Two recent papers from industry bodies have pressed the case for regulatory recognition arrangements to ease regulatory burdens. TheCityUK (TCUK) has made the case for them as part of a strategy for the UK to regain its place as the number one international financial centre. The Futures Industry Association (FIA), a global body, has also been promoting them, as a means of countering market fragmentation, setting out seven principles to enable them to be applied in practice.
Regulatory recognition comes in various forms, and terminology is not always consistent. But the basic concept is simple: one state (the host state) agrees to recognise the adequacy of the regulatory and supervisory regime of another (the home state) and allow market participants who are subject to the home state regime to provide their services in the host state without needing to comply fully with host state regime. Recognition may be granted for a wide or narrow range of purposes. It may be granted on a mutual basis or unilaterally. In some circumstances host states may even exempt foreign entities from aspects of domestic regulation without regard to the adequacy of any home state regime.
“Passporting”, which applies between EU member states, is a highly developed and liberal form of mutual recognition. Interestingly, IOSCO considers it sufficiently different from most mutual recognition arrangements as to put it in a separate category of its own. Passporting allows EU firms to provide in or into other EU states services such as banking, insurance and dealing in investments. It also extends to things like the sale of investment funds, the marketing of securities and the provision of trading and clearing facilities.
Both the EU and the UK also have unilateral recognition schemes for providers of certain types of services based in home states whose regulatory and supervisory regimes are deemed “equivalent” to theirs. And an example of a unilateral exemption for which the quality of home state regulation is irrelevant is the UK’s “overseas persons exclusion”.
The scope of regulatory recognition arrangements is in practice heavily skewed towards wholesale inter-professional business, where investor protection is not so much of a concern for the host state. The WTO GATS agreement prohibits recognition arrangements being operated in a discriminatory manner, by requiring that where they exist they must in principle be open to all WTO members who meet the relevant criteria.
The question I want to consider here is whether new efforts to agree regulatory recognition arrangements can help the UK financial services industry. With a relatively small domestic hinterland, and comparative advantage in this sector, the City needs international business to thrive. Trade liberalisation is therefore a logical policy stance. This has always been the City’s default approach, and it has been supported in this by successive governments of different political stripes. Regulatory recognition arrangements can clearly reduce barriers to trade, and extending the number and scope of these arrangements would therefore no doubt be helpful for the UK industry. TCUK believes they could “dramatically expand [the UK industry’s] footprint and drive business back to the UK”. The real issue seems to be whether a significant increase in these arrangements is likely to be achieved in the near to medium term.
TCUK’s top priority appears to be the UK-US relationship. TCUK is keen that the government should strengthen the UK-US relationship in the wake of Brexit and prioritise maintaining its attractiveness as an international hub for US firms. President Biden has downplayed the prospects of a UK-US trade deal in the near term. Accordingly, TCUK sets it ambitions rather lower, identifying greater regulatory alignment and dialogue as the desired near-term focus. Dialogue is one thing, very much in line with a “global Britain” approach, and the UK government has been happy to talk about its commitment to engaging with the US authorities in this way. Regulatory alignment is another, and potentially a more tricky one for the sovereignty-first aspects of government thinking. Nevertheless, the UK has historically been active in promoting multilateral regulatory alignment through the Financial Stability Board and the international standard-setting bodies, and the UK’s commitment to these standards seems likely to continue. Regulatory alignment at a detailed and granular level is often difficult to achieve, however, and the FIA makes the point that host states should accept comparability of regulatory outcomes as a sufficient basis for recognition.
UK-US regulatory dialogue has been going on for some time in various forms. In recent years, the US-UK Financial Regulatory Working Group has been established in the wake of Brexit to formalise regulatory cooperation with a wide-ranging brief. Its objectives include identifying potential cross-border implementation issues, aiming to avoid regulatory arbitrage, and increasing the compatibility of respective national laws and regulations. The UK’s interests in regulatory recognition can be seen in some of the topics discussed at the most recent meeting: preserving the global asset management industry’s portfolio management delegation model; ensuring the free flow of cross-border financial services data; and the risks of regulatory-driven fragmentation in derivatives clearing markets.
Derivatives trading and clearing is particularly in need of proportionate regulatory recognition arrangements, due in part to the global nature of the market but also to the broad extra-territorial approach that the US has taken to their regulation. Tangible regulatory recognition measures have nevertheless been approved in relation to the US Dodd-Frank Act rules for swaps, where both the CFTC and the SEC have agreed “substituted compliance” arrangements, allowing UK firms to comply with UK, rather than US, rules in certain areas and circumstances. Progress on regulatory recognition generally seems likely to be slow. Where there is progress, recognition is likely to have relatively limited application. But TCUK notes that even small advances in US-UK regulatory compatibility could be very positive for the UK as an international financial centre.
The UK-EU relationship is another TCUK priority. Here, of course, recent history is important. Brexit has just taken the UK out of the EU’s “passporting” arrangements. It has not yet persuaded the EU to agree very much by way of substitute – just two “equivalence” decisions, intended primarily to avoid cliff-edge effects from the Brexit event itself. The more significant of these, for UK clearing houses, is due to expire in June 2022 – what will happen after that is unclear. More generally, there is no sign at present of the EU being minded to expand the range of equivalence recognition for the UK, and it seems unlikely to do so while political tensions remain over such things as the Northern Ireland Protocol. There are also longer-term headwinds, as the EU seeks to reduce its reliance on UK financial services and build up its own capacity. A Memorandum of Understanding on continuing UK-EU dialogue and cooperation in financial services, which the parties had committed to agree by the end of March, and which had apparently been fully negotiated by that date, has still not seen the light of day. If anything, there are signs of the UK and EU drifting further apart: the UK is using its freedom from EU structures to diverge from the EU financial services regulatory regime, and the European Central Bank would like greater EU regulatory involvement, not less, with UK banks doing business in the EU.
It seems that progress on regulatory recognition with the US and the EU is likely to be slow. TCUK notes that agreeing new arrangements is likely to take time and effort, although it believes that, given their potential value to the UK economy, the investment will be worth it.