Evaluate the impact of Brexit on the UK and the EU’s financial regulation Essay Example

Brexit and Financial Regulation 9

THE IMPACT OF BREXIT ON THE UK AND EU’S FINANCIAL REGULATION

Introduction

It is evident that the financial sector plays the most pivotal role to the economy of the United Kingdom. The sector accounts for approximately 7% of the total GDP of the nation. The UK exports approximately one-third of its financial services to the European Union. In the aftermath of the Brexit referendum, the UK recorded a sharp decline in its banking stocks. The result was a shift in financial services from the UK to other EU cities as well as the decision of other multinational corporations to shift their operations to other countries within the economic bloc (Moloney 2017). The heavy regulation of the financial services sector signifies the necessity of protecting public interest through the provision of a stable and strong financial services sector. Until the Brexit, the design, application, and supervision of the UK financial sector was in accordance with the EU’s framework. The essay evaluates the impact of Brexit on the EU and the UK’s financial regulation.

Brexit’s Impact on Financial Regulation in the UK

Brexit would have a significant impact on UK-based financial institutions that depend on the European Economic Area passport in accessing the European market to provide financial services. In essence, Brexit would have an impact on “passporting” requirements. Prior to the exit of the UK from the EU, financial institutions operating in the UK could access other European markets using their home state license without the need to acquire additional license in the new jurisdiction (Ibáñez Díaz 2016). In the aftermath of Brexit, such firms would have to seek additional license in the target European jurisdictions before gaining access to the markets. The exit would also result in the “passporting out” of UK-based firms (Mason Hayes & Curran 2016). With the understanding that they can no longer use their home state licenses to operate in other European markets, financial institutions would resort to move to other markets within the European Union in the quest to continue operating in such markets. However, the establishment of a new framework that would enable UK-based financial institutions to operate in other markets is also probable. As a result, it is also probable that Brexit could result in new terms that would govern the operations of financial institutions.

However, the loss of passporting rights does not imply an end to cross-border trading of financial services between the UK and other countries in the region. As an alternative, UK could resort to “third country” provisions available in particular directives. The directives that support “third country” provisions include Solvency II, AIFMD, and MiFID (Mason Hayes & Curran 2016). The provisions have been contemplating on allowing “third country” banks and other financial institutions. Third country institutions refer to the institutions located outside the EEA (Springford & Whyte 2014). Therefore, this would imply that institutions located outside the EEA could still offer cross-border financial services to other members of the economic bloc using their state home licenses if their regulatory protections are equivalent to those of EEA. Having the rights to operate in other countries using the provision would necessitate the determination of the “equivalence”. Under the “equivalence” determination, it will be the responsibility of the EU to determine whether the regulatory regimes in the UK are equivalent to those in the EU (Lannoo 2016). In the event that the EU finds the regimes to be equivalent, it would grant permission to financial institutions licensed in the UK to engage in cross-border trade with other countries in the region.

However, it is clear that the regulatory regime in the UK is already equivalent to that of the EU. Consequently, it is almost evident that the EU would find UK’s regulatory regime to be equivalent to its regime in the process of equivalence determination. The fact that the UK could decide to abandon the approach or the decision of the EU to make the equivalence determination process a lengthy one could have adverse effects on the operations of UK-based financial institutions in the meantime. Moreover, some EU legislations do not acknowledge the equivalence concept. Moreover, the UK would not have the same benefits as those enjoyed by other EU members (Booth et al. 2015).

Besides focusing on financial institutions that intend to passport outside the UK, it would also be proper to look at institutions that intend to passport in the UK in the aftermath of the Brexit. The first effect of Brexit would be the restricted access to the UK market by firms that intend to passport into the country. Apparently, the regulatory framework that governs the entry of firms in the UK market would change due to the Brexit. Irrespective of the restrictions resulting from the Brexit, it is clear that such restrictions would not have a significant adverse effect on the commercial activity within the country. Rather than disrupting commercial activity in the country, the UK would introduce a distribution framework aimed at ensuring that the current operators in the UK financial market do not witness massive interruptions emanating from the Brexit (Mason Hayes & Curran 2017).

Regulation of financial institutions in the UK rests on three primary pillars. Capital requirements enlisted in the Capital Requirements Regulation and the Capital Requirements Directive IV is the first pillar that determines the regulation of financial institutions in the UK. The Banking Act 2009 provides the second pillar that includes provisions for stabilization, recovery, and resolution. The Bank Resolution and Recovery Directive (BRRD) as well as the financial services structural reforms contained in the Banking Reform Act 2013 is the third pillar in the regulation of financial institutions. CRD IV and BRRD are consequences of EU legislation. CRD IV implements Basel III requirements. The UK still exhibits commitment to the requirements. However, CRD IV contains certain provisions that do not have any associations with Basel III requirements. Restriction on the payment of bonuses of banks is an example of the additional provisions in CRD IV not related to Basel III requirements (Norton Rose Fulbright 2017). In the aftermath of the Brexit, the UK will either amend or abolish such requirements.

It is also probable that the UK parliament could decide to maintain the existing legislation. In such a case, the objective of the UK parliament would be to attain mutual recognition between European and British regulatory authority as well as upholding the current regulatory structure. In order to achieve equivalence, it is evident that the PRA, BRA, and BRRD Rulebook will have to undergo the necessary amendments. It will be the duty of the parliament to weigh the burden of regulatory compliance that the BRRD and CRD IV have imposed on banks. BRA would subject large banks to ring fencing (Norton Rose Fulbright 2017). Even though Brexit is a regime based entirely in the UK, it is clear that it would have an impact on the application of the regulation on the subsidiaries and branches of the EEA. On the aspect of applying the regulation to the Banking Structural Reform, there would be need for the imposition of national legislation aimed at ring-fencing core retail activities. However, the immediate implementation of the BSR regulation is detrimental to the success of the UK in ring fencing its retail activities.

Most importantly, it is proper to acknowledge the fact that the Brexit’s impact on financial regulation in the UK depends on the relationship that exists between the UK and the EU (Pisani-Ferry et al. 2016). For instance, the UK could decide to adopt the “Norwegian option” that would see it access other markets in the EEA without having to be a full member of the EU. In the event that the UK succeeds in becoming a member of the EEA, its institutions would retain passporting rights to operate in other countries within the economic bloc. Besides the Norwegian option, the EU and the UK could also adopt the “Swiss option”. Currently, Switzerland is not a member of EEA or EU. The country depends on negotiated bilateral treaties with the EU that grant it limited access to markets in the region. The third and final option would be the decision of the UK to leave the EU on a permanent basis and not endeavor to become a member of EEA. This would imply that the country would lose its passporting rights in all EU and EEA member states.

Brexit’s Impact on the EU’s Financial Regulation

The fact that global regulators set financial and banking rules implies that the regulatory framework of the financial sector is complex. In particular instances, it is proper to note that the regulatory standards imposed by the UK are higher than EU’s standards. The implication is that the exit of the UK from the EU would cause a minimal impact. However, the stability of the banking sector is one of the areas that could suffer from the Brexit especially in the event of a financial crisis (Grant Thornton 2016). Instability in the banking sector would emanate from the fact that regulators in the UK and EU would give divergent opinions on the crisis. Such a crisis would also present a legislative challenge with legislation that is not covered in the UK law. The continued existence of passporting arrangements would also necessitate the implementation of rapid solutions to the issue in the aftermath of Brexit. The UK would anticipate a favorable position that would enable its institutions to continue having passporting rights to operate in other countries within the bloc. The agreement reached between the UK and the EU would influence the decisions of other global institutions on the best points of locations of their business premises.

It is evident that Brexit would result in the creation of new EU legislation that would require compliance from the UK in order to continue enjoying some of the benefits that it enjoyed while still a member of the EU. In the event that the UK fails to adopt the Norwegian option of becoming a member of EEA or the Swiss option of establishing bilateral agreements with the EU, the Brexit would compel the EU to impose trade restrictions that would revoke the licenses of UK-based institutions. The result would be the inability of UK-based institutions to operate in countries under the EU or EEA. Increasing regulatory demands would still be evident for firms that intend to operate in other markets in the EU besides having to comply with MIFID rules. The EU will also eliminate legal protections on currency grounds both in specific measures of EU financial services and in the Treaty. The exit will also prevent the UK from having a vote or seat in the European Banking Authority (Moloney 2016). Rather than having seating or voting rights in the Authority, the UK would only play the role of an observer.

With regards to financial services and euro-denominated trading, it is apparent that the UK could encounter severe consequences in the aftermath of the Brexit. Rather than enjoying the consideration as a member country in the economic bloc, the EU would regard the UK as a “third country” in the attempt of the UK to access the single market. This would result in the imposition of location requirements that require specific euro-denominated trading or business within the area. As a result, the exit would have a negative impact on critical market infrastructures such as central clearing counterparties and stock exchanges. Since the UK would be operating outside the guarantees and treaties of the EU, the protection of the UK against Financial Union would be insubstantial. The Banking Union is the basis of Financial Union. However, the latter incorporates additional integration of institutions with regards to capital markets (Moloney 2016). The Financial Union endeavors to repatriate specific euro-denominated trading through regulation.

The exit could also subject the UK to adverse network effects. The UK faces the risk of having a less liquid market in the event of the shrinking of the Euro business. This would imply that the UK would witness a general reduction in its business. Finally, the exit would also affect the ability of the UK to influence the regulation of financial services. Over the years, the UK has been using its expertise to influence the establishment of the EU framework of offering financial services. However, the UK will not have such influence on the development of new financial services frameworks for the EU (Allen & Overy 2016). As a result, it would not have the opportunity of tailoring the framework to support its firms to conduct business within the bloc. The financial services industry in the UK would suffer adverse consequences in the event that its institutions have to comply with the new requirements. Currently, Norway has to live with the challenge following its decision to exit the EU.

Conclusion

Brexit would have a significant impact on the UK and EU’s financial regulation. To begin with, UK-based firms that operate in other markets within the bloc with the help of the state home license will have to seek additional licensing in order to continue operating in the countries. Prior to obtaining the license to operate in member countries of the EEA, the EU would have to determine whether UK’s regulatory framework is in accordance with its existing framework. The fact that the UK has played a massive role in influencing the development of the EU regulatory framework implies that the determination process would render it equivalent. However, the exit of the UK from the EU implies that it has lost seating and voting rights. Consequently, it would no longer have the ability to influence the development of new regulatory frameworks for the EU. This subjects it to the risk of not meeting the equivalence requirements in the future.

Reference List

Allen & Overy., 2016. Financial Services Regulation – What Impact will Brexit have on Regulated Firms Established in the UK, Europe & Third Country Jurisdictions?

Booth, S., Howarth, C., Ruparel, R. and Swidlicki, P., 2015. What If…?: The Consequences, Challenges & Opportunities Facing Britain Outside EU. Open Europe.

Grant Thornton., 2016. The Impact of ‘Brexit’ on the financial services sector.

Ibáñez Díaz, M., 2016. The impact of Brexit on the UK financial service.

Lannoo, K., 2016. EU financial market access after Brexit. Intereconomics, 51(5), pp.255-260.

Mason Hayes & Curran., 2017. The Impact of Brexit on the Financial Services Sector. Available from: https://www.mhc.ie/invest-ireland/brexit/the-impact-of-brexit-on-the-financial-services-sector

Moloney, N., 2016. Financial services, the EU, and Brexit: an uncertain future for the city?. German Law Journal, 17, pp.75-82.

Norton Rose Fulbright., 2017. Impact of Brexit on financial institutions. Available from: http://www.nortonrosefulbright.com/knowledge/publications/136980/impact-of-brexit-on-financial-institutions

Pisani-Ferry, J., Röttgen, N., Sapir, A., Tucker, P. and Wolff, G.B., 2016. Europe after Brexit: A proposal for a continental partnership (Vol. 25). Brussels: Bruegel.

Springford, J. and Whyte, P., 2014. The consequences of Brexit for the City of London. London: Centre for European Reform.