Table of contents

1. UK financial sector and importance of trade with the EU

The House of Lords European Affairs Committee published its report into the relationship in financial services between the UK and the EU in June 2022. Its findings are due to be debated in the House of Lords on 17 May 2023.

In its report, the committee outlined the importance of the financial services sector to the wider UK economy, noting that it employs 2.3 million people and makes up 10% of total UK tax receipts. The sector is also an important contributor to the UK’s international trade, comprising 19.1% of all UK services exports. The EU is an important trading partner in this sector, making up 37% of total UK financial services exports in 2019.

Trade between the UK and the EU has been affected by the UK’s exit from the EU, though arguably to a lesser degree than had been anticipated. The committee noted that the post-Brexit UK-EU Trade and Cooperation Agreement (TCA) contained few provisions for trade in financial services but said “this had long been anticipated and prepared for”. The committee observed that financial services jobs have moved from the UK to the EU “but in far smaller numbers than some expected”. Indeed, the committee noted that current estimates suggest 7,000 jobs have moved, compared to estimates of up to 75,000 in the five years after withdrawal made in 2016. However, the committee also warned against “complacency in this regard”, saying that it was “not yet clear whether the impact of Brexit on employment has fully played out”.

During the course of its enquiry, the committee said that the witnesses it heard from were largely optimistic about the future outlook of the financial services sector, whilst “acknowledging the challenges that Brexit has presented”. It noted that London has retained its position as the world’s second largest/most important financial centre and the most important in Europe. It also said there was “a strong sense among the witnesses we spoke to that the sector has retained its resilience”.

However, the committee also said the government must ensure that its approach to financial services delivered for the whole country as well as the City of London. To that end, it made several recommendations, as explored below.

2. Committee recommendations on the UK-EU’s relationship in financial services

The committee’s findings and recommendations were grouped according to the following four key themes:

  • Equivalence. Equivalence is a system which can be used to grant domestic market access to foreign firms in certain areas of financial services. The committee said that there was a “notable” absence of EU equivalence decisions in the current UK-EU relationship in financial services. It said this was “particularly striking” when set against the EU’s approach to other third countries as well as the UK’s own approach to equivalence towards the EU. The committee found a consensus among its witnesses that this approach by the EU was “political rather than technical” and that the UK was “being held to a higher standard than other countries”.

The committee argued that some of the “missing” equivalence decisions would be mutually beneficial for the UK-EU trading relationship in financial services. However, it added that the sector did not appear to view either the general lack of equivalence decisions or the competitive imbalance compared to other third countries “as a matter of fundamental concern”. Moreover, as equivalence decisions are unilateral in nature, the committee noted that the UK government’s ability to rectify the absence of EU decisions was limited. The committee concluded that it “would be unwise for the government to base its strategy for financial services on a process that it cannot control, and which currently seems unlikely to bear fruit”.

  • Regulatory cooperation. The committee noted that the UK and the EU have committed to a memorandum of understanding (MoU) on regulatory cooperation, yet this had still not been signed or entered into force. The committee said this was a matter of “regret” and said there was a widespread view that the MoU has become a “casualty of wider tensions” between the two sides. As with equivalence, the committee said comparisons with other third countries were “striking”. It noted that both the UK and the EU have mechanisms for regulatory cooperation with the USA that they do not have with each other.

The committee acknowledged that the lack of the MoU “does not appear to have caused major problems so far”, particularly as a series of other MoUs for technical cooperation between regulators were in place. Nevertheless, the committee said the MoU would still have value as a mechanism for strategic dialogue. It therefore cautioned the government against “complacency” and called upon ministers to step up political and diplomatic financial services engagement with the EU.

  • Regulatory reform and divergence. The committee noted that the UK’s current rules for financial services were closely aligned with those of the EU. It welcomed the short-term stability this provided but recognised that it had resulted in a “complex and unwieldy regulatory framework”. To rectify this, the committee noted that the government was seeking to give more powers to financial services regulators. The committee said that, whilst this may allow for more flexible and proportionate regulation, greater powers for regulators “must be accompanied by appropriate mechanisms for scrutiny and accountability”. The committee also noted that the government was considering introducing an additional ‘competitiveness’ objective to the remit of the regulators, and said it had asked the government to clarify how this would operate in practice.

The committee said it welcomed the launch of several reviews into the future regulation of financial services in the UK. It noted the ‘State of the sector’ report anticipated from the Treasury and City of London Corporation (published in September 2022) and said it recommended that the first five editions of this annual report should include a dedicated section on the UK-EU relationship in financial services.

More broadly, the committee agreed with its witnesses that divergence between the UK and the EU was inevitable and may present the UK with opportunities to innovate and tailor the UK’s regulation to its own interests. However, it also stressed that the government needed to weigh up the benefits of divergence against other factors including the costs of implementing new rules.

It also said that divergence was likely as the result of developments in the EU, particularly the emphasis placed by the EU on ‘open strategic autonomy’. Noting this focus on control and market location was philosophically different to the UK’s approach, the committee said it was concerned this “could increase barriers to cross-border trade in financial services”. The committee also said that “the UK has inevitably lost influence in the development of future EU rules post-Brexit”, adding it was concerned that the government “appears unwilling to utilise the influence it still has and have asked it to clarify its position”. The committee said this was part of a “detectable theme” that emerged in other areas of its inquiry: that the government was reluctant to fully engage with the importance of the UK-EU relationship, or to acknowledge that developments in the EU still had significance for the UK.

  • Opportunities. The committee said there were opportunities for the UK to establish new rules in “forward-looking and novel areas” where there was currently limited regulation, particularly in the areas of financial technology (‘FinTech’) and green finance.

It said another potential Brexit opportunity was the pursuit of new trade agreements with third countries. The committee noted that free trade agreements often make little provision for financial services and recognised that the government was exploring alternative approaches. Most notably this included negotiating a mutual recognition agreement (MRA) with Switzerland. The committee welcomed this ambition and said it hoped an agreement was concluded swiftly.

More broadly, the committee welcomed the government’s open and nonreciprocal approach to financial services, though it urged them to “continue to recognise the importance of immigration and access to talent in ensuring the sector remains open for business”.

3. Government response to the committee’s report

In the government’s response to the committee’s report, published in October 2022, it said that the UK’s financial services sector was “fundamentally strong”. It added that the government was seeking to grasp opportunities to “deliver its vision for a sector which is open, green, technologically advanced and globally competitive”.

The response added that over the coming years the government would implement a “sweeping set of reforms” to sharpen the UK’s competitive advantage in financial services. It highlighted the Financial Services and Markets Bill (examined in more detail below), which it said would deliver on the government’s “ambitious vision” for the financial services sector to “promote and enhance the UK’s position as a global leader”.

On the specific issues raised by the committee’s report, the government said that it continued to engage with the institutions and member states of the EU, and “[stood] ready to sign the memorandum of understanding on regulatory cooperation in financial services once the EU side is ready to”.

On equivalence, the government  agreed with the committee that other jurisdictions receiving more equivalence decisions from the EU “will not in itself create a competitive disadvantage for the UK”. This was because only certain equivalence decisions within the EU’s overall framework directly grant market access to overseas jurisdictions.

The response added that the government was taking advantage of opportunities to strengthen ties to financial markets outside the EU. It pointed to the mutual recognition agreement currently being negotiated with Switzerland as a key example of this. The response added that the UK government undertook regular financial dialogues with the world’s leading financial centres. For example, it cited the establishment of the UK-Japan financial regulatory forum in June 2022. It also said that the government “remained committed to a position of openness and cooperation” with the EU and that it continued to engage with EU counterparts to strengthen relations.

The government’s response also noted the first ‘State of the Sector’ report jointly published by HM Treasury and the City of London Corporation on 20 July 2022. Among its provisions, the report outlined key performance indicators, comparing the performance of the UK’s financial services sector with those of other major economies. The report also summarised the steps government and regulators were taking to improve the overall environment for the sector and the wider ecosystem, and identified potential areas for further reform.

The government argued that the ‘State of the sector’ report showed there was “strong agreement that the government’s vision for the sector is focused on tackling the right challenges to retain the UK’s place as a world-leading financial services hub”. However, the government acknowledged that there were “clear challenges from industry to do more”, for example on regulator authorisations. It said these also included ensuring “we continue to push to be at the forefront of international standards on emerging areas such as green finance and fintech”. It said these were issues that the government and regulators would be focused on going forward.

4. Recent developments: Financial Services and Markets Bill

The Financial Services and Markets Bill seeks to make wide-ranging changes to the regulation of financial services in the UK. According to summary information prepared by the Treasury the bill would:

  • implement the outcomes of the Future regulatory framework (FRF) review
  • maintain the UK’s position as an open and global financial hub
  • harness the opportunities of innovative technologies in financial services
  • bolster the competitiveness of UK markets and promote the effective use of capital
  • support the levelling up agenda, promote financial inclusion and consumer protection

Among its measures, the bill would provide for the revocation of retained EU law relating to financial services and would give powers to the financial regulators to make rules in these areas.

The bill has passed through the House of Commons and is currently being considered in the House of Lords. Introducing the bill at second reading in the House of Commons, then economic secretary to the Treasury Richard Fuller said that the government would use the provisions in the bill to repeal EU financial services legislation to “implement a more agile and more internationally competitive set of rules that will harness the potential of UK financial services to stimulate growth across the United Kingdom.”

Speaking for the opposition, Shadow Financial Secretary Tulip Siddiq said it was important that the UK took advantages of the opportunities presented by Brexit to “create a more competitive financial services sector”. She emphasised the importance of the UK’s trade with the EU in financial services and said that the government should aim to finalise the MoU on regulatory cooperation and negotiate with the EU. However, Ms Siddiq also argued that the EU could be “overly restrictive” in some areas of financial regulation and welcomed the fact that the bill would enable regulators to take a “more outcomes-based approach” to areas such as financial technology.

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Cover image by Dimitry Anikin on Unsplash.