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The UK-EU relationship in financial services Contents

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Chapter 4: Regulatory reform and divergence

Onshoring of EU legislation

135.Until the end of the Withdrawal Agreement transition period on 31 December 2020, the rules governing the UK financial services sector were derived from EU legislation.

136.At the end of the transition period, in order to prevent systemic financial instability through regulatory uncertainty and the need for rapid and significant regulatory change, the UK converted EU legislation into UK domestic law through a process commonly termed ‘onshoring’.174

137.As a result of the onshoring process, most of the body of UK financial services regulations remain closely aligned with EU law, at least for now. Edwin Schooling Latter of the FCA said that there had been “marginal bits of divergence” so far but that “99.5%” of the UK’s framework remains aligned with the EU.175

138.This approach to regulation was welcomed by witnesses, who noted that onshoring successfully limited regulatory uncertainty at the point of the UK’s EU exit. Peter Bevan of Linklaters, for example, noted that there “was overwhelming welcome [in the City] for the idea that the body of EU law should be retained as is at the point of departure.”176 Caroline Dawson of Clifford Chance similarly noted that “consistency initially was key. No one was keen to see the general upheaval, and on top of that … a wholesale implementation project”.177

139.However, whilst the onshoring of EU legislation was viewed as successfully preventing significant and rapid regulatory changes at the point of the UK’s departure, concerns remain that the newly onshored EU regulation, termed the inherited acquis, is not the most appropriate long-term regulatory regime for the UK financial services sector outside the EU.

140.Witnesses noted that, because of differences in the legislative systems of the UK and the EU, particularly given the latter’s need to operate across (formerly) 28 Member States, the regulatory framework currently in operation in the UK is not clearly and appropriately separated between primary and secondary legislation. For example, Caroline Dawson described the current rulebook as “all over the place”:

“We have regulatory rules, primary legislation, secondary legislation, secondary legislation inherited from the EU and secondary legislation with the force of primary legislation, so the ability for the regulators to waive parts of their rulebook that they have traditionally been able to waive is limited”.178

141.The regulators themselves acknowledged the imperfections of the onshoring process. Sam Woods of the PRA described it as follows:

“What we did in the onshoring was a necessary way to do it at speed, and it has created a viable framework that we are both operating today, but it is extremely complex and unwieldly because of the way in which the rules spread across these different parts of our rulebooks and different layers of law. That makes it difficult to update and very hard to navigate”.179

For the FCA, Edwin Schooling Latter similarly argued that the “overarching framework works. It functions … but it is clunky because bits of it were designed for a multilateral world and a whole EU market, whereas we have a single country and a differently shaped market”.180

Box 1: The role of the UK regulators

The Financial Conduct Authority (FCA) The FCA is the conduct regulator for UK financial services firms.181 According to its website, it regulates the conduct of around 51,000 businesses, prudentially supervises 49,000 firms, and sets specific standards for around 18,000 firms.182 Firms and individuals need to be authorised or registered by the FCA in order to carry out certain activities, and once authorised they need to continue to meet FCA standards and rules. The FCA’s strategic objective is to ensure relevant markets function well, and its operational objectives are to protect consumers, protect financial markets, and promote competition in consumers’ interests. The Prudential Regulatory Authority (PRA) Prudential regulation focuses on the financial safety and stability of institutions and the broader financial system. In the UK, the PRA is part of the Bank of England, and supervises around 1,500 financial institutions including banks, building societies, credit unions, insurers, and major investment firms. The PRA, together with the Bank of England’s Financial Policy Committee, focus on micro-prudential regulation (individual institutions), whereas the Bank’s Prudential Regulation Committee focuses on macroprudential regulation (system-wide). Sam Woods of the PRA characterised his organisation’s role as follows: “We are interested in things such as whether [firms] have enough capital to absorb losses, whether they have liquidity for runs and whether the people running those firms are competent and know what they are doing.”183 Woods also summarised the difference between the PRA and the FCA: “We are responsible, primarily, for firms not going bust in a way that is uncomfortable. Edwin [Schooling Latter] and his colleagues are responsible for the conduct and behaviour of those firms”.184 The relationship between the regulators The FCA and the PRA were both established in 2013 after the Financial Services Authority (FSA) was disbanded, with its functions split between the FCA and the PRA. The two are separate entities but work together on certain issues. An MoU between the FCA and the Bank of England, including the PRA, sets out the different mandates of the two regulators. Under this MoU, the FCA is responsible for regulation of organised financial markets and the conduct of participants in relation to financial instruments and derivative contracts. The Bank is responsible for the oversight of clearing, settlement, and payment systems in support of its financial stability objective, and the PRA is responsible for the prudential supervision of many of the firms that participate in said systems.

The Future Regulatory Framework Review

142.The Government’s proposals for adapting the UK’s regulatory framework for financial services outside the EU are set out in the Future Regulatory Framework (FRF) review, published in November 2021.

143.The FRF forms the regulatory dimension of the plans for the financial services sector articulated in the Chancellor’s July 2021 Mansion House speech and related paper, A new chapter for financial services. There are a number of proposals contained within the FRF but the overall aim is “to achieve an agile and coherent approach to financial services regulation in the UK, with appropriate democratic policy input to support a stable, innovative and world leading financial services sector”.185 To achieve this, the Government intends to transpose large parts of the financial services regulatory framework from legislation to the regulators’ own rulebooks. The first consultation on the proposals closed in February 2021 and a second consultation closed in February 2022.

144.Although the retention in primary legislation of key aspects of EU financial services law at the point of the UK’s departure from the EU was the right decision for regulatory stability, it now means that the UK regulatory framework for financial services is complicated, unwieldy, and difficult to amend. Accordingly, the Committee welcomes the Government’s Future Regulatory Framework Review.

A competitiveness objective

145.The second consultation on the FRF set out proposals to introduce a new statutory objective for the FCA and the PRA requiring the regulators to facilitate the long-term growth and international competitiveness of the UK economy, including financial services. The consultation proposes subordinating this new objective to the primary objectives of soundness, stability and resilience of markets and financial systems. This means that regulators would have to prioritise their primary objectives in the pursuit of this ‘secondary’ competitiveness objective.

146.The regulators themselves welcomed the proposals to position competitiveness as a secondary rather than primary objective. For the FCA, Edwin Schooling Latter noted that “having regard to sustainable economic growth in the UK economy is not something new to our set of aims”, adding that a secondary objective struck “an appropriate balance”. He went on:

“If the competitiveness objective were put on equal footing with consumer protection and market integrity, there would be conflicts between these … a primary competitiveness objective would pose some interesting dilemmas, and there would need to be a lot of thought about how we as regulators were expected to balance those”.186

147.For the PRA, Sam Woods went further, arguing that a “primary objective to promote competitiveness is genuinely a bad idea”. In particular, he noted how it could present challenges to ensuring that the UK was respected as a well-regulated financial services jurisdiction in international regulatory fora, with implications for the UK’s influence in leading the development of international standards in those settings. He stressed:

“we invest a huge amount up stream in international rule-making—the Financial Stability Board, the Basel Committee, the International Association of Insurance Supervisors. I am certain that, if we had a primary objective to promote, say, the international competitiveness of UK financial services firms, our authority in those fora would be quite heavily reduced.”187

148.Michael Dobson, then of Schroders plc, articulated the contrary position, stating that a competitiveness requirement “should be a primary objective. Competitiveness is very definitely not about lower regulatory standards, and I see no conflict between looking after the interests of consumers and London being a very competitively successful global financial centre”.188 Lord Hill, former European Commissioner for Financial Services, agreed: “It seems to me that if it is the wrong objective you should not have it as an objective or you might as well make it a primary objective”.189

149.Separately to a formal objective for competitiveness, other witnesses stressed the importance of the UK’s wider regulatory culture in supporting the UK’s competitiveness.190 Innovate Finance, which represents the FinTech sector, stressed that “the new objectives will only be successfully applied if accompanied by a culture (behaviours and incentives, at all levels of the organisation) that supports them”.191

150.The Economic Secretary confirmed that the Government’s intention is to identify competitiveness as a secondary objective for the PRA and the FCA and warned that “significant dangers emerge from thinking that primary competitiveness has no adverse consequences”.192 This objective will be included in the Financial Services and Markets Bill as set out in the Queen’s speech on 10 May 2022.

151.The Committee notes that, as a result of the Future Regulatory Framework Review, the Government is considering introducing an additional, secondary ‘competitiveness’ objective for the Financial Conduct Authority and the Prudential Regulation Authority. However, it is equally important for the UK’s overall economic competitiveness for the Government and regulators to work together to develop a broader regulatory culture that is responsive, consistent, and proportionate.

152.We ask the Government, in its response to this report, to explain in further detail how a secondary ‘competitiveness’ objective would be applied by the regulators in practice and how success will be measured.

Scrutiny and accountability of regulators

153.With respect to retained EU law,193 the FRF sets out proposals to move regulatory requirements from statute to the regulators’ rulebooks through a programme of secondary legislation. It is anticipated that this will be a time-consuming process, possibly taking several years.194

154.Representatives of the regulators told the Committee that the aim of the FRF was to make regulation “a more coherent process”. Regarding the transposition of powers to the regulators, Sam Woods argued that “the EU method of having a lot in legislation was to make sure that all the countries in the EU do the same thing”, and that this rationale no longer applied to the UK post-Brexit.195 Sir Jon Cunliffe of the Bank of England added that there were advantages to this approach, as “regulators’ rulebooks are more flexible” than primary legislation.196

155.Witnesses from the sector were broadly supportive of the Government’s approach to the FRF. Michael Dobson said that Schroders plc “support the proposal that much of the detailed regulation should be the responsibility of the regulator rather than enshrined in legislation”.197 Caroline Dawson described the benefits of the proposal in further detail, arguing that it would be:

“consistent with the UK’s traditional approach to financial services, which is having a framework piece of legislation and then delegating powers to the regulators, with appropriate safeguards, so that the regulators, which have the day-to-day supervisory experience and the in-depth knowledge of the financial markets, are the ones writing the rules rather than taking up parliamentary time. That makes a lot of sense.”198

156.However, a number of witnesses recognised that such an approach would require a system for ensuring that there was “adequate scrutiny and accountability” of the regulators,199 particularly for avoiding the risks associated with regulatory capture.200 Stéphane Boujnah of Euronext, for example, described a “balance between what you gain in agility and what you lose in accountability and democratic input.”201

157.Representatives of the regulators and the Government seemed alive to scrutiny and accountability considerations. Sam Woods, for example, said that “parliamentary accountability, clear objectives, public reporting and all those sorts of things are a very important control”.202 In a similar vein, the Economic Secretary emphasised the need to “get the balance between the right of Parliament to call the regulators to account”, respecting “the credibility of regulators as independent, very professional and well-respected entities”, and “the freedom to move nimbly to deal quickly with some of the changes that emerge”.203

158.Witnesses also cautioned that greater responsibilities would require regulators to have sufficient staff and resources and to undertake the additional work involved. Andrew Pilgrim of EY noted that “we have excellent regulators but they also risk being short on resources”.204

159.Sam Woods told the Committee that, currently, the PRA had a “budgeted headcount … of 1,340 FTEs”205 and that this “is enough to do the job”. He went on to comment, however, that: “We do, though, need to staff up if Parliament approves this proposal to give us a bigger rule-making responsibility … we are in a very challenging environment from a recruitment and retention point of view”.206 Edwin Schooling Latter added that the FCA faced similar challenges.207

160.The Committee agrees with the Government that, in the interests of flexibility, agility and proportionality, many of the regulations currently contained within primary legislation would be more appropriately managed by the regulators themselves. However, it is essential that this transfer of powers is accompanied by appropriate mechanisms for Parliament to scrutinise the regulators and hold them to account, and that the regulators are given sufficient resources to allow them to accommodate the increase in their workloads resulting from such a change.

161.The details of parliamentary scrutiny and accountability of the regulators are a matter for Parliament, but we ask the Government to commit to facilitating the establishment of appropriate mechanisms as necessary.

Regulatory alignment and divergence

162.Beyond the general regulatory framework set out in the FRF, the Government has launched a number of reviews and consultations that seek to develop the regulation of the UK’s financial services in ways that support the Chancellor’s New chapter for financial services (see Table 1).

Table 1: Status of selected UK financial services regulatory reforms, May 2022

Regulatory Review	Status	Implementation
Future Regulatory Framework Review208	Consultation on proposals closed February 2022.	Government analysis of the consultation is ongoing.
UK Wholesale Markets Review209	Treasury responded to consultation in March 2022.	A number of changes scheduled ‘when parliamentary time allows’.
Solvency II Review210	Call for evidence concluded.	Ongoing—a comprehensive reform package opened for consultation in April 2022. Reforms will be included in the forthcoming Financial Services and Markets Bill.
Review of Overseas Framework211	Consultation concluded. Response published July 2021.	Further consultation expected and assessment ongoing.
UK regulatory approach to crypto assets and stablecoins212	Consultation concluded March 2021. Response published April 2022.	Further specific consultation expected alongside legislation to bring specific stablecoins within the payments framework.
Fintech Strategic Review (Kalifa Review)213	Review published February 2021.	Partially implemented to date.
Review of UK Funds regime214	Summary of responses published February 2022.	Further consultation and specialized reviews required.
UK Listings Review215	Concluded, government response updated April 2021.	Ongoing. Implementation is split between the FCA and HM Treasury.
Payments Landscape Review216	Consultation concluded. Response published October 2021.	Ongoing.
Implementation of the Investment Firms Prudential Regime and Basel 3 Standards217	Consultation concluded April 2021.	Ongoing.
UK prospectus regime consultation218	Outcome published March 2022.	Legislation expected when parliamentary time allows.

Planned UK regulatory reforms

The Listings Review

163.In a statement to the House of Commons on 9 November 2020, the Chancellor of the Exchequer, Rt Hon Rishi Sunak MP, announced that he would be “setting up a taskforce to make recommendations early next year on our future listings regime” in order to “boost the number of new companies that want to list here in the UK”. 219 This review was chaired by Lord Hill.

164.The independent report of this review was published in March 2021. It made 14 recommendations for reforming the UK’s listing regime. These aim to make the UK more attractive for companies planning to list shares to raise capital, particularly technology and life science companies.

165.Lord Hill emphasised to the Committee that many of the recommendations made in the Listings Review were “rules that we could have chosen to change at any time we wanted to, in or out of the EU, and we had not”.220 He also said that the concerns over the competitiveness of the UK’s listing regime which had triggered the review were only partly related to the UK’s departure from the EU: “I do not think that you can say it has zero effect, but when during the review I was talking to founders [of companies] no one said, ‘I have been put off [the UK] because of Brexit’.”221

166.The Review includes a recommendation that the Chancellor present an annual ‘State of the City’ report to Parliament. The Chancellor has agreed to deliver the first of these in 2022.222 In evidence, Lord Hill said that this should:

“put some scaffolding in place whereby the Government and the City and the regulators, all in one place, would have to ask themselves once a year, ‘How have we done?’, ‘Have the changes we have made over the last year worked?’, ‘What has worked?’, ‘What has not worked?’, ‘What can we do better?’, to try to keep the feet of government and regulators to the fire.”223

167.The Committee recognises the need for continued scrutiny of ongoing and future developments that might affect the sector. In this regard, we welcome the Chancellor of the Exchequer’s commitment to make an annual ‘State of the City’ report to Parliament, as proposed by Lord Hill in the UK Listings Review.

168.The Chancellor has committed to presenting the first of these ‘State of the City’ reports this year, but it is unclear when this will be; the Government should provide clarity on this. We recommend that this report includes for at least the next five years a section dealing expressly with the UK-EU relationship in financial services.

Wholesale Markets Review

169.In line with the wider New chapter for financial services, HM Treasury launched a review for consultation of the UK wholesale markets regime in July 2021, which closed in September 2021.224 The proposals are wide ranging and cover issues such as the derivatives trading obligation, which determines where derivatives can be traded, and the production of market data. They also clarify what is and is not included within the scope of FCA regulation.

170.In November 2021, at a speech to UK Finance, the Economic Secretary emphasised the Government’s intention to legislate as soon as possible for changes arising from the consultation, to make changes to the transparency regime for fixed income and derivatives markets to “remove unnecessary burdens for firms”, and in line with the UK Listings Review, to introduce a “simpler, more agile and more effective” approach to listings with the aim of making it easier for firms of all sizes to raise capital.225

171.The Wholesale Markets Review was widely welcomed by witnesses. For example, Sir Jon Cunliffe noted that “the Wholesale Markets Review, which the Treasury is carrying out, will also be of benefit, because at the moment access to the UK market is a bit like a series of archaeological layers”.226

Solvency II Review

172.The Government is also currently running a consultation as part of its review of the Solvency II regime, which governs the prudential regulation of insurance firms in the UK. It was highlighted to the Committee that the EU is also reviewing its own legislation in this area, creating a potential point of divergence.227

173.The Government recently announced that the forthcoming Financial Services and Markets Bill will include an overhaul of the Solvency II regime. In his evidence, the Economic Secretary described these reforms as “massively important”.228

174.The Committee welcomes the launch of a series of reviews into the regulatory framework governing financial services that the UK inherited from the EU. The Committee is concerned, however, that progress on some of these reviews appears to have stalled.

175.The Committee asks for an update on the progress of the various reviews into the regulation of financial services in the Government’s response to this report.

Further UK-driven divergence

176.In its written evidence to the inquiry, New Financial saw divergence between the UK and the EU as taking “several forms”, as follows:

• Passive divergence: the gradual cumulative effect of both the UK and EU making minor changes to their existing rulebooks.
• Accidental divergence: by moving at different speeds in reviewing and reforming their frameworks, one side may reform before the other, causing a period of divergence.
• Parallel divergence: the UK and EU are reviewing many of the same areas of regulation (such as Solvency II for insurance, Basel 3 for banking, and MiFID II for markets). In most cases, both sides are likely to diagnose the same problems, but differ in the solutions they enact.
• Active divergence: In the past few years, the UK government has launched a wide-ranging series of reviews into different aspects of the supervisory and regulatory framework that the UK inherited from the EU, with the conscious aim of taking a different approach to that of the EU in various areas.229

177.There was general agreement that, in the absence of widespread equivalence decisions, and as regulatory rulebooks were updated by both the UK and the EU in the future, a degree of regulatory divergence was inevitable.230

178.Both the regulators and the Government, however, were keen to emphasise that divergence and reform on the UK side did not mean lower standards. For the FCA, Edwin Schooling Latter stressed that “we are talking about evolution rather than revolution of the rulebooks and still achieving the same outcomes in terms of consumer protection and market integrity”.231 For the Government, the Economic Secretary said he had “never sought to describe the UK’s financial services policy as one that would be based on deregulation, a race to the bottom or somehow trying to secure competitive advantage by removing regulations.”232

179.The Committee did not hear significant support for maintaining close regulatory alignment with the EU. Caroline Dawson, for example, said: “As we have gone further forward and realised that equivalence is not going to be given … the benefits of remaining aligned seem less and less.”233 Sir Jon Cunliffe stressed that for financial stability reasons, the Bank of England would not “make it an objective to line up our regulation with another jurisdiction”, be that the EU or another third party.234

180.There was also general positivity about the potential opportunities that divergence from the EU might bring, particularly in allowing the UK to tailor regulation to its own needs and innovate at speed. Peter Bevan summarised this: “The ability to not have to compromise with 27 other Member States but to target regulation specifically to our own needs, and to do it faster than might be possible within EU frameworks, is something that we need to capitalise on.”235

181.However, witnesses also tended to agree that divergence needed to be considered and managed carefully. Michael Dobson’s comments were typical: “divergence between the EU and the UK is inevitable, but in our view it is important that it happens knowingly rather than by accident and that we avoid a change for change’s sake approach”.236 For the PRA, Sam Woods sought to reassure: “we will not diverge just for the sake of it. We will just do it where it is necessary”.237 The Economic Secretary was also emphatic on this point: “I have never wanted to diverge for the sake of doing something differently”.238

182.Witnesses were clear that updating the UK’s regulatory framework needed to be done in a considered manner in order to avoid additional cost and uncertainty for businesses through a prolonged process of piecemeal regulatory reform. As Caroline Dawson noted, “you have to be very careful about how you make these changes. You do not want, essentially, a constant implementation project for the entirety of the financial sector”. She added that “implementation projects are expensive, so, whatever changes the Government make, you need to balance that consideration of the benefit that the change is going to bring versus the cost of implementation.”239

183.The Committee also heard that, although some of the regulations within the inherited acquis are not popular within the sector, firms have already borne the cost of adapting to them, meaning that further changes at this stage could lead to additional costs. Caroline Dawson noted that there were “a lot of things that people found objectionable about Solvency II but, once the industry has gone through the process of implementation, the answer is not necessarily to say, ‘It’s fine, we can scrap the lot of it.’”240 Michael Dobson made a similar point with regard to the EU’s Alternative Investment Fund Managers Directive (AIFMD): “We have suffered the cost of implementing that, and undoing it now would cost more, for little benefit”.241

184.Citing a further piece of EU legislation, the Markets in Financial Instruments Directive (MiFID), the Economic Secretary suggested that he sympathised with concerns over implementation costs: “a lot of people did not like MiFID or how it ended up, but a lot of those people then had to implement it”.242

185. Some witnesses also warned that the impact of divergence on trade needed to be considered carefully. Caroline Dawson said: “Where you end up with divergence being a problem is where you cannot easily comply with one set of regulations … If you have duplicative or conflicting regulation, that presents a barrier to and increased costs for cross-border business”. Peter Bevan added that additional complexity in cross-border business “stifles innovation”, and that therefore “introducing additional complexity through divergence between the UK and the EU is something that we should consider in a targeted way”.

186.This is not to say, however, that there is an automatic relationship between alignment/divergence and barriers to trade when it comes to financial services. New Financial argued that “the trade-off between access and divergence …. is a false dichotomy”.243 Sir Jon Cunliffe pointed out that the UK “manages to have more financial services trade with the US than with the EU—marginally more—without any regulatory alignment at all”.244

187.Diverging from EU law may present opportunities for the UK’s financial services sector, and the Committee notes the sector’s positivity about pursuing these opportunities. Much of the inherited acquis was designed to cater to 28 countries, and Brexit provides an opportunity for the UK to innovate and to tailor the regulation of its financial services sector to reflect the UK’s own interests.

188.It is nonetheless vital that the Government balances the benefits of reform against the cost of implementing new rules, and that the sector is not now subject to a constant process of piecemeal change. Some pieces of EU regulation were unpopular with businesses when they were implemented but are now regarded by the sector as a sunk cost, further reform of which would impose an additional, unnecessary cost burden on the sector.

EU-driven divergence

189.The Committee also took evidence on the EU’s own plans for reforms to its regulation of the financial services sector. In some areas, these reforms reflect developments in the UK. As Stéphane Boujnah noted, “there are similar debates on the other side of the channel and in the Republic of Ireland”.

190.However, the EU’s own reviews are underpinned by its aim of wider ‘open strategic autonomy’, particularly in relation to the development of its capital markets, where it still relies on access to the market liquidity of London. Stéphane Boujnah noted that “we are now focusing on building the capital markets union and building strategic autonomy in competing against US-based institutions”.245

191.Stéphane Boujnah also noted that the UK’s exit from EU discussions and decision-making had changed the EU’s approach to the regulation of financial services:

“the fact that the UK is no longer round the table changes a lot when it comes to financial regulation … the main difference between the pre-Brexit world and the post-Brexit world is that, in the pre-Brexit world, having London as the largest financial centre of the European Union was something like natural specialisation, and it was okay. Post-Brexit, Europe has to make sure that, within the European Union, there is full architecture, from a regulatory and an operating point of view, to allow for a situation where Europeans have some form of control over key pillars of the finance of EU economies … That is what open strategic autonomy is all about when it comes to financial services”.246

192.Witnesses viewed this focus on strategic autonomy, and the emphasis on ensuring key elements of financial services infrastructure are located within the EU, as differing from the UK’s post-Brexit approach of developing an internationally open financial services sector. Some were worried that the EU’s approach could have adverse consequences; for example, Miles Celic of TheCityUK said he was “concerned that in the EU it is more about protectionism”.247 Sir Jon Cunliffe argued: “If the whole world pursued strategic autonomy in financial services, we would lose a lot of the benefit of a global integrated financial system”.

193.Witnesses also warned that, as a result of Brexit, the UK’s ability to influence the future direction of EU regulation was diminished.248 Caroline Dawson said that the UK had “lost a huge amount from not being able to influence that debate” in the EU, explaining:

“In terms of advocacy, it is a much more persuasive argument, if you are within the EU, to say, ‘We should be open to the outside world’, than being right on its doorstep and saying, ‘You should be open to the outside world’. Clearly, it is a very different argument. In terms of cross-border business, that is clearly a lost opportunity for influence.”249

194.The Committee asked the Economic Secretary about the impact of future EU regulatory changes on the UK, and whether the Government was taking any steps to influence the EU’s regulatory process in areas of concern, as other third countries do. The Economic Secretary seemed dismissive of the idea that the UK would seek to influence EU regulation, telling the Committee that he was “not the Financial Services Minister for the EU” and that, while he had had “pretty thorough engagement” with his EU counterparts, “we have left the EU … we are not part of the decision-making process of evolving EU directives.”250

195.UK-EU divergence will also be driven by future regulatory changes on the part of the EU. The Committee notes the contrast between the UK’s approach of an internationally open financial services sector and the EU’s prioritisation of control and market location as part of its drive for ‘open strategic autonomy’ and is concerned that the latter could lead to increased barriers to cross-border trade in financial services.

196.After the UK’s exit from the EU, it was inevitable that the UK would lose the ability as a Member State to influence the EU’s legislative processes directly. Nevertheless, the Committee is concerned by the Government’s apparent unwillingness to use its wider influence and diplomatic resources in order to engage with the EU and its institutions to further the UK’s interests, as other third countries do.

197.The Committee asks the Government to clarify its approach to engaging politically and diplomatically with the EU and its institutions to support and advance the interests of the UK’s financial services sector in the EU’s legislative decision-making processes.

International standards

198.Witnesses broadly agreed that the UK should pursue international dialogues and cooperation in order to shape international regulatory standards in ways that would best support UK financial services.251 This was noted in relation to the competitiveness objective for UK regulators discussed above, but also with respect to the importance of UK regulators being able to shape international standards.

199.Edwin Schooling Latter predicted that, “if you take a multidecade view of this and a longer perspective, because of all the work that we are doing along with others on convergence internationally … you are seeing convergence rather than divergence across jurisdictions.”252 Michael Dobson expressed his organisation’s support for this approach: “We are strongly in favour of more global convergence and we are pleased to see the commitment of the UK authorities towards leading global cooperation and standard setting.”253

200.Notwithstanding the inevitability of UK-EU divergence on the details of financial services regulation, and the opportunities this is likely to afford the UK’s financial services sector, in the long-term, the Committee considers that there is a strong case for pursuing global convergence on the principles and outcomes of the regulation of financial services.

Data adequacy

201.As part of its examination of the impact of potential regulatory divergence on the financial services sector, the Committee’s inquiry examined the future of the current UK-EU data adequacy arrangements (explained in Box 2 below), in the context of the Government’s plans for reform of its data protection regime, and the impact thereof on the UK financial services sector.

202.The Government has indicated that it sees diverging from inherited EU data protection laws as one of the opportunities of Brexit. The Government’s ‘Benefits of Brexit’ report, published on 31 January 2022, set out its intention to establish a “new pro-growth data regime” which would “help to drive growth, innovation and competition across the country”.254 In the Queen’s Speech on 10 May 2022, the Government announced that it would be bringing forward a Data Reform Bill, which will “take advantage of the benefits of Brexit to create a world class data rights regime that will allow us to create a new pro-growth and trusted UK data protection framework”.255

Box 2: Data adequacy explained

Personal data transfers from the EU to third countries, such as the UK, are governed by the 2016 General Data Protection Regulation (GDPR). Under GDPR, the EU Commission may unilaterally grant an ‘adequacy’ decision confirming that a third country provides a comparable level of data protection to that in EU law. This allows cross-border transfers of personal data from the EU to the third country without additional safeguards.256 The EU did not immediately grant the UK data adequacy following the end of the transition period, but the TCA contained a temporary bridging mechanism allowing for the continued free flow of personal data from the EU to the UK, conditional on the UK maintaining its existing levels of data protection and for a period of up to six months.257 On 28 June 2021, the European Commission adopted two data adequacy decisions, replacing the bridging mechanism in the TCA and allowing transfers of personal data from the EU to the UK to continue on a more long-term basis. One decision addressed data sharing on the basis of the EU’s General Data Protection Regulation, the other via the EU Directive on the transfer of data for the purposes of law enforcement.258 These adequacy decisions can, however, be withdrawn at any time—a credible scenario, given the recent case law of the Court of Justice of the European Union (CJEU) on data privacy matters.259 The adequacy decisions also automatically expire after four years, with any renewal contingent on whether the EU still deems the UK to have an adequate system of data protection in place. In his evidence to the Committee, the Economic Secretary described the adequacy arrangements as “strong” but acknowledged that they were “not an enduring, permanent recognition”.260 EU data adequacy decisions cover personal data transfers from the EU to the UK. Transfers in the other direction—from the UK to the EU—are not affected by this process. The UK Government has already implemented provisions permitting the transfer of personal data from the UK to the EEA.261

203.The UK-EU data adequacy arrangements are important for services providers involved in cross-border transfers of personal data, including some in the financial sector—particularly those in retail businesses who are involved in the handling of their customers’ data. In evidence to the former EU Services Sub-Committee’s report, Beyond Brexit: Trade in Services, Nick Collier of the City of London Corporation stressed that “financial services do not work without personal data, particularly in banking and insurance”.262 In this Committee’s inquiry, both Andrew Pilgrim and Miles Celic also emphasised the importance of data to the sector; the latter told the Committee that, for TheCityUK, “data is increasingly as important for our members as capital, if not more so”.263

204.It is important to note, however, that many UK and EU financial service providers do not handle personal data and/or do not transfer it across borders. They would, therefore, not be affected by the loss of adequacy. For Schroders, Michael Dobson told the Committee: “we do not hold personal data for the underlying investors in our funds and we do not process it on a cross-border basis so in, our view, that [loss of adequacy] would not be a problem for us”. Similarly, Stéphane Boujnah said: “There is no issue for Euronext as we do not transfer personal data related to market operations from the EU to the UK.”264

205.The withdrawal or non-renewal of data adequacy would not prevent EU-UK personal data transfers entirely, but firms would have to rely on alternative legal safeguards, particularly Standard Contractual Clauses (SCCs). Sam Woods highlighted that through SCCs, firms would still “be able to move data back and forth across borders in a GDPR-compliant way”.265

206.However, the former EU Services Sub-Committee previously found that these provisions make personal data transfers more “cumbersome and unwieldy” than under adequacy arrangements, and this was further corroborated during this Committee’s inquiry.266 Sir Jon Cunliffe warned that these fallbacks would not “provide the degree of frictionless passing of data that adequacy provides”, and concluded that as a result, data adequacy “might not be life or death, but … it would be important if it was not there”.267

207.In the run-up to the end of the transition period, the UK had yet to receive an adequacy decision. The Government and regulators therefore put plans in place for a ‘no adequacy’ scenario in which firms would need to rely on methods such as SCCs to transfer personal data from the EU to the UK. Sam Woods said that, were adequacy now to be withdrawn, “we would go back to that plan B and reactivate it”, adding, “that would work, but it would be undesirable”.268

208.The Economic Secretary told the Committee that “large UK [financial services] firms are well advanced in mitigating non-adequacy”.269 However, Sam Woods highlighted potential difficulties in ensuring EU businesses were prepared for such a scenario: “we can get the UK firms into shape, which is what we were doing before Brexit. Whether the EU firms would get into shape would rely on our fellow regulators and those EU firms.”270

209.The extent to which the Government is prioritising the retention of adequacy arrangements as it diverges from the EU data protection framework is unclear. In comments reported by POLITICO Europe on 21 April 2022, Chris Philp MP, Minister for Tech and the Digital Economy, said: “We intend to design our changes such that there is no reasonable technical basis on which the data adequacy decision could be revoked”.271

210.The Economic Secretary’s evidence to this Committee, however, was more equivocal, saying that the UK would “take decisions in due course on an ongoing basis that will reflect what is right for the UK interest”—though he did stress that the Government would not “wilfully deviate or complicate our situation for the sake of it”.272 For the FCA, Edwin Schooling Latter said he “would hope that the costs in the financial sector would be taken into account in the wider assessment of costs and benefits if a decision was made to move in that direction.”273

211.In terms of data flows between the UK and the EU, the Committee recognises the possibility that the Government’s plans for reform of the UK’s data protection rules could lead to the withdrawal or non-renewal of the EU’s data adequacy decision for the UK. This could have consequences for a range of service providers engaged in cross-border personal data transfers, including for some financial services providers, primarily those handling retail business.

212.The Economic Secretary told this inquiry that the decisions the Government will take on the UK’s future data protection regime will “reflect what is right for the UK interest”. In the Committee’s view, it is in the UK’s interest that it continues to benefit from the EU’s positive data adequacy assessment.

213.While the future of these adequacy decisions is ultimately a matter for the EU, the Committee urges the Government to ensure that it carefully considers the implications of losing data adequacy, including for the financial services sector, into its future changes to the UK’s domestic data protection framework, particularly under the forthcoming Data Reform Bill.

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