Central to the response of the international community to the global financial crisis was a move to strengthen international regulatory standards and to improve cooperation and coordination amongst regulators. A question for the decade ahead is how much of that global approach will survive?
A focus on Europe is below.
Europe at the crossroads
As already observed, there have been examples in recent years of the EU departing from or going beyond international consensus in agreeing post-crisis regulation. There have also been cases where the EU appeared to operate on the mistaken assumption that if it implemented an international standard in a particular way, the US and others would follow. More recently, there is an example of the EU appearing to follow the US (some would say in reprisal) in proposing that large foreign banks operating in the EU should establish a EU domiciled holding company to sit on top of those operations. Whatever regulatory arguments there may be in favour of such a measure, the proposal is likely to increase the cost of funding for affected banks and result in further regulatory fragmentation.
Within the EU there remains an apparent resolve to continue to strengthen the single market and there does not appear to be any wavering of commitment to institutional structures such as the Single Supervisory Mechanism allowing the European Central Bank (ECB) to oversee the supervision of the largest Eurozone banks.
What impact might Brexit have on international consensus?
For the UK, the immediate effect may be a strengthening of its position at the major standard setting bodies. Generally, the UK already has a seat of its own, for example at the FSB and in Basel at IOSCO but after it leaves the EU, it will no longer have any need to maintain a position consistent with that of the EU. Of course, that may lead to further fragmentation of regulation.
The UK, even as a member of the EU has gone its own way in several important areas including the introduction of ring-fencing legislation, a tougher approach to bank bonuses and the introduction of the senior manager regime to strengthen individual accountability.
In the second half of 2017, the outcome of Brexit negotiations for the withdrawal of the UK from the EU at a political level remains unclear, as just one element of the broader global geopolitical, macro-economic, and environmental uncertainty which prevails in early decades of the 21st century. What is certain, however, is that the EU's financial authorities are making preparations for what some commentators predict to be a mass exodus and what others predict to be just a repositioning of international financial firms from London to the continent.
At the end of May 2017, the European Securities and Markets Authority (ESMA) was the first of the three European Supervisory Authorities (ESAs) to issue principles to guide competent authorities in the remaining EU member states when facilitating relocations into their territories from the UK. In particular, the ESMA principles aim at strictly discouraging the establishment of so-called “letter-box” entities, that is, legal entities which give the firm access to the single market, while retaining substantive activity in London. In July, ESMA provided further more detailed guidance applicable for specific sectors of investment business. The European Insurance and Occupational Pensions Authority and the ECB, as supervisor for the Banking Union, have also issued relocation guidance and materials.
Such principles and guidance, as much as providing an insight into regulatory expectations for firms considering their response to Brexit, also speak to how EU level institutions might attempt to manage competition between Member States for the crown jewels of the financial world which London is expected to cede. Arguably, the principles must also apply to any non-EU, non-UK financial businesses seeking to access the single market. Politically, at least, the ESAs must avoid being seen to penalise the UK more than other non-EU countries.
It will be open to the UK to seek to negotiate a unique relationship with the EU governing financial services. For example, a treaty arrangement might be sought, which sits above the existing complexity of third-country relationships with the EU, governed as they are in a variety of ways by individual directives and regulations. The majority of commentators expect that in the early years post-Brexit the UK will remain close to the EU in the content of its regulation, partly because of the sheer volume of that regulation and the time it will take to review it and partly to enjoy such benefits as may arise from an EU assessment of “equivalence” in a particular area. But the existing equivalence landscape is fragmentary and not a sufficient basis for most banking models to operate out of the UK into the EU. Moreover, there is every reason to expect that on important matters of regulatory policy, the UK Parliament and UK regulators will eventually want to express their own views: divergence from the EU is inevitable over time. Perhaps, on a particular topic, the UK will move closer to the US than the EU, perhaps not. A “third way” seems distinctly possible.
This article is an excerpt from “Global financial regulation – the decade ahead”, currently appearing in the Global Bank Review 2017 publication. Other articles in this series include:
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The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2018