Summer Edition - Financial Services

Divergence Watch is a new quarterly publication by Ibec Global, which looks at the shifting relationship between the EU and the UK across different business sectors and highlights the key areas businesses should keep a close eye on in coming months. In this issue, we focus on the impact of Brexit on the financial services industry, consider where divergence has taken place so far and its impact, and what the key takeaways are for international business leaders.

Background

Ask someone when Brexit occurred, and you may get some very different answers. Some might say 23 June 2016, when the referendum was held, others 31 January 2020, when the UK legally left the EU, and a few might say 31 December 2020, when the Brexit Transitional period ended.

For many businesses, the key date was 31 December 2020 as this was when Brexit impacted on business models. However, the June 2016 and January 2020 dates also mattered for regulated industries like financial services. After the referendum, the UK’s influence over financial regulation began to wane and in January 2020 the UK left the room completely. As such, it could be argued that regulatory divergence really began in 2016, first through a reduced UK voice on EU regulation, then with no UK voice at all, and finally with the UK embarking on its own system of financial services regulation – albeit with the EU system, by and large, frozen into UK law.

Impact so far

The impact of Brexit on the financial services industry so far can be seen as three strands:
a) Market Access;
b) Duplication; and
c) Uncertainty.

The main route for access to the EU single market is equivalence. Different pieces of legislation vary widely (from nothing, to quite liberal access), but, in simple terms, where the relevant equivalence provisions exist the European Commission can decide that a third country has a regulatory framework that is equivalent to the EU’s, and this opens access to the single market. Despite the UK starting with an identical framework, the EU has not granted the UK equivalence in any areas except CCP (Central Counterparty) recognition. This has disrupted business models and we have seen quite significant changes in trading patterns, particularly when it comes to equity and derivative trading.

To address this, firms have had to seek authorisation in both the UK and the EU to secure continued access to the EU single market and EU clients as well as being able to operate in the UK, with many choosing Dublin. This is obviously less efficient, and more expensive, than ‘before Brexit’.

How to lower the costs associated with this duplication is a question that has been taxing leaders in financial services businesses. So far, however, this has proved difficult as a new, predictable paradigm has yet to emerge to provide firms with the confidence and predictability to plan cost reductions. Worse still, there is also uncertainty about how products will be regulated. Firms do not know if the products they offer will meet future requirements so they can be marketed in both the UK and the EU or if different products will need to be developed for each jurisdiction.

All of this has an impact on product development for firms which will ultimately lead to higher costs for the consumers of financial services in both jurisdictions as well as raising costs for businesses seeking access to finance.