UK-EU Relationship in Financial Services (European Affairs Committee Report)

Earl of Kinnoull Excerpts

Wednesday 17th May 2023 Grand Committee

Moved by

[The Earl of Kinnoull]

That the Grand Committee takes note of the Report from the European Affairs Committee The UK– EU relationship in financial services (1st Report, HL Paper 21).

[The Earl of Kinnoull (CB)]

My Lords, on 23 June last year the European Affairs Committee published our report, The UK-EU Relationship in Financial Services. The Government responded in August and we are debating this important subject nine months later. I regret this structural time lag for committee reports, but warmly thank the Senior Deputy Speaker and the Chief Whip for their efforts in trying to address this and in getting our debate today.

Before I begin in earnest, I thank our staff Nick Boorer, Dominic Walsh, Tim Mitchell, Kutumya Kibedi, Sid Gurung and Louise Shewey, as well as the committee’s specialist adviser on this report, Professor Sarah Hall. We are lucky in this House with our committee staff in particular and on the EAC especially. I know that the whole committee felt that they were hugely hard-working and skilful in everything they did to help to settle this report and in the evidence process that underpins it.

We took evidence between February and March last year on the state of the UK-EU relationship in financial services, covering four main areas in the sector: first, the impact to date of the UK’s exit from the single market; secondly, the impact of the absence of a framework for UK-EU regulatory co-operation; thirdly, equivalence; and, fourthly, regulatory form and divergence, and agreements with third countries. I am going to focus on a few themes that the committee felt were especially salient, starting with the impact of Brexit on the UK financial services sector, as we then found it.

The sector employs 2.3 million people and makes up 10% of total UK tax receipts. It comprised 19.1% of all UK services exports. The EU is a very significant trading partner in this sector, making up 37% of total UK financial services exports in 2019. I note that, in the latest ONS “Pink Book”, those numbers are broadly similar. We are all reminded that the sector, although it is traditionally associated closely with the City of London, is well established across the UK. In fact, two-thirds of those employed in the sector are outside London. Our witnesses were generally optimistic about the sector’s future, with many fewer job moves to the EU than anticipated—the EY Brexit tracker, which has now ceased, recorded just 7,000—but we warned against complacency, as it is not clear whether the full impact has yet played out.

The Government’s response provided further details on the steps they were taking on the future of financial services, with reference to the Financial Services and Markets Bill and the State of the Sector 2022 report, both of which were published in July last year, a month after our report. The interesting State of the Sector report provided scant detail about how the Government intend to support financial services outside London, however.

In addition, neither the Government’s response nor the inaugural State of the Sector report engaged with the committee’s recommendation that the report include

“for at least the next five years a section dealing expressly with the UK-EU relationship in financial services”.

My first questions are to ask the Minister to provide further details on how the Government intend to support financial services outside London, when this year’s State of the Sector report will be published and whether it will contain the information that we requested, specific to the UK-EU relationship on financial services.

Moving on to regulatory co-operation, our report also examined the fate of the UK-EU memorandum of understanding, or MoU, for regulatory co-operation on financial services. The UK and the EU concluded technical negotiations on that MoU almost two years ago, yet it has still not been signed or entered into force. We noted

“the widespread view that the MoU has become a casualty of”

wider difficulties in the UK-EU relationship and concluded that, although the non-finalisation was not causing major problems, it

“would still have value as a mechanism for strategic dialogue”.

That is, I am afraid, committee code for conferring a mutual benefit on both the UK and the EU. Following the surfacing of the Windsor Framework, a European Commission spokesman indicated that the Commission was ready to start work on the so-called finalisation of the MoU on financial services. Two and a half months on, what discussions have the Government had recently with the EU on that MoU?

I turn to equivalence. As highlighted in our report, the UK

“has issued positive determinations for EU … states in 28 of the 32 areas identified for the equivalence process”,

whereas

“the UK holds just one, time-limited equivalence decision from the EU”,

on central counterparties. This contrasts with the multiple equivalencies that other jurisdictions, including the US and China, enjoy from the EU. Witnesses to our inquiry suggested that the decision by the EU to withhold equivalence from the UK

“is political rather than technical”.

However, although we expressed regret at the state of affairs, we concluded that this a unilateral decision for the EU and that

“it would be misguided to base the UK’s future strategy for the sector on something that is not in the Government’s gift and that currently seems unlikely to be forthcoming”.

We also concluded that

“the low number of equivalence decisions is not seen within the sector as a matter of fundamental concern”.

The Government’s response indicated some agreement with this analysis, although it provided little detail in respect of the committee’s request to

“set out the extent to which it believes there to be a competitive disadvantage as a result of the imbalance in equivalence decisions”

from the EU for the UK compared with other countries. Have there been any further discussions between the Government and the EU on equivalence in the past six months, in particular in the period since 27 February and the surfacing of the Windsor Framework agreement?

I come to regulatory reform and divergence. I noted at the start of my remarks the size and importance of the sector. In essence, during our inquiry, the Government and the Bank of England were finishing a thorough and sensible analysis of the regulatory environments; it was sensible because the UK had moved from a one- size-fits-28 environment to a one-size-fits-one environment. The analysis involved a substantial number of reviews and consultations; its key elements are set out in table 1 on pages 42 and 43 of our report. The analysis was to lead to legislative change. The largest part of that—the Financial Services and Markets Bill—is before us in this House now. The final stage will be the implementation of the whole new environment.

Although the Government’s response provided, as requested, some further details on their plans for regulatory reform, it was clearer on regulatory changes that were already planned or under way—particularly those included in the Financial Services and Markets Bill—than it was on the future direction and regulatory plans for UK financial services. Our report noted that, under the Government’s plans, greater powers will be moved downwards towards the regulators, in particular the Financial Conduct Authority and the Prudential Regulation Authority. Although we are supportive of this, we emphasised absolutely the need to establish “appropriate mechanisms” for parliamentary scrutiny and accountability of regulators and recommended that the Government facilitate this. Their response was non-committal in this regard; indeed, this has been much debated during the passage of the Bill and will, I suspect, be voted on when we come to Report stage.

Another controversial proposal was the new secondary competitiveness objective, which will be included in the financial services regulators’ remit. The Government are now taking this forward; it is another thing that has been much debated during the passage of the Bill and one that the committee was keen should include regulators being “responsive, consistent, and proportionate”. Indeed, this was covered in one of the amendments to the Bill that I put down.

Divergence will also be driven by changes in the EU, as well as in the UK. In the context of possible changes to EU legislation, the committee raised concerns about the Government’s apparent unwillingness, as we saw it, to actively seek to influence the EU in the UK’s interest and request clarification. The Government’s response described a

“proactive strategy of engagement with the EU institutions and Member States”.

Naturally, that will continue to interest the committee.

Can the Minister provide further details on the specific steps that the Government intend to take to support greater parliamentary scrutiny of the regulators, in recognition of their increased powers? Does she feel that regulators should be responsive, consistent and proportionate?

In closing, I come to the opportunities. Our report also examined areas of opportunity for the financial sector, particularly in novel areas where there is little regulation in place, such as fintech and green finance. We welcomed the Government’s approach to regulatory innovation and the Government have since announced that they plan to publish an updated green finance strategy this year. The committee also welcomed the Government’s pursuit of a mutual recognition agreement with Switzerland. Since then, the Swiss Government have said that the two parties expect this to be concluded by the summer of 2023. Finally, the committee welcomed the Government’s general approach of openness to the outside world and non-reciprocity in our financial services sector. Can we expect publication of the UK’s updated green finance strategy shortly and, if so, when? Do the Government still expect the mutual recognition agreement with Switzerland to be concluded by this summer?

I lived with this report for several months and it was an exceptionally interesting time; we met many very able people in our financial services sector. I very much look forward to the debate that we are about to have. I beg to move.

--- Later in debate ---

[The Earl of Kinnoull (CB)]

My Lords, for once I find myself hoping that the noble Lord, Lord Callanan, will be on his feet for a very long time, but I will not. I thank everyone who has taken part in a most thought-provoking debate all round; what a lot of expertise has been shown. I also thank and praise the Minister, who managed to answer all eight of my questions in one way or another, which was a remarkable achievement. I thank her for that.

I welcome the noble Lord, Lord Livermore. I think we will very much enjoy his expertise in this House over the next period. His speech was jolly good. I thank him for his kind words about our report.

I must finally thank my committee, which was really helpful on what was a very difficult report. Many of the committee were not terrifically experienced in financial services but took to it all round. I will privately thank the noble Lord, Lord Liddle, afterwards for his very kind words.

A lot of very good points were made. I will not repeat them all, of course, but I will highlight three things that came out of the debate. The first was the theme of complacency. Although in the period into which the committee was inquiring it found, slightly to its surprise, that only 7,000 jobs had moved—unfortunately, EY has now stopped doing that particular survey, so it is not possible to see with any certainty what has happened—we need to watch very carefully. If things are seen that are wrong, the Government will have to be very nimble to deal with whatever problems come up. I note that that was mentioned by almost everyone: the noble Lords, Lord Liddle, Lord Bilimoria and Lord Desai, the noble Viscount, Lord Trenchard, and the noble Earl, Lord Effingham, were all keen on this topic.

The second thing was a really good point about divergence risk, made by the noble Lord, Lord Liddle. We are engaged in this three-stage process, as I said: analysis, legislation and implementation. We are almost at the end of the legislation bit of that. The divergence risk remains really important to watch, and that balance between a bit of change to help our differently shaped financial services industry and whatever risk that comes with will be very important to watch as well. That was a very sharp point and I associate myself with those words.

I have labelled the final of the three themes I was going to highlight “workforce”, but it includes visas and the regulatory clearance point. I have heard stories similar to the nine-month thing. Everything that can be done to improve access to talent and to get the processes smooth for visas in financial services would be enormously good in assisting our prize industry and would not cost the Government anything. I hope this will be a theme. The noble Lords, Lord Hannan, Lord Bilimoria and Lord Holmes, majored on that. I thank them very much.

I look forward very much to our discussions about the secondary competitiveness objective. We asked almost all our witnesses about that over the three months and a worrying number of different ideas as to what it actually meant came back. I cannot say that I particularly understand it. There have been lots of amendments to try to give it a bit of shape. We will discuss that again. I was very encouraged by the good words that the Minister just said on the scrutiny of the House.

All that said, I beg to move.

Motion agreed.