Following months of prolonged negotiation, the EU has finally reached a deal with the UK on how to co-operate in shaping rules for banks and financial markets. Though the agreement remains subject to the approval of the EU’s 27 Member States, in recent weeks representatives from the European Commission and the UK’s Treasury department agreed on the contents of a Memorandum of Understanding (MoU) that will create a “Joint UK-EU Financial Regulatory Forum” to discuss rulemaking for the financial sector.
The agreement is a promising start, placing emphasis on co-operation and dialogue. However, the broad outlines contained in the text cannot determine how specific disputes will be resolved. It will therefore be up to the EU leadership and UK Government respectively to approach their relationship in a fair but flexible manner in the coming years.
Striking the right balance is not just a matter of concern for the continent of Europe. The manner in which this MoU is approached and interpreted will set important precedents for financial markets around the world. From a global perspective, the focus should be on the opportunities this MoU presents for doing some things differently.
In essence, the newly agreed Forum represents a commitment to discuss regulatory decisions that may limit access to each other’s markets, and “as appropriate, to consider working towards compatibility of each other’s standards”. The operating principle at play here is that of ‘equivalence’, the EU regulatory process for granting market access to firms if the country’s financial rules are deemed similar to its own.
“In emerging from the pandemic, all economies need to create fertile ground for small companies to grow. At present however, the cost of regulation is killing entrepreneurship”
The wording around this is encouraging. The four-page document includes an agreement for officials from the EU and UK to hold “dialogue” on “autonomous decisions to adopt, suspend or withdraw equivalence relevant to one or the other side” and to hold “exchanges of views on the respective policies, rules and processes concerning deference regimes, such as equivalence”.
Views will undoubtedly differ on crucial issues. The UK will push for EU decisions to be guided by the spirit of the arrangement the bloc struck with the United States in 2016. Under the US deal, equivalence is treated as “outcomes-based.” Britain has called for EU equivalence also to be outcomes based, which would ensure that the focus would be on whether financial rules in Britain and the EU produce the same result.
These issues might seem petty on paper, but they will define the degree to which the next decade will be one of regulatory divergence - not just for the UK but across the world.
The more the UK diverges, the less likely its access to the EU’s financial markets may become. But what could smart divergence look like from a regulatory perspective?
In recent years, there has been much discussion of the potential for the UK, and London specifically, to position itself as a “Singapore on Thames” - a low-regulation alternative to the EU. However, it shouldn’t be forgotten that Singapore survived the 2008 financial crisis because it adopted a tough regulatory regime in the aftermath of the Asian financial crisis of 1997. So rather than deregulation, the more accurate lesson of Singapore is the way it made its system less bureaucratic. Regulators invested in digital regulation and generally opted for a minimalist approach, for example only asking firms for data once.
The UK now has an enormous opportunity to follow in their footsteps and become a world leader in digital regulation. This would help tackle one of the unspoken problems of global finance - which is the rising cost of regulation. Reporting for UK banks alone costs the industry £2bn-£4.5bn per year, according to McKinsey.
The type of all-encompassing legislation which has characterised the EU’s approach to regulation in recent years - such as MiFID II - has made it exorbitantly costly for small to medium sized firms to compete. A direct consequence of regulation aimed at dismantling the cult of ‘Too Big to Fail’ has been the struggle of younger firms who are increasingly ‘Too Small to Comply’.
“Striking the right balance is not just a matter of concern for the continent of Europe. The manner in which this MoU is approached and interpreted will set important precedents for financial markets around the world”
The cost of regulation has long been overlooked in the industry debate on regulatory best-practice. Compliance has become an existential problem for smaller firms, with regulation now expensive enough to act as an obstacle to a sustainable competitive existence, as well as a barrier to market entry altogether.
In emerging from the pandemic, all economies need to create fertile ground for small companies to grow. At present however, the cost of regulation is killing entrepreneurship. Few financial start-ups can afford to enter the market fully equipped with a well-oiled compliance team, especially if it’s required to grow at an unsustainable rate.
Following its departure from the EU, the UK should seek to lead the world in reducing the costs of compliance. Doing so will not just be of benefit to the UK but would set an example for the rest of the world to follow.