The UK-EU financial services economy
Financial services are an important part of the UK and EU economies and will continue to underpin future economic growth, consumer choice and competitiveness after the UK leaves the EU. The sector encompasses a broad range of activities -including banking, wholesale capital markets, insurance, asset management and FinTech – and accounted for 17 per cent of UK GVA in 20171.55 Financial services are heavily interlinked with the wider economy, providing critical support to businesses, savers and citizens across the UK and the EU.
The City of London in particular has developed as a global hub, named this year as the world leading financial centre, for the third year in a row, ahead of New York, Singapore, Hong Kong and Tokyo. The depth of its capital pools and the liquidity and efficiency of its markets is unrivalled in Europe.
lts size attracts global capital to European markets and provides significant benefits to the rest of the EU. Financial markets are global and many businesses operate international business models. ln Europe this has created a highly integrated set of complex relationships in the provision of financial services. For example, €1.5tn of assets are managed in the UK on behalf of EU clients. Around two thirds of debt and equity capital raised by corporates is facilitated by banks based in the UK. 78 per cent of European Forex trading and74 per cent of European interest rate derivatives trading takes place in the UK.
Breaking new ground with an unprecedented financial services agreement
A close relationship on financial services is in the interest of both the UK and the EU27. Such a relationship would seek to preserve the economic benefits of cross-border trade and mitigate against financial stability risks through close regulatory dialogue and supervisory cooperation. A model is therefore required which can address the unique interconnectedness of the UK and EU financial systems.
The UK does not seek passporting access to EU markets. That would be inconsistent with the red lines that the EU27 have set out. Rather, this new partnership should focus on areas of financial services which are most important to financial services trade flows between the UK and the EU and prioritise managing cross-border financial stability risks through structured dialogue and cooperation.
There are existing precedents for trade liberalisation in financial services upon which we can build. However, there is no single model that we would seek to replicate.
The most immediately relevant example is the equivalence framework, which the EU uses to manage its relationships in financial services with existing third countries. Although this framework addresses some cross-border issues, it does so in a way that would be unsuitable to support the volume and range of activity that is particular to the UK-EU relationship. There are three key reasons why such provisions would be inadequate for a deep relationship.
First, the EU’s existing third country framework is the result of an iterative legislative process which has taken place over decades and was never designed to support the depth and breadth of cross-border activity that will exist after the UK has left the EU; it reflects current or historic trade patterns between the EU and existing third countries. lf applied to the deep UK-EU relationship the full service offering which EU clients currently enjoy would be significantly disrupted. For example, there are no powers for the EU to extend market access to non-EU lending banks or insurance companies.
Second, the EU’s third country regime is unstable and therefore unsuitable for long-term planning. The EU is entitled to withdraw equivalence at short notice. Once the UK has onshored the EU acquis via the Withdrawal Agreement Bill, EU27 firms operating in the UK will be subject to the same uncertainties. Firms will be able to partially mitigate these risk by carrying surplus capacity in both jurisdictions to ensure that they are never locked out of either market. However, these arrangements are costly and these costs will be passed onto customers. A better solution would deal with these uncertainties.
Third, an equivalence regime, which by its nature is unilateral, is poorly adapted to providing the kind of deep supervisory co-operation which is necessary to dealwill complex cross-border risks. The EU has, in the past, aspired to using its equivalence framework to promote closer regulatory alignment and deep supervisory cooperation with third countries but has been unsuccessful in doing so. Some equivalence assessments will be premised on the existence or adoption of supervisory cooperation arrangements but these provisions are typically very limited. Whilst that may be tolerable for the EU in relation to third countries, it seems unlikely that it would be satisfactory for either the EU or the UK given the much greater volume of cross-border service provision that exists between the EU and the UK and will continue in future.
Building a new model
A bespoke model is therefore required. This model should represent the deep relationship between the UK and the EU, just as the bespoke agreements between the EU and Turkey, Canada, Singapore, Korea and Japan represented their own unique relationships.
As the Prime Minister set out in her Mansion House speech, our goal in financial services will be to establish the ability to access each other’s markets, based on the UK and EU maintaining the same regulatory outcomes over time, with a mechanism for determining proportionate consequences when they are not maintained.
The Prime Minister also made clear that the UK cannot simply become a ‘rule taker’ and sign up to automatically accept as-yet-unknown future rule change. To do so would make it impossible for UK authorities to guarantee that they will be able to meet their financial stability objectives.
Given the highly regulated nature of financial services, and our shared desire to manage financial stability risks, the UK proposes a collaborative, objective framework that is reciprocal, mutually agreed, and permanent and therefore reliable for businesses.
Fundamentals of a future relationship on financial services
The Chancellor developed the UK’s objectives for a partnership in financial services in his speech at HSBC in March 2018.63 He called for an agreement which would be based on three key principles:
- A process for establishing regulatory requirements for cross-border trade between the UK and the EU;
- Cooperation agreements that are reciprocal, reliable, and that prioritise financial stability; and
- A legal framework that makes this structure durable and reliable for participants in the market and for the businesses that use their service.
Establishing regulatory requirements
The UK and the EU start from a unique position of a common rulebook and harmonised regulation in financial services. As we move forwards, our shared regulatory history and objectives will allow us to progress beyond our Day 1 de facto equivalence and will serve as a strong basis on which to build an ambitious partnership.
The UK’s fundamental regulatory objectives in financial services will not change and our commitment to preserving financial stability is unaffected by our withdrawal; we will remain within the European mainstream. We will continue to advocate for high regulatory standards, contributing actively to their development in global fora and ensuring their robust and rigorous enforcement domestically. We will continue to work with European partners to promote these shared objectives.
ln the future, we recognise that both the UK and the EU will need to amend regulation to ensure they can respond to new and emerging financial stability risks and the specificities of local markets. This requires a system that respects both sides’ autonomy in rule-making, which allows each party to take appropriate measures to maintain financial stability and which does not compromise the integrity of the EU’s single market in financial services.
The UK will not seek market access in all areas that are covered by the EU’s passporting regime. Rather, the UK’s proposed model has as its goal the ability to access each other’s markets in certain areas of financial services, based on the UK and EU maintaining the same regulatory outcomes over time, with a mechanism for determining proportionate consequences where they are not maintained.
A model is required to dealwith the changes in regulation that may evolve. Such a model should set out the high-level objectives of both sides in regulating financial services, but also define in more detail the outcomes that need to be achieved for specific activities.
At a high level, the UK and the EU should build on shared principles to ensure both parties have confidence the other side’s regulatory objectives. This will take into account our shared desire to maintain financial stability, protect consumers, and promote fair and open competition. Such an agreement could draw on international precedents, such as the IOSCO (International Organisation of Secutiries Commissions) principles of secutiries regulation which is based on protecting investors, ensuring markets are fair, efficient, and transparent, and reducing system risk.
For specific activities, the UK and the EU will need to develop more detailed objectives and define outcomes at a more granular level. In come cases, this will be based on international standards. For example, the Basel rules on bank capital have specific quantitative ratios with which firms need to comply. As part of an ambitious agreement on financial services, the UK will agree to continue to meet these standards and update our rules as they evolve in the future with the expectation that the EU will do the same. Where international standards do not exist, the UK and the EU will work jointly to develop more detailed objectives, which will represent the criteria upon which equivalence will be judged. This will be based on the equivalence of outcomes.
Of course, there are circumstances where these criteria are not met as a result of one or both parties changing its rules. Where this has material implications for financial stability, the protection of consumers or fair and open competition, there will be consequences. Those consequences could entail the restriction of market access and, in such instances, there will be clear and robust institutional processes to ensure that any such consequences were reasonable and proportionate and applied in a way that allows industry to plan with confidence.
The above sets out the UK’s proposal for managing the future regulatory relationship between the UK and the EU. It is on this basis that both sides will grant each other equivalence and serve as a foundation for meaningful market access.
Given the complexity of the cross-border relationship between the UK and the EU, close supervisory cooperation will be crucialto ensure risks are appropriately managed, with arrangements that go well beyond what is currently provided for in third country equivalence mechanisms.
Although the UK will cease to be a full member of the European Supervisory Authorities (the ESAs), we can and will continue to maintain a very close working relationship with them and with national authorities. ln the unprecedented model that the UK is proposing, information-sharing will be critical to ensure supervisors have sufficient shared understanding of activity, underpinned by data-sharing agreements within the overarching trade agreement. This could cover market abuse, transaction reporting, and stability monitoring, as well as prudential concerns about individual firms.
The Government welcomes the EU’s desire to safeguard financial stability as part of the future relationship negotiations. The UK will bring a flexible mindset to negotiations and stands ready to explore creative solutions to maintaining as close supervisory cooperation as possible, including in respect of sensitive sectors such a central counterparty clearing, taking into account legitimate shared concerns around financial stability. The UK will approach these negotiations with full recognition that, in the future, as a result of the UK’s exit from the UK and EU legislative changes, there will be more, not less, complex cross-border business models. Supervisory frameworks will have to reflect this reality. Failing to do so would be to discard the progress that has been made since the financial crisis in addressing cross-border risks.
Of particular consideration will be:
- Core principles of supervisory standards – to give confidence in the soundness of firms across jurisdictions, and their proper resolution.
- Supervisory cooperation – to ensure risks arising across financial services groups and pan-EU financial services architecture are fully understood, and addressed in a comprehensive manner, whilst protecting the principle that ultimate decisions are taken by those bearing the financial risk (this may be more than one jurisdiction).
Underpinning our new regulatory relationship will be clear institutional processes that should promote transparency, impartiality and predictability in the future trade framework in financial services between the UK and the EU.
The UK envisages that financial services trade will be subject to the same overarching arrangements that apply to the agreement as a whole including in relation to dispute resolution. However, the financial services part of the agreement may be subject to some specific arrangements unique to this sector.
Our new partnership in financial services will require a robust and efficient way of mitigating and resolving disputes, delivered through an independent arbitration mechanism that has the confidence of both parties. This will ensure that any disagreements about the purpose or scope of the agreement can be resolved fairly and promptly. The highly technical nature of financial services would require that there is space for expert financial services opinion in the dispute resolution mechanism.
Further arrangements will need to be put in place to ensure that, when rule changes are proposed, there is opportunity to discuss ahead of time and agree implications for equivalence findings and, ultimate, changes to market access. An independent arbitration mechanism will ensure that any such consequences are reasonable and proportionate, and that they are applied in a predictable way that allows industry to plan with confidence.
While the precise nature of the arbitration mechanism will require detailed technical talks, it will be designed in a way that protects the autonomy of the EU’s legal order and is consistent with the principle of the exclusive jurisdiction of the CJEU. Case law is developing around this principle, but the dispute resolution mechanism would ensure that disputes over the correct interpretation of EU law would be referred to the CJEU.
The benefits of a continued close partnership
A close relationship on financial services is in the interest of both the UK and the EU27. Such a relationship would seek to preserve the economic benefits of cross-border trade and mitigate against financial stability risks through close regulatory dialogue and supervisory cooperation.
From an economic perspective a deep partnership would allow EU end-users to continue to benefit from the UK’s world-leading financial services offering, keeping costs low.
The concentration of financial services in the UK has led to deep, liquid and efficient markets. Additional regulatory barriers would have a significant impact on financial services and real economy firms alike. [Oliver Wyman has calculated that the wholesale banking industry would need to find $30-50bn of extra capital if new regulatory barriers forced fragmentation of firms’ balance sheets.] [The LSEG estimated that the EU’s proposal on location of clearing houses, if implemented, would increase costs to EU27 firms by around $25bn a year.]
ln some cases this fragmentation would see activity relocate away from the UK. Beneficiaries of this are likely to be established financial centres such as New York, Singapore and Hong Kong, reducing the depth of Europe’s capital markets, Europe’s market share, and cutting access to complex financing. However, in some instances, economic activity may simply cease to take place. [AFME and PwC analysis has shown that some entities in London will simply no longer do business in the EU]. Rising costs and structural breaks could lead businesses to reevaluate their service provision and to withdraw services to non-core customers or markets. This will reduce the service offering available to EU clients and raise costs for consumers.
A deep and collaborative partnership will also be vital to safeguard financial stability. Both the EU and the UK have been highly active in shaping international regulatory reform and promoting global cooperation. Since the financial crisis in 2008 core regulation has been developed both at a global and regional level, strengthening the financiat services sector and mitigating against future losses. Capital requirements have been bolstered, supervision of bank operations have been tightened, and resolution regimes and plans have been put in place.
Much of this has been the result of close cooperation between the UK and the EU. A deep, cooperative partnership on financial services will allow both parties to build on this progress and address the legitimate concerns that both sides have about opening up financial markets.