Brexit continues to grab the headlines following last month’s long-awaited triggering of Article 50, but alongside this landmark in the history of the EU, another critical development is gathering momentum: a reappraisal of the huge corpus of financial regulation introduced by EU supervisors since the financial crisis. Both are likely to prompt a reversal in the decades-long trend of harmonisation. While this won’t result in a loosening of standards, there will be implications for all participants in financial markets.
Three things to watch
If the UK is to retain access tariff-free to the single market, roughly equivalent standards in some capacity will be required to enable business to continue with the EU, its biggest trading partner. This principle of mutual recognition is a reality for any trading relationship.
To a degree yet to be determined, it is unlikely that the UK will retreat from much of the EU regulatory settlement in financial services, given that the UK and the EU had common cause over much of it – to the extent that UK regulators frequently “gold-plated” EU rules.
Financial regulation in Europe has passed its peak.
In the financial sector across Europe, the pendulum is swinging back from the imposition of new regulation, and instead is focusing increasingly both on areas of potential overlap and on addressing any unintended consequences. This review is not necessarily related to US developments so much as to a recognition that rules were getting onerous, particularly within an environment of weak growth and reduced lending.
The reform process since the crisis has been slower in Europe than it has been in the US; it has also been more complex, with 41 major pieces of legislation compared with one. Regulatory tightening probably peaked with the implementation of the Basel III rules, and regulators have since been working with market participants to scale back. Standards will still get tougher, as new measures are implemented over the next few years, but they are less aggressive than originally drafted.
Clarity on regulation is important for banks, in order for them to switch their focus from building up capital to ramping up lending, which in turn is beneficial for consumers and businesses. Lending in the US has been more robust and balanced in terms of supply and demand, and our expectation is that Europe will start to catch up, particularly against a backdrop of improved economic growth.
As European regulators row back, a global fragmentation is also likely to take effect, as authorities worldwide retreat from the attempt to enforce global standards.
Since the early 1990s, regulators have worked toward global harmonisation and standards for capital requirements were introduced to help build trust in foreign banking systems, and promote the globalisation of banking products and services. That trust broke down after the financial crisis, as regulators turned inward, focused increasingly on their own banking systems rather than broader global networks. Re-regulation has been brought into effect as each jurisdiction has revised its own standards in isolation, with more barriers being erected on the basis that it is easier to supervise smaller banks with compartmentalised capital and funding.
As formal divorce proceedings begin for the UK and the EU, and as supervisors around the world assess the implications of their attempts to stave off the next crisis through smarter and more integrated rules, a few likelihoods – if not always certainties – are emerging.
One, the UK certainly is leaving the EU, but that doesn’t mean a wholesale retreat from its current regulatory stance; two, EU supervisors know that they have overreached themselves and will seek to repair the unintentional damage this has caused; three, the emphasis in regulation has turned from global to local, with a proportionate change on the winner/loser ledger board in financial services.
So much else remains unknown, but we are confident that these will remain guiding trends as the regulatory and political cycle enters its next phase.