Within the first week of the new Government, the Chancellor made a bold statement of intent to deregulate UK financial services and to diverge from EU rules.
The term used by Kwasi Kwarteng, “Big Bang 2.0”, is not new. In 2020, the former Chancellor, Rishi Sunak, made the same reference to a Thatcherite deregulation agenda for the City. Sunak’s intent came to fruition in the Financial Services & Markets Bill that is currently under consideration in Parliament. That legislation will set the framework and the means for deregulation by scrapping all onshored EU rules and requiring the financial regulators to decide whether to keep, amend or scrap those requirements (our article explains the Bill and its context). But the question of content remains: which reforms should be made?
The new Chancellor has set some parameters, according to the Financial Times, but has also said: “We need to be decisive and do things differently”. The aim is to improve financial services’ openness and competitiveness. The Government’s focus is on immediate improvements rather than longer-term reforms. The latter reforms are likely to happen in any case as the UK and the EU undertake separate and parallel reviews of their rules, and as the UK introduces its own regimes in areas of innovation such as cryptocurrencies and FinTech. The Government is already legislating for reforms to Solvency II to make it easier for insurers to deploy their capital in long-term investments, although there are reported disagreements between the Government and the regulators on the nature and speed of those reforms; perhaps a precursor to further disputes.
The Government has also appointed an experienced businessman and government minister, Andrew Griffiths, as the new City Minister: a clear sign that this is not a drill.
In February 2021, we attempted an inventory to determine some of the options for divergence from EU regulations. It is timely to revisit that exercise now considering the Chancellor’s request of the industry to come up with ideas, and to ask, what could Kwasi do?
- Retail investor disclosures, and specifically the much-criticised PRIIPs Regulation and MiFID II cost disclosures, are low hanging fruit. The disclosures have been criticised for being complex, poorly understood and misleading, resulting in confusion among investors and the potential for poor investment decisions. A UK review of retail disclosures is already underway, and it is therefore an obvious example of an area in which a new regime suitable for the digital age could be introduced. Moreover, the FCA has already tweaked the UK’s version of the PRIIPs disclosure, meaning that firms operating across borders in the UK and the EU will effectively comply with two sets of rules from 1 January 2023, and so why not diverge in a more efficient way?
- On the topic of MiFID II, a more fundamental reform of distribution rules could better serve the UK’s aim to get more investment, especially retail money, into longer-term assets and to help people save for their retirement (see, for instance, the creation of the Long Term Asset Fund and changes to pensions and insurance investment rules). Although the FCA does not appear to have any strong desire to get rid of suitability and appropriateness assessments, the EU is considering replacing those operationally onerous tests with something more practical (albeit beset with its own problems). If divergence is likely anyway, why should the UK not strike out on its own? And while doing so, why not clarify the fuzzy border between regulated advice and “guidance”, and introduce a new semi-professional investor category, changes that could help the pensions and private wealth industries better serve their clients?
- Taxes are a common concern for the industry because of the great influence taxation has on both incentives and firms’ profitability. Bank taxes have received a lot of recent attention. But addressing the taxation of investment funds, on the contrary, was dismissed in the Treasury’s review of the UK Funds Regime as being too costly to consider in the short-term. However, a Treasury with new fiscal rules and a more expansionary policy could consider changes that would reinforce the UK’s position as a global hub for asset management and ultimately make private investment a more attractive prospect.
- The AIFMD is important to asset managers that wish to market their funds in the EU and consequently must comply with the rules. However, many managers have viewed parts of the regime as unnecessary and have criticised newer additions, such as pre-marketing and de-notification requirements. It is also notable that the EU’s AIFMD II review is edging towards a more protectionist approach in respect of the UK. The UK could look to Guernsey for inspiration: a dual regime comprising a baseline level of scaled-back regulation for onshore and other funds, with “full AIFMD” add-ons for managers that wish to market their funds into the EU. Moreover, this dual “Global Britain” outlook – streamlined, principles-based local regulation sitting alongside internationally consistent opt-ins when necessary – might serve as a model for other areas in financial regulation.
- More competition is possible in banking and payments by removing burdens and scaling back the requirements for smaller firms. For example, the Interchange Fees Regulation implements a price cap for payment service providers. Given that around 40% of UK FinTechs are payments businesses, a more liberal approach might make the market yet more competitive and innovative. Bank capital is another area that might be addressed to strike a different balance between financial stability and greater levels of investment in the real economy. This could represent a shift in perspective in the UK, which since the financial crisis has considered stricter rules as a competitive advantage for the City. More generally, costs can be removed. The Chancellor reportedly wishes to scrap the politically controversial bankers’ bonus cap, but also consider the mechanisms that socialise the costs of failure in financial services: the Financial Services Compensation Scheme (FSCS) and bank resolution pre-funding. The FSCS levy has increased from £300m in 2012 to over £700m in 2022, and the ever-escalating costs have become a contentious issue for UK financial firms, large and small. If the UK wishes to bolster its competitiveness, now is a good time to look at a better system to ensure that the polluters pay their own way. The polluters pay principle could imply that firms should hold higher levels of capital: a balance will need to be struck.
- The UK is already seeking to become a global leader in ESG through its proposed Sustainability Disclosure Requirements (SDR). The SDRs seek to remedy some of the problems seen in the EU’s regime, such as the unavailability of ESG data needed to comply with the rules and the sense that product labels are at best unhelpful and might even encourage greenwashing. However, the UK does intend to follow the EU’s broad approach to the Green Taxonomy. Given the Government’s immediate priority to ensure the UK’s energy security, and a desire not to follow the EU’s lead in financial regulations (which in respect of the Taxonomy has been controversial even within the EU), now might be the time to pause. There are currently 23 taxonomies implemented or under development across the world. Is another one even needed or will the SDRs alone be sufficient?
- The Overseas Funds Regime will introduce a new and streamlined process for managers that wish to market foreign funds in the UK. The FCA is likely to begin the transition to the new regime in 2023, although decisions are dependent on the Treasury making a positive determination about other countries’ regulatory equivalence. Quick and decisive announcements from the Treasury would be a clear sign that the City remains open as a global financial centre. The status of UCITS (the most important foreign fund type in the UK) is questionable because neither the UK nor the EU are keen to grant the other equivalence while post-Brexit issues such as the Northern Ireland Protocol remain under negotiation. The UK could circumvent these concerns by granting equivalence to specific EU Member States, namely, Luxembourg and Ireland as the key fund jurisdictions. However, there are legal and political questions as to whether granting unilateral equivalence to specific Member States would work.
It is clear from this brief survey that the Chancellor has options. Divergence from the EU is an increasing reality even if the UK decides to remain static. Whether intentional and more drastic divergence is a net benefit to the UK will depend on the nature of the reforms. Either way, the Government will wish to point to tangible reforms come the next General Election (expected in 2024), even if the costs and benefits might take much longer to materialise.