Notwithstanding the political grandstanding coming out of London, Brussels and Strasbourg, the tone of the conversation around the UK exit vote vis-a-vis capital markets regulatory and market outcomes has changed markedly from one of depression, catastrophe, upheaval, debacle and tragedy on Friday and Monday to a clearly still-uncertain but much more pragmatic and constructive one as the week passes.
At Societe Generale’s annual London press party last night at the Victoria & Albert Museum, senior executives were at pains to underline their continued commitment to London. They confirmed they would indeed be moving into their new building in Canary Wharf in 2019, where they’ve agreed a pre-let of around 280,000 square feet at 1 Bank Street to house their 4,000 London-based staff.
Another case in point: a note out in the early hours from US law firm Akin Gump about third-country arrangements for MiFID II passporting highlighted an important issue on MiFID/MiFIR, and by extension made a much wider point with regard to negotiation latitudes for the UK and EU. This latter element was the subject of the ICMA conference call on Tuesday, which attracted 680 registrations.
If you accept that discussions will not be framed by total implacability and harsh rigidity (largely on the basis that politicians are typically not ideologues but opportunists who will do whatever is required to get re-elected) and that any outcome will be reached through horse trading and compromise, you do end up in a slightly better place as your head tries to process the data emanating from the trauma of the UK vote.
Access to the single European market has been cited by people across the spectrum of opinion as being central to the fortunes of the UK and the EU. Who knows what the give-ups will have to be around migration, but even on that fraught topic a number of potential options have been aired.
On the ICMA call, head of market practice and regulatory policy Paul Richards said there will likely be substantial changes in UK legislation as a result of any repeal of the European Communities Act 1972, especially since capital markets regulations are largely set at the EU level either in the form of directives that are transposed into UK law or regulations that apply directly without transposition.
“The UK government will need to decide to keep, modify or discard EU directives that have been transposed to UK law,” Richards said. EU regulations will cease to apply once the act is repealed. The question then becomes on what basis EU regulation is replaced. Regulatory and technical standards are currently drawn up by European supervisory authorities but it’s unclear what the future arrangement might be between ESMA and the UK.
“In terms of capital market regulations,” Richards said, “the UK might have a better chance of negotiating favourable terms of access to the EU single market if existing EU legislation is grandfathered. But this assumes that the UK will be willing to grant cross-border access to the EU on a reciprocal basis.”
Third-country rules
On the issue of the regulatory equivalence test, Akin Gump – in its piece Light at the End of the (Channel) Tunnel – noted that in the event of full exit, the UK could become a third country under MiFID, and UK firms registered with ESMA would become third-country firms under Article 46 of MiFIR.
Subject to certain conditions being met, this means they can still benefit from the MiFID II passporting regime and provide investment services or perform investment activities in respect of eligible counterparties and professional clients on a cross-border basis throughout the EU.
Richards took up this theme on the ICMA call. “Some EU legislation provides that the EU can deem third-country regimes to be equivalent in exchange for reciprocity although this does not apply in all cases. The EU will be expected to insist that as a condition for future access to the EU single market on favourable terms, UK law should be kept up-to-date and in conformity with EU law.”
That seems an acceptable condition although the red line there could be the primacy of the European Court of Justice over UK law.
On MiFID II/MiFIR, a key condition of third-country acceptance is the existence of a fully functioning legal, supervisory, prudential and enforcement framework that has an equivalent effect to requirements already laid out. This includes, among other things, capital adequacy, organisational requirements for internal control functions, conduct of business, market abuse safeguards; exchange of information and co-ordination with ESMA.
That all sounds eminently workable. However “the obvious fly in this particular ointment,” wrote Akin Gump, “is that the decision to recognise the UK as having financial regulation with “equivalent effect” to that in the EU is entirely within the gift of the Commission. However, at the point of departure (assuming that it is after January 2018), the law in the UK will not just be equivalent to that in the EU; it will, in fact, be exactly the same”.
“The only reason, then, for the Commission to refuse that equivalence determination will be political. Of course, the Commission may well have many political reasons to refuse to make the determination – but, unless there is to be a complete breakdown in the relationship between the UK and the EU (which would be in no one’s interests), there is reason to believe that pragmatism will prevail.”
Fragmentation risks
Post-withdrawal, Richards said it wasn’t clear that leaving the EU will lead to less capital markets regulation in the UK than would otherwise be the case. First, because the overall framework is set at a global level by the G20 and the UK will continue to participate at the G20. Second, because the UK will need to continue to comply with EU regulations if it wants to obtain favourable terms of access to the EU single market after leaving; and because national regulators in the UK have been prominent in promoting strict regulations since the international financial crisis.
Capital markets fragmentation between London and the EU and a brake on Capital Markets Union are obvious outcomes if the UK is no longer member of the EU single market. “The resignation of Lord Hill is not surprising in the circumstances but it’s a step backwards for capital markets integration between the UK and the rest of the EU,” Richards said.
Other issues cited are the approach of the ECB to counterparties in the UK as it draws euro markets and the euro market infrastructure including central counterparty clearing from London into the euro area; the UK’s membership of the European Investment Bank; the location of the European Banking Authority (currently London) and the use of English law, currently widespread in financial contracts.
● As a postscript, Akin Gump mentioned the exit options as “soft-Brexit” and “hard-Brexit” options. I must say that took me all the way back to 1990 when John Major, then UK finance minister serving under prime minister Margaret Thatcher, proposed a new currency regime called the ‘hard ECU’ as an alternative to the euro.
For those too young to know (or too old to remember), the European Currency Unit was a basket of European Commission member state’s currencies functioning as a unit of account that operated in parallel with national currencies.
By 1990, the ECU was on track towards the single currency. Major proposed that instead of ditching legacy currencies, the Commission implement what he called a hard ECU, a currency arrangement that would continue to operate alongside existing currencies and be managed not by a single European central bank but by a European monetary fund.
Needless to say, it didn’t catch on and the euro marched on with great fanfare into the core eurozone in 1999.
That almost brings us full circle…
