instruments  OJ L173/84.
34ESMA, 'ESMA sets out its final view on the Derivatives Trading Obligation' (25 November 2020) available at: https://www.esma.europa.eu/press-news/esma-news/esma-sets-out-its-final-view-derivatives-trading-obligation-dto [Accessed 12 October 2021].
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40Mansion House Speech 2021—Rishi Sunak (1 July 2021) available at: https://www.gov.uk/government/speeches/mansion-house-speech-2021-rishi-sunak [Accessed 12 October 2021].
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46UK Listings Review (19 November 2020) available at: https://www.gov.uk/government/publications/uk-listings-review [Accessed 12 October 2021].
47Regulation 2019/2033 on the prudential requirements of investment firms  OJ L314/1; Directive 2019/2034 on the prudential supervision of investment firms  OJ L314/64.
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49Deloitte, 'Ruling the waves or waiving the rules? The UK's options for deregulation and competitiveness after Brexit: Part 2—Prudential Regulation' (22 March 2021) available at: https://ukfinancialservicesinsights.deloitte.com/post/102gtir/ruling-the-waves-or-waiving-the-rules-the-uks-options-for-deregulation-and-comp [Accessed 12 October 2021].
50UK Government, 'Review of the UK funds regime—A call for input' (January 2021) available at: https://assets.publishing.service.gov.uk/government/uploads/system /uploads/attachment_data/file/955542/REVIEW_OF_THE_UK_FUNDS_REGIME_-CALL_FOR_INPUT.pdf [Accessed 12 October 2021]. 'What is the Future Regulatory Framework Review'
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