In the run-up to Brexit last year, many within the industry lobbied the UK government extensively arguing for a bonfire of EU regulations – as they applied to financial services. While a sweeping away of EU rules never materialised, the UK has gradually been diverging away from the EU on some regulations.
Take ESG [environment, social, governance] as an example. Although the EU introduced its Sustainable Finance Disclosure Regulation [SFDR] and is in the process of developing a Taxonomy to provide investors with a benchmark outlining what economic activities are sustainable, the UK is unlikely to onshore either of these provisions. Instead, the UK is demanding asset managers running at least £5 billion produce ESG disclosures which are based on the Financial Stability Board’s [FSB] Task Force for Climate-related Financial Disclosures [TCFD]. Some lawyers have argued the UK’s approach is incredibly sensible, pointing out the TCFD is a global, pre-existing standard, in contrast to the EU’s Taxonomy, which is being manufactured from scratch. This means more global institutions are likely to have adopted the TCFD standard, unlike the EU’s taxonomy, which is expected to be far more euro-centric. However, the dual regulatory approach does risk creating challenges for investment firms with operations straddling both the UK and EU.
The Central Securities Depositories Regulation [CSDR] is another piece of regulation on which the UK has deviated from the EU. Although many investment firms assume CSDR is applicable to post-trade providers only, the rules will be felt widely, including within asset management. Under the CSDR’s Settlement Discipline Regime [SDR], counterparties to failed trades will be subject to cash penalties and mandatory buy-ins. While the industry begrudgingly accepts that the threat of cash penalties will help drive up settlement discipline, mandatory buy-ins could prove destabilising, by creating added costs and undermining liquidity. The European Securities and Markets Authority [ESMA] has recognised this and is advising the European Commission to delay the phase-in of mandatory buy-ins beyond their current implementation date of February 2022. Some industry associations have warned the EU that CSDR’s buy-in rules could have catastrophic implications during periods of extreme volatility, highlighting that systemic events might have occurred [especially in the bond markets] had the rules been in place during March/April 2020. While there is speculation the EU could make buy-ins voluntary, the UK already confirmed that the SDR will not apply in the domestic market, in a move that has been largely welcomed by the industry. Nonetheless, UK managers will still need to comply with SDR for any European transactions which are settled by EU-based central securities depositories.
Beyond ESG and settlement discipline, the UK is also making tweaks to other EU rules. It recently acknowledged that non-financial counterparties [NFCs] do not need to report under the Securities Financing Transaction Regulation [SFTR]. Similarly, it is believed that the UK’s Financial Conduct Authority [FCA] could ease some of the research rules and best execution obligations imposed under the Markets in Financial Instruments Directive II (MiFID II). Proposals have emerged suggesting the UK could exempt SMEs with a market cap of less than £200m together with FICC [fixed income, currencies, commodities] research from MIFID II unbundling requirements. Elsewhere, MiFID II share trading obligations and double volume caps have also been shelved by the UK regulators. These revisions to EU regulations are receiving a positive response from the industry.
Although the UK is shifting away from a handful of EU rules, the differences are not massive and certainly do not represent a race to the bottom. Instead, the UK appears to be taking a proportionate and sensible approach to post-Brexit rulemaking, at least for now.