Limited Room to Reform UK Regulatory Regime

Global Risk Regulator

Following statements by officials and various reports, clues are emerging over the future shape of the UK’s regulatory framework – a minor makeover at best as the scope for divergence is restricted. By Justin Pugsley 

Before Brexit on January 31, the UK had cut and pasted the bloc’s rules into its own framework, simply replacing the names of relevant supervisory authorities such as the European Securities and Markets Authority (ESMA) with domestic equivalents – in this case the Financial Conduct Authority (FCA). 

But Brexit has provided UK policy-makers with more freedom, with UK financial services regulators being empowered with legislative responsibilities that were once the exclusive preserve of the EU authorities. 

The big question now is how will the UK exercise those freedoms? And how far is it prepared to go to maintain the City of London’s competitiveness? Answers are gradually starting to emerge.

It is almost certain that a regulatory race to the bottom, or creating a so-called ‘Singapore on the Thames’, remains a fantasy confined to certain quarters of the ruling Conservative party. The reality is that this is not what UK policy-makers are discussing. Even the industry is resistant to significant deregulation, fearing it would undermine the City’s position as a trusted global financial centre. 

“The markets have borne the costs of these regulations and markets have adapted to them. Winding them back will add more costs,” says Ben Springett, European head of electronic and program trading at Jefferies International Limited.

Yet UK supervisors do not want to be tied to the EU’s apron strings, and seem prepared to sacrifice equivalence with the block if that is what it takes. Their public statements suggest a tinkering with the edges of the framework, trying to make rules work better, reducing red tape, to be more responsive to industry and to adapt rules more quickly to new growth areas, such as fintech and sustainable finance. 

“There isn’t a need for a bonfire of regulations — they work well for the most part,” says Jason Waight, head of regulatory affairs and business management at fixed-income trading platform provider, MarketAxess. He adds that the main focus is likely to be on the markets in financial instruments directive (MiFID) 2, which the EU is also reviewing.  

“Now that Brexit is done, everyone has to accommodate this situation. UK politicians have to prove it was the right thing to do and in the EU, they have to prove that it is better to stay in the EU,” says Hans Joachim Lefeld, consulting partner at LPA Group. “I think the aim of the UK government is to modernise the current regulations to empower companies to do more than they have done [when the UK was in the EU].”  

Deregulation benefits questioned
Karan Kapoor, head of regulatory change at consultancy Delta Capital does not believe there will be material deregulation. “There wouldn’t be any massive benefit from that. Massively diverging is not the right way to go,” he says.

Nonetheless, the EU publicly remains sceptical.“While some leading stakeholders in the City say close alignment with the EU is necessary, others talk about a ‘big bang’ opportunity to diverge, and that has unsettled the Europeans a little bit,” says Constantin Cotzias, global head of external relations at data and financial services firm Bloomberg. On observing the latest policy discussions — such as the Kalifa and Lord Hill reports and comments from city minister John Glen — he detects a more evolutionary than revolutionary approach towards the UK’s financial regulatory regime. 

The Kalifa report looks at boosting the competitiveness of the UK’s fintech sector while Lord Hill’s report delves into making the UK’s listing regime more attractive (See March GRR: Kalifa report welcomed by UK fintechs, but will the government act? & Lord Hill proposes radical shake-up of UK’s listing regime to boost competitiveness). 
“The fact that the UK commissioned the Hill report shows just how seriously [it] is taking the opportunity that comes with its departure from the EU,” says Harry Stahl, director capital markets strategy at fintech firm FIS. He says the report contained some bold recommendations and was a first major effort in exercising post-Brexit flexibility. 

“There’s a real willingness to change and to be more competitive,” says Thomas Vita, a partner at law firm Norton Rose Fulbright. But in terms of the proposals around special purpose acquisitions companies (SPACs) he does wonder if they haven’t come a bit late in the day. SPACs are booming in the US as they have become favoured vehicles for companies to gain a quick stock market listing by reversing into them. 

Mr Vita notes that most of what’s in the report is largely already practiced in other respected capital markets. “They’re not going beyond what is done elsewhere. It is not proposing a wild west,” he says. 

Ed Adshead-Grant, general manager and director of payments at payments firm Bottomline Technologies believes the Kalifa report has a good “buffet of ideas” to support UK fintech growth.  

“We speak to most market participants and we would agree that the UK should maintain high and globally consistent standards, but at the same time use this regulatory autonomy to nuance, make [the UK’s rules] more agile for driving competitiveness,” says Mr Cotzias. 

Mr Cotzias explains that contours of the UK’s regulatory regime are becoming clearer and that becoming a ‘Singapore on the Thames’ is not on the agenda, adding that “High standards are the focus because it is a competitive advantage”. 

He believes that so far, UK policy-makers are making the right noises on areas such as sustainable finance and fintech, but that it will ultimately come down to execution as to whether these ideas will work. 

Commenting on anti-money laundering rules, Rachel Woolley, global director of financial crime at regulatory compliance firm Fenergo, says the UK has a vested interest in aligning with global peers, with its closest being the EU. “This has a big impact on attracting investment,” she says. She explains that the UK is further along than many EU countries in dealing with financial crime. 

Jake Green, a partner at law firm Ashurst says the UK cannot deregulate significantly as much of its rule book is based on internationally agreed standards. Mr Green, who looks at areas such as asset management, says there might be some scope to deregulate conduct or reporting, but this risks undermining the UK’s international standing if it goes too far. The UK has implemented its senior managers and certification regime independently of the EU, arguably creating tougher conduct standards than elsewhere. 

“There’s not a lot you can do. We can deregulate some reporting, but this could give the EU more cause to say no to equivalence. It’s very difficult. We are in a weak bargaining position,” he says. 

Mr Green wonders whether the UK ever had a plan to deal with financial services after Brexit and is now simply trying to muddle through. He says this is either because the government didn’t understand financial services or thought it could negotiate something further down the line, or believes it would find new areas for the City’s growth. 

Prioritising competitiveness
“We are glad they are thinking about competitiveness,” says a senior public affairs executive at a global bank who asked not to be named. They believe the government needs to show more urgency about the UK’s regime.  

The advocacy group the City UK is establishing a competitiveness committee to help advise the government on financial services. They say: “Our thoughts into the UK Treasury have been, rather than sequencing events with the EU, get on with competitiveness now.” They explain that the UK should press on regardless of what the EU is doing and set out its plans for regulation quickly so that firms can start planning now. They remain highly sceptical of the UK ever winning any significant concessions from the EU on financial services or being granted equivalence in new areas. “The UK’s relationship with the EU is in the toilet and getting worse,” the bank executive says. “Equivalence has been weaponised.” 

On March 26, the two jurisdictions said they had agreed the basics of a memorandum of understanding to create a Joint UK–EU Financial Regulatory Forum. It means the two sides can cooperate on regulation and it might pave the way for the EU to eventually grant the UK equivalence on more financial services areas. 

Meanwhile, the EU has granted the UK temporary equivalence in only two areas. By contrast, EU firms are allowed to continue selling a wide range of wholesale financial services into the UK, and UK-located firms are permitted to trade instruments such as derivatives on EU venues — moves which do not look set to be reciprocated anytime soon. This is hurting the revenue of some EU banks with London branches. But, on balance from an EU perspective, this stance appears effective. Most trading in euro-denominated shares has moved into the bloc.

However, Mr Springett notes that only the trading of those shares has moved to EU financial centres. Otherwise, the people, hardware and data centres are all still in London. 

Possibly more worrying for the City is that, according to IHS Markit, the UK’s share of the euro interest rate swaps market has plummeted from 40% to 10% as business has moved to the US and the EU. The news agency Reuters reports that around 300 UK financial firms have opened new operations in the EU, though apparently more than 1000 EU financial institutions plan to do the same in the UK. 

The bank executive is adamant for the government to think more proactively about innovation relating to fintech and sustainable finance. “We had the chancellor’s (UK finance minister) speech in November and we have had loads of consultations and statements. But does that add up to a serious competitiveness programme? We’re not quite sure,” they say. “What we want is for the UK to focus on openness and being an offshore centre for huge investment.” 

They want the authorities to make sure the regulatory regime ensures that big global banks continue to use the UK for their risk management and booking models.   

“Once you've got that, the ecosystem follows — all the lawyers and accountants and so on,” they continue. 

Looking at the UK’s capacity to diverge from the EU, they says much depends on what the latter means by strategic autonomy. “If it is a competitiveness play then each side will have to react to moves by the other to make their system more inviting and attractive. If it is a protectionist play then the UK can easily win,” they note. 

Divergence starting
With Brexit only just formalised, divergence between the two jurisdictions is largely confined to quite technical areas. 

Last year, the UK stated that firms will not have to conform with the cumbersome mandatory buy-in rules contained in the Central Securities Depositories Regulation, but they do still apply in the EU. 

“The UK authorities felt that mandatory buy-in hampered smaller players,” says Iain MacKay, global product owner for post-trade services at securities lending trading platform, EquiLend. 

He is concerned that the EU and UK could diverge on the Securities Financing Transactions Regulation (SFTR), creating extra costs for firms operating in both jurisdictions. SFTR is a demanding set of rules and implementation is proving complex. For instance, when it was first introduced, there was much industry concern over requiring both counterparties to report on their transactions, which have to match; in the US, for instance, only one of them has to report, normally the sell-side firm. However, Mr MacKay says the industry has largely overcome this difficulty. 

Meanwhile, the UK plans to remove limits on the amount of stock that can be traded in dark pools versus lit venues, and is rethinking some of the rules around pre- and post-trade transparency. 

Mr Waight says it is not clear what the UK’s plans are for a consolidated tape for bonds, which the EU is enthusiastic about. The problem is that most bonds are hardly traded after a few months, meaning that many of the transparency requirements, which were borrowed from equities markets, do not work well for fixed-income and create unnecessary burdens on market participants. 

He also identifies certain reporting requirements relating to trading venues as potentially being overly burdensome. Venues have to gather vast amounts of data on the people trading on them, even though they are already regulated and therefore known to supervisors. 

Another area UK regulators could look into, says Mr Waight, are some of the best execution reports, which are overly complex. 

Mr Lefeld thinks the UK has an opportunity to do a deep dive into its regulatory framework and ask whether the rules are working as they should. It could go further and even use the FCA’s sandbox approach to fintech for new legislation where it can be safely trialed before being made mandatory.

On prudential rules, divergence is also appearing. The Bank of England is firmly opposed to counting software as core bank capital, as it paints a false picture of an institution’s loss-absorbing capacity, but this is allowed in the EU. Whereas all EU banks are subject to the Basel regime, which is designed to regulate global systemically important institutions, the UK looks set to follow the US by subjecting smaller institutions to a still rigorous, but simpler regime. 

“This new regulatory framework will have to balance the needs of work inside the global system while offering the chance to be a global leader in the future of capital markets,” says Mr Stahl, adding that the direction of travel partly depends on the type of relationship the EU wants to have with the rest of the world.  

Mr Adshead-Grant believes that speed and nimbleness with adapting the regulatory framework to technological changes will become increasingly important as digital technologies become more pervasive. He says being nimble would give the UK a competitive edge, which should be possible given that UK regulators have been given legislative powers to act quickly if necessary. 

Fraser Reid, a senior solutions architect at risk analytics firm AxiomSL, like others, has noted that UK regulators are listening more to the industry. “I think they are becoming more collaborative,” he says, adding that before the Brexit vote they were less attentive. “This will help the transition and in setting out a new roadmap.” 

Crown jewels 
“The UK’s single biggest asset is the overseas persons exemption (OPE) that allows people to trade in the UK, and that needs to be massively protected. We don’t want them to review it and close it. In fact, they should in some way improve it,” the bank executive says. In short, it allows certain financial activities to be conducted in the UK by overseas entities without regulatory authorisation – a measure few other jurisdictions replicate.  

Many in the industry were surprised when in November 2020 the UK finance minister, Rishi Sunak, announced a consultation about the OPE, given it is widely considered to be working well. The UK Treasury’s consultation launched in December, called it a learning exercise. It asked questions about its risks, complexities, comparisons with similar regimes, how the industry uses it and types of activity conducted under the OPE.  

“It is not about selling services to the rest of the world, it is about bringing the rest of the world to London,” the bank executive says. “The industry has sort of solved that, but the banks need to be even more encouraged to be here [following Brexit].” 

In terms of the motives for revisiting the OPE, Mr Green thinks that could be because many UK politicians were unaware of its existence and now want to understand it. 

Numerous industry sources have expressed surprise at how little knowledge there is about the financial services sector among UK members of parliament, given its outsized importance to the country. 

Mr Green thinks the FCA might also be concerned that the regime is being exploited by certain overseas firms targeting UK retail investors with high risk investments. And following Brexit, the FCA will have less cooperation with European regulators in overseeing promoters of these investment schemes and may therefore want to close certain loopholes. 

Cross-border finance, which is crucial to the City, depends heavily on trust from other jurisdictions and acting within common global frameworks, such as Basel III for prudential regulation. That limits the ability to diverge dramatically from other leading jurisdictions. Also, there is limited industry appetite for deregulation. 

The senior bank executive explains that the UK being a relatively small country should now give greater support to the global standard setters, as that helps drive regulatory consistency. But he notes that the EU and US, which both like to export their rules, do not necessarily favour strong global standard setters as it can blunt their influence abroad. 

Instead, the UK will likely sustain its competitive edge in financial services by being nimble, forward looking and promoting more cross-border financial services activity for the City of London. 

By Justin Pugsley