The UK and EU have already begun to diverge in the way they oversee financial markets as hopes the two will reach a broad agreement on supervisory “equivalence” in the wake of Brexit fades.
Britain has outlined tweaks to areas including the rules surrounding equity, fixed income and commodities trading just months after the end of the Brexit transition period on December 31.
The subtle rule changes strike at the contrasting philosophies between the EU and UK on how markets should be regulated.
Among the potential changes, the UK plans to scrap caps on the amount of trading done in dark pools, private venues where investors can trade shares without signalling their plans to the rest of the market in advance.
It is also weighing changes to how much information is provided publicly both before and after the completion of trades in the stock and bond market, and to remove limits on the amount of commodities contracts traders can hold.
The EU’s priority is to develop a more harmonised internal capital market. By contrast UK politicians view Brexit as the chance to return to restore powers and discretion to regulators and exchanges, lost by layers of detailed and prescriptive EU rulemaking.
UK politicians want to give watchdogs greater leeway to write technical policy; exchanges and trading venues may also have greater freedoms in policing their users and products, according to a Lords Committee reviewing the future of UK-EU relations.
“The UK was always an outlier in Europe,” said Kay Swinburne, vice-chair of financial services at KPMG and a former member of the European parliament.
Swinburne drew a comparison with the US system: “In the US, self-regulatory organisations take on a lot more responsibility rather than relying on the regulator. The EU has never believed a financial market infrastructure is suitable to be self-regulated,” she added.
Alignment between Britain and the EU is largely dependent on the EU recognising the UK’s standards as “equivalent”. With the UK looking to diverge, the EU has approved only two temporary permits, which grant UK institutions more direct access to customers in the bloc.
But politicians and business executives’ attachment to the framework is waning and its value diminishing with every passing week. “You can’t have divergence and equivalence,” said Mairead McGuinness, the EU’s financial services chief, on Tuesday.
“If you’d asked us in the early autumn we’d have said that equivalence is vitally important for every area and need to be sorted but things have developed. Equivalence has a short shelf life,” said Baroness Rita Donaghy, chair of a House of Lords committee reviewing the future of UK-EU relations.
She urged the UK to strike a close relationship with the EU but admitted: “The atmosphere at the moment is rather cool, and that doesn’t help.”
European rulemaking was often a balancing act between Britain, France and Germany. Now that the UK has departed, the EU is going back to its bank-based system and Britain will have much more flexibility to adapt its rules than the EU, said Karel Lannoo, chief executive of European think-tank CEPS.
“It reminds me of the [wholesale] changes we have gone through the last 30 years. The UK had a diverse, very much self-regulatory system before the single market started,” he noted.
Nevertheless, the UK’s new system may leave parliament with less ability to scrutinise rules and hold regulators accountable, Baroness Donaghy warned. “Government and regulators now hold significant power in setting financial services regulation.”
Still, while the UK and EU are likely to go separate ways on important parts of financial rulemaking, there are also areas where they may overlap.
This year both London and Brussels will change unsuccessful parts of the mammoth banking and markets legislation designed to improve the financial system after the 2008 crisis, such as Mifid II, Solvency II for insurers and CRR, which covers bank capital.
The EU may also mimic the UK’s plans on failed trades and both are looking at the rules to boost competition in Europe’s futures markets. The so-called “open access” regime allows investors to use a clearing house of their choice but they have repeatedly been delayed.
Even then, there may be nuanced but important differences. In a series of “quick fixes” to Mifid II, Brussels has raised the cap on the amount of commodities contracts traders can hold, to 300,000 lots per trader.
But the UK is looking to go further because its markets, which include Brent crude oil futures, are much bigger and more global, according to three people familiar with the government’s thinking.
Under consideration are plans to let exchanges manage traders who hold large positions. The exchange would also decide limits to the size of blocks of trades that are agreed privately, away from the market.
A “talking shop”, to enhance regulatory co-operation and compatibility between London and Brussels, is expected to be finalised by the end of the month.
But the accord is likely to be rare common ground as each side uses Brexit as a chance to strike out and tailor regulation of major markets like equities, futures and fixed income to their own philosophies. As McGuinness noted on the EU’s equivalence decisions: “There’s no rush.”