Regulatory cooperation between EU and UK post-Brexit

Brexit continues to pose unique challenges for financial sector policymakers in the European Union (EU) as the most important financial centre in Europe it is now outside its regulatory framework, a challenge especially when it comes to clearing. The UK, on the other hand, has rediscovered the financial sector as growth engine and wants to strengthen London and the UK more broadly as global financial centre. Regulatory divergence between the UK and EU is all but assured, even if the UK only decides not to follow EU regulatory changes or not to adopt the new rules in EU financial and banking regulation (passive divergence). This is not to mention active divergence where the UK will change inherited EU rules following the Financial Services and Markets Act (FSMA) 2023.

Regulatory cooperation in the financial sector was all but left out of the the Trade and Cooperation Agreement (TCA) from 2020, with only eight out of 783 articles directly covering this sector. The TCA did include the plan for a Memorandum of Understanding  establishing a framework for financial services regulatory cooperation, including a regulatory forum.  However, implementation was held back until earlier this year by the stand-off over the Northern Ireland/Ireland Protocol. The resolution of this conflict through the Windsor Framework allows for closer cooperation and building mutual trust, with the MoU on financial services regulatory cooperation finally signed by the EU and the UK on 27 June 2023.

Will this MoU and the joint Regulatory Forum be a major change in financial sector cooperation between the EU and UK? I would strongly disagree with such a hope and promise. A careful look at the MoU shows an emphasis on ‘exchanges of views and analysis’ and ‘dialogue’.  Critically, the MoU provides right after the general objectives that‘regulatory cooperation should not restrict the ability of either [the EU or the UK] to implement regulatory, supervisory or other legal measures that it considers appropriate.’

This rather thin basis for cooperation is not surprising. The European Commission has made it clear that it sees any action that allows access to the EU’s financial market by third country provider as unilateral decision, not subject to negotiation, as we will discuss in the following. The caveat on the ability to implement measures is the quintessence of the regulatory autonomy both parties want to preserve. Moreover, the limited scope of the EU-UK MoU is also in line with the provisions on financial sector cooperation attached to the recent trade deals signed by the UK with third countries, which are similarly thin, focusing on regulatory dialogue and non-discriminatory market access.

More broadly, there is a reason why the financial sector was excluded in the first place from the TCA (any reference to trade in services explicitly exclude the financial sector). While allowing entry of foreign financial institutions and market participants into a country’s banking system, countries insist for a reason on national regulatory autonomy and the independence of supervisory power and are loath to share it. And while it is true that the last decades have seen an increase in global and cross-border cooperation (especially after 2008), the sovereignty principle rules strongly in the financial sector policy framework (Beck and Wagner, 2016). There are a few cases where countries formally integrate regulatory and supervisory power in a shared system, such as in the case of the banking union in the euro area (Petit, 2022). One important explanation of regulation and supervision remaining at the national level, in addition to high economic costs (including for non-stakeholders) of fragility of regulated and supervised entities and crisis in the sector, is the fiscal responsibility that countries often take on for financial sector losses and failures. These are additional obstacles for a functioning framework for cooperation, which comes as a second best to more integrated relationships between jurisdictions at regulatory and supervisory level.

It is therefore not surprising that the EU is reluctant to move towards systematic equivalence in the financial sector and relies only a thin cooperation framework embodied by the recently signed MoU, and choses instead a sector-specific equivalence agreement with the UK (or Switzerland, for this matter). Equivalence granted by the EU in the financial sector exists currently with the UK in only one area, i.e., for Central Clearing Counterparties (CCPs). And even here, this equivalence decision is temporary (extended until mid-2025), with a clear political will in the EU to attract more euro clearing away from London into the Single Market and preferably into the euro area. The European Commission legislative proposal for clearing at the end of 2022 actually showed a further tightening of equivalence regime in the financial sector.

This is not to say that the MoU and the regulator forum are not important, but it is important to keep expectations realistic.

References

Beck, T. and Wagner, W. (2016) ‘Supranational Supervision: How Much and For Whom?’ , International Journal of Central Banking 12, 221-68, 2016

Petit, C. A. (2022) ‘Differentiated Governance in the Banking Union: Single Mechanisms, Joint Teams, and Opting-Ins’ (2022) 7(2) European Papers – A Journal on Law and Integration 889

Petit, C. and Beck, T. (2023).  ‘Recent trends in UK financial sector regulation and possible implications for the EU, including its approach to equivalence.’ Study requested by the Econ committee of the European Parliament.