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Brexit: Would Disruption to the Financial Industries Be Worth It?

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About The Author

Helen Morse (Writer)

Helen is studying Law (European & International) LLB at the University of Sheffield, now entering her final year having spent an Erasmus year at the University of Vienna, Austria. Helen is interested in international and commercial law. Outside of law, Helene is a keen sports woman, playing at county level.

This article is part of the 'Brexit' series, edited by Matt Bogdan.

With the upcoming referendum on the UK's membership of the European Union, the Brexit series intends to explore key issues surrounding Brexit, particularly what effect EU law currently has on the UK, and what would be left with it gone.

Other articles from this series are listed at the end of this article.

As part of Keep Calm Talk Law’s Brexit series, this article will give a brief outline of some issues to consider when casting your vote in the referendum from the perspective of financial regulation in the UK.

The UK’s financial sector is heavily influenced by regulations derived from EU law and ensuring compliance is fundamental to the industry. Therefore, the effects of Brexit could be extensive and thus critical to the future of many banks, investment firms and other providers of financial services operating within the UK.

The nature of any future financial regulatory regime and the extent of its potential disruptive effect largely depends on the nature of the arrangements put in place post-Brexit. Given that the negotiations on these arrangements are certain to be complex and time-consuming, a period of legal and financial uncertainty for UK financial institutions is bound to follow. However, will this predicted period of economic volatility be worth the increased freedom to legislate as the UK wishes?

The financial regulatory authorities

As a result of the amendments made to the Financial Services and Markets Act 2000 (FSMA 2000) by the Financial Services Act 2012, there are two primary financial regulatory authorities in the UK. There is the Financial Conduct Authority (FCA), which is mainly responsible for conduct regulation of financial institutions and then there is the Prudential Regulation Authority (PRA), which regulates deposit takers, insurers and major investment firms. As these are national authorities, there is no reason why they cannot continue to operate in the same way if the UK were to leave the EU.

The European Supervisory Authorities (ESAs) have significant powers to propose draft rules and make decisions that are binding on the FCA and PRA. If there was a Brexit, then obviously both of the national authorities will no longer be limited to act within the limits set by the ESAs. Instead this role will fall on the government to redefine the scope of the FCA and PRA’s regulatory powers.

The regulations

What is likely to cause more disruption within the UK financial regulatory regime are changes to the specific rules and laws themselves. Much of the UK’s current framework is derived from EU regulations which are directly applicable to the UK. If Brexit occurred, the government would need to decide to what degree any new legislation should stay in line with the current EU standards.

Similarly, there have been a number of EU directives with regard to financial regulation, which, because they are not directly effective, have been implemented through national legislation. To what extent this legislation is kept, amended or repealed will also need to be determined by the government. This uncertainty surrounding which prudential requirements financial institutions will be subject to could be costly whilst also putting off foreign institutions from investing or operating in the UK.

A Europe Economics report for Business for Britain recently considered to what extent EU regulation and tax measures affecting wholesale financial services would have been introduced had the UK been acting alone. It concluded that half of the measures considered would have been introduced in their current, or very similar form. Seven measures would have been unlikely to be introduced because they do not address the needs of the UK. Only three of the measures would not have been introduced because the UK outright opposed them.

The three measures were the Alternative Investment Fund Managers Directive (AIFMD) (2011/61/EU), ESMA Short Sale Restrictions (236/2012) and the bonus cap restrictions in the Capital Requirements Directive (CRD) IV. All of these measures were introduced to avoid a future financial crisis.

However, the EU has arguably taken a very different approach to the one the UK would have taken. For instance, the UK believes that limiting bankers’ bonuses will impede the competitive position of the European financial services sector and increase risk, as firms may raise their base salaries and thus be less able to cut their costs by reducing the level of bonus payments in the event of a fall in revenue. Similarly, the AIFMD intended to create a European framework for the regulation of alternative investment fund managers. The eurozone is particularly vulnerable to asymmetric shocks and often struggles with high unemployment, hence why this directive was deemed essential by the EU. However, the UK is arguably more willing to tolerate funds often responsible for relatively risky investments, as it  can  better  absorb  the  effects  when  those  investments  go  wrong,  with  flexible exchange rates and a relatively robust labour market. The UK would therefore not have necessarily introduced such broad and costly regulations.

These examples show, in the event of Brexit, there could be significant changes to the landscape of the UK’s financial regulatory regime to place it more in line with the unique trends and features of the UK market.   

That said, the CEO of the FCA recently played down the impact of a potential Brexit. He said that even if the UK does leave the EU, it is very likely that it would still choose to abide by much of the financial regulation that Brussels produces and that therefore ‘in the short term, not as much would change as you might think.’

As noted by a European Union Committee report into the implications for the UK from the post-crisis EU financial regulatory framework, the UK continues to exert strong influence over EU financial services regulation. Brussels sees the UK as an expert in the field and its opinions are respected. It is fair to conclude that the UK has played an influential role in shaping much of law to come from the EU on financial regulation over the last few years. This supports the above position that the UK will probably continue to follow the majority of the existing rules and regulations since it reflects what the UK would have done, even if it was acting alone. 

There is clearly a high level of uncertainty and disagreement surrounding what financial rules and regulations might look like if the UK were to leave the EU. Ambiguity is never good for market confidence or investment. Equally, if financial regulation in the UK does end up just largely reflecting EU law, then arguably all the disruption that comes with Brexit will hardly seems worth it.

The arrangements

One of the major benefits of EU membership is the unrestricted cross-border access to other EU markets. In the area of financial regulation this is encompassed in the ‘passporting’ which allows financial institutions to offer financial services or products in any of the States that make up the European Economic Area (EEA), subject to fulfilment of certain conditions in the relevant single market directive. Passporting removes the need to ask for authorisation from the State authorities, a process which can be complicated and costly.

It will be to the UK’s benefit to ensure that some sort of similar regime is kept in place if it were to exit the EU. Without it, it will make cross-border access more burdensome for domestic financial providers and dramatically reduce incentive from outside institutions to stay or enter the UK market.

As I am sure will be common theme across the series, much of the same analysis with regard to the UK’s options post-Brexit found in Matt Bogdan’s article on EU competition law also applies here.  

One option is for the UK could follow the approach of Switzerland, which has negotiated a number of bilateral arrangements with the EU for each specific market it wants access to on a case-by-case basis. This would give the UK more freedom in the sense it would not be bound to transpose all EU legislation; best-case scenario, it could cherry pick the markets, and their related standards, it wants access to. However, in reality, where a bilateral arrangement exists, (and I would strongly argue it is essential for bilateral arrangements to be put in place for cross-border access to EEA markets) the UK would still have to comply with EU laws in that area. As similarly concluded by Matt, this would mean the UK will have even less control of financial regulation as it will no longer be in the position to affect the rules that govern it.

Another option is to become a member of the EEA, as Norway, Iceland and Lichtenstein have done, despite not being a member of the EU itself. This will mean the UK still has access to the single market, but has opt-outs on certain EU policies. This seems appealing as financial institutions operating from the UK would still be able to engage in the unrestricted cross-border passporting arrangements. But once again, EEA membership comes at a price: the UK would have to implement all single-market legislation, but it will be excluded from the decision making process.

The very reason Eurospectics often advocate Brexit, with respect to financial regulation, is to regain control and be able to legislate in the UK’s best interests. However, with both of the above arrangements, which I believe will be necessary if the UK wants to maintain its strong financial services sector, the UK actually loses its influence over the rules and regulations it must follow.

Conclusion

Overall, with regard to financial regulation, Brexit would not be in the UK’s best interests. The specific rules and regulations will not look that much different from their current forms, raising the question of whether all the surrounding uncertainty is really worth it.

If the UK were to leave the EU, it will be highly detrimental to the UK’s financial services market if it does not come to some form of arrangement with the EU with regard to market access. Therefore, it will likely have to follow the models currently used by Switzerland or Norway which, in reality, take away any control the UK legislators had. At least if the UK remains in the EU it still will be able to continue to influence the financial regulatory rules, as opposed to being dictated to by the EU in exchange for market access.

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Tagged: Banking & Finance, Commercial Law, European Union

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