Two recent documents from industrial organizations pleaded in favor of regulatory recognition agreements in order to reduce regulatory burdens. TheCityUK (TCUK) pleaded for them as part of a strategy for the UK to regain its place as the world’s leading financial center. The Futures Industry Association (FIA), a global body, has also promoted them, as a way to combat market fragmentation, setting out seven principles to enable them to be applied in practice.
Regulatory recognition comes in many forms and terminology is not always consistent. But the basic concept is simple: one state (the host state) agrees to recognize the adequacy of the regulatory and supervisory regime of another (the home state) and allows subject market players home state regime to provide their services in the host state without having to fully comply with the host state regime. Recognition can be granted for a wide or narrow range of purposes. It can be granted on a mutual basis or unilaterally. In some circumstances, host states may even exempt foreign entities from certain aspects of domestic regulation without regard to the adequacy of the home state’s regime.
The “passport”, which applies between EU member states, is a highly developed and liberal form of mutual recognition. Interestingly, IOSCO considers it sufficiently different from most mutual recognition agreements to place it in a category of its own. The passport allows EU companies to provide services such as banking, insurance and investment trading in or in other EU states. It also extends to things like the sale of investment funds, the marketing of securities and the provision of trading and clearing facilities.
The EU and UK also have unilateral recognition regimes for providers of certain types of services based in home states whose regulatory and supervisory regimes are considered “equivalent” to theirs. And an example of a unilateral exemption where the quality of home state regulation is irrelevant is the UK’s “overseas exclusion”.
The scope of regulatory recognition agreements is in practice strongly oriented towards inter-professional wholesale trade, where investor protection is not so much of a concern for the host State. The WTO GATS agreement prohibits recognition agreements from being applied in a discriminatory manner, requiring that, where they exist, they are in principle open to all WTO members who meet the relevant criteria.
The question I want to consider here is whether further efforts to enter into regulatory recognition agreements can help the financial services industry in the UK. With a relatively small national hinterland and a comparative advantage in this sector, the City needs international trade to thrive. Trade liberalization is therefore a logical political position. This has always been the City’s default approach, and it has been supported in this by successive governments of different political stripes. Regulatory recognition agreements can clearly reduce barriers to trade, so extending the number and scope of such agreements would undoubtedly be helpful for UK industry. TCUK thinks they could “significantly expand [the UK industry’s] footprint and bring business back to the UK ”. The real question seems to be whether a significant increase in these agreements is likely to be achieved in the short or medium term.
TCUK’s top priority seems to be the UK-US relationship. TCUK wants the government to strengthen UK-US relations following Brexit and prioritize maintaining its attractiveness as an international hub for US businesses. President Biden has played down the prospects for a near-term UK-US trade deal. As a result, TCUK sets its ambitions at a rather low level, identifying increased regulatory alignment and dialogue as the desired short-term goal. Dialogue is one thing, very much in line with a ‘World Britain’ approach, and the UK government has been happy to talk about its commitment to engage in this way with the US authorities. Regulatory alignment is another, and potentially more delicate for sovereignty aspects of government thinking. Nonetheless, the UK has always been active in promoting multilateral regulatory alignment through the Financial Stability Board and international standard-setting bodies, and the UK’s commitment to these standards appears likely to continue. . However, regulatory alignment at a detailed and granular level is often difficult to achieve, and the FIA stresses that host states should accept comparability of regulatory outcomes as a sufficient basis for recognition.
Regulatory dialogue between the UK and the US has been going on for some time in various forms. In recent years, the US-UK Financial Regulation Task Force has been established in the wake of Brexit to formalize regulatory cooperation with a far-reaching mandate. Its objectives include identifying potential cross-border implementation issues, aimed at avoiding regulatory arbitrage and increasing the compatibility of respective national laws and regulations. The UK’s interest in regulatory recognition is evident in some of the topics discussed at the last meeting: preserving the portfolio management delegation model of the global asset management industry; guarantee the free flow of data on cross-border financial services; and the risks of fragmentation induced by regulation on derivatives clearing markets.
The trading and clearing of derivatives is in particular need of proportionate regulatory recognition agreements, in part because of the global nature of the market, but also because of the broad extraterritorial approach the United States has taken to its regulation. Tangible regulatory recognition measures have nonetheless been approved in relation to the US Dodd-Frank’s rules for swaps, where the CFTC and the SEC have both agreed to “substituted compliance” agreements, allowing UK companies to comply with UK, rather than US, rules in certain areas and circumstances. Progress in regulatory recognition generally appears slow. Where there is progress, recognition is likely to have relatively limited application. But TCUK notes that even small steps forward in regulatory compatibility between the US and UK could be very positive for the UK as an international financial center.
Another priority for TCUK is the UK-EU relationship. Here, of course, recent history matters. Brexit has just taken the UK out of the EU’s “passport” regime. He has yet to convince the EU to really agree by way of substitution – just two “equivalency” decisions, intended primarily to avoid the cliff-edge effects of the Brexit event itself. The most important of these, for UK clearing houses, is set to expire in June 2022 – what will happen after that is unclear. More generally, there is currently no indication that the EU is willing to expand the range of recognition of equivalence for the UK, and it seems unlikely that it will do so as long as political tensions persist over issues such as the Northern Ireland Protocol. There are also longer-term headwinds as the EU seeks to reduce its dependence on UK financial services and build its own capacity. A memorandum of understanding on the continuation of dialogue and cooperation between the UK and the EU in financial services, on which the parties had committed to agree at the end of March and which had apparently been fully negotiated on that date, has still not seen the light of day. On the contrary, there are signs that the UK and the EU are moving further apart: UK is using its liberation from EU structures to deviate from the EU financial services regulatory regime , and the European Central Bank would like more regulatory involvement from the EU, not less, with UK banks operating in the EU.
It appears that progress on regulatory recognition with the US and the EU is likely slow. TCUK notes that accepting new deals will likely take time and effort, although it believes that given their potential value to the UK economy, the investment will be worth it.