Quo vadis financial centre UK post Brexit?

My former EUI colleague Christy Petit and I have written a report for the European Parliament, published last week on recent trends in UK financial sector regulation and implication for financial sector cooperation between EU and UK.   A short summary.

Brexit has posed unique challenges for financial sector policymakers in the EU as the most important financial centre in Europe is now outside its regulatory framework. The Trade and Cooperation Agreement agreed in December 2020 between the UK and the EU includes a very thin financial sector chapter, with eight out of 783 articles directly covering this sector. A Memorandum of Understanding to establish EU-UK structured regulatory cooperation on financial services has not been signed and any regulatory cooperation has been paused due to the conflict about the Northern Ireland Protocol, part of the UK Withdrawal Agreement.

Divergence of UK regulation from EU regulation is almost a given outcome following Brexit. The UK’s rationale to actively diverge from the EU pertains to broader political choices and regulatory objectives: flexibility, common law principles-based, competitiveness, growth, and innovation. In addition to such active divergence, there can also be passive divergence, with the UK not keeping up with EU legislative changes or not following new EU regulation in the financial services sector.  While there has not been that much divergence yet, one can expect a fair amount over the coming years.

We discuss different scenarios of low, medium and high divergence in the report. Which scenario will materialise is almost impossible to predict, but will to a large extent depend on the resolution of the current stand-off between the EU and the UK over the Northern Ireland Protocol. Before the resolution of this conflict, it is difficult to see any progress happening in terms of regulatory cooperation in the financial sector. A lot will also depend on future governments in the UK and whether they want to bet the economic future of the country on an aggressive strategy to grow the financial sector, including in new segments, such as crypto.

Since 1 January 2021, the UK is a third country and access to the European Single Market can only be given through equivalence decisions by the European Commission, based on the principle of proportionality and a risk-based assessment, but also with some degree of unilateralism and discretion, including political factors. One specific challenge for European authorities is the treatment of CCPs in London. On the one hand, there is the intention to build more clearing capacity within the EU, in particular with the legislative proposals from the European Commission to further develop the EU Capital Markets Union in December 2022. On the other hand, there are financial stability concerns on having a large part of transactions be cleared outside the EU. Supervisory cooperation is therefore critical, but equivalence decisions are not exclusively driven by technical criteria but also by (legal/political) risks stemming from a scenario where such an equivalence would be withdrawn.

Writing this report was not without challenges, the main one being that things change rapidly in London, with new political initiatives popping up frequently, but not always followed through. One can also clearly see a tension between the current government wanting to grow the financial centre UK, similarly as before the Global Financial Crisis, as engine for the overall UK economy, while regulatory and supervisory authorities are much more cautious and more focused on stability. This tension will continue to play out and partly drive the degree of active divergence we will observe between regulation in the UK and the EU.