Summary of conclusions and recommendations
The origins of regulation and supervision
1.UK regulators have been highly influential at both technical and political levels within the international standards-setting bodies. The backbone of this engagement is personnel: without the right people in place, the UK will not be able to exercise the same clout. It is important that the UK’s financial services industry is reassured that regulators are adequately resourced and supported. The Government should, furthermore, take decisions about key leadership positions as early as practicable. (Paragraph 54)
2.The UK’s domestic regime for the regulation of financial services is largely, and increasingly, shaped by the context of international standards and EU law. The UK has been highly influential in shaping the form of supranational regulation, both at the international and EU levels. The UK has also shown leadership in areas of regulation in which it is not constrained by international standards, such as conduct and FinTech; these measures have subsequently served as models for other countries to follow. While leaving the EU may provide opportunities for the UK to tailor its regulation to domestic needs, such opportunities will be necessarily constrained by the UK’s continued participation in international fora. (Paragraph 60)
3.It is imperative that the UK continues to devote sufficient resources to engagement with international standards-setters. The Government should continue, as a minimum, to adhere to international standards, and to work vigorously to shape them in future, especially if there is a risk of them being undermined by other states. It is crucial that such standards remain the base of the UK’s domestic regime, and that the UK acts to ensure that they are properly implemented worldwide. (Paragraph 61)
4.The Government should also seek to develop new international relationships, to fortify the extant engagement taking place within formal standards-setting bodies and more broadly. This may include considering ways in which further cooperation can be sought within a bilateral context, including setting up joint fora to monitor regulatory developments. Embedding a network of global cooperation via these means could help to synchronise standards within and beyond the EU. (Paragraph 62)
5.Post-crisis changes have served to promote financial stability and the Government should continue to advocate these reforms. This is especially the case if faced with initiatives by the EU that in fact lead to market fragmentation and a reversal of the post-crisis commitments—such as is the case with current proposals that would potentially require CCPs to relocate within the EU. (Paragraph 63)
Incorporating the EU acquis in financial services
6.A crucial element of the EU (Withdrawal) Bill process will lie in the resolution of ‘inoperables’: references to, for example, EU bodies that will no longer have jurisdiction after Brexit. Translating the acquis will also require dealing with the agreements the EU has with third countries. These cover areas such as equivalence rulings with non-EU members (for example the agreement with the US under EMIR, which allows EU clearing members to use US CCPs). The UK will need to decide how to incorporate these agreements. UK regulators have also begun to make statements regarding their proposed treatment of EU businesses within the UK. The clarity that these decisions will ultimately provide is very much to be welcomed. However, insofar as there is a risk to UK financial stability in granting access to third country firms, a new domestic permissions regime must be carefully managed. (Paragraph 77)
7.The Government will need to adopt a nuanced approach towards the translation of EU regulation into domestic law. In future some rules will need to be enshrined in statute, which could be effected using powers contained in the European Union (Withdrawal) Bill. However, it may be more appropriate, where it is important that rules be flexible and dynamic, or where they concern more technical areas, for regulators to issue guidance and set standards. The Government should develop an appropriate architecture for the future domestic regulation of financial services. (Paragraph 89)
8.Any future regulatory regime will probably result in a significant increase in the powers of domestic regulators to determine rules and provide non-statutory, but binding, guidance. It is vital that Brexit, in transferring powers to domestic regulators, should not result in an unintended deficit in democratic scrutiny and accountability. (Paragraph 90)
9.The EU’s multi-layered approach to financial regulation is underpinned by detailed and resource-intensive scrutiny by the European Parliament. Assuming that domestic regulators will gain powers as a result of Brexit, the Westminster Parliament will need to increase commensurately the resources available to support a similar level of scrutiny. This is particularly the case with regard to the regulation of financial services, where powers transferred from the EU to UK regulators will require ongoing specialist scrutiny if the UK is to replicate the level of oversight that the European Parliament has to date provided. (Paragraph 91)
10.We note that this issue concerns both Houses; we also note the forthcoming review of the Committee structure of the House of Lords, which is being conducted by the House of Lords Liaison Committee. In light of these factors, we do not seek to make specific recommendations on future parliamentary scrutiny. It is clear, however, that financial services will require increased scrutiny and resources in relation to domestic, EU and international level regulatory standards, and that the burden will necessarily fall upon Parliament. We look forward to the House of Lords Liaison Committee addressing this issue in the course of its review. (Paragraph 92)
Possibilities for a transition period
11.Transition should in the first instance provide a standstill extension of the current conditions of market access: this appears to be envisaged by both the Commission and the Government. To be useful, however, any period of transition needs to form part of a three-stage process. First, a standstill period, allowing time for the two sides to agree the terms of their future relationship; then, once that relationship (the ultimate destination) is known, a period of adaptation; and, finally, the seamless commencement of trade under the terms of the new relationship. Absent all these elements of transition, financial services firms will be forced to activate their worst-case scenario contingency plans, with stark implications for the continued provision of services and for financial stability. (Paragraph 102)
12.We welcome the announcement by the European Council that the first priority for negotiations in 2018 will be agreement on transition. Such an agreement needs to be announced soon for it to prevent the enactment of the financial services industry’s contingency plans, with the disruption and uncertainty that would cause for counterparties in both the UK and the
EU-27. (Paragraph 119)
13.We note the views of those in the financial services sector who seek a legally binding transition agreement in Q1 2018. Whether or not this is feasible, any such agreement will need to be at least politically binding if it is to provide reassurance to firms that there will be no cliff-edge in 2019. Due to the central position of the UK’s financial services sector within the EU’s financial services industry, and the number of EU-27 clients that rely on accessing this market, it is in the interests of both the UK and the EU that such an agreement is in place, in order to prevent large-scale risks to financial stability. (Paragraph 120)
14.It will be essential, either alongside or as part of a transition agreement, to provide clarity on issues of contractual continuity. Insurance contracts will need to be ‘grandfathered’—treated according to current terms—for their duration. It may be possible for other contractual issues, such as the servicing of derivatives contracts, to be provided for within the time-limited confines of a transition period, but such a period cannot be expected to solve all issues. It is imperative therefore that continuity of contracts is treated and resolved comprehensively. (Paragraph 121)
Alignment and market access
15.The EU’s equivalence regime is patchy in composition, and too politically insecure for firms to feel confident in making use of its provisions. It would not allow the highly integrated web of financial services within the EU to persist in anything like its current form. Equivalence provisions are currently undergoing a review; depending on how equivalence is in future interpreted, there is a serious risk that it may leave the UK a rule-taker. And if the UK is no longer able to influence the composition of EU laws, these rules could increasingly become unsuited to the UK financial services sector, which is the largest provider of such services in the EU. (Paragraph 135)
16.There are various legal means by which to facilitate mutual access. Equivalence, as currently framed under EU law, would not be sufficient, but could, with political will, potentially provide a basis for negotiating a more comprehensive agreement in the form of an ‘enhanced equivalence’ regime. A free trade agreement, or a separate bilateral agreement on mutual market access, would achieve a similar result. (Paragraph 149)
17.An agreement granting secure, symmetric access would be to the mutual economic advantage of both the UK and the EU, but significant political hurdles remain. The Government, in approaching the next phase of negotiations with the EU, must work to foster the goodwill and understanding necessary to achieve this goal. (Paragraph 150)
18.We conclude that the current equivalence regime would fail to provide the level of market access for financial services that both sides require, and that it would inhibit the UK from developing an appropriate regulatory framework. The Government should not settle for an agreement based on equivalence without securing substantial changes to that regime. (Paragraph 157)
19.There are various possibilities for a future agreement covering financial services. These include a free trade agreement to include services, a standalone mutual recognition regime, and possibly some form of so-called ‘enhanced equivalence’. We do not come to a view on which of these would be preferable, although all would be more satisfactory than equivalence. However, it has to be acknowledged that free trade agreements take time, sometimes years, to agree, and there is no precedent for an agreement on the scale that the Government seeks. (Paragraph 158)
20.Whichever option is pursued, it will be vital to put in place a robust dispute resolution mechanism, which is as yet undetermined. This may require new institutions to arbitrate such matters, or involve existing courts. The Government should make clear which arrangements it favours, given its well-publicised red line on the jurisdiction of the Court of Justice of the European Union. (Paragraph 159)
21.We recognise that the EU, or individual Member States, may be politically motivated to reject a bespoke agreement regarding future access. However, such an agreement would be in the overriding economic interest of all sides. Without it, EU counterparties stand to lose the substantial benefits that come from being able to draw on the services offered by the UK. The EU has in the past shown ambition and imagination in seeking to include financial services in the TTIP free trade negotiations. We urge all sides to show similar imagination in negotiating the future UK-EU partnership. (Paragraph 160)
Supervisory cooperation
22.The Commission’s proposed revisions to EMIR contain both good and bad elements. Giving ESMA additional powers of oversight will help reassure financial market participants, especially to the extent that this will involve cooperation with the NCAs. However, proposals to demand the relocation of systemic CCPs within the eurozone will not achieve the Commission’s objectives of bolstering financial stability. They will instead increase costs to market participants, particularly those inside the EU-27; cause fragmentation, by reversing G20 measures taken to contain risk within CCPs; and result in the loss of clearing business for both the UK and EU-27, as clearing members move their positions to New York. The Government should resist these measures by whatever means possible. (Paragraph 186)
23.The existence of supervisory colleges, and the relationships between third-country NCAs and ESMA, could serve as a template for future supervision of financial market infrastructures. To the extent that such supervisory cooperation promotes financial stability, as would be the case with the proposals to revise EMIR, it may also obviate the need to relocate those infrastructures within the EU. Further measures to enhance such cooperation within the European legislative structure should therefore be encouraged, although proposals to centralise authority in ESMA will need to be carefully scrutinised. (Paragraph 187)
24.The evidence we heard consistently highlighted the strength and depth of existing supervisory cooperation and the extent of the EU’s reliance on the UK’s contribution. While the UK’s technical expertise is an asset for the EU, the Government should not treat this as a guarantee that the UK will be able to continue to contribute to the decision-making process. We therefore urge the Government to seek to secure continued participation for UK regulators at all levels of the supervisory architecture post-Brexit, to be imaginative in developing new forms of cooperation, and to continue to invest in international and bilateral relationships. (Paragraph 188)
Regulatory innovation, FinTech and the future
25.While there might be reason to change some aspects of Solvency II, the benefits of flexibility will in all cases need to be balanced against the possible consequences of regulatory divergence. The key issue raised in evidence to this inquiry was the risk margin. The Government and regulators should consider whether Solvency II requirements need to be updated in order to reflect the specificities of the UK insurance market, within the bounds of whatever agreement is reached with the EU on future market access. (Paragraph 200)
26.Basel rules were meant to apply to large cross-border institutions, and requiring smaller firms to comply with them may be unduly burdensome. Post-Brexit, it would be desirable for regulators to have the ability to apply any regulatory framework in a proportionate manner, where they judge this to be in the interests of consumers and the broader industry. The Government should consult on this once the terms of the UK’s access to the EU are agreed. (Paragraph 206)
27.The UK is a world-leader in the field of FinTech. One reason for this is its pioneering approach to regulation of the sector, and the regulators should be commended on initiatives such as the FCA’s ‘sandbox’ and the Bank of England’s ‘accelerator’, which capitalise upon their substantial expertise. Moves by the EU to legislate in this field should be resisted by the Government if they threaten the UK’s flexible and adaptive approach. (Paragraph 219)
28.We also urge the Government to support the sector’s access to capital, given the potential loss of funds from the European Investment Bank. The Government should in particular strengthen the resources of the British Business Bank, not merely to replace the levels of funding offered by the EIB, but to increase UK firms’ access to venture capital overall. (Paragraph 220)
29.The FinTech industry is reliant on access to skilled labour, as is the wider financial services sector. We call on the Government to consult with the sector in developing its post-Brexit immigration and visa policies, to ensure that the UK’s financial services sector, and FinTech in particular, can attract the best global talent. (Paragraph 221)
30.As the intensity of international competition facing the UK post-Brexit increases, it may become clear that regulators are unduly constrained by their current objectives. We recommend that the Government consider and consult on the desirability of adding a duty to promote international competitiveness to these objectives. Any change should be accompanied by strengthened Parliamentary scrutiny, given the potential trade-offs inherent in adding such an objective to the remits of the Bank of England and the FCA. (Paragraph 225)
31.Whether or not the Government decides to add to the UK regulators’ remit, it is important that we engage with all of the pieces of the international regulatory jigsaw. Global competition and global regulatory standards-setting will become yet more crucial after the UK leaves the EU, and the Government should fight to ensure that the international regime for financial services continues to thrive. The Government must not squander the opportunity to enable UK financial services to become more outward-facing and access new markets, and should ensure that the regulators are appropriately equipped to oversee firms operating across borders. (Paragraph 226)