What will happen to UK financial services after Brexit? In the midst of disputes over fishing, automobile manufacturing and agriculture, financial services have faded from the public. Regardless of whether Britain and the EU reach an agreement, Britain will regain control of the city's ability to regulate from this December.
In a speech last week, Rishi Sunak outlined a number of areas in which he intended the UK and EU regulations to differ. Since access to the EU markets is based on statements from both sides stating that different rules are "equivalent" – that is, their effects are good enough without full alignment – this is perfectly compatible with the parties working in other areas to reach an agreement.
Britain has asked for a new kind of mutually agreed "permanent equivalence", but Europe would be crazy to agree to that. Equivalence with Europe is regulated in the usual way: situationally at the discretion of the Commission.
The great positive thing about declarations of equivalence is that they allow two regulatory systems to differ slightly while maintaining mutual access. The downside for Britain is that the need to grant equivalence gives the Commission a huge impact on the city that it will be happy to use.
Brussels has recently empowered European regulators to continuously monitor recipients of equivalence statements to see how 'equivalent' they are. Only last year did the EU expire a declaration with Switzerland after the Swiss parliament had not ratified a trade agreement. The disadvantage of equivalence for Europe is that it could work. Or, as the European Capital Markets Institute puts it, "equivalence does not prevent British financial institutions from moving to the EU".
With Britain and the EU currently having the same rules, equivalence is not a problem, but neither British nor European financial regulation will stand still. The current regulatory landscape on the financial markets is dominated by an extensive law called Mifid II.
Mifid II is not perfect, but it has increased transparency and contributed to market efficiency. It is also the most beautiful thing, a European regulation that does not really undermine national sovereignty and in a way actually strengthens it. Mifid II was managed by the British in Brussels through both the Financial Conduct Authority and British employees.
As the British leave and take their opinions away, the Commission is under pressure to reform Mifid II as it leads the way towards a European Capital Markets Union. The Commission and ESMA, the European regulator, are being attacked on all sides by eloquent national regulators and lobbyists in order to achieve personally beneficial regulatory changes on behalf of European unity and "end investors".
Although there are exceptions, resistance to national or corporate pressure is not a major strength of European regulators. Systematic internalizers (SIs) are an example. SIs were first created by Mifid I (the predecessor of the current regulations) and essentially enable banks and private companies to operate their own mini exchanges. They work with another form of exchange called the "dark pool" so that companies can act as efficiently as possible. The London Stock Exchange realized some time ago how the wind was blowing and bought its own dark pool, Turquoise, which is the market leader today. Deutche Bourse and Euronext did not do this, and wherever the two European stock exchanges go is followed by the German and French regulators.
Dark pools and SIs are currently also being examined by ESMA. This has made it possible to increase their reporting requirements and limit the types of orders they can process to only large-scale orders.
In recent years, the British have tended to understand better than their European counterparts that the purpose of financial regulation is not to protect the market as it is, but to enable it to develop and improve in a way that is fair for all participants. One of Mifid II's greatest accomplishments has been to force banks to invoice investment research separately, and to require asset managers to make their own decisions or pass costs on to customers separately.
Research unbundling has been strongly endorsed by the FCA to increase transparency in financial services. The Commission is now proposing that banks do free research on small businesses to help corona viruses recover. Which is not the case, especially since the entire concept of written business-oriented research is no longer up to date anyway.
However, European regulators, particularly the French AMF, which weren't big fans of the requirement from the start, were convinced that the change would boost growth and support traditional research providers. So here we are.
Whenever the Commission changes the rule, the UK could only sigh and copy it. The Chancellor's speech makes it clear that Britain is likely to move in the opposite direction. The process of translating European legislation into British law has significantly strengthened the role of British politicians in financial regulation.
The Chancellor's speech shows that he will not miss the opportunity. Sunak referred to insurance capital requirements and an extremely complicated rule that would have resulted in unsuccessful transactions that failed because the UK would try to deviate from Europe. None of the rules have been passed taking into account the interests of the UK. At best, this heralds a world in which Britain and the EU have competing, but generally "equivalent" regulatory structures. If the experience of financial regulation in recent years has mattered, this is a world where Britain can expect very good results. And that is the problem for the EU.
A French source points out an important truth about the European Commission: it is under structural pressure to change things, as any change made at a pan-European level strengthens the European project. In practice, it will be difficult to achieve a European Capital Markets Union if the center of European capital is outside the EU's regulatory orbit.
The UK has two options, one deeply uncomfortable and the other extremely risky: accept ill-considered regulatory changes that it does not like to violate its own interests, or ignore them and risk Europe panicking and withdrawing market access .
We can now be pretty sure what the government's decision is, and it's hard to argue that it's not the right one. However, regulatory competition and regulatory equivalence are unlikely to happily coexist.