The Roller Coaster Ride is Over
For several years now, we’ve peered into our crystal ball, attempting to gauge what the post-Brexit asset management landscape would ultimately look like. It’s been an extended period of deadlines, announcements, and “cliff edges” for the industry particularly in the lead up to the end of the transitionary period on December 31, 2020. Immediately preceding that date, the E.U. and U.K. finally reached a “Brexit Deal” in the shape of the 1,246-page Trade and Cooperation Agreement (TCA). Of all those pages, only six related to financial services in total, so all eyes then turned to a promised Memorandum of Understanding (MOU) to be agreed by a March 31st deadline.
Now, the MOU has also arrived and anyone hoping that it would bring an end to the continued Brexit uncertainties will be very much disappointed. The much anticipated financial services draft MOU runs to just 4 pages, and the rulebook for future interactions between the E.U. and U.K. for asset management and other financial services currently remains unwritten. All eyes were peeled for anything related to regulatory equivalence but unsurprisingly to those close to topic, there was no progress and it will remain an issue for another day. As a reminder, equivalence decisions are granted at the E.U. Commission’s discretion, and unlike the single market passport that U.K. firms previously had access to, regulatory equivalence is a privilege, not a right and can be revoked at short notice without much reason. As time has passed without it, the benefit of the equivalence has become an asset with diminishing return as U.K. firms made contingencies by setting up E.U. beachheads or found E.U. partners to collaborate with among their product supply chain.
What the MOU ensures is that after the hectic roller coaster and uncertainty of recent years, we are now entering a period of methodical and slower paced regulatory considerations for interactions between U.K. and E.U. policymakers. The shape of the future relationship will not be cast in one big dramatic moment, but rather through a slow-moving, iterative process over the years to come.
It's Not Right, but It’s Okay
Even to the most cynical, the MOU cannot be said to be nothing, but also it does not solve any of the practical issues that asset managers in both the E.U. and U.K. continue to agonize about. The only concrete commitments it contains is that the respective regulators agree to share information as required. It also foresees holding two meetings a year with one another, with an option to hold others as they see fit (in emergency scenarios?). The proposed U.K./E.U. Financial Regulatory Forum will act as a “platform to facilitate dialogue on financial services issues.”
To anyone who has been close to the topic, it was never expected that the hottest topics of market access and regulatory equivalence would be dealt with in any substantive fashion within the MOU. The pact really is scant of any detail on this element saying only that the respective parties will “jointly endeavor to pursue a robust and ambitious bilateral regulatory cooperation”. What is also interesting about the vague nature of the E.U./U.K. MOU, as only recently decoupled partners, is that they now have a much looser regulatory collaboration arrangement in place than say the E.U. and U.S.. The E.U. and U.S. supervisory authorities meet regularly and have robust discussions about mutual topics of interest. In fact, they released their notes of a recent U.S.-EU Joint Financial Regulatory Forum, which shows their strong level of interactions.
The hope is that the new forum could act as one to settle common standards and thus, unlock future targeted equivalence decisions. However, senior E.U. policymakers, such as Mairead McGuinness, European Commissioner for Financial Stability and Financial Services and Capital Markets have been vocal about the fact that the E.U. is in no rush to make equivalence determinations for the U.K. and gave some stark warnings that that U.K. divergences would hamper any such equivalence decisions.
“There is no possibility of a bundle of equivalence decisions. The E.U. will make decisions to look after its own interest as will the U.K.,” said McGuinness, at a recent industry event.
While the E.U. continues to talk about continued convergence as a key consideration for the granting of equivalence, the U.K. has started to independently assess recasting its own market proposition beyond the strictures of the E.U.. In terms of investment funds, there is already an open public consultation looking for comments on how U.K. funds can be more competitive, particularly in terms of exporting. Historically, U.K. funds have not managed to sell outside of the U.K. and have found it hard to compete with Ireland and Luxembourg as cross-border centers. While it is hard to see U.K. funds catching up any time soon, it is indicative of a regulatory independence and growth mindset in a post Brexit environment. There was also a recently commissioned U.K. capital markets report by Lord Hill, a renowned financial policymaker, (who used to be central to E.U. policymaking on recommendations for easing U.K. listing rules) to facilitate easier access for FinTechs and other high growth companies to the U.K. markets. Additionally, this fosters a more vigorous IPO market by allowing dual class structures on the premium listing segment of the London Stock Exchange (the recent disappointing Deliveroo IPO won’t be helpful in short term). Another growth area in the U.S. has been special purpose acquisition companies (SPACs) and the Hill plan suggests the U.K. should make itself attractive for this new innovation in capital markets.
However, all changes and innovations the U.K. makes in the short term will have an influence on how the E.U. perceives its continued alignment with E.U. standards. The U.K. has opted out of adherence with the E.U.’s ESG rules (SFDR) and the E.U.’s Central Securities Depositories Regulation (CSDR) settlement regime, so divergence is already occurring and will strongly influence the E.U.’s stance on equivalence. Even non-financial areas of friction such as the politics that surround the U.K./E.U. vaccine interactions and the recent decision of the U.K. government to unilaterally extended the grace period for checks on food imports to Northern Ireland have an indirect influence the interactions around financial services; they remain inextricably linked.
A Marathon Not a Sprint
The Brexit story has entered a new phase. We now move on from a period of frantic and contentious “cliff edges” that immediately preceded Brexit, to a recognition of a slower paced, and fairly predictable policy path that the E.U. and U.K. both now seem more comfortable with taking relatively separate regulatory paths into the future. That’s not to say that on both sides there are areas of mutual benefit, which will probably be worked upon in the short to medium term, but more strategically the structural consequences of this new relationship will take years to truly manifest.
Despite certain points of tension and a large amount of supply chain reordering across the asset management industry in the lead up to Brexit, overall things have been pretty calm in the wake of the “divorce”. This is largely attributable to the level of preemptive measures taken in advance of Brexit. Besides, it is understandable that the E.U. wishes to reduce its dependence on the City of London in particular, and they have vocally expressed this as a policy goal within Capital Markets Union and elsewhere. There is no comparable dependence on an offshore financial center at this scale anywhere else in the world.
It seems that divergence is inevitable. It is just the pace and scale of the divergence that remains unknown. From experience, it is highly unlikely that the E.U. will get drawn into a regulatory competition. The E.U. normally sets their regulatory bar to the highest level, whereas the U.K. will now see the possibilities to be more pragmatic. While no “race to the bottom” is likely to ensue, they may be able to use their autonomy to make the U.K. market landscape more “user friendly” in some areas. They will also look to benchmark and calibrate their framework not exclusively to the E.U., but also to the other global centers such as United States, Switzerland, and Hong Kong.
All in all, the post Brexit landscape will continue to change, but not as quickly nor dramatically as we perhaps anticipated in recent years since the vote.