What happened to equivalence?
The Political Declaration setting out the framework for the future relationship between the EU and the UK included a deadline of the end of June 2020 for concluding equivalence assessments. This deadline was missed. On 9 November 2020 UK Chancellor, Rishi Sunak, announced the publication by the UK of its own equivalence assessments for EEA states. However, with two temporary exceptions (only one relating to UK central counterparties persisting), so far, the EU has not issued equivalence decisions in favour of the UK.
The European Commission indicated that it wanted to "better understand how the UK intends to amend or alter the rules going forwards". Mairead McGuinness, European Commissioner for Financial Stability, Financial Services and the Capital Markets Union, has repeatedly said there is "no rush" to grant any more equivalence decisions to the UK.
Despite the UK government's previously stated intention that it hoped to reach a comprehensive set of mutual decisions on equivalence between the UK and the EU, the UK Chancellor, Rishi Sunak, in his Mansion House speech on 1 July 2021, acknowledged that has not happened. Chancellor Sunak seemed to indicate that the UK government had given up waiting, declaring that "Now, we are moving forward, continuing to cooperate on questions of global finance, but each as a sovereign jurisdiction with our own priorities. We now have the freedom to do things differently and better, and we intend to use it fully".
These may not have been the words of comfort the European Commission was waiting for from the UK, although the Chancellor also insisted, "But I can equally reassure you: the EU will never have cause to deny the UK access because of poor regulatory standards".
With this backdrop, it is unsurprising that the UK and EU financial regulatory frameworks are beginning to diverge.
The EU legislative program continues to evolve as it progresses with its own domestic policy agenda without the UK.
In the UK, as early as April 2021, HM Treasury and the UK FCA were already consulting on alleviating regulatory burdens on certain financial services firms, notably by removing unnecessary reporting requirements under MiFIR. These amendments include removing the RTS 27 best execution reporting obligation – a similar step being pursued by the EU (MiFID II Quick Fix), but on a different timetable. In addition, in a surprising departure from the EU position, the UK is removing the RTS 28 report requirement completely, demonstrating a significant early willingness to diverge from the EU. While RTS 27 and 28 were originally introduced to give transparency to investors, the FCA's view is that they are considered unhelpful by users and have not met their objective.
The lack of positive equivalence decisions from the EU is prompting the UK government to focus on its own international competitiveness. In July 2021, the UK Chancellor said the UK needed a plan for the financial services industry "which sharpens our competitive advantage while acting in the interests of our citizens and communities". He continued, that the UK "will use our new freedoms to follow a distinctive approach founded on UK law, protected by independent UK regulators, designed to strengthen UK markets".
In pursuing this goal, the UK government is reviewing domestic law and regulation in a raft of areas.
In financial services specifically, as part of its "Future Regulatory Framework Review", the Treasury is consulting on an approach to move retained EU law into the regulators' rulebooks. The government says that, in many instances, it would expect the regulators initially to adopt similar rules to the current retained EU law. However, the government acknowledges that it will also allow for the regulators "to ensure that the rules are properly tailored for the UK markets, and appropriately reflect their objectives". Having regulation rather than law will also allow for the efficient evolution of the rulebooks, for example in response to new global standards, or to take account of new business models.
"I want to make it clear that our intention is eventually to amend, replace or repeal all retained EU law that is not right for the UK."
Michael Ellis, Paymaster General statement to the House of Commons, 16 September 2021
While a wholesale review of EU retained law and regulation will take many years, once retained EU law is in financial regulators' rulebooks, its future amendment in the UK will potentially be much faster that the EU legislative process.
Moving away from this overarching approach, there are also plenty of specific examples of potential UK divergence in the pipeline. A small selection includes:
- ESG: For example, the UK government did not onshore the Sustainable Finance Disclosures Regime and retained only the high-level framework of the Taxonomy Regulation. While it committed to match the ambition of the objectives of the EU Sustainable Finance Action Plan, the UK is now consulting on its own disclosure regime, sustainable investment labelling and also intends to produce its own taxonomy:
"The government will take an approach that is suitable for the UK market and consistent with UK government policy. There will also be a clear focus on the benefits of coherence and compatibility with other international frameworks."
HM government, "Greening Finance: A Roadmap to Sustainable Investing", October 2021
- Digital finance: The European Commission's EU digital finance package of measures was announced in September 2020 and includes a Digital Finance Strategy, legislative proposals to introduce a regulatory framework for cryptoassets (MiCA) and on a digital operational resilience enhanced framework (DORA), and an enhanced Retail Payments Strategy. As these initiatives were still underway when the UK transition period ended, the UK government is not obliged to adopt them and is developing its own legislative proposals in these areas. It remains uncertain to what extent the EU and the UK will diverge.
- PRIIPs Regulation: The UK is consulting on amendments to its PRIIPs regime, including replacing Key Information Documents (KIDs) with a more investor friendly document. This could lead to in-scope investments marketed in both EU and UK require two different KIDs in future. In another area of divergence, UCITS funds will be exempt from KID in the UK until the end of 2025, whereas this exemption applies only until June 2022 in the EU.
- MiFID/MiFIR: While the EU review of the MiFID II regulatory framework is underway, the UK is also conducting a "Wholesale Markets Review" to specifically consider how its onshored regime can be adapted now that the UK has left the EU. Amendments under consideration in the UK are numerous, including removing requirements that limit firms' ability to execute transactions where they can get the best outcomes for investors, for example by removing the share trading obligation and double volume cap, and reviewing the commodities regime to ensure that market activity is not unnecessarily restricted, while ensuring that markets function efficiently.
"With the development of the EU's single market, much of our regulatory approach to capital markets was set in Brussels. Now that we have left the EU, we can tailor our rules more closely to the unique circumstances of the UK, improve standards and make regulation more proportionate."
John Glen, Economic Secretary to the Treasury, 2 July 2021
- Data protection: The UK's Department for Digital, Culture, Media and Sport (DCMS) is consulting on proposals for reform of the UK data regime which could result in a major overhaul of existing standards. These proposals also form part of the UK’s wider strategic plan to reform current regulations following its departure from the EU and was described by Lord Frost in a statement to the House of Lords on Brexit opportunities as "a pro-growth trusted data rights regime that is more proportionate and less burdensome than the EU’s GDPR". Clearly mindful of the risks divergence may raise in relation to the adequacy assessment with the EU, the DCMS states:
"…the government believes it is perfectly possible and reasonable to expect the UK to maintain EU adequacy as it begins a dialogue about the future of its data protection regime and moves to implement any reforms in the future. European data adequacy does not mean verbatim equivalence of laws, and a shared commitment to high standards of data protection is more important than a word-for-word replication of EU law."
DCMS: Data: A new direction, 10 September 2021
On the European side, there has also been a recognition that there may be a need for simplification, at least in certain areas, for example, its consultation on making listing on EU public markets more attractive for companies and facilitating access to capital for SMEs.
Although some at the European Commission indicate that the movement for simplification pre-dates Brexit, given the time frames for European regulation, the movements do seem to be working in parallel.
What does divergence mean for firms?
While for many UK firms the most difficult part of Brexit may be the difficulty of attracting qualified staff going forward, divergence is still a major issue.
Whether it be EU firms or UK firms, the relaxation of the domestic regime could be a welcome relief by firms active only in their domestic market.
However, some businesses may choose to comply with the more onerous rules, particularly where this may grant them access to a wider market.
Further, some complex challenges could arise for international firms faced with differing obligations and regulatory timelines in the different jurisdictions. From a practical perspective, this could lead to increased compliance costs and firms having to choose between a jurisdiction by jurisdiction approach to compliance or considering whether adopting the highest regulatory standard will tick the relevant boxes.
Moreover, some UK firms have obtained limited permissions in EU jurisdictions and understanding exactly at which point traditionally exercisable activities need to be switched over to their EU institutions may not be easy.
Those third-country firms that provide cross-border business into the EU under Member State regimes or branches in the EU must also be alert to the European Commission's drive to protect the financial stability of the EU and strive for harmonisation across the EU through its Capital Markets Union and Banking Union. This is exemplified by the Commission's recent proposal to introduce a requirement to establish a branch for the provision of banking services by third country undertakings (except on a reverse solicitation basis), and new minimum standards for the regulation and supervision of branches of third-country banks in the EU.
Therefore, ongoing monitoring of regulatory change is going to be crucial for the foreseeable future.
Of course, it is not only the private sector which is monitoring developments. The UK standard setters will continue to monitor regulatory developments in the EU, perhaps trying to lend their expertise where possible, maybe through more willing jurisdictions such as Ireland and Luxembourg. On the other hand, as a major financial centre, regulatory developments in the UK, like regulatory developments in the US, will likely be at least a benchmark for financial regulatory developments in the EU going forward.
Hogan Lovells has expertise across the UK and the EU. We can advise you on tracking regulatory developments, liaising with relevant regulators at an EU and Member State level, and considering how areas of potential regulatory divergence and might impact your business.
Authored by Rachel Kent, Jeffrey Greenbaum, and Yvonne Clapham.