The UK played a leading role in the development of the EU financial services regulatory framework up until the country’s departure at the end of December 2020. Since Brexit, there has already been some regulatory divergence by the UK from the EU’s rulebook – perhaps indicating a future direction of travel. So, does this mean that regulatory compliance is about to become a lot simpler for UK firms?
Unfortunately, the answer is no. Since most UK firms also operate in the EU, their compliance teams now need to meet both sets of regulations, and manage the regulatory change associated with potentially more divergence.
This blog looks at the challenges that this evolving situation is creating for financial services firms today, and how the regulatory environment is changing in the UK and EU as a result of Brexit.
Firms operating in the UK and the EU faced significant compliance complexity even before Brexit happened. Over the past few years, regulatory change has been accelerating, with rules such as the Markets in Financial Instruments Directive II and Regulation (MiFID II and MiFIR) coming into force. The whole package of MiFID II rulemaking is about 30,000 pages, and it covers topics such as detection and prevention of market abuse, best execution, and trade transparency. Then there are other recent rules as well, such as the European Markets Infrastructure Regulation (EMIR), the Market Abuse Regulation (MAR) and the UK’s Senior Managers & Certification Regime (SMCR).
Post-Brexit, as the UK is beginning to reshape its rulebook, one might wonder if this will make it easier for UK firms meet their regulatory obligations. Certainly, part of the drive for deregulation is to make the UK financial markets more attractive, globally. And while many of the UK regulators’ changes are welcomed by the financial services industry, these changes do create an additional layer of complexity for firms that operate in both the UK and the EU, in that they now have to comply with two sets of rules that remain complex and are diverging.
Some examples of where we have seen divergence from the Financial Conduct Authority (FCA):
In late June 2020, the UK government announced that it would not be implementing phase four of the EU’s Securities Financing Transactions Regulation (SFTR), or the Central Securities Depositories Regulation (CSDR).
In April 2021, a UK FCA consultation proposed to make changes to the UK’s approach to MiFID II’s research unbundling and best execution regimes that are different to the changes the EU is implementing.
UK counterparties to derivatives contracts now need to comply with the new UK EMIR, instead of the EU EMIR. Among other changes, this requires firms trading derivatives in the UK to report transactions to approved UK trade repositories.
So far, the UK government has carried over most EU financial services rules for Brexit to help ease the transition for firms. They were, after all, key players in shaping the regulations. However, more change will certainly occur over the next few years. The UK regulator is pragmatic and recognises that some elements of MiFID II – as well as other EU rules – have not delivered the real-world outcomes anticipated at drafting.
A good example of this is MiFID II’s RTS 27 and RTS 28 rules. Although these requirements were originally meant to increase transparency around best execution outcomes for clients, many firms found that the reports were complex to create. Further, because of the lack of specificity in the MiFID II rules, firms also compiled the reports in different ways. As a result, clients were not able to easily compare reports between firms. The UK regulator has therefore found that the RTS 27 & 28 reports don't serve their intended purpose and are consulting on discontinuing these reports.
In other areas, the UK regulator looks set to increase its regulatory focus and possible enforcement activity. Recent UK FCA Market Watch newsletters have made it clear that firms must improve the quality of their transaction reporting data, as well as the robustness of their market abuse compliance programmes, including trade surveillance and e-communications monitoring. So, although some sensible deregulation is on the cards in some areas, the FCA is adamant that it wants the UK markets to remain a global leader when it comes to transparency, safety, and soundness. So, while UK-based firms can expect more changes to UK regulation, they should not anticipate UK deregulation moves that would undermine this goal.
The EU has not been as constructive in its engagement with the UK around financial services negotiations as many had hoped at the start of the Brexit process. However, the failure to grant the UK equivalence by 31 December 2020, and linking the granting of equivalence to unrelated areas such as fishing rights, has taken some by surprise.
Commentators seem to agree that behind much of this is an EU desire to reclaim financial services market share to centres such as Paris, Amsterdam, and Frankfurt – raising the question of whether we might see future EU regulatory change to meet this goal.
Firms operating in the UK will now have to ensure that they meet both UK and EU regulatory obligations. For example, transaction reporting requirements under MiFID II became significantly more complex for UK firms on 1 January 2021, as under certain circumstances firms now have to engage in dual reporting – reporting the same transactions to both the UK MiFIR scheme and the EU MiFIR Scheme.
This could become extremely burdensome. However, both technology and data management have evolved significantly over the past three-to-five years which means that firms could and should have the ability easily comply with both UK and EU regulatory requirements. The solution lies in taking a data-driven approach to compliance, with firms establishing a single source of their regulatory data.
As a result of Brexit, financial services firms operating in the UK and the EU are facing increased complexity in complying with existing rules and managing regulatory change. It will take some time to fully understand the final regulatory outlook in both jurisdictions – there are a wide range of factors that will impact how things develop.
Although compliance requirements are likely to grow more complex over time as the UK and EU regimes diverge further, meeting regulatory obligations doesn’t have to become more complicated. Firms that take a data-centric approach will find that they will be able to meet regulatory change with agility.
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