UNCHARTED WATERS

Beyond Brexit: The Future Shape of UK Financial Services Regulation

Prior to the end of the Brexit transition period, the UK government made a number of important announcements, setting the direction of travel for the future of the UK’s financial services sector outside the EU.

Throughout 2020 and, in particular, during the final few months leading up to the end of the Brexit transition period on 31 December 2020, the UK government announced a range of measures which established the foundation for the future of the UK’s financial services sector – a future which now exists outside the European Union. These measures provide some important insights into how the UK is likely to shape its financial services sector in the years to come.

Some of these measures were specifically designed to create certainty for financial services businesses in the absence of an agreement between the EU and the UK on the future relationship which adequately dealt with financial services. Other measures were more indicative of the UK’s general policy approach to the future of the financial services sector and the governing framework pursuant to which the UK’s law-makers and regulatory bodies will operate the UK’s regulatory regime now that it can make its own rules outside the EU.

Maintaining openness and creating certainty, while asserting independence

In the lead up to the end of the Brexit transition period, it was clear that the UK financial services regulators had generally adopted a philosophy of seeking to maintain the openness of the UK’s markets, while also trying to create a fairly high degree of certainty for financial services businesses operating in the UK, particularly for those incoming EU firms that had historically relied on the passporting regime.

The Temporary Permissions Regime, the Financial Services Contracts Regime and the Temporary Transitional Powers Regime, were all evidence of this approach. Likewise, the UK’s decision to permit UK firms to be able to satisfy the MIFID II mandatory share trading obligation by executing trades on EU trading venues, even in the absence of the EU making a reciprocal decision, was also indicative of an overarching philosophy of openness and a desire to create certainty.

In June 2020, the Chancellor, Rishi Sunak, provided the clearest and the most definitive indication that the UK would be prepared to depart from EU rules in specific areas following the end of the Brexit transition period. Amongst other things, the UK unilaterally decided that the controversial settlement discipline provisions of the Central Securities Depository Regulation would not be adopted in the UK. At the time the Chancellor declared that the UK would maintain the “highest international standards” in the financial services sector, but would also need to focus on “what is right for the UK” in relation to the future onshoring of EU law.

Rule Making and Democratic Oversight – The UK’s New Regulatory Framework

In October 2020, HMT published the second phase consultation paper relating to the “Financial Services Future Regulatory Framework Review” (with the consultation closing on 19 February 2021). This phase of the review is designed to examine how the UK should adapt its approach to regulation outside the EU, while building on the strengths of the existing UK framework. The key principles of the new proposed model framework are as follows:

  • HMT and Parliament will be responsible for setting public policy standards pursuant to which the UK’s regulators will operate. HMT and Parliament will also establish the priorities for areas of regulation;
  • The UK’s regulators will set direct regulatory rules, including those based on onshored EU standards from the end of the Brexit transition period. The idea is that the regulator’s rules books should become the single source of the regulatory requirements applicable to firms;
  • In keeping with the theme of reasserting the UK’s sovereignty, the model will ensure appropriate democratic oversight and scrutiny of the regulators by HMT and Parliament; and
  • A second and more detailed consultation due in 2021 will set out specific proposals on how the future regulatory framework will be delivered.

Critically, working with regulators and the industry, HMT will explore whether moving away from the EU rule structure makes more sense in the UK context. In the forward to the consultation paper, John Glen (Economic secretary to HMT), stated that Brexit allows the UK to take back control of the decisions governing the UK financial services sector and the UK can now regulate differently where it needs to and regulate better. This mantra echoes that expressed by the Chancellor in June, that the UK will adopt a flexible and proportionate approach to financial services regulation and will do what is right for the UK.

Interestingly, the consultation paper also states that the statutory objectives of the UK regulators will not be amended to include a “competitiveness” objective. However, it is arguable that, depending on how HMT and Parliament exercise their respective oversight and policy setting roles in relation to the actions of the regulators, something similar to such a competitiveness objective could be de facto created via the back door.

The Financial Services Bill and the Vision for the Future of Financial Services in the UK

On 21 October 2020, the UK’s Financial Services Bill was introduced to Parliament (the “Bill”). The Bill sets out a range of measures across various subject matters, including:

  • establishing the UK’s new prudential framework for investment firms (based largely on the EU’s Investment Firms Directive and Regulation);
  • making changes to the EU-derived PRIPPs rules as they will be applicable in the UK following the Brexit transition period; and
  • establishing the framework for the UK’s approach to the MiFIR third country access regime.

While many of the provisions in the Bill effectively empower the UK’s regulators to make more detailed rules in the subject matter areas which are covered, it is clear that the UK, by adopting such an approach, is seeking to provide itself with a significant degree of regulatory flexibility in order to adapt its rules to a UK-specific context.

In addition, on 9 November 2020, the Chancellor set out his vision for the future of the UK’s financial services industry, which comprised a number of initiatives, the main ones being as follows:

  • The UK would be unilaterally granted equivalence to the EU in a number of key areas (for example, the EMIR intra-group exemption for clearing and margining). Importantly, the UK made these equivalence decisions in the absence of reciprocity from the EU, citing the importance of creating certainty for businesses and improving financial stability as justifications for the UK acting unilaterally;
  • The provision of guidance from HMT on the principles and processes that will underpin the UK’s equivalence framework for financial services going forward;
  • A call for evidence on how overseas firms can best access the UK market in the future;
  • The UK will create its own Green Finance taxonomy and measures, using the EU’s as a starting point. A Green Technical Advisory Group will be established to determine whether the EU’s rules are appropriate in the UK context; and
  • HMT will launch a consultation in relation to the appropriate regulatory framework for stablecoins, while also continuing to consider, together with the Bank of England, whether the central bank can issue its own digital currency.

In delivering his vision, the Chancellor stated that the UK will maintain the highest regulatory standards while remaining an open and dynamic global financial centre. The vision is “based not on a race to the bottom, but for a financial services industry that is open, is innovative; and leads the world in the use of green finance.”

What does it all mean?

All of the above announcements and measures clearly indicate that, for financial services, the UK is prepared to depart from EU regulatory rules (whether already onshored or otherwise) where it deems it appropriate to do so in the best interests of the UK, its markets and its consumers. We discussed the early indications that the UK is prepared to depart from EU standards as part of our discussion on the future of financial regulation post-Brexit as part of our Emerging Themes webinar on 14 January 2021. There is not, however, a general deregulatory agenda at play. Any roll back of onshored EU requirements will necessarily be tempered by the following considerations:

  • The UK has stated that it will continue to adhere to international regulatory standards in financial services, even after its departure from the EU.
  • There are many advocates within both HMT and the regulators of the view, with sound justification, that appropriate high standards of regulation can in fact increase competitiveness and attract businesses, whereas lax regulatory standards can have the opposite effect.
  • The UK and its regulators have championed and been responsible for the introduction of large swathes of the EU’s rules regulating the financial services industry. It is highly unlikely that the UK will look to change the rules in these areas, in the short to medium term at least, given that the UK sponsored their introduction.
  • Further, the UK has often gold-plated EU financial services regulatory requirements or created its own bespoke regimes which go well beyond the standards mandated by the EU. For example, the focus on personal accountability implemented through the Senior Managers and Certification Regime is a regulatory phenomenon unique to the UK. As is the focus on non-financial conduct and culture, which are at the heart of the PRA’s and FCA’s supervisory and enforcement approaches. The rules in these sorts of areas are again unlikely to be watered down or rolled back in any way for the foreseeable future.

Changes to the UK’s regulatory rules will generally be incremental and measured, but potentially with deliberate and relatively swift departures from those EU derived rules with which the UK has never been particularly comfortable.

Accordingly, it seems that any changes to the UK’s regulatory rules will generally be incremental and measured, but potentially with deliberate and relatively swift departures from those EU-derived rules with which the UK has never been particularly comfortable (for example, the overly broad application of the product governance rules and many of the trading transparency requirements set out in MiFID II).

The UK’s regulators and law makers are likely to focus on maintaining international openness and access to the UK’s capital markets and market infrastructure, while also ensuring that consumers are given appropriate protection. Following various FCA announcements in 2019, the UK will adopt a more “outcomes focussed” approach to regulation rather than allowing mere compliance with perspective rules to discharge a firm’s regulatory obligations.

Finally, it is clear that the UK intends to distinguish itself from other jurisdictions by continuing to lead the way in the creation of appropriate but effective regulatory regimes to foster the innovative use of technology in the financial services sector (ie. Fintech).

CONCLUSION

What is far less clear over the longer term, however, is whether the consequences of Brexit and other broader macro-economic factors and global trends will have a negative impact on the UK’s financial services sector to such an extent that the UK might feel compelled to deregulate more generally in order to remain internationally competitive – and not just in relation to financial services regulation.

While there are certainly strong arguments that good regulation and high standards instil confidence and transparency in the financial services sector and therefore increase competitiveness, as ever, a balance needs be struck. As the UK moves into uncharted waters, only time will tell if it will get this mix right.


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MEET THE AUTHORS

DANIEL CSEFALVAY

Partner, London

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ANTHONY WILLIAMS

Associate, London

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This document provides a general summary and is for information/educational purposes only. It is not intended to be comprehensive, nor does it constitute legal advice. Specific legal advice should always be sought before taking or refraining from taking any action.

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