The Impact of Brexit on the UK and the EU’s financial regulation

Brexit
Brexit

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The Impact of Brexit on the UK and the EU’s financial regulation

  1. Introduction

The 1999 EU regulatory initiatives were meant to ensure that there were maximum financial markets activities among member countries. The regulations were also meant to contribute to the removal of existing legal barriers in the financial sector among EU members. The cross-border financial market initiative benefitted the UK and contributed to an increase in trade in the sector. However, Brexit’s move on 23rd June 2016 might have resulted in an end to the many of the financial conveniences that the UK enjoyed (Grant Thorton, 2016).

According to Wellink (2009: 13), and World Bank (2013: 15), regulatory arbitrage is one of the greatest disadvantages that can emerge from an exit of a country from a Union with existing guidelines and policies. According to Wen (2016), there is a possibility of businesses undercutting each other if the current financial market is deregulated. Brexit might contribute to deregulation of the UK’s financial sector, therefore contributing to undercutting of some firms through unscrupulous dealers. Some of the firms that have their headquarters in the region might initiate planning on moving to other regions that they consider favourable; especially those within the European Union coverage.

Institutions in the global financial market will be affected to great lengths as a result of Brexit. Institutions that are directly related to the UK or the European Union might have to “revise” the location of their headquarters or location of their subsidiaries. The adjustments are necessary for the firms to survive in the market. Brexit has a major impact on financial firms because the sector is strictly regulated, and might contribute to challenges especially for UK firms.

  • Impact and challenge of Brexit on the UK’s financial sector regulation

According to Claessens and Kodres (2014: 78), regulation of the financial sector contributes to securing of firms so that the shareholders’ wealth is maximized.   The UK financial institutions will have to meet the requirements of strict regulations which emanate from Brussels. Before Brexit, the UK might have had an upper hand in negotiating for strict financial regulations such as their refusal on the imposition of tax bonuses. However, the EU might want to use them (UK) as an example of the disadvantages that countries are bound to face when they exist the EU.

The regulatory arbitrage for the UK might have complex consequences since some of the financial sector regulations for the UK and EU are different. The UK might have more strict rules in comparison to those that are issued by the EU. The EU might have less stringent rules based on the need to accommodate many different members who have different backgrounds.

The UK has been part of the EU for over forty years, and most of its financial sector laws are based on policies in the EU regulations. Therefore, Brexit could contribute to instability of the UK banking system since most of the financial regulations that have been in use, have not been enshrined in the UK law for the forty years that the country has been a member of the EU. The effects from pass porting will determine the future of the financial sector for the UK.  It is not all gloom for the UK’s financial sector after Brexit since the country will attain independence to make its own decisions in the sector.

Any loopholes that might be used by firms for arbitrage purposes should be identified and sealed so as to minimize any chances of illegal activities. Banker bonus cap has been raised as one of the areas that the bank of England and the European Parliament discussed as possibly contributing to financial regulation arbitrage.


There will be immediate need of business continuous amidst the new and old regulations, or lack of clarity in the regulations that should be applied. Existing international financial firms that are located in the UK will have to make decisions on the viability of their current location. If the firms decide on a new location within the EU, they will have to make assessments on the suitability of a location that will contribute to a high level of business.

The short duration of confusion might lead to loss of business for some international firms. Financial firms in the UK will also have to ensure that they follow the MIFD II rules that will be established in 2018. The UK’s economy will be negatively impacted by a move of the financial firms that will want to relocate especially from London. Most of the international firms owned by EU member countries might want to relocate to other capital cities within the EU in order to make maximum gains.

The UK owned financial firms that have been conducting business in the EU will face higher costs and double rules if they will continue trading within the EU (Ashurst, 2016: 4). The low costs and EU financial regulation rules will no longer be accessible to those firms. Companies in the UK will also face stringent measures as required by the European Commission and the UK in the acquisition of partners from the EU.

The regulatory authorities in the UK are likely to increase the sector’s interest rates so as to make up on the deficit from being charged high rates through trade involving the EU. Clients will consider financial firms in the UK as being less stable as compared to those in the EU. Therefore, the clients might ask for higher returns on their investment based on the higher level of risk.

Financial firms will in turn have to invest in projects that have a high return, but take a long duration to give the expected profit on the investment made. The regulation of the financial sector institutions and supervision is largely national, even if the country is a member of a larger body (Omarova, 2010: 665: International Monetary Fund, 2009).

  • Evaluation of UK and EU’s financial regulation

The EU is quite strict on “bailing out” of companies since it results in the depression of the economy. Funds that could have been injected into projects contributing to the development of the economy, or boosting the economy are put into several companies that might not have a major positive impact on the economy (Heath, 2013: 32). Bailing out of companies by the government might contribute to lowering of ethical standards in companies.  

The companies would know that the government would bail them out in the event that they collapsed. UK based financial companies are bound to face strict regulation especially since clients are likely to demand higher returns based on the higher level of risk. The EU is viewed as contributing to stability among its member states, and therefore making transactions that they engage in safer and more likely to give the planned return.

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The consequence arbitrage that has resulted from Brexit is highly influenced by non-financial effects of the initiative. The UK is no longer being considered as a major stakeholder in the making of foreign policies that might be required in times of conflict. Therefore, the UK has less bargaining power if it requires making deals with other countries. It is critical for a country to have a high bargaining power so as to negotiate trade and profitable financial agreements for its institutions (Weil, Fung, Graham, and Fagotta, 2006: 68).

The consequence arbitrage is the exit of major international financial institutions from London to other European Union capital centres. International financial organizations such as banks have already operated in the European Union and in the EU for decades. The move will contribute to the undoing of many years work, since the UK government has made numerous deals to bring the firms into the country (Ashurst, 2016: 4). Governments usually have to spend reasonable resources and adjust their regulations so as to be attractive to investors from foreign organizations.

Many other countries usually compete for the foreign firms. Therefore, countries have to ensure that their package offers are as friendly as possible. Furthermore, a financial Maginot line is necessary to deal with any eventualities that might arise such as collapsing of hedge funds. A hedge fund with a large volume of deposits could collapse and contribute to the collapse of banks in the region. The collapse or discovery of missing funds in a hedge fund could be triggered by sudden national financial moves such as the one triggered by Brexit.

Clearing houses might also contribute to negative consequences in the financial sector. According to Wen (2016: 9), clearing houses deals defaulting by a few traders can contribute to the system’s collapse. The collapse would result from the system’s insolvency. The central banks in different nations oversee the financial systems of those countries. However, there is no institution to oversee the central banks of different countries.

In the event of a collapse of the central banks of the countries involved in Brexit, there would be a collapse of all other financial institutions in involved nations. Financial regulatory organizations are focused on maintaining the regulations in place, especially because of the hefty fines that have been put in place. Therefore, in the event that the central bank was collapsing, it might take time for signs to be recognized by the financial firms that are the major focus of regulation.

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4.0 Conclusion

If it would not make the UK appear inconsistent, I would recommend a return to the European Union. However, since the decision and necessary steps have already been taken, the UK has to make do with its current situation. The UK has to establish clear guidelines in its financial sector since it has mostly used those in the European Union for about forty years. The opportunity should be utilized in coming up with financial sector regulations that will promote growth and have a competitive edge over countries in the European Union.

The regulatory authorities in the UK are likely to increase the sector’s interest rates so as to make up on the deficit from being charged high rates through trade involving the EU. However, the UK will have to come up with clear financial policies so as to mitigate the occurrence of a crisis. In the past, there has been severe and a high level of frequency of financial crisis that have occurred across the globe. The regulation and supervising of firms in the financial sector of a country is largely a national responsibility.

Both regulation and consequence arbitrage results are likely to be experienced by countries in the UK due to its exit from the European Union. There are international banks that have been situated in the UK for a long duration. These firms might have to relocate to other geographical locations in the EU so that they can continue enjoying the same regulations that they are used, especially if their parent firms are located in Europe (Ashurst, 2016: 6).

The geographical move would result in loss of revenue and employment for many UK nationals. Financial firms in the UK would be motivated to move because they would be expected to comply with a double regulation of the financial sector in EU, and that of the UK. Clearing houses could also contribute to a major collapse of the financial sector as a consequence of a failure of payment by a few dealers especially if they trade in high volumes. The solution to the possible loopholes that might occur is strict regulation of the financial sector for both the UK and EU.

Bibliography

Ashurst, 2016, Brexit: potential impact on the UK’s banking industry. Ashurst.

Claessens, S. and Kodres, L. 2014, The Regulatory Responses to the Global Financial Crisis: Some Uncomfortable Questions, IMF Working paper.

Grant Thorton, 2016, The impact of ‘Brexit’ on the financial services sector, http://www.grantthornton.co.uk/globalassets/1.-member-firms/united-kingdom/pdf/Brexit-impact-financial-services.pdf

Hopkin P, 2013, Risk management. London: Kogan Page.

Heath, R., 2013, “Why Are the G-20 Data Gaps Initiative and the SDDS Plus Relevant for Financial Stability Analysis?” IMF Working Paper 13/6 (Washington: International Monetary Fund).

International Monetary Fund, 2009, “Restarting Securitization Markets: Policy Proposals and Pitfalls,” Chapter 2 in the Global Financial Stability Report (Washington: International Monetary Fund).

Omarova, Saule T., 2010, “Rethinking the Future of Self-Regulation in the Financial Industry,” Brooklyn Journal of International Law, 35, (3): 665.

Weil, D., Fung, A., Graham, M., and Fagotta, E. 2006, “The Effectiveness of Regulatory Disclosure Policies,” Journal of Policy Analysis and Management, Vol. 25, No. 1, pp. 155-81.

Wellink, A.H.E.M, 2009, “The Future of Supervision,” Speech given at a FSI High Level Seminar, Cape Town, South Africa, January 29, at http://www.dnb.nl/en/news/newsand-archive/speeches-2009/dnb212415.jsp

Wen, J. 2016, some gaps in the financial Regulatory system. Class Notes.

World Bank, 2013, Global Financial Development Report, Rethinking the Role of the State in Finance, (Washington: World Bank).

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