On 31 January, the UK’s Cabinet Office published its paper on the Benefits of Brexit. A good deal has been written on this paper and the benefits it outlines, however, rather than repeat that debate, I wanted to focus on regulation and highlight two interesting aspects that haven’t received much attention: ‘alternatives to regulation’ and ‘regulatory diplomacy’.
Regardless of how you feel about Brexit, there are some things that are undoubtedly true about regulation within the EU. First, the very structure of EU decision making means change can only happen slowly and only the most fervent Europhile would describe EU regulation as agile. Second, although it would be wrong to say the EU machine does not produce effective regulation, there are often occasions where the goal of harmonisation and the need for compromise lead to regimes that are not exactly perfect for anyone. This second point is reflected in the axiom familiar to anyone who has been involved in EU negotiation that a good compromise is one where nobody is happy.
These two issues are clear targets for improvement in the in the Benefits of Brexit paper. Free of the need to compromise with 27 other countries (and also the European Parliament) and outside the laborious EU processes needed to reach such compromises, the UK really does have an opportunity to tailor its regime to the UK’s position and act more quickly to deficiencies that emerge in the regime or through evolving markets (for example, because of new technology). The paper embraces these possibilities and it is striking how often the paper stresses the need to revisit regulation through the lens of UK competitiveness and UK priorities. The paper also states that the UK will seek alternatives to regulation wherever possible and targets £1 billion in cost savings (and Jacob Rees Mogg, the recently appointed cabinet minister for Brexit Opportunities, has also been tasked with getting rid of 1000 pieces of regulation).
This focus could make many people nervous, particularly those responsible for financial service regulation in Brussels who have expressed concern about the potential risks of undercutting standards in a lightly regulated City of London. However, the UK process of making regulation more effective and efficient should not automatically mean lower standards (and the paper does state that high standards need to be maintained). High regulatory standards are recognised by many as part of the UK’s competitive advantage in financial services and memories of the global financial crisis and the deficiencies of the previous worldwide regulatory regime are still fresh enough. However, that is not the same as saying fresh approaches cannot or should not be sought.
While being outside of the EU and the need for its compromises and adherence to its processes means that the UK can be more agile, it has lost its ability to influence directly regulation in other EU member states. As the largest firms operate internationally, the risk is that any improved efficiency in the UK is meaningless as, for practical reasons, compliance is often simply set at the level of the highest requirements globally and it can be unhelpful and raise costs to have one jurisdiction doing things very differently. The UK will seek to address this through what it describes as ‘regulatory diplomacy’.
So, what can we expect from the combination of alternatives to regulation and regulatory diplomacy and what might this mean for financial services and those following regulatory developments? Much of the current regulatory framework stems from global political decisions made through bodies like the G20, with the more technical framework agreed by regulators globally in standard setters such as IOSCO and Basel. Specific legislators, such as the US or EU, then adapt the agreed frameworks into their own applicable law and specific rules. I believe that, outside of the EU, the UK’s regulatory diplomacy will focus on these global standard setters. It is here that the UK will attempt to shape international regulation and ensure global consistency. We can probably expect more activity in coming years in such bodies and, perhaps, frameworks set at this level will become more granular than they are now.
This is where the alternatives to regulation could come in. I think that instead of detailed rules, the UK will increasingly use more principle based and outcome focussed regulatory codes. Codes are a way of committing in scope parties to certain outcomes while providing flexibility in how the outcomes are delivered. Levels of detail can be very different, but generally they provide a common set of guidelines or principles that participants in scope must adhere to, but these are not rules per se. Codes also lend themselves to global application precisely because they allow international alignment but flexibility for jurisdictions with different legal practices. A number of examples already, such as the FX Global Code of Conduct, but I expect to see more and to see them discussed at standard setters.
Of course, there will be a number of questions over an increased use of codes, such as whether they would be enforceable, lead to regulatory competition and light touch regulation, or lead to genuine consistency for international firms. There could also be tension between the UK regulatory regime being more explicitly focussed on UK interests while also engaging in ‘regulatory diplomacy’ to convince others of the merits of the UK approach. But codes would be a new approach with new roles for standard setters and even firms and industry groups. One thing is certain, those of us who spend our lives following regulatory developments are in for an interesting time with even more places and issues to follow!
– David Cook, Managing Director International Financial Services