Summer Edition - Financial Services
As stated above, the EU has been continuing regulatory reform with little or no UK voice since 2016. After 2020, these reforms no longer applied to the UK.
So far, actual divergence between the UK and EU has been relatively limited. 2010 to 2016 saw a fundamental re-regulation of the financial sector following the global financial crisis. Since then, many changes have been largely cosmetic, fixing issues such as timing, or individual measures that were not delivering results in a proportionate way. These have included in the EU, limited changes to MIFID2 (Markets in Financial Instruments Directive) and the Benchmarks Regulation.
This means that industry have not yet felt a significant impact from diverging regulatory requirements. However, there are several interesting measures, which have not yet been fully applied, around the regulation of ESG (Environmental, Social, and Governance) and climate change related issues, digital and operational resilience. There are also reforms around asset management that are currently passing through the EU and UK legislative machinery.
In the UK, following the onshoring of EU legislation, there are significant programmes underway that could deliver considerable divergence. As well as ESG/Climate change regulation, there is a Future Regulatory Framework Review and a Wholesale Markets Review.
While we cannot cover all areas of divergence, potential or real, in a short report, we will focus on the key areas business leaders should be focussing on.
ESG Financial Regulation
On ESG regulation, the EU has made itself a world leader by moving ahead with an ambitious package of regulatory measures. These requirements have created a complicated framework of detailed requirements around disclosure and measures to avoid greenwashing. The key laws include SFDR (Sustainable Finance Disclosure Regulation), CSRD (Corporate Sustainability Reporting Directive) and the Taxonomy regulation.
The UK has largely held back. Although it said it would follow the same science as the EU, it will design its regulation for the UK. However, its programme has been moving far more slowly than the EU. The UK has implemented some corporate disclosures stemming from the TCFD (Task Force on Climate Related Financial Disclosures) but the detail of the wider regulation is still under development. This has led to concern about the alignment of the two regimes.
The difficult question for the UK authorities and the people seeking to influence policy will be whether it is better to develop a different regime that avoids some of the problems and learning the lessons from the EU, or simply keep the UK regime as close to the EU for consistency.
Similar to the ESG agenda, the EU has moved ahead of other jurisdictions on the regulation of the growing digital sector. This includes rules that aim to address the risk of outsourcing to non-financial digital specialists, known as DORA (Digital Operational Resilience Act) as well as a framework for crypto assets, known as MICA (Markets in Crypto Assets).
The UK has been working to develop and improve its own framework on the risks around outsourcing. While this is an area where the regimes are largely compatible, firms should keep an eye on these developments as the rules can be extraterritorial (given suppliers are often in other countries) and potentially very burdensome if not coordinated. For example, if the checks required on a digital provider are inconsistent, a firm operating in, or supplying to, the UK and EU could find itself having to meet duplicative and expensive requirements.
In the UK things have run more slowly, with the UK government very clear that it wants the UK to be a centre of crypto assets (although the regulators remain focussed on the risks to investors or financial stability). There is also work ongoing in both jurisdictions on central bank digital currencies. It remains to be seen where the UK will land on this work but there could be a significant burden on firms if the frameworks mean that businesses must implement different compliance frameworks for the UK and EU in what is a very international market.
An area of real divergence could be in the way financial markets are regulated. The extensive MIFID2 regulation was originally a compromise between different approaches to market regulation and contains significant national discretions, although these generally focus on the treatment of retail consumers.
Within the EU there have been some relatively minor adjustments to the way MIFID2 works since Brexit and these have been largely consistent with actions in the UK. However, the ambition of the UK through the Wholesale Markets Review is expected to lead to significant divergence. This is likely to include transparency and reporting requirements, as well as more flexibility in how markets are structured. Although any moves in the UK are probably going to be relatively friendly to markets, it will be important to ensure there remains compatibility between the regimes, otherwise any gains in efficiency could be lost or lead to duplication, especially if location requirements are introduced by the EU in response to UK regulatory change.
Furthermore, a difference of approach is likely to be seen as the EU appears to have a greater appetite for direct intervention when the market does not appear to be delivering on EU policy objectives. For example, the EU has recently passed the ESAP (European Single Access Point), which will be an ESMA (European Securities and Markets Authority) managed database providing access to a vast amount of data that is required to be reported under EU regulation. Similarly, the EU is working to agree a consolidated tape that would be provided by monopoly providers appointed via public tender.
It is very unlikely that the UK will adopt such interventionist measures, and this could lead to different approaches to the crucial topic of data in the two jurisdictions and leaders at many firms are watching very closely. It remains to be seen whether the EU’s approach will lead to easier access to more standardised data thereby encouraging investment, innovation and lowering costs; or have the opposite effect on the business landscape.
The regulatory framework around investing, including pensions and insurance is already quite diverse as the EU framework sought to accommodate the very different traditions of the member states (including the UK). However, the UK and EU are now looking at these areas in very different ways.
In the UK, the government is seeking to encourage long-term productive investment. It has introduced the LTAF (Long Term Investment Funds), a new type of authorised open-ended fund that aims to encourage investing in long-term illiquid assets. This should make it easier for pension funds to make investments in private equity, venture capital and infrastructure (which should support UK Government priorities such as sustainability and levelling up). Further changes are expected in the UK to promote such pension investments as well as free up capital from insurance companies for similar purposes (though a review of the key insurance regulation, Solvency II). For those interested in alterative investments, this could represent a massive opportunity.
The UK LTAF provides much more flexibility compared to the EU version, ELTIF (European Long Term Investment Fund), which has existed since 2015 but has not been particularly successful. It has more restrictive rules around which assets can be held. Although there are currently negotiations in the EU to provide more flexibility for ELTIFs, it will end up being quite different to the UK LTAF.
Similarly, the UK has introduced adjustments to the rules around PRIIPS (Packaged Retail Insurance and Investment Products), the key information documents that must be supplied to investors into packaged investments. There has been controversy around whether the PRIIPS framework provides useful information in a proportionate way and the UK has acted to make targeted changes, including around disclosures around performance, risk and charges. A more fundamental review is expected to follow, and firms will be hoping for a significant reduction in the compliance burden.
The EU has also been looking at its own changes to PRIIPS and this is likely to mean different disclosures for the same of similar products will be required in the two jurisdictions – something likely to increase the burden on the manufacturers of retail investment products.