Brexit: what does it mean for financial markets to be open?

Speaker: Andrew Bailey[1], Chief Executive
Event: City Week ‘The International Financial Services Forum’, Guildhall, London
Delivered: 24 April 2018
Note: this is the speech as drafted and may differ from the delivered version

Highlights

• Now is the time for the UK and EU authorities to come together and work on the solutions to reduce the risks to financial stability that Brexit could pose. 
• At the FCA we want to work closely with ESMA and national EU regulators to continue to enhance the stability and effectiveness of global markets. 
• This has global implications, not just for the UK and EU, so it is important that we get this right.

I want to take this opportunity to talk about Brexit, where things stand from a financial services perspective. In doing so, I will focus on what it means to have open markets, and how we can preserve them for the benefit of all.

It is useful to divide the subject into 2 parts: the prospects and reasons for a transition or implementation period; and what the steady-state future world could look like. I will follow that approach today.

Before I do, I will make one point: we – that’s the UK and the European Union (EU27) - will not be able to achieve a successful outcome during both transition and steady-state without working together. Now is the time for the UK and EU authorities to come together and work on the solutions to reduce the risks to financial stability that Brexit could pose. At the FCA we want to work closely with European Securities and Markets Authority (ESMA) and national EU regulators to continue to enhance the stability and effectiveness of global markets. This has global implications, not just for the UK and EU, so it is important that we get this right.

Transition or implementation period

I welcome the agreement at the European Council on 23 March 2018 that there should be a transition or implementation period. UK withdrawal from the EU without such an agreement would create risks for both the UK and the EU27 of a so called cliff edge - which we should all want to avoid. The UK Government, supported by regulators, has taken a strong and very welcome stand on the need for a transition or implementation period, and I am encouraged by the acceptance of this point on both sides. This matters in financial services because the risks around contract continuity, data sharing, and broader market disruption could jeopardise financial stability, the preservation of which is a shared objective of both sides. If you want to know more about these risks, there is a useful description in the statement of the Bank of England’s Financial Policy Committee following its most recent meeting in March.

There are 2 reasons in my view why we need a transition or implementation period. First, we need more time to mitigate these cliff edge risks – call that the transition reason. Second, it makes far more sense for firms and authorities to put into effect their plans only once they know what the steady agreement looks like – call that the implementation reason.

The cliff edge risks are symmetric in that they are present in both the UK and the EU. To reiterate, regulators and authorities in the UK and the EU share common objectives to preserve financial stability, and we have a common obligation to do everything we can and work together to do that. Financial stability is far too important to engage in a standoff.

I do recognise that the overall transition or implementation package is viewed as indivisible and that there remain issues to be agreed on it which are outside the area of financial services. But that does not stop authorities both here and in the EU working together to mitigate the cliff edge risks, even if we do not yet have a final agreement on what these arrangements will be.

The best thing we can all do now is to engage openly and speedily together to work on solving these issues and thus to preserve financial stability and protect consumers and users of financial markets. By doing this, we can create confidence that we will put into effect as smooth a transition as possible. We are ready to get to work on this. And, I would echo the words of Vice President Dombrovskis, namely that the ‘most important common objective in relation to Brexit must be to preserve financial stability’.

But for the moment we cannot assume that such arrangements will be in place and so the UK authorities have also set out plans for unilateral action in the UK to minimise cliff edge risks, providing continuity for firms doing business in the UK and confidence for their customers. The Government has committed to legislating for a temporary permissions regime. I welcome this, something that has been a priority for the FCA for some time as we believe that this provides certainty for firms which passport into the UK from the EU.

Alongside this, we are working to ensure a functional regulatory framework on day one of Brexit and as much continuity as possible in any scenario. Crucial to this is the very large amount of work we are undertaking on the EU withdrawal legislation.

But – and it is a big ‘but’ – while it is necessary to have unilateral actions in place for the UK, this is nonetheless a distinctly second best solution to the UK and EU authorities working together to deal with the risks. Let’s get on with it please.

The steady-state

Dealing with the transition will allow us collectively to focus on the steady-state future. The central guiding principle here must surely be that both the UK and the EU have a long history of promoting free trade and open markets. Open markets run deep in the history of the City of London - in fact as deep as you can get. The third Mayor of London, Serlo le Mercer, was a signatory of the Magna Carta in 1215 which stated that:-

‘All merchants are to be safe and secure in leaving and entering England, and in staying and travelling in England ……… to buy and sell free from all maletotes [unjust taxes] by the ancient and rightful customs’.

His successor, William Hardell was responsible for enforcing it, the predecessor of the FCA’s enforcement function.

On day one of Brexit the UK and the EU will have deeply integrated financial markets with aligned regulatory rules. That is a benefit to both sides. Moreover, the benefits of open markets are worth preserving. And we can do it. We can together build an approach that supports mutual recognition of each other’s standards to support cross-border business. To reiterate the point I made on transition, this is the best way to maintain financial stability.

Unfortunately, I have heard the argument made that the best way to preserve financial stability would be to become less open, to limit cross border flows of business, to restrict domestic parties from having access to overseas markets, and thus to ensure that activity takes place in the home jurisdiction. Let me reiterate, to do this means restricting the activity of parties in the EU. I say this because I have no doubt that the City of London will remain open to business, so the question is whether EU parties will be allowed to do business here, not whether we will allow it.

In my view, closing access to financial markets which are global not regional will undermine not enhance financial stability. It will reduce the potential for financial markets to support growth and trade, impair innovation and limit the ability to manage risk, and thus make the overall financial system more fragile.

Moreover, closing off access to markets by not recognising on a robust basis other jurisdictions amounts to an own goal from the perspective of choice and competition.

This has been recognised in a draft report from the European Parliament by Brian Hayes MEP, which notes that increased regulatory and supervisory cooperation between the EU and third countries has improved global consistency and made the EU more resilient to financial shocks. The report also notes that unlike equivalence, international agreements can provide mutual access between the EU and third countries which can better advance international cooperation.

Yes. I agree. Equivalence decisions and even better mutual recognition, increase choice and competition in home markets. They are good for users. The EU has already made over 200, and continues to make equivalence decisions which demonstrate this.

For example, equivalence decisions in the derivatives and trading space have allowed European banks to service clients across the world and EU investors to access pools of liquidity anywhere in the world.

UK markets are highly open and have remained so notwithstanding the experiences of the crisis. It would have been tempting to retreat from such openness following the crisis, but it would have been the wrong thing to do. In the UK we already have a policy for branches from non-EU countries in the UK which allows them to establish under certain sensible criteria. One of the less well known features of the UK regime is the Overseas Person Exclusion which allows overseas firms to provide services to UK based clients on a range of wholesale business without the need to set up a branch. We think approaches like this are a sensible and proportionate way to support stable global financial markets. It is underpinned by close supervisory cooperation which we have been strong advocates for and practitioners of.

I agree with Brian Hayes MEP that the current EU equivalence regime doesn’t best suit any of the parties. Mutual recognition, as he suggests, would be the better way to establish the steady-state between the UK and the EU in future.

How could mutual recognition work?  We can start by recognising that our regulatory frameworks are equivalent on day one of Brexit. This will be delivered, no doubt about that.

Both the UK and the EU will retain autonomy in rule making, but we should put in place cooperation and coordination structures that work to keep them materially consistent. For instance, at the FCA we want to work closely with ESMA and national EU regulators to promote common standards in international fora in order to enhance the stability and effectiveness of global markets. Our supervisory cooperation should be commensurate with the integration of our markets.

We should always base our rules on prevailing international standards. Continued alignment with such standards should be a clear intended outcome of any responsible financial centre, and where rules implement international standards, there should be a strong presumption of equivalence.

But international standards are not always sufficiently detailed, and in some cases jurisdictions may wish to go further, and expect that firms operating in their market do likewise. As our rules evolve, we should regularly assess the differences on the basis of the outcomes they deliver. It should be possible to develop a set of principles by which we assess outcomes based equivalence, and that these work across the financial services landscape. It should give both sides comfort about risks, critically in terms of risks to our goals of financial stability, market integrity, consumer protection and competition. And, it should not promote regulatory arbitrage.

On this basis, mutual recognition seems to be to be eminently achievable. And, to be clear, this is not cherry picking, because that phrase gets used rather loosely at times. It is in fact the opposite.

Conclusion

I am encouraged that there are now fewer comments to the effect that financial services cannot feature in the steady-state agreement between the UK and the EU. They can and they should because the benefits of open markets will be realised by both sides. And, it is the best way to ensure financial stability, the integrity of markets, the protection of consumers, and competition and choice. These are the key public interest objectives for all of us, here and in the EU27. Meanwhile, we have to work together now to mitigate the immediate cliff edge risks. I’ll say again, now is the time for the UK and EU authorities to come together and work on the solutions to reduce the risks to financial stability that Brexit could pose.