July 2016

Assessing the impact of Brexit on the regulatory regime for trading

James Hughes

Deputy Head, Brussels, Cicero Group

In February, David Cameron is expected to conclude his negotiation of the UK’s relationship with the EU. This will be followed by a referendum that is officially scheduled to be held before the end of 2017 but may well be held as soon as this summer. Given the potential proximity of a vote, it is worth considering what the impact of Brexit could be on the current regulatory framework for trading. Will markets be set loose after the shackles of EU regulation are thrown off or will we see something a bit less dramatic? 

The question is difficult to answer because of the sheer number of unknowns about both the relationship between the UK and EU that would exist after a Brexit and the regulatory regime that the UK would choose to adopt. The questions are interconnected as the answer to the former very much dictates the conditions for the latter.

In spite of the numerous uncertainties, it is possible to outline some of the factors that will shape a post-Brexit structure. The first point to note is that following a vote to leave the EU, the UK does not suddenly leave the EU the following day. Instead, the government would be instructed to initiate a process set out in Article 50 of the Treaty of the European Union. It is worth bearing in mind that the UK might not notify the EU of its intention to leave immediately. A ‘leave’ vote might cause considerable political instability. It could, for example, threaten the position of David Cameron as leader of the Conservative party, assuming that he has campaigned to remain in the EU. The government may need to collect itself and set out its position to the public before initiating the process to leave.  

In order to leave, the government must formally confirm its intention to the European Council. This marks the beginning of the leave process, which largely consists of a negotiation between the UK and the European Commission, who negotiate the terms of the UK’s exit on behalf of the Council. The Commission’s negotiating mandate is set by the remaining Member States in the Council and the final agreement on the terms of exit must be unanimously approved by the Council following an endorsement from the European Parliament. An overview of the process is as follows: 

If exiting the EU is agreed, the UK would then leave the EU either two years after the date of first notifying the Council or on a separately agreed date. Given the enormous complexity of managing the UK’s potential exit from the EU, the time it takes to leave the EU could well be longer than two years. Greenland’s exit from the EU took two years and consisted of a much narrower negotiation focusing largely on fishing rights. It has been suggested that the UK’s negotiation, which would cover the breadth of EU competences that range from agriculture, to customs to energy policy, could take as long as a decade.

During this time, the UK would remain a normal member of the EU, participating in legislative discussions and fulfilling its treaty obligations. This means that all legislation that is currently passing through the legislative process would be implemented in full. MiFID II, which is expected to take effect from around January 2018, will apply long before the UK left the EU.

This comes to the question of the post-Brexit regulatory environment. Would the UK repeal onerous parts of MiFID II and other legislation affecting trading venues once free of its EU obligations? This is of course, impossible to answer without knowing the conditions on which the UK left the EU and guessing the policy of future governments. However, it is possible to speculate that the UK would continue to require some level of access to the EU’s Single Market either as part of their new relationship with the EU or because the government judged it important to UK businesses. Accessing the Single Market in financial services would require the UK regime to be deemed equivalent to the rest of the EU. Failing to do this would prevent UK based trading venues from offering their services in EU markets, for example, or heavily penalise counterparties clearing transactions through CCPs located in the UK. Given the need to maintain equivalence, it is difficult to imagine that a Brexit would result in a much lighter regime as has been suggested by some ‘leave’ campaigners. Additionally, the bonus cap would certainly be removed but it is hard to picture a bonfire of regulation. The number of areas where UK requirements are currently stricter than those imposed by the EU also suggests that UK policymakers have little appetite for ‘light touch regulation’.   

In the future, the ability or attractiveness of maintaining equivalence may diminish as future EU legislation is drafted without any input from UK officials. A challenge for a hypothetical future government would be to balance the value of accessing the Single Market with the cost of implementing rules that are not drafted with the UK’s interests in mind.  

Email the author: James.Hughes@cicero-group.com