Trade and Cooperation Agreement: impact and implications
In December 2020, the United Kingdom (UK) and the European Union (EU) signed a Trade and Cooperation Agreement (TCA), delineating the new trade rules between the bloc and the UK after Britain’s decision to exit (‘Brexit’) the EU.
While for other aspects of trade (such as goods) the Agreement and its implications are clear, the TCA does not contain specific rules around financial services between the UK and the EU. Instead, the TCA contains some more general requirements:
- neither the EU nor the UK should limit either the number of the other’s firms that can operate in its market or the number of people they can employ
- the other’s firms should be treated equally to other national or foreign suppliers and should have the ability to access any state-operated payment systems
- both entities will ensure that international financial services standards (such as those from the G20, the Financial Stability Board and the Basel Committee on Banking Supervision) are implemented and applied.
Furthermore, the general rules around financial services have a so-called ‘prudential carve-out’, which allows each entity to adopt prudential rules – for example, to protect investors or ensure the integrity and stability of their financial systems. Another key aspect of the TCA is that both the UK and the EU have the ability to revoke equivalence decisions around financial services without consulting each other.
While this is potentially a positive aspect for the UK, as it permits regulatory divergence on financial services, it also represents a form of risk as the EU is not obliged to give British investors the same rights that they enjoyed when the UK was a member state.
Overall, the rules on financial services in the TCA provide for freer EU/UK access in financial services than would have applied under a ‘no deal’ scenario. However, access still falls far short of what businesses had previously enjoyed across the European single market.
Joint Declaration and Memorandum of Understanding
As the TCA does not set out specific rules around the regulatory aspects of financial services, the UK and the EU also signed a Joint Declaration, on 24th December 2020. Under the Declaration, the two entities agreed to work towards the establishment of structured regulatory cooperation on financial services. This would allow for exchanges of views and analysis relating to regulatory initiatives and other issues of shared interest. Such cooperation would also facilitate more transparency and easier dialogue over (for example) adopting, suspending, and withdrawing equivalence decisions – as well as enhanced coordination with international bodies.
The Joint Declaration also committed the UK and the EU to work towards agreeing a Memorandum of Understanding (MoU) by the end of March 2021 to establish a firmer framework for cooperation, including equivalence determinations. The UK Government confirmed at the end of March 2021 that the MoU had, in its view, been agreed in principle and needed only to be formally signed.
Among its other provisions, the MoU aims to establish what was called a ‘Joint UK-EU Financial Regulatory Forum’ to serve as a platform for dialogue on financial services issues. The MoU also focuses on non-legally binding cooperation but does not address the politically contentious issue of single market access for UK financial services. Reports have highlighted that the MoU has yet to be signed or, therefore, put into force.
This has potentially negative consequences for the UK financial services market, as it is simply reliant on equivalence decisions made by the EU. While the UK has published its own equivalence assessment, the EU has yet to make equivalence decisions for the UK (except for two temporary decisions granted at the end of the transition period – one of which expired at the end of June 2021). This means that UK firms’ access to EU markets depends on the rules which each member state applies to third country businesses.
As substantial equivalence decisions from the EU seem unlikely, the UK Government has indicated that it will change the UK’s financial services regulatory regime in the hope of delivering a so-called ‘Brexit dividend’.
Impact on financial services
It will obviously take time to determine the full impact of the Brexit deal on the UK’s financial services sector. Nonetheless, there have been some early indications of the effects of both Brexit and the TCA’s implementation.
In particular, there has been a shift of certain trading operations and staff from the UK to the EU/European Economic Area, with London losing out to cities such as Frankfurt and Amsterdam. This has been most notable in the cases of share trading, euro-denominated derivatives and asset management, although the scale of the lost business and employment is lower than some experts had predicted.
Britain has also lost its ‘passporting’ permissions which has, for instance, necessitated the restructuring of many UK firms’ European businesses. When the UK was part of the EU, firms could export products and services to each member state without the need for a specific licence as a result of the financial ‘passport’ system. Now, due to the absence of equivalence decisions by the EU, UK firms have had to either cease conducting regulated business in the EU, open authorised European subsidiaries or restructure their European businesses to ensure they remain outside of the relevant member state’s regulatory perimeter.
Indeed, the Financial Times (FT) reported that 2021’s first trading day saw €6 billion of EU share trading shift from London to EU marketplaces such as Madrid, Frankfurt and Paris. While share trading is not the most lucrative business within the financial services sector, the FT noted that the shift would still mean lower tax receipts for the UK Government. In addition, the newspaper subsequently reported, in February 2021, that Amsterdam had become Europe’s largest share trading centre after a range of EU-based financial institutions had moved away from trading in London due to the failed equivalence decisions. According to the think-tank New Financial, about 7,500 jobs have moved from the UK to the EU since the 2016 Brexit referendum, while banks and asset managers have transferred more than $1 trillion in assets – about a tenth of the total value. Finally, City A.M. reported in June 2021 that, according to data from EY (Ernst & Young), two in five financial services firms have moved or plan to move some UK operations and/or staff to EU member states. However, many employees would reportedly rather quit their jobs than be relocated. The financial services sector will also be affected by the TCA’s mobility provisions, which allow firms to send employees to deliver services in the EU, subject to conditions, with the exact rules varying between each member state.
UK domestic policy-making – financial services
In July 2021, the Chancellor of the Exchequer (Rt Hon Rishi Sunak MP) used his set-piece Mansion House speech to outline his vision for the sector. It included commitments to implement at least parts of two Government-commissioned reviews: first, Lord Hill’s review of the UK’s companies listing regime and, second, the Kalifa financial technology (fintech) review.
The British Government hopes that reforming financial services regulation will help firms trial technological innovations and scale up new products – helping the UK carve out a ‘first mover’ advantage by quickly developing new regulatory regimes that encourage firms to launch advanced products and innovate more quickly than other countries. It also hopes that such reforms could drive the financial sector to help deliver the UK’s net zero environmental ambitions.
The Treasury duly opened two consultations on the ‘Financial Services Future Regulatory Framework Review’, to gather views on the proposals for reforming some aspects of the financial sector’s reguation. Such reforms offer the opportunity to ensure that the UK maintains a coherent, agile, and international approach.
The first consultation was a proposal to define a clear allocation of responsibilities between Parliament, the Treasury and the financial sector. Other proposals included Government and Parliament to be responsible for setting the policy framework for the financial sector. The Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) should be responsible for designing and implementing the relevant regulatory standards. The PRA and FCA should also be subjected to transparency requirements around activity – specific policy framework legislation.
In November 2020, Parliament’s all-party Treasury Committee also launched an inquiry into the future of UK financial services in order to examine how regulations should be set by Parliament and the Government once EU-based rules had ceased to govern the sector. As part of its inquiry, the Committee responded to the Treasury’s consultation with a series of recommendations. On the one hand, for example, the Committee agreed with the Treasury that the EU financial services rules that were on-shored – in short, the process of amending the legislation and regulatory framework, so that they can work in a UK-only context, while the UK was leaving the EU – should be moved into the regulators’ rule books. In contrast, the Committee does not believe there is compelling evidence to allow Ministers the absolute right to see regulators’ policy proposals before they are published for consultation. Regulators must be free, in the Committee’s view, to choose what they share with the Treasury. The Committee also believes there may be a role for the Government to use ‘activity-based’ principles to instruct regulators’ approach to specific business sectors, but it recommended that the Government should be sparing in their use. In addition, the Committee believes that there should be a targeted approach to effectively scrutinise regulatory proposals. Under the future Financial Services Regulatory Framework, the Committee suggested that proposals made by the FCA or the PRA should be put out into consultation. This means that industry stakeholders would have an opportunity to put forward their views before the proposal is integrated within the regulation.
As a response to the Treasury Committee and as a subsequent proposal on the Financial Services Future Regulatory Framework Review, the Treasury expanded on the previous consultation. This recently closed, on 9th February 2022. The Government intends to provide for a greater focus on the financial services sector’s growth and competitiveness by introducing new statutory secondary objectives for both the PRA and the FCA. More specifically, Ministers are hoping to amend the existing regulatory principles – especially those introduced as a result of EU regulation – to ensure faster but sustainable growth. The Treasury is also looking to create a new regulatory framework using primary legislation, moving the EU-derived rules into UK regulators’ rulebooks and, finally, allowing regulators to make changes to the regulatory framework as they feel appropriate.
Lastly, the House of Lords’ European Affairs Committee launched, in February 2022, another inquiry into UK-EU relationships in financial services. It will examine: Brexit’s impact, so far, on the UK’s financial services sector; the impact of the absence of a functioning framework for UK/EU regulatory cooperation; the future of cross-border financial services in the absence of equivalence; and the impact of regulatory divergence and agreements with third countries on UK/EU financial services trade.
It is clearly still an uncertain period for financial services. The failure to sign the MoU by March 2021, as planned, and the EU’s unwillingness to make an equivalence decision have encouraged the UK Government to push harder for a divergent regulatory framework for financial services.
Its decision to create a different regulatory framework from the EU may have both benefits and costs for the UK. In terms of benefits, its financial services sector enjoys a comparative strength that allows the UK to possibly diverge and expand its reach in non-EU countries. On the other hand, regulatory differences can trigger disputes, especially around the rules implemented by the TCA.
What is certain is that the UK Government seems willing to move towards a divergent financial services regulatory framework. It will take some time to see how various consultations, inquiries and future legislative proposals will affect this sector, and their true impacts might become apparent only in the longer term.
Piece by Lavinia Troiani. To discuss the outlook for financial services, please email firstname.lastname@example.org