Divergence

By Charlotte Service

Following the 2016 Brexit referendum, media attention has been concentrated on the high-stakes trade negotiations between the U.K. and the E.U., whilst coverage of discourse related to the future of financial services has been noticeably absent. On the one hand, the ‘Christmas Eve’ deal signing failed to meet Britain’s expectations for the industry, on the other, it facilitated the discussions and co-operation needed for the memorandum of understanding between the two parties ratified at the end of last month. The recently proposed forum will be key to determining the U.K.’s future financial market-access rights, alongside determining the nature of the unfolding relationship between the E.U. and the U.K.

Britain is eager to uphold the benefits of the pre-Brexit system and hopeful that its open-access relationship with the E.U. will be preserved. U.K. regulators are seeking to obtain an equivalence agreement, something that is vital if U.K. firms are to continue serving and connecting with their E.U. clients. However, it is inevitable that the notion to diverge fromBrussels’ regulations will compromise the prospects of such a favourable outcome. Negotiations over financial rules and trade deals which have been nearly forty years in the making was never going to be simple, but the U.K.’s intentions to diverge from Brussels’ regulations has not made matters any easier. Exposure to the risks of future competition has induced E.U. regulators to proceed with caution – it could just be a case of playing hardball, but either way it, Brussels has been averse to making decisions quickly. Britain has positioned itself to be at regulatory odds with the E.U. whilst simultaneously presupposing that it can continue to be treated as an equal. It is hardly surprising that this approach has not been particularly well-received by Brussels. 

Prior to Brexit and throughout the transitionary period, financial services trade with the E.U. has been conducted via specific permitted passporting agreements, those which bypass the need for extensive regulatory clearance. The U.K. hopes to maintain the ease of this method with its proposed post-Brexit equivalence, which will permit U.K. firms to passport into the E.U. and trade with other European financial players. Yet, Britain no longer has to align with all the E.U. rules and has made clear that it is planning a more outcome-driven regulatory framework, which will make full use of new-found powers and discretion. U.K. regulators are set on creating a much more liberal financial market, with a strong focus on the encouragement of competition and diversity. They also aim to make changes as to how particular regulations apply to minor financial firms, in addition to advocating the removal many financial caps and limits. However, any migration towards a more liberalised regime could stand to jeopardise London’s financial reputation, raising questions as to whether the proposed changes are the best way to both keep and promote international business in London.

The inauguration of the new forum has laid the groundwork for progression towards equivalence decisions, as well as allowing for the individual development of the now separate financial systems. The forum is a “framework for voluntary regulatory co-operation in financial services”, encouraging regular cooperation and rulemaking discussions between the two sides. It steers negotiations in what appears to be a positive direction for both parties and puts an emphasis on less regulatory uncertainty, as well as focussing on eliminating the possibility of regulatory arbitrage, the situation in which jurisdictions with weaker rules become more attractive. 

Given the expiration of the post-Brexit transition period on January 1st of this year, U.K. regulators had hoped the memorandum would have materialised much sooner than March. However, Brussels blames the delay on the lack of certainty concerning the U.K.’s forthcoming regulatory volitions. A particular report released in January, known as the “strategic autonomy” paper, highlights a lack of trust in Britain, delineating the shift of European contracts away from London into the E.U. due to what Brussels decrees as matters of financial stability. It is no secret that the E.U. negotiators are keen for the U.K. to comply with their rules as so to avoid disadvantaging E.U. players. The U.K.’s decision to diverge has made progress slow and though the memorandum appears to be a step in the right direction, it is rather minimal in its content; the forum is a basic commitment to the exchange of information twice a year and lacks any formal or legally binding arrangements. The necessitation of basic levels of communication is inconsequential – it is self-evident that regulators from both sides must make contact with their counterparts if any progress is to be made, they surely do not need to be prompted to do so. This simplistic and wanting nature of the memorandum is a reflection of what has become a distrustful and fractured relationship between the EU and the UK, alluding to the never-ending Brexit negotiations of which we have become all too accustomed.

Britain’s ambitious market intentions mean that there is considerable uncertainty surrounding the breadth of single market access that will be available to U.K. firms. The E.U.’s rather prudent approach to financial regulations mean it will grant equivalence to areas only where there are questions of financial market stability; provision of the agreement to the U.K. cannot be presupposed. Equivalence itself is also much more limited than the current passporting system in place, suggesting that the U.K. has really taken more of a damage-limitation approach than anything else. The regime does not enable the cross-border provision of core banking services and can be also revoked with a mere 30 days’ notice; the U.K. will have no guaranteed permanent access rights to the E.U., not to mention the leeway for particularly abrupt destabilisation. Even if Brussels does grant equivalence, it seems likely that the U.K. will have to acquiesce rules that it has little control over – a particularly ironic situation since one of the main arguments for Brexit was affiliated with greater control over U.K. regulations.

Given the above, the proposed U.K. guidance understandably puts a large emphasis on transparency. It affirms that the withdrawal of equivalence requires sufficient backing, to be considered only as a ‘last resort’. Additionally, a period of adaption has been suggested if the agreement is indeed ever to be withdrawn. However, such potentialities are a long way off and as it stands, Brussels has approved “only two temporary permits, which grant UK institutions more direct access to customers in the bloc”

With regard to the regulatory divergence, it is also important to consider what a freer financial system will mean for Britain. Though London’s consummate economic environment, infrastructure and communications network will prevent it from becoming irrelevant, Brexit has unleashed forces with the capacity to pull business away from the city. In all probability, London’s financial success is largely associated with its thorough rules and legalities; such formalities guarantee security, a quality which is especially attractive to investors. Looser regulations may create conditions more suited to financial innovation, and thus favour the endeavours of money-making. However, gaps in regulations make for easy and lawful wrongdoing and stand to tarnish the honest reputation that the U.K. so dejectedly prides itself in. 

Weaker regulations will inevitably lead to more unscrupulous behaviour because holding individuals accountable becomes far trickier. U.K. regulators should be focussing on the establishment of better rules; choosing to raise rather than lower the benchmark for financial regimentation will be beneficial to both Britain’s reputation and levels of international trust. Brexit is an opportunity to reset the scales and the domineering and influential capacity of Britain means it has the power, and perhaps the social responsibility, to set a good example.

The newly proposed forum is progress, but it is directed at the easing of political tensions, focussed on amicable cooperation over anything else. The U.K.’s financial divergence from the E.U. is undoubtedly fated to a lengthy adjustment period, and the developments over the following months will be consequential for Britain. It is unlikely that there will be any huge fundamental changes, but U.K. regulators must carefully consider the consequences of branching away from EU regulations. Evidently, complete administrative alignment is unrealistic, but the less the U.K. adheres to EU rules, the less market access it will be able to ensure. Any changes to existing regulations must be properly thought through – not pursued purely for the sake of the new-found freedom to indulge in independent decision-making. Britain must consider how its choices will affect both its financial reputation and its relationship with the E.U., along with the rest of the world.

The views expressed in this article are the author’s own and may not reflect the opinions of The St Andrews Economist.

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