PricewaterhouseCoopers LLP (PwC) – Written Evidence (FRS0019)

1. This submission is made by PricewaterhouseCoopers LLP (PwC or we), the UK member firm of the PwC network. In the UK, we are the auditors of many regulated firms, as well as providing advisory services to a significant proportion of financial services firms. Our practical experience of financial services firms and their business models comes from a wide range of assignments as advisers, including in working with many organisations in helping them assess the impact of the UK’s withdrawal from the EU and in developing strategies to deal with it. We also have a team of dedicated specialists focusing on the impact of the UK’s withdrawal from the EU (Brexit) and the effect new regulatory developments will have on the financial services sector. Our response to the sub-committee’s inquiry is not intended to represent the views of our clients.  

2. We welcome the opportunity to respond to the House of Lords EU Financial Affairs sub-committee’s inquiry into financial regulation and supervision in the UK after Brexit. The inquiry raises important issues at a key time for the UK’s financial services industry. The UK’s regulatory and supervisory approach to the financial sector will be a key determinant on the degree to which the UK’s financial services sector can continue to serve the needs of consumers, remain globally competitive, and continue to successfully contribute to the UK economy and society. The financial services sector is vital to the UK. Over 2.2 million people[1] are employed in financial and related professional services - two-thirds of whom work outside of London. In 2015 the financial services and related professional services sector contributed 10.7% to the UK’s gross value added and 11.5% to the total tax contribution.[2]

3. The UK’s financial services sector, with its deep pools of liquidity and talent, international focus and broad range of financial services firms, also brings significant benefits to the EU and global economies. 

4. Our response is structured around four broad themes as follows:

• Transitional provisions - a transitional period is necessary for financial services firms to reduce the operational and financial stability risks posed by Brexit. The purpose of the transition period should be twofold:  i) to allow the UK and EU time to strike an agreement on their future relationship and ii) to allow firms time to transition to the new arrangements. Bearing in mind international precedents on the time it takes to negotiate free trade agreements (FTAs) it is highly unlikely that an FTA will be agreed between the UK and EU before March 2019.  As such the transition period should last up until the point an agreement is reached plus (at an absolute minimum) two years from this point to allow businesses, governments and regulators time to adjust to the new arrangements. The transition period should replicate current market access arrangements as closely as possible.

• Market access - in our opinion optimising reciprocal market access to the EU and UK for financial services firms post-Brexit should be a key priority for the Government. But market access and openness should not be limited to UK-EU relations. Further initiatives are needed at the global level to facilitate trade in financial services based on robust, internationally consistent regulatory standards and high quality supervision.

• Future UK regulatory and supervisory regime - the UK’s financial services regulatory and supervisory regime is considered to be one of the best in the world, but Brexit represents an opportunity to reflect on how it can be improved even further. We highlight a number of areas where we think progress could be made, and comment on the need for supervisory cooperation with EU regulators post-Brexit, including on the supervision of CCPs.

• Innovation in the FS sector - the financial services sector faces profound changes in the coming years, driven by innovation and technological change. FinTech in particular has the potential to change the delivery of almost all financial services and to disrupt existing business models. It’s vital that the UK’s regulatory and supervisory framework is equipped to not only react to these developments, but also create an environment which actively encourages and facilitates innovation and growth.

5. We believe that addressing these themes will be key to ensuring the success of the UK’s financial sector and the robustness of our regulatory and supervisory regime over the medium to long term. We have not answered the questions raised in the Call for Evidence sequentially but we have highlighted where our commentary on these themes relate to specific questions (please see Appendix 1). 

6. It also important to note that at the point of the UK’s withdrawal from the EU the majority of the UK and EU’s financial law and regulation will be identical. The UK Government plans to import the ‘aquis communautaire’ into UK law through the EU Withdrawal Bill and although there will be some differences in supervisory approach (which indeed exist between EU-27 Member States) there will be a very significant degree of alignment. This should facilitate reciprocal market access for EU and UK financial services firms post-Brexit, particularly if a mechanism is agreed to limit future divergence and ensure equivalent supervisory and regulatory outcomes.

7. We recently produced a report for TheCityUK setting out a vision for a transformed, world-leading industry. A number of the recommendations made in the report are pertinent to the Committee’s inquiry.

Section 1. Transitional arrangements

8. The UK and EU financial systems are deeply entwined, with interconnectedness that has built up over decades. For example:

• 78% of European FX trading occurs in the UK
• 74% of European interest rate derivatives trading takes place in the UK
• 50% of European fund management activities (by assets) are undertaken here
• lending from UK-based banks to EU corporates amounted to €1.2 trillion as of 2016 Q2, which accounts for around 9% of total lending issued to EU residents
• around one-third of insurance premiums in the UK have been written by the UK branches or subsidiaries of EU-based insurers
• London is the leading location for foreign firms, including EU-based institutions, wishing to list in the most attractive location.

9. Access to the UK’s financial sector, with its full suite financial eco-system, brings significant benefits to the EU’s financial sector, as well as to consumers of financial services. The UK’s financial sector includes a broad range of financial institutions such as banks, insurers, asset and wealth managers as well as some of largest financial market infrastructures (CCPs, exchanges and others) in the world. This concentration facilitates the efficient allocation of capital and reduces costs for consumers of financial services.

10. Many of the arrangements, such as passporting, which have driven this integration are unlikely to remain in place in their existing form post-Brexit. Financial services firms have been working towards designing, and in some cases implementing, new structures to deal with the loss of automatic EU Single Market access. However, the challenges in doing so are significant, particularly at a time when financial services firms face significant operational and business challenges unrelated to Brexit and are still implementing key pieces of post-financial crisis regulation[3]. Proposals such as the requirement for large banks to form an intermediate parent undertaking (IPU) in the EU will create further complexity and operational challenges. We described the operational challenges facing firms in our report for the Association for Financial Markets in Europe (AFME).

11. 1A scenario where there is no transitional period significantly increases the likelihood of financial instability, operational risks crystallising, market dislocation and discontinuity of the provision of financial services in the UK and EU-27. At present, despite the Prime Minister’s welcome announcement in her speech of 22 September that the UK Government would seek an ‘implementation period’, financial services firms will contingency plan on the basis that there is no transitional up until the point at which one is fully agreed by both the UK and EU-27. 

12. If firms do not have arrangements in place to serve their EEA clients by March 2019, they risk breaching regulatory requirements, as well as potentially committing a criminal offence for carrying on regulated business without required authorisations. Equally it is important that regulators in both the UK and EU-27 have arrangements in place as soon as possible to allow financial institutions the ability to transition to the new legal framework (for example through authorisation).

13. PwC’s report for AFME shows that, depending on business models, Brexit change programmes for capital markets participants are likely to take between two and four years. This is based on our experience of large scale change programmes and the time needed for regulatory authorisation and design and implementation of operating models. Our experience of working with our clients to gain authorisation in the UK and in Member States across the EU suggests getting a banking licence can take up to 18 months. These programmes are likely to cost firms very significant resources and divert valuable resources away from business development and innovation. This non-discretionary investment and change risks dominating the agenda, senior management’s time, and the focus of subject matter experts.

14. These challenges, and the relatively short time frame permitted by the Article 50 withdrawal process, mean a transitional period is essential for the financial sector and the wider economies of both the UK and EU. A transitional period is needed for two reasons. First, to allow the UK and EU time to agree future arrangements to govern reciprocal market access and second, to allow regulators and firms the time needed to adapt to these new arrangements.

15. Any transitional arrangement should ideally deliver the same degree of reciprocal market access (or as close as possible) to financial services firms operating in the UK and EU27 as is currently the case. The transitional period should last, at a minimum, for two years from the point at which the new arrangements are agreed (based on the assumption that this is after March 2019), but it may be appropriate to consider the needs on a sub-sector basis. It may also be beneficial to consider mechanisms for managing ongoing regulatory alignment during this period. Retaining existing EU regulation during the transitional period would, in our opinion, be appropriate, but any arrangement under which the UK automatically adopts new EU regulation (including for example binding technical standards) could prove problematic as the UK would in effect be a ‘rule taker’. Bearing in mind the relatively short time period until the UK leaves the EU, agreeing a bespoke transitional arrangement is likely to be very challenging.

16. Greater certainty could also be given to EEA financial institutions operating in the UK through branches on their status post-Brexit. Currently there is no mechanism for EEA-based firms’ UK branches to seek authorisation here as third country branches. Providing greater clarity on these firms’ ability to continue operating as branches, and the authorisation process they will face, would be helpful. As all EEA branches are already operating in the UK (and in many cases have been for decades) and are well known to the UK authorities, we would hope that some form of streamlined authorisation process would be possible. Regardless, creating more certainty for a key part of the UK’s financial system, at an early stage, would help avoid erosion of inbound financial services business from the EU.

17. Post-Brexit, it is important that the UK remains open to branches of financial institutions from the EEA. Currently the UK is relatively open to third country branches, particularly compared to some other EU Member States which often apply far more requirements on third country branches in their jurisdiction. It’s important the UK maintains this open approach post-Brexit.

18. Agreeing as part of the transitional arrangements a bilateral agreement between the UK and EU with regard to financial contracts which extend beyond the point of Brexit- notably derivatives and insurance contracts - is also of vital importance. Without a bilateral agreement which would enable the terms of these contracts to be met post-Brexit, fulfilling them (for example exercising options on a derivatives contract or the payment of insurance claims or pensions on a cross-border basis) may not be possible. 

Section 2. Market access

19. The trade in financial services throughout the EU, facilitated by the Single Market, has brought great economic benefits to the UK. Access to the Single Market in particular has benefited London as a financial centre, but it has also brought significant benefits to businesses and consumers throughout the EU who can access London’s financial eco-system with its deep and liquid markets and robust regulatory framework.

20. The post-Brexit arrangements between the UK and EU should, in our opinion, ideally retain as many of these benefits as possible by establishing as open a new trading relationship as possible. We provide some thoughts on a potential framework post-Brexit which could govern this trade relationship in the financial services sector. However, in our view, the UK will need to make a broader effort to boost trade in financial services at a global level, in part, to counteract the likely reduction in financial services business with the EU27.

21. On many metrics the globalisation of financial services has reduced since the 2007/08 financial crisis, partly due to regulatory initiatives that require increases in local capital and liquidity requirements, deleveraging and cost reduction programmes in financial services firms. This trend reduces the efficiency of the financial system. And whilst there has been welcome progress on agreeing common global standards such as Basel 3, implementation has at times been slow and divergent across the globe[4]. Inconsistent application of global standards increases complexity, increases costs to industry, creates frictions and reduces the effectiveness of regulation. 

22. There has also, at times, been a trend towards extra-territorial application of regulatory standards. The US has in particular done this through derivatives and market trading regulation, i.e. imposing US derivatives rules on overseas financial institutions with large exposures to US persons (Dodd-Frank Title VII) and imposing prop trading restrictions on foreign firms that are remotely connected to US banks via affiliation and group structure (Volcker). The recent proposals by the European Commission to amend the treatment of third country CCPs is another example of extra-territoriality.

Global openness

23. The UK has the most globally focused financial centre in the world. It should continue to take a leading role in advocating and fostering global openness, based on consistency and promoting robust, internationally consistent regulatory standards, high quality supervision and strong regulatory cooperation.

24. Since the financial crisis the international infrastructure for agreeing global regulation and monitoring its implementation has been boosted by the establishment of the Financial Stability Board (FSB) and the work of its Standing Committee on Standards Implementation. In addition, initiatives such as the Basel Committee on Banking Supervision’s (BCBS) Regulatory Consistency Assessment Programme, as well as work by International Organization of Securities Commissions (IOSCO) and the International Association of Insurance Supervisors (IAIS) have played an important role in driving consistency in implementation. For a number of years the International Monetary Fund (IMF) has also assessed key jurisdictions’ approach to financial supervision through its Financial Sector Assessment Programme (FSAP) process. But, in our opinion, there is scope to further develop these global bodies and expand and formalise international arrangements further to improve consistency. Post-Brexit it is even more important that the UK authorities remain active and influential in international bodies such as the FSB, BCBS, IOSCO and IAIS. Playing a leading role in shaping global standards will be the best way for the UK to influence EU regulation post-Brexit.

25. The UK should work to achieve an agreement among the key financial services jurisdictions globally to grant reciprocal market access to each other’s financial institutions, without the need to meet excessive local regulations and establish separate subsidiaries. Such reciprocal market access should be subject to an objective assessment that a firm’s home jurisdiction has implemented and complies with key aspects of international regulatory standards and has adequate supervision and enforcement regimes. The role of assessing compliance could be undertaken by the FSB, the IMF or another independent body. Global consistency will be increasingly important for the UK post-Brexit, particularly to prevent deviation between the EU and US, two extremely important markets to the UK’s financial services sector.

26. We acknowledge that gaining international agreement for such an approach may be challenging, but there are precedents. In 2008, the US and Australia signed an agreement which provides a framework for US and eligible Australian stock exchanges and broker-dealers to operate in both jurisdictions, without the need for separate regulation in each country. And more broadly the Australia allows the provision of cross border financial services into its jurisdiction without the need for authorisation, subject to some conditions[5]. The UK also has a model which allows relatively easy access to the UK market using the Overseas Person Exemption or through a third country branch, subject to certain conditions[6]. There are also signs that there may be appetite in national authorities to reassess the emphasis on applying local regulatory requirements with the US authorities, for example reassessing their approach and thresholds for applying their IHC rules.

EU27-UK relations

27. The global model advocated above in para 25 and 26 could, in our opinion, form the basis of market access arrangements between the EU27 and UK post-Brexit. However, the level of integration between the UK and EU27’s financial sectors means that a greater level of coordination between the UK and EU27 post-Brexit will be needed than with other jurisdictions.

28. As noted above the agreement between the EU and UK should retain as many of the benefits accrued from the current levels of financial integration. As such, from a financial services perspective the agreement should be as comprehensive as possible and afford reciprocal market access, without the need for local authorisation, to as broad a spectrum of financial services firms as possible. 

29. At the point of the UK’s withdrawal the majority of the UK and EU’s financial law and regulation will be identical. The UK Government plans to import the ‘aquis communautaire’ into UK law through the EU Withdrawal Bill and although there will be some differences in supervisory approach (which indeed exist between EU-27 Member States) there will be a very significant degree of alignment. The process of bringing EU financial services legislation into UK law or regulatory rules will bring significant legal and operational challenges. Financial services is a very intensively regulated industry and as a result there is a very large amount of EU financial services regulation which has been developed over decades. Identifying those provisions in EU legislation (both currently applicable regulations and the UK’s implementation of EU directives) which would be inoperable in the UK context will prove challenging, as will identifying workable solutions to the issues identified. This is especially the case as the challenges posed by bringing one piece of sectoral legislation into UK law may not be the same as those found in another piece of regulation.

30. This level of alignment should negate the need for a time consuming equivalence assessment by the European Commission. Post-Brexit the UK should not become an automatic rule taker, but a joint EU-UK mechanism designed to identify and manage issues arising from divergence between the UK and EU’s regulatory regimes would be welcome. The role of this body would not be to ensure that regulation in the UK and EU is identical on a line-by-line basis, but rather to ensure that both regimes continue to achieve consistent regulatory and supervisory outcomes. A degree of divergence between the EU and UK’s regime should be possible without negative consequences for financial stability and consumer protection. As such the joint EU-UK mechanism could consider the degree to which divergence is material, act as a forum to share information and more generally facilitate supervisory cooperation between the UK and EU.

31. A mechanism for resolving disputes between the EU and UK will also be required. This could build on structures included in existing FTAs in which adjudication bodies make judgements on countries’ compliance with provisions in relevant FTAs. Under this mechanism neither the ECJ or UK Courts would have a final say on interpreting the agreement.

32. If, after discussion in the joint EU-UK forum and formal dispute resolution process, the UK and EU are still in disagreement over the degree of regulatory divergence then there should be an option for market access to be revoked over an appropriate timeframe. However, this should be seen as a last resort and all steps should be taken to try and avoid this outcome. Should market access be revoked then a mechanism for re-aligning and reopening market access should be available.

Section 3. Future UK regulatory and supervisory regime  

Improving the UK regime

33. The UK has one of the most developed, comprehensive and sophisticated supervisory regimes in the world, with deep levels of expertise embedded in it. The Bank of England (BoE), Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) are well-respected worldwide for their credible, balanced and predictable approach to regulation, and the confidence and stability they help engender in the leading global financial centre. In many areas (prudential regulation, conduct and resolution) the UK authorities have taken a lead in developing regulation at the international level. Financial services firms generally find the UK’s regulators to be approachable, knowledgeable and open, which is an important factor in attracting new financial services businesses to the UK.

34. The UK’s financial services sector is at a key point in its development. Brexit represents a significant challenge, but the competitive landscape in the UK is also changing dramatically as a result of other regulatory changes, financial innovations including FinTech, the emergence of new competitors to established businesses, a proliferation of new products in areas like green finance, Islamic finance, etc. We believe the financial services sector is likely to continue to change significantly in the coming years. It is important that supervision and regulation in the UK does not impede the financial services industry’s ability to innovate, and to provide key economic services to meet changing societal needs. In particular it is important that the regulators’ objectives are assessed on an ongoing basis to ensure they remain fit for purpose.

35. The UK’s regulatory and supervisory regime could be further improved post-Brexit in a number of ways as follows:

• Strategic partnership between government, the industry and regulators - there should be effective collaboration between different government departments, the industry and regulators in order to agree on priorities and actions. A joint body will need to be instituted to meet regularly, led by HMT and with representation from multiple government departments (e.g. the Home Office, the Department for International Trade (DIT), the Foreign & Commonwealth Office (FCO), the Department for Business, the Energy and Industrial Strategy (BEIS), the Department for Work & Pensions (DWP), Department for Education (DfE), Ministry of Justice (MOJ) and the industry). Government should facilitate this discussion with the industry, with regulators observing. Together, a coherent strategy for the industry that supports national objectives and delivers positive customer outcomes should be shaped and agreed. All key industry stakeholders should work together in a coordinated and mutually supportive way to drive success for the UK and its financial and related professional services industry.

• Introducing greater proportionality - the UK’s financial services sector is made up of a diverse range of financial services firms. In some instances proportionality is not fully embedded into financial services regulation in the UK. For example, under the Capital Requirements Regulation/Directive small banks and investment firms are captured in the same prudential framework as Globally Systemically Important Banks (G-SIBs). In its response to the European Commission’s call for evidence on the EU’s financial services regulatory regime, the BoE indicated it would support a simpler, more proportionate prudential regime for smaller institutions. This position is very positive, and the UK authorities should take the opportunity Brexit represents to inject a greater degree of proportionality into the UK’s regulatory regime more generally. For example, the requirements placed on small and start-up asset managers, investment firms, insurers and FinTech firms should be reassessed. Regulatory reporting, disclosure and authorisation requirements should also be re-examined to try and reduce burdens and increase the ease of doing business. 

• Embedding judgement-led supervision - one of the key lessons from the financial crisis was that supervisors need to employ judgement when assessing risks. The UK regulators have acknowledged this was not done sufficiently in the run up to the financial crisis, and have subsequently developed a judgement-led approach to supervision. We believe that further steps are needed to fully embed this philosophy into supervisory approaches. To exercise judgement-led supervision, supervisors must have extensive experience and expertise, because judgements can have significant impacts on a firm’s business strategies and, ultimately, its success or failure. Staff turnover at the PRA and FCA is relatively high, particularly at more junior levels. This situation has the potential to undermine the implementation of a judgement-led approach to supervision due to a lack of experience. Steps should be taken by the regulators to build the depth of expertise in supervisors (e.g. by incentivising individuals to stay in post for longer) and to broaden the staff skills base (e.g through secondments to/from firms, including FinTech firms and other technology providers).

• Enhancing accountability of regulatory bodies - regulatory bodies wield significant power. Responsibility and power has in particular been concentrated in the BoE since the current regulatory framework was implemented in 2013, and arguably it has increased even further now the PRA has been fully incorporated into the BoE. Brexit has the potential to increase the powers and centralisation of the PRA and FCA significantly, as they are granted further direct and indirect supervisory and rule making powers post-Brexit. These developments further emphasise the need for accountability and scrutiny of the regulatory bodies by Parliament (through existing mechanisms) and openness and dialogue with industry and other stakeholders on regulatory decisions (something that the joint body referred to in the first bullet point on page 8 could help facilitate). By international standards, the UK regulators are already accessible to stakeholders, but more can be done. 

• Increasing the resources of regulatory bodies - the demands of Brexit over the medium term, and our regulators’ increased responsibilities post-Brexit, mean that the resources available to them need to be re-examined. There is a risk that the demands of Brexit could take precedence over other priorities to the detriment of financial stability, consumers and indeed the industry. Steps should be taken to mitigate this risk, as the potential costs of this risk materialising would outweigh the costs of providing additional resources.

• Assessing the effect and interactions of financial regulation - the financial crisis and its aftermath resulted in the development of a large amount of financial regulation over a short period of time, both internationally and domestically. The scale and impact of the financial crisis clearly required a robust, internationally-coordinated regulatory response, which should not be reversed wholescale. However, it is now an appropriate time to assess the impact of existing regulation, how different elements interact and whether there are any unintended consequences. This process is already underway at the international level through the FSB, and the UK authorities should continue to play a leading role in this process. But the UK authorities should also consider the impact of domestic regulation and look at areas where the UK has chosen to be super-equivalent to international or EU standards, to see if some refinement of existing regulation would be appropriate, particularly with the competitiveness of the UK’s financial services sector in mind.

• Protecting vulnerable consumers,  supporting sustainability and closing gaps in the provision of financial services - much of the focus around Brexit has been on the impact on London’s wholesale financial markets, but Brexit is also expected  to impact retail consumers in the UK,  in terms of the availability, choice and cost of financial services and products. There is a risk that vulnerable consumers may be more negatively affected than others, if the economy and/or the financial sector contracts as a result of Brexit. The FCA has already put protecting vulnerable consumers at the heart of its approach, but the scale of the challenge means more should be done, both by Government and the regulators. As the House of Lords Committee on Financial Exclusion found, 1.71 million adults in the UK do not have bank accounts, 40% of the working age population have savings of £100 or less, and 31% of the population report one or more signs of financial distress[7]. Environmental sustainability is also an increasing priority for regulators and financial services firms. Brexit should not divert attention away from these issues. Appropriate financial regulation should support efforts to address the causes of them. 

Coordinating with EU regulators post-Brexit

36. As noted above the UK and EU’s financial systems are interconnected to a significant degree, and this will remain the case post-Brexit. This level of integration means that deep cooperation arrangements will be needed post-Brexit, particularly between the BoE and European Central Bank (ECB). In particular existing cooperation and information sharing arrangements between the BoE and ECB will need to be enhanced and broadened.

37. The PRA and FCA will also need strong supervisory cooperation arrangements with the European Supervisory Authorities (ESAs) and National Competent Authorities (NCAs), as well as regular dialogue on the evolution of existing regulation and the development of new regulation. As the implementation of post-crisis reforms beds in, the focus of regulation in the EU27 and the UK is likely to focus further on measures designed to both strengthen the financial services sector and improve its provision of services to the real economy. A good example of this is the EU’s Capital Markets Union initiative, which aims to help facilitate companies accessing capital from market based sources. Cooperation and coordination on future measures will be important in ensuring their success. The UK authorities retaining observer status on the ESAs would also be one practical way of ensuring effective coordination and maintaining alignment of regulatory outcomes.

38. In light of the very significant level of inter-connectedness between the UK and EU markets post-Brexit, coordination on the identification and mitigation of systemic risks should continue. This could be through continued UK membership of the European Systemic Risk Board (ESRB) or through joint meetings between the ESRB and Financial Policy Committee (FPC).

39. Maintaining robust market infrastructure post-Brexit is critical to ensuring financial and market stability, and should be a high priority for the negotiations. Where Member States or institutions in the EU27 have specific concerns, such as the large scale clearing of euro denominated trades through CCPs in London, an arrangement between the UK and EU regulators for joint supervision or oversight could be envisaged.

40. Joint supervisory oversight is not a completely new or unique concept, for example non-EEA branches of banks operating in the UK are primarily supervised by the home supervisor (the Federal Reserve Board, Japanese Financial Services Authority, etc.) but the BoE and UK regulators retain a degree of supervisory powers. Although oversight of euro-denominated clearing represents a somewhat different situation, as the majority of the institutions involved in euro denominated transactions are not EU institutions[8]  and CCPs undertaking much of the activity are not headquartered or even located in the EU-27. Joint oversight could work in a number of ways, ranging from joint direct supervision through a joint UK/EU27 supervisory team, to a coordination mechanism which allows information sharing and consultation between UK and EU27 bodies. There are risks associated with any of these models; in particular there is a risk that supervision of CCPs in the UK becomes unresponsive due to difficulty in making and implementing decisions because of difficulty in reaching joint decisions. There is also a risk that regulatory costs increase due to duplication in regulatory and supervisory requirements. Despite these risks, enhanced cooperation would be preferable to fragmentation between the UK and EU markets due to the risks of market volatility and associated costs[9].  

Section 4. A framework which reacts to future developments

41. The financial services sector is changing significantly, and is likely to continue to do so in the coming years. These changes are driven partly by technological developments, but also by changing needs and demands from consumers.  We believe that post-Brexit the UK can remain a leading global hub for innovation in financial services. But to do so, the UK needs a future legal and regulatory framework that is robust but flexible, and evolves to enable both existing and new financial services businesses to develop and flourish, and interact effectively with other global markets (including the EU) to meet evolving customer demands. We also believe that UK regulators have a strong role to play in fostering innovation, while ensuring that our markets remain stable and competitive.

42. Brexit poses significant challenges to the sector, but a number of developments, such as FinTech, have the potential to disrupt traditional business models and fundamentally alter the nature of the financial services sector.  FinTech has the potential to change almost every aspect of delivery of financial services, and is already doing so. The most prominent example so far is the innovation by payment service providers, which offer payment services using digital wallets or eMoney. Wholesale and capital markets activities have been heavily influenced by technology for some years, with the role of high frequency traders coming under increasing scrutiny.  Wholesale payments, clearing and settlement have gained the most attention recently, largely down to the emergence of distributed ledger technology (DLT). However, other traditional retail and commercial financial services activities are being impacted by innovations such as robo-advice, peer-to-peer lending and big data analytics.  

43. Innovations such as FinTech also have the potential to lead to jobs growth in the UK’s regions as emerging financial centres focus on the potential growth from financial innovation.

44. However FinTech develops, it will clearly have a profound impact on the financial services sector. It is vital that the UK has a regulatory and supervisory framework which is able to react to, and encourage, innovation. The UK is currently a FinTech leader, in part due to its regulatory regime, but competition from financial centres in the Far East, Europe and North America is building and action is needed if the UK is to retain its position.

45. The UK should continue to build on its strong reputation as a country that welcomes and supports innovation in financial services. The UK regulators are amongst the most forward thinking when it comes to innovations such as FinTech. UK regulators have also played an important role in promoting innovation. The FCA launched Project Innovate in October 2014 to support firms with ‘fast, frank feedback on the regulatory implications of their concepts, plans and choices’. As part of Project Innovate, the FCA also created a regulatory sandbox to allow businesses to test innovative products and services in a live environment without immediately incurring typical regulatory consequences. The regulatory sandbox demonstrated the FCA’s greater commitment to flexibility and supporting innovation compared to other regulators. It is open to regulated entities and FinTech start-ups – in the first cohort there were 24 successful applications from a pool of 69 applications.

46. The FCA has also been active in building relationships with other authorities around the globe to allow cooperation and coordination on FinTech. Currently the FCA has seven such agreements, more than any other regulator except the Monetary Authority of Singapore. It should continue, and perhaps expand, on these efforts post-Brexit.

47. The UK regulators are in a strong position but, in our opinion, more can be done to position the UK as a world leader in FinTech and other financial innovations, for example by:

• ensuring the UK’s regulatory regime balances the imperative to fully support and promote innovation with the need to protect customers - to promote competition, and help the industry to address societal challenges that matter to consumers
• maintaining close dialogue with firms that are driving innovation in product areas or seeking to address ineffective markets (e.g. in infrastructure financing, financial advice gap, green finance), and ensuring they do not suffer inappropriate regulatory roadblocks
• identifying ways of increasing the availability of data, which FinTech and other firms can use to innovate, without sacrificing customer protection
• using technology to help firms deal with regulatory challenges (so called RegTech) such as regulatory reporting and Know Your Customer (KYC) checks.

48. Equally, the UK regulators should seek to drive international consistency in the regulatory approach towards FinTech. Currently the regulatory landscape for FinTech firms operating globally is fragmented, increasing costs. Over the past year, policy makers at the global and EU level have increased their focus on FinTech (with consultations or reports from the World Economic Forum, FSB, Basel Committee, European Commission and European Banking Authority). It is important that the UK regulators play a leading role in the development of regulation focusing on FinTech and other new developments in the financial services sector, and advocate a proportionate, innovation friendly and globally consistent approach. 

We hope that our evidence proves helpful to you. I would be very happy to discuss any aspect of it with you further.

Appendix A: Questions answered in PwC response

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?

Please see paragraph 35 (bullet 2)

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?

Please see paragraphs 36-40.

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?

Please see paragraphs 19-26.

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?

Please see paragraph 29.

5. What would be the key priorities for a transitional arrangement, and how much continuity would you expect to see under such an arrangement?

Please see paragraphs 8-18.

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?

Please see paragraphs 12-15.

7. What are the benefits and drawbacks of seeking equivalence? What conditions are likely to be attached by the EU to any equivalence decisions?

Please see paragraphs 27-32.

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?

Please see paragraphs 25, 26, 36-40 .

9. What effect will the loss of the UK have on the development of the EU financial services framework and its capital markets?

Please see paragraph 36-40.

10.                     Where is there scope for the UK to amend its regulatory regime? What precedents exist under current equivalence decisions for divergence to occur?

Please see paragraphs 27-40.

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?

Please see paragraphs 41-48.

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 organisations such as the FSB and IOSCO in setting international standards?

Please see paragraph 24.

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?

Please see paragraph 37.

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?

Please see paragraphs 36-40.

15.                     How would supervisory cooperation (as envisaged for CCPs) work in practice? Are there any precedents? What are the potential risks?

Please see paragraph 39 and 40.

29 September 2017