Part of the promise of Brexit was that the UK would be free to shape its own regulatory system, no longer constrained by the one-size-fits-all EU single market – the “regulatory dividend”. This post will look at some of the ways in which the UK has been using this freedom since the transition period ended in December 2020, after first considering the restraints that in practice are tending to limit or slow UK-EU divergence.
A significant restraint is the commitment on the part of both the UK and the EU to following international standards. These now exist in a wide range of areas where regulatory failure in one jurisdiction can have an international overspill. Their scope has grown over the years and was significantly expanded in the wake of the Global Financial Crisis of 2008-9. There are core principles for the regulation of banking, insurance and securities, and recommendations for combatting money laundering. There are also more specific standards covering such things as bank capital requirements and measures aimed at ending “too-big-to-fail”, central clearing of derivatives contracts, and the regulation of money market funds, to take just a few examples. Although in themselves these are not legally binding even on national governments, various international trade agreements, including the UK-EU Trade and Cooperation Agreement, include commitments to adhere to them.
In some areas these standards are quite high-level, and where this is the case there continues to be considerable scope for UK-EU divergence in the manner of implementation. In other areas, such as central clearing of derivatives, this is less so. The general direction of travel seems to be towards a widening of the scope of international standards (for example, recent developments in sustainable finance and cryptocurrencies) and for standards to become more granular over time. Their constraining effect on UK-EU divergence is therefore set to continue, if not increase over the longer term.
More generally, the UK has historically seen itself as a high-standards jurisdiction. This is an approach broadly supported by the industry itself. In some areas the UK has gone beyond the EU; the UK’s requirement that retail banks be “ring-fenced” is a good example. Clearly with public statements of intent in this area allowance has to be made for the fact that policy makers are never likely to see or describe their regulatory changes as a lowering of standards. But even so, a general move towards the UK adopting lower standards than the EU as a competitive strategy seems unlikely at present. Though of course this is not to say that government and industry do not believe there are currently instances of over-regulation and poorly framed regulation.
An important question is the extent to which the EU regulatory regime will exert a gravitational pull on the UK that will be hard to resist. One aspect of this concerns the value to UK market participants of formal recognition by the EU that the UK regulatory regime is “equivalent” or “adequate”. In areas where these recognitions are available, such as market access for investment firms and handling of personal data, there is an incentive for the UK to stay closely aligned with the EU so that recognition may be granted or, once granted, not withdrawn. But the gravitational pull may extend beyond that. The development of regulation around sustainable finance will be an interesting case study here – the EU has been pioneering in this area, and it is possible that industry’s interest in international consistency will in practice prevail over UK policy-makers’ desire for UK “improvements”.
Some degree of inertia is also slowing the pace of change. At the end of the transition period the UK was fully in step with EU single market requirements, and the UK onshored the EU regulatory regime as “retained EU law”. There are capacity constraints both for policy makers and market participants in processing changes to this status quo, as well as the time lags necessitated by consultation and all the procedural steps of rule-making and the need for market participants to adapt. Nevertheless, the government has announced a comprehensive review with the stated aim “eventually to amend, to replace, or to repeal all that retained EU law that is not right for the UK”.
The instances of divergence that have emerged so far can be divided into two categories: those arising from dissatisfaction with the EU legacy, and those resulting from the potential for differing UK and EU responses to emerging issues. The distinction is not entirely clear-cut: in some instances where the UK is unhappy with the EU legacy (e.g. prudential requirements for insurers, and money laundering), the EU itself recognises there are problems with the existing rules and is looking at making improvements – perhaps a case of potentially different responses to an emerging problem.
Legacy issues: adapting the EU regime to UK needs
Prudential requirements for banks – The UK is planning to introduce a simplified and less onerous prudential regime for non-systemic and domestic banks – an initial consultation paper is expected in H1 2022. The current EU regime, onshored by the UK, essentially applies Basel standards uniformly to all banks, though there are calls within the EU for the EU regime to take a more differentiated approach in some areas.
Prudential requirements for insurers – The UK is reviewing the prudential regime for insurers, with a view to making it more proportionate and flexible. Areas of focus include the rules governing risk margin and the matching adjustment. A consultation paper is expected in Q1 2022.
Wholesale markets review – A wide-ranging review of the regulatory regime governing the wholesale markets is under way, focussed on amending aspects of the MiFID II framework. Issues being looked at include clarifying aspects of the regulatory perimeter for trading venues, removing requirements around the execution of transactions (including the share trading obligation), recalibrating the transparency requirements for fixed income and derivatives markets, reforming the commodity derivatives regime, and making improvements to market data.
Prospectuses – A fundamental re-think of the prospectuses regime has begun. This looks set to reduce the circumstances in which a prospectus is required and simplify and streamline the required contents of a prospectus. Detailed rule-making powers are to be given to the FCA, enabling future rule changes to be made more quickly. This review was one of the recommendations of the “Listings Review” undertaken by Lord Hill – interestingly, its other most significant recommendations can be implemented within the existing EU-based framework.
Money laundering – The government is reviewing the UK’s supervisory and regulatory regime for countering money laundering and terrorist financing, with a view to improving its effectiveness and avoiding unintended consequences.
Emerging issues: potential for different UK and EU responses
New international-level standards, unintended consequences, developing technologies, business innovations, crises and market failures, shifts in popular concerns – all can call for regulatory responses. Even if the effects of these things are experienced in the same way in both the UK and the EU, it would be surprising if they were to take exactly the same approach to addressing them. Here are two current examples where there is potential for divergence:
Bank prudential requirements – The EU has recently published proposals for implementing the remaining elements of the Basel prudential standards agreed in 2017 (variously called Basel 3.1 or Basel 4) - the UK’s proposals are not expected until H2 2022. The EU is looking at a 2025 start date for these, two years later than the Basel due date. It has justified this on the basis of the time needed to pass EU legislation and for member states to prepare. It will be interesting to see how the UK deals with this timing aspect in particular. On the one hand, the Governor of the Bank of England has recently said that the PRA (the regulator that will be making the rules) “remains committed to the implementation of robust prudential standards in the UK, maintaining a level of resilience at least as great as required by international standards”. But on the other, in making these rules the PRA is required by recent UK legislation to have regard to “the likely effect of the rules on the relative standing of the United Kingdom as a place for internationally active credit institutions and investment firms to be based or to carry on activities”. Ironically, boasting of the agility of its new regulatory system, the UK can hardly avoid this tension by pleading the slowness of its rule-making processes.
Sustainability – The EU has been in the forefront internationally in developing a detailed regulatory regime for the shift to a greener economy. The EU Taxonomy Regulation is a key aspect of this, providing a common vocabulary and defining what counts as green, both for corporate reporting and investment labelling purposes. The UK is in the process of developing its own UK Green Taxonomy, using a structure and scientific metrics based on those of the EU taxonomy. However, the details of this may still be adapted for the UK market, and the extent of any UK-EU divergence is still unclear. The UK has nevertheless acknowledged “the benefits of coherence and compatibility with other international frameworks” and, more generally, both the UK and the EU will face pressure from industry to ensure consistency with international-level standards as they continue to develop.
Despite the restraints of international standards, the UK’s aim to remain a high-standards jurisdiction and the potential gravitational pull of the EU regime, increasing UK-EU divergence seems inevitable over time as the UK adapts the EU legacy to suit its own requirements and as the UK and EU respond differently to emerging issues.