Chapter 1: Introduction
The future of financial regulation and supervision post-Brexit
1.The UK is currently subject to over 40 EU Regulations and Directives on financial services, together with innumerable pieces of technical (‘level 2’) legislation shaped by the European Supervisory Authorities (ESAs). The UK has also played a leading role in drafting this legislation. After it leaves the EU, the UK will have to choose how to regulate, and supervise, the domestic financial services industry. Nonetheless, the depth of the interdependence between the UK and EU means that there is likely to be mutual interest in some form of ongoing cooperation, in order to maintain access, align regulation, and ensure financial stability. This may in turn restrict the scope for regulatory innovation.
2.The UK’s financial services sector is a crucial part of the domestic economy. In the words of a recent paper by the House of Commons Library:
“In 2016, financial and insurance services contributed £124.2 billion in gross value added (GVA) to the UK economy, 7.2% of the UK’s total GVA. London accounted for 51% of the total financial and insurance sector GVA in the UK in 2015. There are over one million jobs in the financial and insurance sector (3.1% of all UK jobs). The UK had a surplus of over £60 billion on trade in the financial and insurance sectors in 2016. In [2015/16], the banking sector alone contributed £24.4 billion to UK tax receipts in corporation tax, income tax, national insurance and through the bank levy.”1
According to a report produced annually by the City of London Corporation, the UK financial sector as a whole contributed £71.4 billion in tax (which includes wider measures of taxation such as business rates), 11.5% of total government receipts, in 2015/16.2 For 2016/17 the figures were £72.1 billion and 11% respectively.3
3.Moreover, serving as a hub for the provision of financial services to counterparties from third countries, including EU Member States, makes the UK financial services industry a global asset. Analysis by the consultancy Oliver Wyman calculated that annual financial revenues from the UK industry were around £200 billion, £90–95 billion of which is domestic business, £40–50 billion relates to the EU, and £55–65 billion relates to the rest of the world.4 London is, as Professor Eilís Ferran, Professor of Company and Securities Law at the University of Cambridge, noted, “the home location for systemically important banks globally”.5 The concentration of service provision within London is such that it could not be straightforwardly replicated by another European hub, and if fragmentation occurs, it would carry significant costs for consumers across both the UK and EU. Simon Gleeson, Partner at Clifford Chance, summarised the “really significant concern in the industry” that the upshot of the Brexit process will be “to make European financial service provision … uncompetitive globally”.6
4.The UK’s regulatory and supervisory system is a key element of the UK’s pre-eminence as a financial services centre. Stephen Barclay MP, the City Minister,7 told us that “the United Kingdom’s regulatory strength is seen as one of the industry’s key strengths, alongside our legal system, time zone, expertise and talent”.8 A well-designed regulatory structure will continue to be important to preserving London’s financial services ‘ecosystem’—the suite of services that the UK is able to offer—which means that the future should not include a race to the bottom on regulation. Mark Hoban, a former City Minister and Chair of the International Regulatory Strategy Group (IRSG), concurred: “It is very clear from talking to members of the IRSG and to City businesses that they are not looking for a bonfire of regulations post-Brexit. They believe that strong regulation is an asset for London post Brexit and would expect the regulators to continue in that vein.”9
5.UK financial services institutions that sell products into the EU Single Market can currently do so via the pan-EU ‘passport’, which allows a firm authorised in one EU (‘home’) Member State, to provide services or open branches in other EU (‘host’) Member States, with relatively few authorisation requirements.10 Passporting is based on principles established by the common prudential capital regime established under EU law, and on the mutual recognition of licences. Banks, insurers and other financial services firms based in the EU engage in the same process in order to access the UK’s market. Financial services across the UK and EU-27 have therefore grown symbiotically since passporting was established in the 1980s, and it will prove very difficult to separate the two. As Sam Woods, the Bank of England’s Deputy Governor for Prudential Regulation, told us, “It is pretty likely that if passporting falls away for significant sections of cross-border business … we will end up with more complicated structures of firms, because of the interconnections that there will be between business they are doing in the EU 27 and business they are doing here in London.”11
6.Once passporting falls away, the UK and EU face substantial losses of business opportunities, unless a replacement agreement, including financial services, is concluded. It is therefore critical that the financial services industry, and regulators across Europe, are given as much clarity as possible over the future relationship—and time to adapt. A transition period—discussed also in the European Union Committee’s recent report, Brexit: deal or no deal12—will be crucial to achieving this aim. Some firms are already at an initial stage of implementing contingency plans, in the event that such a period is not agreed. (The evidence we received on the impact of Brexit on different sectors of the financial services industry is summarised in Appendix 5.) While analysis in 2016 by Oliver Wyman suggested 75,000 jobs being lost as a result of Brexit, Sam Woods told us that current expectations were of a “day-one movement of perhaps 10,000”.13 The future of the UK’s financial services industry, and its ability to provide services to EU counterparties, will depend on the nature of a future agreement, and the period of transition to get there.
7.Dr Kay Swinburne MEP suggested that there was concern that the Government’s negotiating position for financial services lacked detail. She told us that “my colleagues in Brussels have not had a clear statement about what we are looking to transition to at the end of the negotiations”.14 Karel Lannoo, Chief Executive of the Centre for European Policy Studies, thought that these concerns had also fallen by the wayside in popular consideration: he felt that that the City of London’s success was a result of “the fact that it has become a capital for financial services and services more broadly in the EU”, and that, regrettably, “A lot of the debates on the importance of single-market freedoms started only after the Brexit decision, not before.”15 The need for an agreed vision of what will replace Single Market membership is now urgent.
The purpose of the inquiry
8.The purpose of this inquiry was to examine how financial regulation and supervision could evolve following Brexit in order to promote the stability and development of the UK’s domestic market while enabling it to continue to serve international business. The UK is a hub for a range of cross-border financial institutions, which are supervised in accordance with regulatory standards that are often set at the global level. A domestic regime for financial services will be circumscribed by the UK’s continued participation in international standard-setting—and by the desire to maintain a close relationship between the UK and EU regulatory regimes in order to preserve cross-border market access. There may however be opportunities to tailor the UK’s regime both to reflect our existing markets better, and to reflect those that are developing, for example in areas such as FinTech.
9.This report is usefully read alongside our previous report into financial services, Brexit: financial services,16 published in December 2016, which considered the anticipated effects of withdrawal on the UK industry. Prior to this, the Committee has examined the regulatory landscape for financial services on numerous occasions, most recently in The post-crisis EU financial regulatory framework: do the pieces fit?17 in 2015. Where little substantive change has occurred, these reports are referred to directly in order to avoid repetition. The present inquiry has focused on the regulatory and supervisory implications of withdrawal, although an appendix (Appendix 5) provides a brief summary of some of the evidence we received on the differentiated impact of Brexit upon the UK financial services industry, in light of political developments since the last report.
The EU Committee’s work
10.The EU Financial Affairs Sub-Committee, whose members are listed in Appendix 1, launched the inquiry at the end of July 2017 with a call for evidence. We received over 40 pieces of written evidence, and held oral evidence sessions with 13 panels of witnesses from September to December 2017. We are grateful to all our witnesses, and also to those who participated in a seminar held in collaboration with the City of London Corporation on 13 September 2017, in order to ground our thinking.
11.We tried throughout the inquiry to take evidence from a balanced range of witnesses across both the UK and EU. Indeed, we planned to take evidence from EU-based witnesses in situ in Brussels, as we have done during previous inquiries. However, following the EU’s decision to designate Michel Barnier as its sole negotiator with the UK during the Brexit negotiations, we have been unable to secure evidence from the EU institutions; we therefore had to confine ourselves to taking evidence in London, inviting Brussels-based witnesses wherever possible. Every effort has been made to corroborate and counterbalance the evidence we received from UK-based interlocutors with statements from EU actors.
12.We make this report to the House for debate.
1 House of Commons Library, Financial services: contribution to the UK economy, Briefing Paper, No. 6193, March 2017
2 City of London Corporation, Total Tax contribution of UK financial services (9th edition), City of London Corporation Research Report (December 2016): https://www.cityoflondon.gov.uk/business/economic-research-and-information/research-publications/Documents/research%202016/total-tax-report-2016.pdf [accessed 12 January 2018]
3 City of London Corporation, Total Tax contribution of UK financial services (10th edition), City of London Corporation Research Report (November 2017): https://www.cityoflondon.gov.uk/business/economic-research-and-information/research-publications/Documents/research-2017/total-tax-report-2017.pdf [accessed 12 January 2018]
4 European Union Committee, Brexit: financial services (9th Report, Session 2016–17, HL Paper 81) para 4
7 Stephen Barclay gave evidence to us on 5 December 2017, and was replaced as City Minister on 9 January 2018 by John Glen. Mr Barclay is referred to as the City Minister in the present tense throughout this report.
10 British Banking Association (BBA), What is ‘passporting’ and why does it matter?: Brexit Quick Brief #3: https://www.bba.org.uk/wp-content/uploads/2016/12/webversion-BQB-3-1.pdf [accessed 12 January 2018]
12 European Union Committee, Brexit: deal or no deal (7th Report, Session 2017–19, HL Paper 46)
16 European Union Committee, Brexit: financial services (9th Report, Session 2016–17, HL Paper 81)
17 European Union Committee, The post-crisis EU financial regulatory framework: do the pieces fit? (5th Report, Session 2014–15, HL Paper 103)