As the Brexit debate has trundled along, I realize that the Brexit Hedge Fund Myth I wrote about last month, is really a symptom of a larger issue I have dubbed the Brexit FinReg Fallacy.
Basically, those who fall for this fallacy believe that if the UK can escape the technocrats in Brussels, the City will be free of burdensome regulation and British financial services will flourish. The Brexit FinReg Fallacy is perfectly articulated by this Daily Mail article, which hypothesizes what a post-Brexit UK would like in 2020.
London, too, is booming. Eurocrats never had much sympathy for financial services. As their regulations took effect in Frankfurt, Paris and Milan — a financial transactions tax, a ban on short selling, restrictions on clearing, a bonus cap, windfall levies, micro-regulation of funds — waves of young financiers brought their talents to the City instead.
Much like the hedge fund myth, this is an extremely attractive idea and also, sadly, not likely to be true. There are two reasons why the Brexit FinReg Fallacy is just that.
First, the concept suffers from the same structural issues as the Brexit Hedge Fund Myth. Post-Brexit, there are two likely scenarios for the UK:
- The “Norwegian model”, which means the UK would leave the EU but remain in the European Economic Area (EEA). If the UK goes down this road, as a condition of EEA membership, it will be required to implement EU financial regulation.
- The UK completely leaves the EU and does not join the EEA. Even in this case, it will still need to play by EU rules to access the market. For example, much like AIFMD, the new MiFID 2 rules require third countries (i.e. non-EU countries) to be deemed equivalent by the EU Commission. UK banks that seek to set up in the EU post-Brexit will also have to follow EU regulation in order to do business.
No matter the outcome, the UK financial services industry will have to play by the EU rules in order to access the EU market. The biggest difference will be that the UK will no longer have a say in the final shape of the rules.
This brings me to the bigger weakness in the Brexit FinReg Fallacy, the belief that UK policymakers will be more lenient on the financial services industry than Brussels. There is little evidence that this is true, and in fact it is quite the opposite. In the years since the global financial crisis, the UK has generally been tougher on financial services than its European peers. For example, the controversial unbundling of investment research fees in the MiFID 2, was championed by the UK despite objections from countries like France and Germany. Similarly, the UK’s Retail Distribution Review, which bans the payment of trailer fees to investment advisors, is far stricter than the final equivalent rules in the MiFID 2.
Beyond asset management, the UK has also been far tougher on its banks. For example, the Bank of England’s ring fencing rules (similar to the US Volcker rule), which will eventually force UK banks to ring fence their retail and investment bank activities, are far more stringent than what’s been proposed at a EU level. Additionally, the UK has been much more successful in persuading non-UK banks to close their UK branches and establish local, better capitalized, subsidiaries.
Overall, between the realities of what accessing the EU market actually entitles and the position of the UK policymakers, it is hard to see any reality in the Brexit FinReg Fallacy. Bottom line, the UK is unlikely to see a material reduction in financial regulation post-Brexit.