Summary

Introduction

The UK financial services sector is of vital importance to the UK economy as a whole, employing 2.3 million people and making up 10% of total UK tax receipts. Though traditionally closely associated with the City of London, the sector is well-established across the UK; two thirds of employment in the sector is outside London. The sector is also an important contributor to the UK’s international trade, comprising 19.1% of all UK services exports.

The EU is an important trading partner in this sector, making up 37% of total UK financial services exports in 2019. The post-Brexit UK-EU Trade and Cooperation Agreement (TCA) contained few provisions for trade in Financial Services, but this had long been anticipated and prepared for. Financial services jobs have moved from the UK to the EU as a result of Brexit, but in far smaller numbers than some expected; current estimates suggest 7,000 jobs have moved, compared to estimates of 75,000 in 2016. Nevertheless, the Committee warns against complacency in this regard, as it is not yet clear whether the impact of Brexit on employment has fully played out.

While acknowledging the challenges that Brexit has presented for the sector, witnesses the Committee spoke to were largely optimistic in their outlook. London has retained its position as the world’s second largest (or most important) financial centre and the most important in Europe, and there was a strong sense among the witnesses we spoke to that the sector has retained its resilience. However, the Government must ensure that its approach to financial services delivers for the whole country and the whole economy as well as the City of London.

Equivalence

A notable dimension of the current UK-EU relationship in financial services is the absence of EU equivalence decisions. This is particularly striking when set against the EU’s approach to other third countries (as well as the UK’s own approach to equivalence vis-à-vis the EU). The Committee found a consensus among its witnesses that this approach by the EU is political rather than technical and that the UK is being held to a higher standard than other countries.

Some of the missing equivalence decisions would be mutually beneficial for the UK-EU trading relationship in financial services. But the sector does not seem to view either the general lack of equivalence decisions or the competitive imbalance compared to other third countries as a matter of fundamental concern. Moreover, as equivalence decisions are unilateral in nature, the Government’s ability to rectify the absence of EU decisions is limited. The Committee concludes that it would be unwise for the Government to base its strategy for financial services on a process that it cannot control, and which currently seems unlikely to bear fruit.

Regulatory cooperation

The UK and the EU committed, alongside the TCA, to a Memorandum of Understanding (MoU) on regulatory cooperation, yet this has still not been signed or entered into force. The Committee regrets this and notes the widespread view that the MoU has become a casualty of wider tensions between the Parties. As with equivalence, comparisons with other third countries are striking; both the UK and the EU have mechanisms for regulatory cooperation with the USA that they do not have with each other.

The Committee acknowledges that the lack of the MoU does not appear to have caused major problems so far, particularly as a series of other MoUs for technical cooperation between regulators are in place. Nevertheless, the Committee believes that the MoU would still have value as a mechanism for strategic dialogue. We therefore caution the Government against complacency in this area. We also call on the Government to step up its political and diplomatic financial services engagement with the EU.

Regulatory reform and divergence

Having onshored the EU’s regulatory framework for financial services at the point of Brexit, the UK’s current rules for financial services are very closely aligned with those of the EU. The Committee welcomes the short-term stability that this has provided but recognises that it has resulted in a complex and unwieldy regulatory framework. To rectify this, the Government is seeking to give more powers to financial services regulators. While this may allow for more flexible and proportionate regulation, greater powers for the regulators must be accompanied by appropriate mechanisms for scrutiny and accountability. The Government is also considering introducing an additional ‘competitiveness’ objective to the remit of the regulators; this has been the subject of debate and the Committee has asked the Government to clarify how this would operate in practice.

The Committee welcomes the launching of a number of reviews into the future regulation of financial services in the UK. We await the Chancellor’s first annual ‘State of the City’ report, as recommended in the UK Listings Review, and recommend that the first five editions of this annual report include a dedicated section on the UK-EU relationship on financial services. More broadly, the Committee agrees with its witnesses that divergence between the UK and the EU is inevitable and may present the UK with opportunities to innovate and tailor the UK’s regulation to its own interests. However, it also stresses that the Government needs to weigh up the benefits of divergence against other factors including the costs of implementing new rules.

Divergence is also likely as the result of developments in the EU, particularly the emphasis placed by the EU on ‘open strategic autonomy’. This focus on control and market location is philosophically different to the UK’s approach, and we are concerned that it could increase barriers to cross-border trade in financial services. The UK has inevitably lost influence in the development of future EU rules post-Brexit, but we are concerned that the Government appears unwilling to utilise the influence it still has and have asked it to clarify its position. This is part of a detectable theme that emerged in other areas of our inquiry: that the Government is reluctant to fully engage with the importance of the UK-EU relationship, or to acknowledge that developments in the EU still have significance for the UK.

Opportunities

As well as adapting its existing regulatory framework, there are also opportunities for the UK to establish new rules in forward-looking and novel areas where there is currently limited regulation, particularly in the areas of financial technology (‘FinTech’) and green finance. In both areas the UK has already shown ambition and creativity, which we welcome.

Another potential Brexit opportunity is the pursuit of new trade agreements with third countries. Free Trade Agreements often make little provision for financial services, but the Government is exploring alternative approaches, most notably by negotiating a Mutual Recognition Agreement (MRA) with Switzerland. The Committee welcomes this ambition and hopes that an agreement is concluded swiftly.

More broadly, the Committee welcomes the Government’s open and non-reciprocal approach to financial services, though we urge them to continue to recognise the importance of immigration and access to talent in ensuring the sector remains open for business.

Conclusion

Overall, the outlook for financial services after Brexit seems relatively positive. Most of the Committee’s witnesses were optimistic about both the Government’s approach and future opportunities more broadly, marking a contrast to some of the other sectors of the economy that this Committee and others have examined. However, the UK is at an early stage of the adjustment to life outside the EU and there is no room for complacency, particularly as the impact of Brexit on the sector has not yet fully played out. We therefore urge the Government not to disregard the importance of a cooperative and constructive UK-EU relationship in financial services.