Brexit Institute News

Post-Brexit UK Fund Regulation: Equivalence, Divergence or Convergence?

Elizabeth Howell (London School of Economics)

The UK’s collective investment scheme (‘CIS’) sector is a key aspect of UK financial services. With the UK’s departure from the EU, it has also become a politically salient topic, with various Member States competing to lure business to their financial centres in light of Brexit. Brexit prompts hard choices and a key question arising for the CIS industry is whether the UK should continue to shadow EU law or whether elements of regulatory divergence could be envisaged. With a view to a greater understanding of the nuance contained within this issue, this paper (available here) considers the case study of the UK’s Collective Investment Scheme (‘CIS’) sector, an area of considerable significance to the UK’s economy.

Specifically, following Brexit,  the UK will be classified as a ‘third country’ under EU law, and will be required to utilise the EU’s ‘equivalence’ system in order to seek future access. In general terms, equivalence is the concept used by the EU to determine whether a third country’s regulatory and supervisory regime is sufficiently similar to that of the EU’s for access rights to be available. At the same time, there are clear disadvantages to this set up. Only some EU financial services legislation provides for an equivalence regime (for instance, the CIS regime only has limited third country rules); the EU-decision process with respect to granting access rights can be complex and slow; and such decisions can be unilaterally revoked by the Commission on relatively short notice. Taken together, Brexit will generate additional layers of legal complexity and costs for the UK CIS sector, and there are no guarantees with respect to future market access rights.

Yet markets and financial regulation are used to change; they constantly co-evolve. In this regard, Brexit need not necessarily be destructive for the UK, and there can be opportunities in terms of its CIS regulation. Indeed, some limited regulatory divergence could be considered by the UK provided that it remains in line with international standards, and (ideally) also continues to be recognisably similar to be regarded as equivalent under EU law. This certainly holds true in the event that equivalence is interpreted as more of a holistic assessment that could extend to embrace an element of regulatory competition. The paper draws specifically on the example of recent EU proposals within the CIS sector (such as with respect to pre-marketing practices in relation to professional investors) to demonstrate that, in the event that such initiatives severely impede upon the operations of the UK fund sector, the UK could inject a targeted element of regulatory competition into the equation. The proposition that there could be selected divergence also becomes more probable given that UK CIS managers are likely to be in a difficult position following their shift in status to third country actors. Any such regulatory divergence could also be framed as being of an optional nature, in order to grant CIS businesses full flexibility with respect to which regime they wish to comply.

At the same time, in practice, it is unlikely that there will be any large-scale deregulation occurring at the UK level. First, such a strategy would generate considerable transaction costs for a legacy industry such as the UK’s CIS system. Next, UK regulators have traditionally chosen not to take a minimalist stance to regulatory design, and in fact often bolster the UK’s laws via the gold plating of EU requirements. Further, since the global financial crisis, financial governance has been shaped around notions of regulatory convergence, rather than competition or regulatory arbitrage. The UK will also have more capacity to shape regulation globally via the international standard setting bodies if the UK and the EU remain closely connected. Both the UK and the EU have a common interest in a well-functioning international financial system that they can contribute to and seek to influence.

Rather, a UK domestic policy framed around strands of regulatory competition is advocated. This would occur in those carefully targeted areas where the UK can marshal its core strengths and develop credible alternatives or ambitious new approaches where an existing policy of EU harmonisation has underperformed and created difficulties for market sector. More broadly, the UK could seek to be a first mover and embrace the opportunity to do some things differently over the longer-term, particularly when new challenges emerge. Indeed given the impact fintech could have on the CIS sector, the UK adopting an innovative approach to the domestic CIS industry could help strengthen its competitive position. This would be not so much in relation to trying to directly compete with the EU, but with respect to the world stage.

Elizabeth Howell is Assistant Professor of Law at the London School of Economics and Political Science, London.

Image credit: the Gerkin by Mariano Mantel via a CC BY-ND 2.0 licence

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