UK-EU Financial Services Regulation and Regulatory Cooperation after Brexit

Regulatory cooperation in the financial services sector has been collateral damage in the UK-EU dispute over the implementation of the Northern Ireland Protocol. While the EU-UK relationship has been politically revived with the Windsor Framework announced on 27 February 2023, the regulatory divergence between the two legal orders has already effectively started, with different prospects across a range of policy areas, including the financial services sector.

Financial sector legislation and regulation in the UK has already started diverging from the EU framework, and will further diverge in the short to long-term. We built three scenarios of low to high divergence from the EU, following research and engagement with several stakeholders. Such findings are part of a study ‘Recent trends in UK financial sector regulation and possible implications for the EU, including its approach to equivalence’, published in February 2023 by the European Parliament, upon the request of the Committee on Economic and Monetary Affairs.

Hereinafter we present three key takeaways from the study: first, we outline our findings related to current and prospective regulatory developments in the UK financial services sector, including in the UK’s trade deals with third countries. Second, we address concerns in relation to tax evasion and the anti-money laundering framework in the UK. Third, we sketch out the three scenarios for the development of the UK’s financial regulatory framework.

First, the UK has a specific rationale in diverging from EU regulation, as a matter of principle. More specifically, the UK has a different philosophy in setting and re-framing its regulatory objectives, which differentiate it from the European approach. The UK insists not only on flexibility, competitiveness, growth, and innovation as objectives, but also on a common law principles-based approach. Broader political choices underpin these objectives as manifest in both international trade deals and regulatory developments. In this part of our study, we identified some trends in UK regulation and trade deals, in particular in the deals’ financial chapters. In the regulatory sphere, we observe a change of statutes to rulebook and a shift in the regulators’ mandate. The UK government introduced the Financial Services and Markets Bill that would amend, repeal or replace most of retained EU law and give regulators greater responsibility, introduced in parallel with the Retained EU Law (Revocation & Reform) Bill. The UK approach will thereby reinforce the regulatory and supervisory model set by the 2000 Financial Services and Markets Act. In addition, secondary objectives for regulators will focus on growth and international competitiveness of the UK economy, and consequently differentiate the UK regulators’ mandate from its EU counterparts that act primarily for financial stability, market integrity and investor protection, with due care for a level playing field. In the trade deals, the UK diplomatic and political strategy is geared towards a ‘global’ UK, with a turn to the Pacific. It has recently concluded Digital Trade Agreements (with Singapore, Ukraine) and included sustainable finance provisions in financial services chapters (with Australia, New Zealand), even if they might be depicted as ‘best endeavour’ commitments, as opposed to laying down enforceable obligations. Hence, we will need to wait for evidence of the implementation of the developments in the digital/sustainable finance areas.

Second, as counterintuitive as it may be, there seem to be limited (immediate) concerns of easing of the tax evasion and anti-money laundering (AML) frameworks in the UK after Brexit. The concerns are found in the effective implementation. On the one hand, the lack of verified data on tax fraud and tax evasion to date remain fundamental unresolved issues. This is a missed opportunity for revenue generation, as stressed by the House of Commons’ Committee of Public Account in a Report published in January 2023. The effort to calculate a new ‘offshore tax gap’ – in order to reduce the difference between the tax that should be paid and the amount actually paid – requires not only better quality of such data but also an effective enforcement to access and evaluate accurate data. This second aspect of enforcement raises the issue of institutional capacity building in resources. On the other hand, regarding AML rules, there does not seem to be any weakening of the UK regulatory framework. To the contrary, at least in the letter of the law, the UK has strengthened the framework for beneficial ownership registries, with a view to improving transparency and better enabling the exercise of enforcement powers. In contrast, the EU seems to be going backwards in the transparency that beneficial ownership registries could and should provide across the EU, considering a recent preliminary ruling of the Court of Justice of the EU (judgment WM and Sovim SA v Luxembourg Business Registers joined Cases C‑37/20 and C‑601/20). Moreover, the need for further transparency to reduce tax avoidance in Crown Dependencies and Overseas Territories has also been stressed. But, since the publication of our study, the EU has updated its list of non-cooperative jurisdictions for tax purposes, which now includes the British Virgin Islands (which are part of the UK Overseas Territories). This development will have to be monitored, together with further updates to the EU’s list of high-risk third countries presenting strategic deficiencies in AML regimes.

Third, our study investigates three possible scenarios of divergence, after having examined the current state of play in a number of areas in the UK financial sector: the implementation of Basel III, the reforms of Solvency II for insurance, the wholesale markets regime and capital markets sector, the approach to FinTech and Digital Finance in particular in relation to crypto assets, and, the greening of the financial system. Under low divergence, there will be adjustments to some UK regulations as well as other initiatives to increase the competitiveness of the UK as a financial centre and of the UK economy, but, areas with international standards (eg bank capital regulation) would remain at a low level of divergence. Under medium divergence, there would be more divergence in two types of areas: first, wherever international standards are less preeminent, and secondly, where the UK has not inherited any EU regulation (eg green finance or crypto asset developments). Under high divergence, an aggressive legislative and regulatory drive in the UK would make it diverge significantly from EU regulation. In particular, the UK would replace existing EU rules with new regulation and rulebooks, and adopt divergent rules/approaches where such rules were not inherited from EU Law. This could happen in particular in areas where UK authorities see growth opportunities with less ties from international fora and cooperation initiatives (eg for crypto).

Which scenario will materialise is difficult to predict. It will depend on the immediate developments in the wake of the Windsor Framework. Furthermore, the EU’s reaction to UK regulatory developments and its potential (renewed) approach to grant equivalence to the UK is also discussed in the study. We consider that the EU granting equivalence to the UK is likely and feasible for a few financial sector segments only, and could be critical to preserving financial stability and market integrity in both the UK internal market and the EU Single Market. To be sure, equivalence is not the panacea in itself and should be combined with functional regulatory cooperation and dialogue, as well as strengthened supervisory cooperation. The UK-EU relationship in this sector will depend, once again, on the broader political relationships across the channel – for which constructive discussions and negotiations will re-start, also in sectors beyond trade. Following the adoption of the Windsor Framework, we could expect a reactivation of the financial services regulatory dialogue between the EU and the UK, including the signing of the unpublished draft Memorandum of Understanding on financial services, which has been pending for two years.

Thorsten Beck is Director of the Florence School of Banking & Finance, European University Institute.

Christy Ann Petit is an Assistant Professor at Dublin City University (DCU) and Deputy Director at DCU Brexit Institute.