Essay: EU-wide laws on financial services and Brexit

The United Kingdom acceded to the European Economic Community in 1973, an organisation that has gradually evolved into the European Union that we know today. Concurrent with the evolution of the European Community has been the transformation of the very nature of the British economy, from a largely production-based one in the first half of the 20th century to one dominated by the services industry in the present day. Official statistics evidence this: in 2013, 79% of the UK’s GDP came from the services sector, up from 46% in 1948. Financial services account for a significant proportion of the UK’s services sector, indeed the UK remains the world’s largest exporter of financial services. The importance of this sector to the UK economy as a whole can, therefore, not be understated and a critical analysis of the impact Brexit will have on the legal regime of UK financial services is essential.
The UK has been a member of the European Union for over forty years. An inevitable consequence of this membership has been the application of EU-wide laws on financial services and an integration and entwinement of European law with domestic UK law. As the UK prepares to leave the European Union, this essay will attempt to evaluate the impact this will have on the legal regime of British financial services. At this juncture, the precise settlement that the United Kingdom and European Union will reach is uncertain. What is certain, however, is that the “corporate citizens” of the EU may be profoundly affected by Brexit . Moreover, leading academics judge the plausibility of a so-called ‘no deal’ Brexit, as “anything but unlikely” . Particular focus will be given to the impact of Brexit, particularly a sub-optimal Brexit (from a corporate perspective), the passporting regime, and the third country equivalence regime. Due consideration will also be paid to the impact Brexit will have on relevant domestic legislation and the implications on some of the important sectors that form part of Britain’s crucial financial services industry. Finally, this essay will endeavour to analyse the opportunities that Brexit may create for the British financial services legal regime, with particular respect to areas in which the UK excels and is regarded as a pioneer, notably in connection with FinTech, and innovations such as the prized regulatory sandbox: “The UK’s Financial Conduct Authority…has been leading the way in nurturing and regulating FinTech. Its ‘sandbox’ is one of the most innovative supervisory solutions that helps new and traditional entrants test a range of innovative products” . Other UK regimes, such as the senior managers regime will also be examined.
An examination of the ‘passport regime’, and the implications of Brexit on this regime, will act as a cornerstone of this essay. In essence, passporting enables firms that are authorised in any EU/EEA state to trade freely in any other EU/EEA state with minimal additional authorisation. An EU passport enables a firm that is authorised in one EU country, referred to as the ‘home’ member state, to provide a comprehensive range of services and open offices and branches in other ‘host’ EU member states. Passporting rights are, therefore, highly significant and underpin the ‘ecosystem’ that is the single market for financial services. There are nine different passports that financial services companies can utilise in order to deliver their core services to businesses and customers cross the EU. The inherent concept of passporting is based around community-wide principles established by the EU’s common prudential capital regime and on the granting of mutual recognition of licences. Explicit in its very nature, passporting is the preserve of countries that are members of the EU or European Economic Area (EEA). Unequivocal assessments of the terms of the UK’s departure from the EU cannot yet be given but it seems almost certain that the UK is bound to leave the single market and, by default therefore, will lose passporting rights. Such an outcome can only be considered sub-optimal to many in financial services and has the potential to cause huge disruption and substantial business loses. Nevertheless, Michael Randall’s article in the Edinburgh Law Review, presents a convincing argument that whilst a loss of passporting rights is not a triumph, the prognosis is not as bleak as some would suggest particularly in the longer term. The argument that Randall proposes: that core regulation is likely to remain similar between the EU and UK when further consideration is given to mutual, recognition and free trade agreements (a comprehensive one being sought by the British government as a matter of priority) is a strong one. Recent British domestic legislation on financial services has been heavily influenced by EU law, moreover, Randall correctly identifies the opportunities that Brexit may present for the UK to independently innovate in the longer term. This is especially true with respect to FinTech. This essay will scrutinise passporting, most prominently with regard to its application in different sectors, the EU legislation that grants passporting rights, such as Undertakings for Collective Investment in Transferable Securities (UCITS) directive, and the third country equivalence regime.
The European third country equivalence regime is a recent European innovation that provides the opportunity for non-EU/EEA countries (“third countries”) to operate in EU/EEA member states in certain sectors, in situations where the regulatory regime in the third country “is seen by the EU to have a broadly-equivalent regulatory regime”. The consequence of fulfilling this criteria is that financial institutions headquartered in third country states, as the UK will become following its planned departure from the EU, will be able to conduct their business operations across the EU and provide certain financial services to clients, as per the Markets and Financial Instruments Directive. On first appraisal, the third country equivalence regime may be considered as a direct substitute for the existing ‘passport’ arrangement that the UK enjoys as an EU member state. It is clear that the day the EU leaves the European Union, the domestic legislation that exists in the UK will, by virtue of the country’s previous EU membership, be compatible with EU law. Pursuant to this point, this essay will analyse the impact of Brexit on British financial services, with specific reference to the third country equivalence regime.
As already argued, contrary to the beliefs of many commentators, there is strong potential for Brexit to create opportunities in the UK. The UK will have greater autonomy over how it regulates financial services and will be able to continue to innovate, such as with its Senior Managers Regime and with FinTech. Indeed, the opportunities that the latter presents have been well documented: “recognising the opportunities that FinTech provides for the City, particularly in a post-Brexit context, UK regulators have been pioneers in developing a progressive approach in recent years”. This is something the essay will examine, in conjunction with the overall impact of Brexit on existing UK financial services legislation.
Amongst academic, commentators and politicians, virtually the only source of consensus on the subject of Brexit is that the ultimate outcome remains uncertain. The post-Brexit model that will be negotiated and adopted between the EU and the UK will ultimately determine the impact. In spite of this, assessments can still be made and, in light of this, there is a strong argument to suggest that a loss of passporting rights will affect the UK more seriously than countries that remain within the EU/EEA , and that whilst the third country equivalence regime may provide continuity in certain financial services sectors, many financial services sectors do not have equivalence regimes. Furthermore, some existing equivalence regimes are rejected as unsuitable by industry bodies, such as in private equity and venture capital and, therefore, do not present an optimal replacement for the existing ‘passporting’ scheme. Lastly, in spite of the plethora of problems that Brexit undoubtedly presents, it will not impact existing UK legislation and it will enable to the UK to further develop existing regulations, such as the Senior Managers Regime, and areas such as FinTech where as a country we are a world leader. This is most notable with respect to the UK Financial Conduct Authority which “has been leading the way in nurturing and regulating FinTech”.
UK Regulations
One of the most fundamental UK financial services regulatory initiatives of recent years is the Senior Managers Regime. The Senior Managers Regime, in essence, replaces the Approved Persons Regime. In the post-financial crash era, the Parliamentary Committee on Banking Standards was appointed by Parliament to consult, consider and report on the ethics, culture and professional standards of the UK banking sector. The subsequent report that was published by the committee in 2013 gave a damning indictment of the British banking culture and the Approved Persons Regime. The report cited a consistent lack of personal responsibility throughout the industry and suggested that senior figures have continued to shelter behind an accountability “firewall”. It was out of these charges that an evolution in banking regulation occurred and what we now know as the Senior Managers Regime was conceived. Fundamental to the debate on the impact of Brexit on the British financial legal regime is the fact that, unusually, the Senior Managers Certification Regime is entirely distinct from EU law, a fact noted by legal commentators: “the SMCR is a (rare) example of UK regulatory policymaking that does not derive from EU legislation”. As a purely domestic regulatory framework, it stands to reason that the impact of leaving the EU on the Senior Managers Certification Regime (SMCR) will be minimal at most. Whilst it is certainly true that the disruption caused by Brexit on the SMCR will be negligible compared to some elements of Britain’s financial services industry, on a closer analysis of the functioning of the SMCR, it would be erroneous to suggest that the initiative will be left unscathed by the disruption of Brexit.
It is part 4 of the Financial Services (Banking Reform Act) 2013 that effectively establishes the SMCR, amending the Financial Services and Markets Act 2000. There are three key parts to the Senior Managers and Certification Regime: the Senior Managers Regime; the Certification Regime; and the Conduct Rules. The new regulatory framework is established by the Prudential Regulation Authority (PRA) – the Bank of England body responsible for supervising, assessing and promoting the safety of systemically important firms – and the Financial Conduct Authority (FCA) – the body tasked with ensuring the smooth running and integrity of markets and consumer protection. The framework aims to promote transparency and individual responsibility, alongside focusing accountability on those with the greatest responsibility at the top of financial institutions. The Senior Managers Regime covers senior managers that are carrying out senior management functions, defined as where that person is responsible for managing one or more aspects of the business, where a risk of serious consequences for the business is involved. This covers a range of expected and predictable roles, such as Chief Executive Officer and Chief of Finance (PRA designated functions) and also less high-profile roles such as individuals in charge of money laundering reporting and compliance oversight. (FCA designated functions). The certification regime “covers employees who are not actually senior managers but whose role means they may have a significant impact on customers, markets, or the business itself and have the potential to cause significant harm”. The Conduct Rules proscribe a basic level of expected behaviour for all of those covered by the various new regimes. The rules are applied comprehensively to all of those that work in a financial services institution, exceptions only being extended to those in roles such as security and receptionists. The Regime focuses regulatory responsibility onto individuals, who then become natural targets for regulatory enforcement. Indeed, if a breach does occur, the regulators can take enforcement action. The statue even stipulates that senior managers could face prosecution, by the PRA or FCA, in the face of decision making which results in the failure of their institution.
There is no doubt that the SMRC represents a small-revolution in terms of what is expected and required of responsible employees in financial services institutions. The territoriality of the SMRC is another remarkable and note-worthy aspect of the Regime, particularly when taken in the context of Brexit and the fact that the SMRC is one of the few regulatory frameworks in the UK with no EU regulatory influence. At present, there is no territorial scope to the SMRC. Senior managers in British firms are bound by the same regulations, irrespective of whether they work or are domiciled in the UK or overseas. By way of an example, a senior manager, based in Tokyo, who is in charge of an important influential committee of a British subsidiary of a Canadian bank, will be bound by the regulations. Undoubtedly, this represents a contrived scenario, however, it is equally certain that such a situation is not unrepresentative of the complex way in which financial institutions operate.
In principle, one could easily advance the argument that Brexit will have little or no impact at all on the SMRC, it is after all frequently touted as being the recent exception to the rule that EU law has shaped modern British finance law. In spite of this, it would be naïve to suggest that the tornado that is Brexit will have no tangible impact on the SMRC, irrespective of how independent and unique it is to domestic UK law. This problem has been mooted by commentators and legal experts. In a recent article in Financial News London, the scenario of banks relocating senior staff to EU countries (post-Brexit) was addressed, alongside the difficulties of attempting to enforce the Senior Managers Regime in an EU country post-Brexit. In the very same article, an employment partner at Allen & Overy suggested that UK regulators may have to scale back their regulatory ambitions post-Brexit, especially in-regard to non-UK resident senior managers if they’re relocated to a jurisdiction that British regulators feel is ‘suitably regulated’ by local authorities. There is no doubt that this represents a cogent and coherent argument that is difficult to refute. As a consequence of Britain’s long membership of the EU, the regulatory standards in Britain and other countries in the single market are, in many cases, standardised and complement each other. It is not difficult to envisage the FCA, who already find enforcement a challenge , finding it difficult to, and difficult to justify, enforcing SMRC regulatory standards in EU jurisdictions where, for the foreseeable future, they are so similar to British standards.
It is, therefore, entirely possible that, depending on the ultimate outcome of Brexit, deals are struck between the UK and EU/EEA member states, where regulatory standards are broadly similar, which will enable EU/EEA member states to enforce regulatory obligations against those in breach and in a situation where enforcing the SMRC regulatory standards is difficult. This is, therefore, a clear implication that Brexit has on the SMRC, despite the fact that the EU law has no bearing on this domestic regime.
Furthermore, it is clear that another likely impact of Brexit on the regime is the potential for the UK to strengthen and develop the regime and bolster its reputation as a country of smart regulation. This sentiment has been expressed by commentators: “with Brexit negotiations about to commence, it is even more crucial for the UK to bolster public assurances in the financial services sector because…recent bank scandals have demonstrated that the combination of market uncertainty and corporate misconduct can create an economic crisis. This calls for robust regulations and good leadership to promote confidence. Therefore, the answer is to strengthen legal accountability and nurture better leadership”. Particularly taken in the context of the fact that the SMRC is entirely UK based and no other European country has implemented, or has indicated plans to implement, a similar regime, this will largely insulate this important and popular regime from any damage Brexit may cause to the sector. Moreover, there is considerable scope for the SMRC to be developed. There is a convincing case to be made that this will not only lead to a greater focus on accountability for those in positions of power in the industry, but also to a more resilient insurance and banking as well as wider financial services sector. Brexit, therefore, provides an opportunity for the UK to develop its existing and unique SMRC, which will burnish the integrity and regard of the British financial services industry and continue to differentiate the UK from European competitors. As addressed, whilst there may be more issues with regard to regulatory enforcement in EU/EEA countries which share similar regulatory standards, it is clear that the impact Brexit will have on the SMRC is minimal and, furthermore, the regime could be developed and play an even more important role in shaping the UK financial services industry’s integrity and strength.
All things considered, the day after the UK leaves the EU, the UK’s domestic legal regime on financial services will remain unchanged. The landmark pieces of legislation: The Financial Services and Markets Act 2000 and the Financial Services (Banking Reform) Act 2013 will remain in place. EU standards will be retained and only minor technical amendments to the aforementioned legislative frameworks are planned. In reality, it seems clear that the direction that the UK will take will still depend on international standards and, moreover, will be defined, at least to a limited extent, by whatever long-term trade agreement (if any) is reached between British and European negotiators. Nevertheless, Brexit will enable the UK to pursue, to an extent, its own distinct domestic agenda, which has often been at odds with the settled will of other EU nations. A clear of example of this divergence in opinion is with respect to bankers’ bonuses. The fourth Capital Requirements Directive (CRD IV) in 2013 instituted a bankers’ bonus cap. Article 94 of the CRD IV established that a bankers’ bonus should not exceed 100% of their salary, this figure can rise to 200% if approved by a qualified majority of the firm’s shareholders. At the time the measure was proposed, it instigated considerable consternation amongst Prime Minister David Cameron’s Government. The principle argument being that the measures were self-defeating and inflexible and could disproportionately affect the UK, as a consequence of London’s position as the world’s pre-eminent financial centre. It is difficult to argue with the rationale of this argument. Moreover, the introduction of such a measure is easy to dismiss as a reaction to the ‘populist’ anger directed towards bankers in the aftermath of the financial crisis. It is difficult to justify. It is, therefore, unsurprising that on multiple occasions since the Brexit vote, high-profile members of the Conservative Party have argued for the scrapping of the bankers’ bonus cap, in addition to other EU ‘red tape’, a sentiment which has been recently echoed by Mark Carney, Governor of the Bank of England, who has rightly previously criticised the EU’s bankers’ bonus cap. It can be said that this divergence epitomises the UK’s uneasy relationship with the EU in recent years. Brexit, therefore, presents the opportunity to reverse this mis-guided policy and continue to gradually introduce regulations that are more flexible and suited to the UK’s dynamic financial services industry. This was intimated by Mark Carney who has suggested that there are areas in which the UK can make regulatory changes, caveated by a desire to continue to maintain the highest possible levels of resilience and robust regulatory standards. This is an eminently sensible position to adopt and provides a clear avenue for the UK to take advantage of leaving the EU to implement a more flexible regulatory regime, that strives to eliminate unnecessary ‘red-tape’ and better serves the interests of UK financial institutions.
A further clear example of the UK’s difficult relationship with the EU, with respect to aspects of financial services regulation, is clearly illustrated by the rancour aroused by the disagreement over the EU’s Short Selling Regulation (SSR). This provision granted powers to the European Securities and Market Authority (ESMA) to limit or ban the practice of short-selling. The SSR aims to increase the transparency of short positions held by investors in certain EU securities and reduce the risk involved with short selling. Ultimately, the UK’s opposition to this measure was defeated, losing their challenge at the European Court of Justice. In concurrence with the opportunity to reverse the EU imposed bankers’ bonus cap, a further impact of Brexit on the legal financial services regime in the UK is the ability to reverse this regulation and, if the prerogative of government, replace it with a more suitable, flexible and tailored regulation, in order to meet the needs of finance in the UK.
It is not inaccurate to suggest that the immediate impact of Brexit on domestic financial laws and regulations will be negligible. This essay has highlighted the accepted narrative that all existing UK financial legislation will remain in place upon departure from the EU, perhaps with some incremental technical amendments. What is note-worthy, however, is the opportunities that Brexit will offer in relation to UK statutes and regulations: the country can further develop its successful SMCR (in spite of the fact that enforcement is likely to be more difficult in certain situations post-Brexit) and importantly correct inflexible and mis-guided financial regulations that are not suitable and do not work for the British economy.
The Passport Regime and Third Country Equivalence Regime
As outlined in the essay’s introduction, one of the fundamental challenges posed by Brexit on the current legal regime of UK financial services is the situation with respect to the existing passporting regime. Analysis suggests that a continuation of the current passporting arrangements is unlikely to be feasible politically. This analysis once would have seemed almost incontrovertible, the political direction in Westminster was decidedly against any form of customs union or single market integration. Recent events in Westminster have intensified uncertainty regarding the arrangement that the EU and UK will reach (if any) upon the UK’s departure, and have raised the prospect of the UK remaining within a customs union with the EU. Nevertheless, such an outcome is unlikely at best and it is of great importance to analyse, in so far as possible, the outcome Brexit is likely to have on the passporting regime. Passporting, whereby EU laws’ so-called ‘country of origin’ principle provides that admittance in the state of origin suffices for distribution throughout the European Union and EEA, is advantageous for a number of reasons – principally in cutting the enormous amount of ‘red tape’ required when a company wants to expand into new territories, alongside cost savings. It is, therefore, clear why the very real prospect of UK firms losing their right to ‘passport’ is of concern to financial institutions.
There are nine different types of passport, each of which cover a different aspect of financial services. This essay will briefly examine some of the passport regimes and the areas that they cover. The Capital Markets Directive (CRD IV) grants passporting rights and covers banking services, including deposit taking, lending and other forms of financing. It is important to note that upon leaving the EU, the UK will not be bound by the CRD IV, however, the UK will still be committed to the requirements set out in Basel III (which covers capital adequacy standards) and which the CRD IV effectively implemented. The Solvency II Directive sets the prudential framework for insurance with the ultimate aim of creating a harmonised regime and a more closely integrated insurance market. This directive enables EEA firms to offer reinsurance and insurance services either cross-border or by establishing a branch in another state. It is common knowledge that the United Kingdom, and London in particular, is an international powerhouse in the insurance industry. Its importance cannot be understated and nor can the administrative disruption that a loss in passporting rights post-Brexit would cause. Conversely, it is almost ubiquitous that far-reaching EU commercial regulations will be sub-optimal in some way for Britain. This essay has already addressed the opportunities that Brexit poses for tweaking existing regulations to be more in line with the UK’s requirements and strategic corporate objectives, the case of Solvency II is no different. It has already been identified that once the UK leaves the EU, it will be under no obligation to apply Solvency II standard to UK insurers and reinsurers, therefore, allowing the PRA (subject to any Brexit agreement) to make changes to UK rules that it has previously expressed a desire to implement but has been unable to do so, such as re-evaluating the risk margin. It can be argued that this again presents a marginal benefit to the UK, nevertheless, it is dubious to suggest that this will compensate for a total loss in passporting rights, particularly in context of the fact that Solvency II provides no third party equivalence regime for direct insurers, resulting in dozens of UK insurance companies being unable to operate in the EU/EEA without a local licence, a costly and bureaucratic process. The Markets in Financial Instruments Directive recently revised and now MiFID II provides for passporting for financial services institutions, specifically for services such as securities, funds and derivatives and recently came into force in conjunction with the Markets in Financial Instruments Regulation (MiFIR). The Undertakings for Collective Investment in Transferable Securities (UCITS) is a longstanding regulatory framework that provides passporting rights. UCITS specifically deals with asset management. The UK is Europe’s largest asset management centre and has, therefore, enormously benefitted from the passporting regime: 244 UK asset management passport into continental Europe (‘outbound’ passport), this compliments the many EU domiciled firms that passport into the UK (inbound passport). One consequence of leaving the EU, therefore, is a loss of this highly prized passporting right, exacerbated by the fact that UCITS does not provide for a third party regime. The Investment Association has lauded assurances by the British government that, going forward, UK domiciled asset management institutions will be able to establish funds that are based on the same structure as UCITS in the UK. This, therefore, represents a further tangible impact that Brexit will have on the UK financial services regime – the UK will have to develop its own regulations in certain sectors and, in this case, will attempt to emulate existing EU regulatory frameworks in the asset management sector, despite the fact that the privilege of passporting will not be extended to the UK post-Brexit and no equivalence regime exists. Nevertheless, for the asset management sector, it will provide an internationally recognised and respected regulatory system which should enable to fund managers to continue to prosper after Brexit.
A different approach that asset management firms could adopt, in the face of Brexit and a loss of passporting rights and no equivalence under UCITS, is to market their funds as Alternative Investment Funds (AIFs). AIFs are governed by the Alternative Investment Funds Directive (AIFD) – a regime which grants passporting rights and third country equivalence .
The third country equivalence regime is another highly significant regime and is especially relevant in the context of this essay. It is judged that mutual recognition and equivalent treatment talks between the European Union and the United Kingdom, in financial services, are likely to form a significant part of the political discussions and long-term planning between the two respective negotiating teams. As outlined earlier in this essay, this regime enables countries that are not members of the EU or EEA, third countries, to access elements of the single market by way of the principle of equivalence. This is provided for by some EU legal instruments, where companies domiciled in third party countries (the home country), are subjected in the home country to equivalent regulation and supervision. It is, therefore, purported by many that as Brexit will remove the opportunity to ‘passport’ from the UK’s financial services regime, third party equivalence can provide an adequate solution, which will allow financial services firms to continue with minimal disruption. This, naturally perhaps, has endeared itself to British negotiators as the preferential option for establishing future trading relations with the European Union. This is set out in Reynolds and Donegan’s journal article on the future opportunities and challenges that Brexit presents. The article clearly establishes that a great many of the EU’s sectorial legislation relating to financial services makes provision for access to EU markets and customers for financial services institutions when an equivalent regulatory regime is applied in that country. Nevertheless, crucial to our analysis of Brexit’s impact is the fact that equivalence regimes are applicable by virtue of existing EU legal instruments in many cases but not in all cases.
There are further drawbacks to a devout reliance on equivalence as a solution to post-Brexit market access problems. Chief among the concerns surrounding equivalence is the fact that equivalence is a recognition that is granted unilaterally by the European Union and, furthermore, that such recognition can be revoked by the European Union with relative ease and with as little as thirty days’ notice. The status quo of the regime is, therefore, perhaps palatable to some but certainly sub-optimal. This essay advocates the position that pursuing the ‘equivalence’ regime is a viable option and one that should be extensively explored by negotiators, concurrent with an examination and exploration of ways in which the negative aspects of the ‘equivalence’ regime can be mitigated in the UK’s interests. This approach is one that has gained some traction amongst British negotiators as was reported in a Times of London article last year. To indulge momentarily in a cliché, however, the only thing that is clear is that nothing is clear. The terms of Britain’s withdrawal from the EU (if the UK does ultimately withdraw) remain uncertain and unknown, yet the proposition to try and extend and adjust existing equivalence rules, in order to better serve the interests of Britain’s financial services sector, remains a sensible and distinct possibility. This would clearly represent a tangible impact of Brexit on the legal regime of the UK’s financial services – in essence – re-structuring existing regulations and developing new regulations in order to meet present and cultivate future equivalence regimes. Naturally, the fact that this approach relies on the good-will and willingness of Britain’s European counterparts intensifies uncertainty, particularly as it is known that several European countries, such as Germany, are attempting to woo British financial institutions to the Continent post-Brexit . The implications of this situation reinforced the remarks made by Jonathan Hill, the former Commissioner for Financial Stability, Financial Services and Capital Markets Union: “competitive pressures and political reality influence how people think about the equivalence process”. To suggest that such an attitude may hinder UK plans to capitalise on and develop the equivalence regime could be regarded as cynical, however, it certainly would be naïve if no contingency plans or other market access plans were discussed. Nevertheless, this essay advocates that an extension of the equivalence regime seems like an eminently sensible route to explore. Whatever happens with respect to equivalence, however, will undoubtedly have a tangible impact on the UK financial services legal regime: whether that be a negotiated extension of third country market access; or a shaping of future UK regulations around a need to fulfil the criteria required for third country equivalence; or indeed entirely re-writing and developing a distinctly separate legal regulatory framework, designed to differentiate Britain from its European counterparts and pursue an independent ‘global-minded’ trade policy. Whilst the latter approach is frequently touted by those who, generally characterised as ‘hard brexiteers’, want a clean break from the EU and champion a ‘global Britain’, all evidence suggests that a complete divergence from all EU regulatory standards and a hard Brexit would be deeply dangerous for the UK’s economy, and is not a strategy that this essay advocates.
At present, there is an established process for determining the applicability of a third country to have market access by way of equivalence. An assessment must demonstrate that a third country’s regulatory framework demonstrates equivalence to that of the EU’s corresponding regime, with regard to: having legally binding requirements; having effective supervision by authorities; and achieving the same results as the EU corresponding provisions and supervision in an outcome-based analysis. The process to reach determination is a two-step process: a technical analysis carried out by the relevant EU agency, in the case of financial services: European Securities and Market Authority (ESMA); European Insurance and Occupational Persons Authority (EIOPA); and European Banking Authority (EBA). Once all technical assessments have been conducted, in the event of all necessary criteria being fulfilled, the determination of equivalence is decided by the Commission and is then put to a vote of EU member states – the commission’s decision can ultimately, be vetoed by the European Parliament or Council. This essay argues, therefore, that this process of determination elucidates the comments made by Jonathan Hill , in so far as it is not difficult to argue that in a community as diverse and large as the EU, competing political and economic interests may play a significant role in a country’s perspective on whether or not to grant equivalence to a third country, particularly in the case of the UK, where the financial services market is so lucrative and Europe, arguably, has much to gain from a bad Brexit. In spite of this, even the most pessimistic appraisal of the current UK financial regime would conclude that at present, the regime would fulfil the criteria to qualify for the third country equivalence regime.
Crucially, however, in its present form the third country equivalency regime does not extend to all sectors of financial services and, therefore, cannot act as a direct substitute to passporting. No country has so far managed to obtain equivalence in all applicable areas and, even if the UK were to achieve this, it would be necessary for the EU to greatly enhance the equivalence scheme, in order for the status quo to continue, as under the passporting regime. For instance, the CRD IV currently provides for passporting, however, no comparable third-party equivalence regime exists. As this essay previously established, CRD IV covers banking services, therefore, in the event of a loss of passporting rights, institutions that provide services such as deposit taking, lending and financing will suffer. Solvency II provides an equivalence regime for reinsurance but not direct insurance. Geoffrey Maddock and Alison Matthews article examining Solvency II proposes the argument that in any attempt to achieve equivalent status, the UK must keep its regime the same, if not very similar, to the existing regulations enshrined in Solvency II. It can be said, therefore, that a cogent theme is emerging that, even though one of the key messages of the Brexit campaign was that Brexit would enable the UK to take back control over its laws, the UK will have to adhere closely, if not exactly, with certain EU regulations if they hope to achieve third country equivalence. This is a key impact that Brexit will have on the UK financial services regime. Additionally, as it has been established, UCITS provides for no third country equivalence regime, a fact that may result in UK domiciled asset managers having to establish a branch in each and every EU country that they wish to conduct business it, a situation that is far from ideal. This brutally lays out the flaws in suggesting that the UK can simply rely on equivalence as a substitute for passporting in the post-Brexit world. Pursuant to this point, whilst nothing is certain, this essay proposes the notion that this will have two discernible impacts on the UK financial services legal regime. Firstly, in relation to regulatory regimes that currently allow third country equivalence, such as AIFMD and MiFIR , the UK will have to ensure that their domestic regulatory frameworks remain similar or identical to those in their EU equivalents and strive to evolve in line with EU developments. Secondly, in order for the UK to truly compensate for a loss in ‘passporting’, it is clear that it will have to negotiate and attempt to extend (‘enhance’) the provision of equivalence regimes in a bespoke arrangement. On the latter point, academics have suggested that an enhanced equivalent regime (“equivalence plus”) would go some way in counteracting the problem that equivalence has never covered the full spectrum of financial services and provide a more adequate replacement for ‘passporting’.