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David Woolcock 03-Aug-2021 09:03:32 10 min read

A Disturbance In The Force – A Schism In The Making

A Disturbance In The Force

Five years on from the referendum question, which posed, should the UK leave the European Union, yes or no, we are seeing a dramatic schism opening up in regulatory approaches. Since the Global Financial Crisis and the pivotal G20 Pittsburgh summit, we have seen a remarkable alignment in Financial regulation based around some fundamental high-level principles. For the then European Union 28, it was manifested in that great tome MiFID II. Now the 28 has become the 27 with the UK leaving; we see a schism opening up between what had been perfectly aligned regulations between the UK and EU.

“I am altering the deal. Pray I don’t alter it any further.”

– Lord Vader quipped, foretelling of the toll one pays for striking deals with powerful empires.

The UK’s current approach is encapsulated by the House of Lords European Affairs Committee, which considers the UK’s relationship with EU and EEA and supports inter-parliamentary cooperation with the European Parliament and the EU Member States. The committee currently foresees greater leeway for UK firms to write technical policy and police their users products. In financial services, the UK’s pragmatic assumption was that the UK would find common ground with the EU, given our regulatory regimes were perfectly aligned. Both would regard their regimes as equivalent and enjoy the attendant benefits that would bring.

In looking to conduct business within the EU, trading partners are effectively met with Obi-Wan-esque “These are not the Regulations you are looking for…” messages.

The situation we now find ourselves in is one of a degree of mistrust between the negotiating parties. It seems that equivalence is off the Brussels menu for the foreseeable future. Pragmatism has given way to European politics, and it is now certain that the UK will diverge from EU regulations and adopt a UK regulatory framework to suit UK interests. This divergence by the UK will remove the need for compromises between, in essence, the UK, German and French regulatory approaches. The UK has traditionally been more open to self-regulatory organisations rather than the EU’s prescriptive rule-based approach to financial regulation and the total reliance on the regulators in the EU Member States.

Financial Institutions doing business in both the UK and EU will now have to adapt and balance how they comply with differing regulations. It is a bit easier for EU firms as the UK acted swiftly in bringing in the Temporary Permissions Regime (TPR) for about 1,450 EU firms. The UK Parliament and FCA are now pursuing a course of closer harmonisation and a deeper relationship with US regulators alongside working with India, Japan, Singapore, China and Switzerland, which have longstanding ties with the City of London. In the words of EU commissioner Mairead McGuiness, the EU now needs to break its “dependence” on London and “build our own infrastructures.” Given the lack of progress on the EU’s Capital Markets Union project, which has been 50 years and counting in the making, this may be a more difficult prospect with a breakthrough on national issues unlikely anytime soon.

Meanwhile, the UK has set out its stall in a speech by FCA CEO Nikhil Rathi on the 22nd of June. Nikhil stated that

“although the UK is open for business, it is not open to firms who do not meet our regulatory expectations. All firms can expect to be held to the same high standards.”

He also noted that these standards could be higher than those in the EU in certain areas but would be consistent with international standards in which the UK has played a hugely significant role in creating. Firms that meet these standards will find a principles-based regulator, rather than rulebook domination, and a regime designed to foster innovation and tailored with respect to financial institutions who require special nurturing in the start-up phase to become Challengers effectively. The Kalifa report expands on this and has been broadly welcomed by FinTechs and incumbents. 

It is currently estimated that the UK has more than 10% of the Global FinTech market share. With the proposal to establish Government growth funds and an appropriate regulatory regime, this will likely be built upon. The Kalifa recommended “Scalebox” to support FinTechs as they scale, and the FCA regulatory sandbox, which offers the ability to test products and services, are good building blocks.

“Difficult to see. Always in motion is the future.” Yoda

Innovation is firmly at the heart of UK financial services and whilst we have seen ever greater regulation to deal with poor behaviours and malpractice, the approach of the UK regulators is evidently to embrace the future and not stifle innovation.

The widening gulf between EU and UK financial regulation is evident with the FCA looking certain to scrap RTS 27 & 28 following the suspension of RTS 27 due to the pandemic. The FCA welcomed the MiFID II objectives of increasing transparency and improving information about how firms execute and transmit their client orders; they were concerned that RTS 27 & 28 had not delivered these objectives in a meaningful or effective way. Other areas in which UK divergence is likely to occur are dark pools, Market Abuse Regulations, and certain other areas where the UK is a market leader. These will likely include matters pertaining to the FX market, such as pre-trade hedging and commodities trading.

Other areas of divergence emerge in the report from the Taskforce on Innovation, Growth and Regulatory Reform (TIGRR) and include other areas such as CCP Margins, GDPR and PRIIPS KIDS. It also tidies up some anomalies, such as the AML requirements on Account Information Services and Payment Institution Services, which do not hold client monies and so can rely on the bank AML checks. Also, it builds on the light touch proposals from the PRA by recommending a modification of the CRR2 to allow for a graduated scheme to encourage Challenger banks.

For Global banks, this divergence comes at a cost. ESMA and the ECB are looking more vigorously at the demand that the EU requires more assets, people and business to move from the City of London, so that risk from EU clients are managed inside the EU bloc. The ECB has commenced a granular review of each bank’s risk management setup in the EU to ensure this objective is met. Already we heard of the ECB looking closely at risk defeasance against EU banks London trading rooms, which seems to be ratcheted up. The upshot of this will be increased costs as banks may well end up requiring a dual trading room strategy to continue to have access to the City of London’s markets and continue to service EU clients.

The FCA’s current consultation ended on the 23rd of June and is the first part of a broad review of Capital Markets. It is expected that HM Treasury will launch its consultation this summer. As noted by Nikhil at the end of his speech,

“5 years is all it takes for the shape of financial services to change. Today I have shared how we are embracing change by building a regulatory environment for the future. We are also transforming the FCA to become a data and technology-led regulator to meet these challenges. While we are taking these steps to deal with the changes we are expecting, I am confident they will stand us in good stead when less predictable changes come our way, which they surely will.”

Indeed, many will be reviewing their technology stack to make sure they are fireproofed for the forthcoming changes. Please do feel free to get in touch if you want to discuss any aspect of how Siena can help you navigate the known unknowns alongside being well prepared for any unknown unknowns!

“You can’t stop the change, any more than you can stop the suns from setting.” — Shmi Skywalker

Being prepared to navigate the changes is key!


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David Woolcock

David Woolcock is an independent consultant and Director, Business Consulting at Eurobase. In addition, David is Chair of the Committee for Professionalism at ACI – The Financial Markets Association as well as Vice-Chairing the ACI FX Committee. He is also a member of the Market Practitioners Group for the Bank of International Settlement's FXWG that wrote the FX Global Code.