Regulatory divergence between the UK and the EU is expected to increase the complexity and cost of regulatory programmes and international firms will need to focus on developing a comprehensive approach towards cross border governance, risk management and compliance. In this blog we explore the “EU / UK Regulatory Divergence” as a regulatory theme of particular interest to our capital markets clients, following publication of the Financial Markets Interim Regulatory Outlook 2021.
The UK and the EU have already begun to diverge in regulatory frameworks and approach to overseeing financial markets in their respective jurisdictions. Post Brexit the UK regulators are modifying and tailoring regulation to promote global competition based on the UK market structures whereas the EU regulator’s priority is to develop a more harmonised internal capital market. The two regulators are not only taking a different approach to important areas of the legislation but, a more challenging aspect is that they are also diverging on the respective implementation timelines that will require sophisticated infrastructure and data management to achieve compliance.
Although the UK’s new regulatory regime will be less operationally burdensome, the divergence will pose a significant challenge for capital market firms operating in both the UK and the EU jurisdictions. Cross border firms will now need to manage dual reporting requirements, bear a significant increase in compliance costs, and have added pressure placed on internal teams to implement the regulatory changes.
Given the ongoing pace of divergence, it is particularly crucial for the international capital market firms to build a strong regulatory strategy and be proactive in their regulatory planning to effectively deal with the uneven regulatory landscape.
Unsurprisingly MIFID 2 revisions are a key area where the UK and the EU are going separate ways.
The EU has proposed to amend key parts of the regulation that have not proved to be beneficial such as relaxing requirements on share trading obligations, dark pools and adjusting double volume caps. In contrast the UK appears determined to remove (as opposed to amend) these less beneficial rules.
Similarly, the UK’s proposal to eliminate the best execution obligations is wider than the EU’s ‘Quick Fix’ amendments on suspending some of the reporting obligations. There is also a potential for the UK regulators to propose independent amendments for transaction reporting, further creating a fragmented reporting architecture for cross border firms.
Another area where divergence is evident is the adoption of Basel 3.1 revised capital standards.
In June 2021 the EU implemented the SA-CCR regulation (Standardised Approach to Measure Counterparty Credit Risk) for derivatives portfolios whereas the UK and the US are expected to adopt it by January 2022. Although the new regulation is more risk sensitive and provides better recognition of netting and collateralization benefits, it is hugely data intensive and demands both new and more granular level of data. Firms will face enormous pressure to develop new technical solutions and improvise their data management systems to support monitoring of exposures on daily basis.
Similarly, Standardised treatment of exposures to unrated corporates under SA (Standardised Approach) for credit risk is a candidate of divergence. The EBA recognises that the revision is not well suited for the EU market – since EU SMEs are less expected to have a credit rating unlike their US counterparts.
As capital market firms globally transition into the new regimes, internationally active firms will face challenges with different implementation timelines and complexities of managing dual methodologies during the transition period.
The EU regulators are also diverging from international counterparts in the prudential regime.
In June 2021 the EU adopted a new harmonised prudential regime IFR/ IFD (Investment Firm Directive and Investment Firm Regulation) that applies to all EU authorised investment firms. In contrast the UK regulators have decided to target an implementation date of January 2022. Along with the deviation in implementation timelines, the regime is also expected to differ in key aspects such as the scope of the regulation, frequency of reporting, data requirements and reporting templates.
The way forward
Growing divergence between the UK and the EU clearly underlines the need for cross border firms to closely monitor regulatory changes in both jurisdictions to maintain compliance. Capital market firms need to focus on developing a comprehensive approach towards cross border governance, risk management and compliance.
Firms need to consider which option is more cost efficient in the long run – to implement an expensive single global approach and framework at the highest level of compliance OR manage separate jurisdiction-specific frameworks with an expensive maintenance program?
To better navigate the impact brought upon with divergence of regulatory regimes, capital market firms must take the following key measures:
- Build a strong mechanism to monitor regulatory developments and track divergence: Consider using RegTech and other automated tools to follow rule changes, exemptions or identify implications on controls and processes.
- Conduct cost benefit analysis between jurisdictional frameworks vs single higher standard framework: Set up clear decision processes to select single standard vs two separate standards.
- Efficiently manage different implementation timelines: Consider utilizing the opportunity to pilot certain frameworks at an EU/UK subsidiary level before rolling them up groupwide.