Neena Gill, CBE, MEP – Written Evidence (FRS0013)
1. What is your overall assessment of the EU’s financial services regime, in light of its current application to the UK? To what extent is it effective, and for whom?
When first conceived, the primary objective of EU financial markets regulation was the creation of a single market for financial services. Since the financial crisis of 2008, ensuring financial stability and strengthening investor and depositor protection have become the most important regulatory objectives. Current regulation therefore focuses on macro prudential oversight, in addition to micro prudential supervision, clearing, the settlement of financial transactions and investor ownership rights of financial instruments.
By striving to achieve all of these policy objectives - in line with internationally agreed commitments - the financial sector has become safer and more robust. This evolution serves the EU economy as a whole and the UK economy in particular. The sector contributes £124.2 billion in gross value added (GVA) to the UK economy, which is 7.2% of the UK's total GVA. The new regulatory framework makes the UK financial system more stable and protects tax payer’s money more effectively than it did pre-2008.
Obviously, no system is perfect, and every change brings some possible obstacles often raised by the industry. At present, the emphasis is on implementing and translating EU legislation into national law and adopting secondary legislation.
2. Are current EU proposals on banking and financial services in your view positive for financial stability? How do you expect the EU’s regulatory framework to evolve in the coming years?
Currently, several key legislative proposals are being discussed in the European Parliament and the European Council, each of which aims to strengthen the financial stability of the European Union (EU). Below the most critical proposals are noted:
Firstly, the ‘banking package’ proposals aim to update the Capital Requirements Regulation (CRR), Capital Requirements Directive (CRD), Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism Regulation (SRMR). Both of these contain crucial provisions aim to reduce the amount of risks in the EU banking sector, by building on the agreed global standards while taking into account the specificities of the European banking sector:
Secondly, the review of the European market infrastructure regulation (EMIR) regulation and the central counterparty (CCP) recovery and resolution proposal. Both proposals aim to strengthen the supervisory regime applicable to CCP’s and to establish a recovery and resolution framework for CCP’s which are failing or likely to fail, and this mainly in line with standards set at an international level.
Thirdly, the review of the European Supervisory Authorities (ESA) as proposed on the 20th September 2017 has the aim of extending the role of the ESA’s, increasing their budgets and improving their governance structure.
Each of the above proposals will positively contribute to the financial stability in the EU, assuming they are adopted and implemented across the Member States.
The banking package will play a significant part in contributing to financial stability given that it aims to reduce the risk that individual banks are exposed to and sets up a mechanism for the resolution of failing banks. The underlying objective is that the tax payer does not have to bail out banks anymore.
In line with this, the EMIR regulation will increase financial stability by more strictly supervising CCP’s; and by ensuring that proper recovery and resolution plans are in place for the unlikely case of a CCP exposed to failure.
The belief in the European Parliament is that stronger EU supervision is necessary and that this could contribute to the expansion of a capital market union (CMU). This will enable the EU economy to diversify its funding sources and to improve financial stability.
Given the significant amount of legislative initiatives adopted post crisis, the focus will shift in the coming years towards: more implementation; the review of existing legislation taking into account recent experiences (e.g. the Alternative investment funds managers’ directive (AIFMD); and the Undertakings for Collective Investment in Transferable Securities (UCITS) directive). Furthermore, the focus will also shift towards more secondary level legislation (delegated acts, technical standards etc.) and the implementation of these.
3. What are the key differences between financial regulation as agreed at the international, EU and UK levels, and where are the gaps? How important is it to maintain a level playing field for regulation?
The Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system.
The Basel Committee on Banking Supervision (BCBS) is the primary global standard setter for the prudential regulation of banks. It provides a forum for cooperation on banking supervisory matters. Its mandate is to strengthen regulation, supervision and the practices of banks worldwide, with the purpose of enhancing financial stability.
The International Organization of Securities Commissions (IOSCO) is the international body that brings together the world's securities regulators and is recognized as the global standard setter for the securities sector. IOSCO develops, implements and promotes adherence to internationally recognized standards for securities regulation.
In line with minimum standards set on the international level, the emphasis within the EU has traditionally been the integration of 28 national markets which differ substantially. However since the financial crisis, the main focus of the EU legislation has shifted towards creating more financial stability and investor/consumer protection (e.g. the recent resolution of Spanish and Italian banks in order to protect tax payers’ money). European legislation takes the form of either a regulation, which needs to be transposed directly by every Member State, or a directive, which leaves the Member States much more room for national discretion and implementation.
At the national level, the UK is often accused of ‘gold plating’ by adding layers on top of European regulation, in order to adapt to the specific UK context.
By trying to establish a functioning internal market and CMU, the EU aims to create a level playing field. This addresses the issues surrounding regulatory fragmentation and increasing funding sources for the SME sector. Of course an internal market will increase efficiency gains, choice and at the same time reduce costs for consumers. The objective of the EU regulation is to reduce regulatory competition and to avoid a race to the bottom amongst Member States in terms of attracting inward investment.
4. Are there any particular legal or practical challenges related to incorporating the existing body of EU financial services legislation into the UK’s domestic law, for example the PRA rulebook?
There should not be any practical or legal challenges given that the main part of the existing EU financial legislation has already been implemented by the UK. Therefore many of the EU rules are already applicable in the UK. It is important to note that this does not necessarily apply to laws that are being debated presently or to those that come into force after March 2019.
Banks and other financial institutions in the UK are preparing for a post-Brexit scenario. This has increased pressure on the prudential regulation authority (PRA), which has scrutinized the plans of 401 City firms to ensure each one was ready for Brexit and also to establish whether there were “broader financial stability risks, which could arise from the collective execution of the contingency plans”.
5. What would be the key priorities for a transitional arrangement, and how much continuity would you expect to see under such an arrangement?
The key priority of a transitional agreement would be to continue the status quo, whilst recognizing that the UK has no more voting rights on rule-changes or influence within the EU institutions.
Most important would be the continuation of the existing passport regime, as this would the least disruptive option for the financial service providers. Ultimately the UK needs to avoid a scenario where authorizations suddenly lose their validity in March 2019. The consequence of this would be that firms conducting cross-border business from the UK to the EU27 would be doing so unlawfully.
What is needed for a transitional arrangement?
During the transitional period, agreement needs to be reached on the modalities of the equivalence regime and the supervisory regime.
As Brexit is 1000 times more complicated than MIFID, it cannot be executed rapidly. Therefore, during the transitional period, deliberations need to be taken on the equivalence arrangements, as well as the applicable supervisory regime and a dispute settlement regime.
The UK should be aware that amongst the 27 other member states there are serious concerns about how the exposure of UK based financial companies to EU member states will be supervised by UK financial supervisors.
6. In practical terms, how and when could a transitional arrangement be agreed and put in place? How long would such a transition need to last?
A transitional period should be as long as necessary, but the mindset in the European Parliament (EP) is that no one wants it to be indefinite. A transitional period over 5 years would not be acceptable to EU players. Therefore, discussions around the length of the transition period should range from two to four years after the day of departure. This transition period has to be used effectively to enable both sides to continue in a constructively dialogue, to address the issues which have been outlined in this submission.
7. What are the benefits and drawbacks of seeking equivalence? What conditions are likely to be attached by the EU to any equivalence decisions?
The clear benefit is the fact that there will be no disruption to financial services provided from London. From EU point of view, the benefit is maintaining an open and integrated financial centre. It promotes regulatory convergence in the internal market area and is a first step in upgrading regulatory convergence between the key partners, with the added benefit of financial stability and investor protection.
However, the main weakness of the existing equivalence regime is that, in many instances, equivalence provisions simply do not exist in banking regulations and laws. Therefore there is no possibility to apply for the assessment of a third-country regulatory system. In other cases, equivalence provisions are mainly technical and narrow in scope, and as such do not provide passport-like rights of access (for instance in retail banking activities).
There are other significant drawbacks to equivalence. All control of the process is in the hands of the European Commission. If the European Commission decides to grant equivalence to the UK, this is a necessary but not sufficient condition for UK based market operators to get access to the entire single market. Therefore there is no guarantee that equivalence entails access for UK firms.
The conditions attached by the European Commission to an equivalence decision will vary from topic to topic, but they will broadly be in line with the considerations outlined in its paper: “EU equivalence decisions in financial services policy: an assessment”. Typically, equivalence provisions require verification by means of an assessment that a third-country framework demonstrates equivalence with the EU regime in some or all of the following aspects. Depending on the actual scope of the equivalence provision under consideration, this will require that:
Provisions to protect professional secrecy and provisions to enforce effective anti-money laundering regimes could also be added. In some instances, there is also a requirement that the third-country tax system is in line with OECD tax standards.
8. What alternatives may exist for maintaining alignment between the UK’s and EU’s regimes? What options could be considered for resolving disputes or arbitrating on such matters? What would be the barriers to a more bespoke arrangement?
A variety of other mechanisms exist:
In terms of resolving disputes, the UK will have to recognise the authority of the Court of Justice.
As an alternative, a consideration could be given to a European Free Trade Area (EFTA) Court as an ad-hoc international court which has jurisdiction with regards to EFTA States that are parties to the EEA agreement (at present Iceland, Liechtenstein and Norway). The court is capable of dealing with infringement actions against an EFTA State, with regard to the implementation, application or interpretation of EEA law rules. Thus the jurisdiction of the EFTA Court largely corresponds to the jurisdiction of the CJEU over EU States, including passport-ing rights which are extended to EEA countries.
9. What effect will the loss of the UK have on the development of the EU financial services framework and its capital markets?
The main effect will be a loss of efficiencies and higher end costs for customers. The European flagship, the capital market union (CMU) depends to a very large extent on capital market financing that takes place in the UK.
10. Where is there scope for the UK to amend its regulatory regime? What precedents exist under current equivalence decisions for divergence to occur?
There will be limited scope to amend its regulatory framework if it wants to remain equivalent. Every divergence has to be negotiated with the European Commission which can withdraw equivalence at any moment.
The most probable scenario is that the UK will either be obliged to keep implementing EU law, or it will need to maintain regulation that is close enough to EU standards to enable the UK to achieve positive equivalence assessments from the EU.
It is important to note that, in many areas, the EU regulatory framework implements internationally agreed standards (e.g. G20 Basel commitments) that the UK will align with in any case. This also limits the scope for change. It is important to emphasise that equivalence is a unilateral decision which could be retracted by the European Commission at any moment.
11. What challenges will expected innovations in financial markets, for instance in the FinTech sector, present in respect of regulation and supervision post-Brexit? How can these challenges be overcome? Can the UK maintain a competitive advantage while adapting to a new regime? If so, how?
The UK has been at the forefront in the development of the FinTech sector. However the continuation of its leading position will depend on whether London remains a main financial centre.
Within EU, FinTech remains high on the political agenda, in particular under the present Estonian presidency. Despite the general shared belief that FinTech will change the financial sector substantially, the first challenge is getting agreement on which type of regulatory framework is necessary and whether this should be on a national, European or global level.
In 2015, the UK set up a regulatory sandbox to enable innovative companies to test new ideas under close supervision from the regulator to ensure there is no negative impact. Nevertheless it is important to recognise that the ultimate aim is for successful ideas to become regulated.
Currently a handful of EU (27) Member States are fighting to attract UK based FinTech companies in the context of a looming Brexit. Therefore different jurisdictions have begun to set up their own regulatory sandboxes, with differing models and standards. It has been argued that this could create a regulatory ‘Wild West’. This could potentially be dangerous for the consumers. It could also lead to regulatory arbitrage.
12. Will leaving the EU affect the way that the UK represents itself in international fora? How can the UK continue to maintain influence when dealing with organizations such as the FSB and IOSCO in setting international standards?
It is unlikely that the UK will be marginalised by the international organisations, as it will continue to stay a major member in the short term. It is a member of FSB and IOSCO in its own rights, and it should be able to provide technical advice concerning future international financial standards. Nevertheless, the UK’s status is uncertain in the medium term. If London ceases to be a key financial centre, its influence in these organisations will diminish.
13. The Commission is currently conducting a review of the European Supervisory Agencies. What, in your view, are the key areas where reform should be pursued and what might be the impact of such reform on UK supervision?
The key points of the reform should be the financing of the European Supervisory Agencies (ESA’s), governance and the tasks allocated to the ESA’s.
The key issue for the UK is the relocation of the EBA as a result of Brexit, which will critically influence the reform debate. The UK needs to monitor the reform of ESMA because it has been given substantial new powers. The view over here is that a more integrated EU supervision is necessary, although some degree of national flexibility needs to be taken into consideration, given differences in the development of the financial services sectors in the member states.
It is clear that ESMA will get a much greater say on third country issues in the future, where the UK could find itself in absence of a bespoke deal. ESMA will also be the major supervisor in the whole development of the CMU.
It is also important to note that there is a second level of reform of ESMA concerning the governance structure. The proposals are to set up a smaller permanent board that prepares the decisions of the board of supervisors. It is believed that this would increase efficiency.
Thirdly, the funding of ESMA is a key issue that is likely to be addressed within these reforms. As the role of ESMA increases, clearly there is a need for more resources. One suggestion is that this could be financed by an increased contribution from industry. However it must avoid putting the supervisor’s independence at risk.
The impact of this reform on UK supervision could be considerable. A benefit could be that the Bank of England/FCA would only have one point of contact in the EU 27 to discuss and cooperate on regulatory matters and equivalence etc. If we are to minimize the impact of Brexit on financial services and capital markets, it is absolutely critical that we have a clear understanding how supervision will work in the future.
14. How could an enhanced role for ESMA and the ECB in respect of euro-denominated clearing work? What are the options for the UK to retain euro clearing in the light of the European Commission’s recent proposals?
This could work through direct supervision and registration models which are very common in other jurisdictions, including the United States of America.
Global CCP’s operate according to a direct registration model in several jurisdictions because they enable a closer relationship between local regulators and give greater protection and financial stability. This allows clients, all around the world, to safely access a very deep pool of liquidity to cover their risks. Direct licensing and supervision mean that a clear and strong relationship with regulators can be built. Furthermore, it will enhance their understanding and expertise of the local regulatory requirements and mean that they abide by local laws. This is critical to protect clients’ assets.
The possibility for third country CCP’s is of systemic importance for the EU. Direct registration and supervision by ESMA is in line with the regulatory framework of other jurisdictions and the practice of international CCP’s. This is the case at present for UK CCP’s in other jurisdictions. They are subject to direct supervision. Of course this would be conducted jointly by the BOE and ESMA and any other regulator with direct supervisory models. This could include the CFTC with deferential arrangements, where appropriate, as per European Commission proposal.
As an alternative to the location policy, the third country based CCP’s - of systemic importance for the UK - could be directly supervised by ESMA. This would be in conjunction with the regulatory framework of the other jurisdictions and the practice of international CCPs. Successful supervisory cooperation could be ensured if the regulators agree ex-ante on any specific issues and how to resolve them.