Will Brexit upend the UK’s regulatory framework in financial services?

In the period since the UK voted to leave the European Union (EU), speculation about the extent to which the regulatory environment will change, and what it means for financial services, has been rife.

Much of the discussion centres around the concept of ‘taking back control’, and Boris Johnson proclaimed last year that the UK now has the opportunity to extricate itself from the ‘EU’s extraordinary and opaque system of legislation’. In financial services at least, this statement rests on an underlying assumption that the UK wouldn’t have chosen to implement these rules if it wasn’t for the EU.

But this is implausible. The majority of current EU framework stems from internationally agreed principles and guidelines, and has worked to the UK’s benefit. As the Bank of England noted, ‘the resulting legislation has substantially raised the quality of regulation in the EU overall. By ensuring those strengthened standards apply EU-wide and with the force of law, this helps support financial stability in the UK’.

The UK has also influenced how EU legislation has been developed. While it may have lost the battle over the bonus cap, it’s won many others. Successes include rejecting EU location requirements for EU denominated clearing (a fight that’s now back under serious consideration by the EU), and refusing the financial transaction tax.

All this means it’s reasonable to assume the underlying framework and content of most existing UK regulations will remain the same. This reflects their appropriateness and effectiveness, as well as the significant investment financial services institutions have put into implementing EU regulations. It also recognises the likely need for equivalency to access the single market.

But that’s not to say all areas will go unchanged. The UK has a history of gold plating EU law, as well as developing and implementing rules separate from EU legislation. For example, the UK has been a global leader in the development of conduct and culture related regulation. Jurisdictions such as Hong Kong and Australia have already announced their intentions to replicate the UK Senior Manager Regime rules locally.

The UK’s work to support the FinTech sector is also worth mentioning here. Part of the reason the UK has successfully become a world-leading hub for FinTech innovation is in large part due to the supportive regulatory environment led by the Financial Conduct Authority (FCA).

It is very likely that this willingness and capability to develop rules outside the EU framework will continue. 

Equivalency

 Post-Brexit, equivalency is going to be an essential part of the UK’s decision making on legislation – regardless of the agreement reached in the negotiations on Britain’s relationship with the EU. As the European Commission highlighted, equivalency means countries must be able to demonstrate that their rules ‘achieve the same objectives as in the EU… [but] it does not mean that identical rules are required’.

As the UK takes control of the entire legislative process, it will need to assess equivalency. This assessment must consider precedent established by other third country equivalency determinations, and the likelihood of the EU accepting new or altered UK law as equivalent. When we consider the bonus cap, the US regime has been granted equivalency to the Capital Requirements Regulation, but no bonus cap exists there. If an agreement can be reached with the EU that allows for changes to the current requirements without compromising equivalency, what else could change?

The bonus cap

The Governor of the Bank of England, Mark Carney, and Andrew Bailey, CEO of the FCA, have argued that the bonus cap could have undesirable side-effects for financial stability if it reduces the scope for remuneration to be clawed back. In particular, they’ve said it’s likely to make it harder for banks to adjust variable remuneration to reflect the financial health of the individual bank. It could also limit the use of deferral arrangements that can better align remuneration with the long-term interests of the bank.

Tier 1 capital conversion

When we look at the Capital Requirements Regulation, we see that there are specifications regarding the threshold at which certain contingent capital instruments convert into the highest quality regulatory capital – which is the point at which those instruments can count towards banks’ capital requirements. But the regulation doesn’t permit national authorities to require a higher conversion threshold if it’s needed to help safeguard domestic financial stability – which is the kind of flexibility the UK could introduce.

Beyond the above, the UK may also seek to address reporting and disclosure requirements, proportionality of rules, uniformity of definitions, and timing and connectedness of rules. The UK may not be able to address all of these concerns independently from the EU. But it could move at a faster pace to reduce regulatory burdens and increase competition.

Brexit has introduced countless uncertainties, but it’s a good bet that the underlying framework for financial services regulations will remain unchanged and may in some cases be improved.