Brexit continues to pose unique challenges for financial sector policymakers in the EU, as the most important financial centre in Europe is now outside its regulatory framework (Macrae et al. 2016, Jackson, 2016). The UK, on the other hand, considers its financial sector a potential growth engine at the global level and has initiated regulatory reforms to strengthen its status as a global financial centre (Edinburgh Reforms 2022, TIGRR Report 2021, Portes 2023). Regulatory divergence between the UK and EU is all but assured, even if the UK only decides not to follow EU regulatory changes or adopt the new rules in EU financial and banking regulations (passive divergence). This is not to mention active divergence, whereby the UK would change inherited EU rules following the Financial Services and Markets Act (FSMA) 2023 and the (new) missions granted to UK regulators in lieu of legislators.
A new chapter in financial sector cooperation?
On 27 June 2023, the UK and the EU signed a Memorandum of Understanding (MoU) establishing a framework for financial services regulatory cooperation. The Windsor Framework agreement paved a new way forward for the Protocol on Ireland/Northern Ireland in February 2023, which in turn unlocked cooperation between the UK and the EU in different areas such as financial services and the UK’s access to Union programmes. Following the signing of the MoU, a joint EU-UK financial regulatory forum will be established and will take place for the first time this autumn to discuss regulatory changes and issues of common interest – including market developments, financial stability issues, and fostering enhanced EU-UK cooperation ahead of global forums such as the Federation of Small Businesses (FSB) and the Basel Committee on Banking Supervision (BCBS). The MoU implements the joint declaration attached to the Trade and Cooperation Agreement (TCA) from 2020.
In a report for the European Parliament’s ECON Committee, we summarise and discuss recent trends in financial sector legislation and regulation in the UK, divergence between the EU and the UK, and the threats posed by such divergence for financial stability in the EU (Petit and Beck 2023). Critically, we assess the equivalence policy and strategy of the EU towards the UK. We also discuss the options to deepen regulatory cooperation while ensuring financial stability, market integrity, and competitiveness.
The developments since the completion of our report, including the signing of the MoU and the establishment of the joint EU-UK regulatory forum, have – in our opinion – not changed our general assessment, namely, that even if cooperation will be favoured and sustained at a working level among authorities, it will remain limited and dependent on the political environment, and regulatory divergence is all but guaranteed.
The new UK regulatory approach: Growth and international competitiveness
The UK’s renewed approach to regulation will lead to the transfer of most rules from the statutory level to the regulators’ rulebook. FSMA, which received royal assent at the end of June 2023, will give greater responsibility to regulators. The bill intends to amend, repeal, or replace retained EU law in the financial services and insurance sector.
In addition, secondary objectives are added for regulators to “facilitate, subject to aligning with relevant international standards, the international competitiveness of the UK economy (including in particular the financial services sector) and its growth in the medium to long term” (Hunt 2022). Following FSMA, secondary objectives include the competition objective, and the competitiveness and growth objective for the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). This change differentiates the UK regulators’ mandate from its EU counterparts, whose mandate is safeguarding financial stability, market integrity, and investor protection, while maintaining a level playing field in the EU Single Market.
Divergence, but how much?
Divergence of UK regulation from EU regulation is a given outcome of Brexit. Active divergence would occur when the UK “deliberately legislates to move away from retained EU Law” (Reland et al. 2022). Passive divergence would reflect the UK not keeping up with EU legislative changes, including newly adopted legislation.
The UK has already undertaken initiatives that could result in regulatory divergence from the EU in several areas:
- The implementation of the final Basel III reforms will differ between the UK and the EU both in timeline and substance. The EU reached a provisional inter-institutional agreement in June 2023, deviating from the Basel III agreements on several grounds, inter alia through adaptations based on proportionality concerns for small entities, and a specific implementation of the output floor that risks lowering regulatory capital. The current Spanish presidency of the Council intends to finalise the CRD6 and CRR3 to maintain an entry into force in January 2025. As regards the UK, the Basel III implementation is postponed until July 2025 (instead of January), with two policy statements setting potential deviations from Basel III (expected at the end of 2023 and in 2024).
- Both the UK and the EU are reviewing the Solvency II regulatory framework for insurers, with the objective of fuelling more equity investment by insurers through different regulatory adjustments. Following the FSMA, the UK’s PRA unveiled its proposed matching adjustment rules in September 2023, which forms part of the implementation of the Solvency II review and would allow insurers to make broader and quicker investments in MA portfolios, ultimately giving a more significant role to the life insurance sector in the UK economy.
- The UK aims to reform different aspects of its wholesale markets regime and capital market sector, though these reforms are considered low impact.
- The UK aims to become a global centre for fintech and crypto assets through several regulatory and supervisory initiatives, including a financial market infrastructure sandbox that is already up and running, a FinTech hub at the Bank of England, and encouraging the development and use of stablecoins. The EU has a different approach, which will lead most likely to active divergence, with markets in crypto assets (MiCA) regulated as of 2024 and further regulation tightening.
- Greening Finance: A Roadmap to Sustainable Investing, published in 2021, stipulates that the UK Green Taxonomy will adopt the EU’s six environmental objectives. In March 2023, the UK government published its Green Finance Strategy and a consultation on the regime for economic, social, and governance (ESG) ratings providers. The UK government has yet to release its consultation on the UK Green Taxonomy, expected in Autumn 2023, but some divergence is to be expected from the EU’s version.
While divergence between the EU and the UK may be considered minimal before the adoption of FSMA, we can expect substantial divergence across different segments of the financial sector during the next five to ten years (for further details, check the scenarios-based analysis in Petit and Beck 2023).
From TCA to Windsor
While the TCA is extensive, it includes a very thin chapter on the financial sector, with only eight out of 783 articles directly covering this sector. Deeper cooperation in the financial sector 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.
A thin basis for cooperation
Will this MoU and the Joint Regulatory Forum be a major change in financial sector cooperation between the EU and the UK, and limit regulatory divergence? We would strongly discourage such hope and disagree with such a promise. Under the MoU arrangements, there is no certainty of continuity and stability of the cooperation channels. A careful look at the MoU shows an emphasis on “exchanges of views and analysis” and “dialogue”. Furthermore, the MoU provides 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”, thereby making cooperation dependent on the broader (political and economic) circumstances.
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 on national regulatory autonomy and the independence of supervisory power for a reason, and are loath to share it. And while it is true that recent 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 2013 2016). In a few instances, countries formally integrate regulatory and supervisory power in a shared system, such as in the case of the banking union (Petit 2022).
It is therefore not surprising that the EU is reluctant to move towards systematic equivalence in the financial sector and relies on only a thin cooperation framework embodied by the recently signed MoU, choosing instead a sector-specific equivalence agreement with the UK. Equivalence granted by the EU in the financial sector exists currently with the UK in only one area, namely, central clearing counterparties (CCPs). 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 showed a further tightening of an equivalence regime in the financial sector. In the medium term, the Joint Forum may undertake dialogue on equivalence decisions, but this will remain contentious for some time.
Divergence between financial sector regulation in the UK and the EU will happen through reforms on both sides. Functioning and effective regulatory cooperation, however, can limit negative repercussions from such divergence. The resolution of the conflict around the Northern Ireland Protocol with the Windsor Framework has paved the way for closer cooperation between regulatory authorities in the UK and the EU, following the adoption of the MoU on financial services regulatory cooperation. Some supporting measures for cooperation, despite their non-binding nature, may follow the meeting of the Joint EU-UK Regulatory Forum in autumn 2023. However, such cooperation will face limits, not to mention the fluctuating political environment across the channel.
Beck, T and W Wagner (2013), “Supranational supervision: How much and for whom?”, VoxEU.org, 20 July.
Beck, T and W Wagner (2016), “Supranational Supervision: How Much and For Whom?”, International Journal of Central Banking 12, 221–68.
HM Treasury (2022), “Financial Services: The Edinburgh Reforms”, GOV.UK, 9 December.
Hunt, J (2022), “Recommendations for the Financial Conduct Authority - Letter from the Chancellor”, 8 December, accessed 4 January 2023.
Jackson, P (2016), “Brexit – what happens to banking?”, VoxEU.org, 9 August.
Macrae, R, J-P Zigrand and J Danielson (2016), “On the financial market consequences of Brexit”, VoxEU.org, 24 June.
Petit, C A (2022), “Differentiated Governance in the Banking Union: Single Mechanisms, Joint Teams, and Opting-Ins”, 7(2) European Papers – A Journal on Law and Integration 889.
Petit, C and T Beck (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.
Portes, J (2023), “The impact of Brexit on the UK economy: Reviewing the evidence”, VoxEU.org, 7 July.
Reland, J, J Rutter and A Menon (2021), “UK-EU Regulatory Divergence Tracker”, UK in a changing Europe 2021, 1st edition.
TIGRR (2021), “Independent Report - Taskforce on Innovation, Growth and Regulatory Reform”, May.