4 minute read 22 Oct 2021
Drone shot looking down on a bridge crossing over lake Konstanz, Bavaria, Germany

How regulatory divergence is challenging cross-border financial firms

By Andrew Pilgrim

EY UK Government and Financial Services Leader

Expert in public sector engagement and financial services. Worked across political, regulatory and policy issues that shape the sector.

Contributors
4 minute read 22 Oct 2021

Boards need to review their post-Brexit operating models to ensure they are optimal, given diverging regulation and digital innovation.

In brief
  • Cross-border firms will need to monitor and understand the impact of increasingly different global regulatory approaches, especially between the UK and EU.
  • As rules change, boards need to ensure they have the right strategy and operating model - especially across technology, ESG, data, FinCrime and people.

Successful businesses are those that think several moves ahead, while also not losing focus on the current state of play. It is a skill that cross-border financial services (FS) companies need more than ever, as they operate in an increasingly fragmented world.

It’s clear that the next few years will see FS firms having to make vital strategic choices around their future optimal strategy and operating model. To make the right decisions they will need to monitor and assess the impact of differing regulatory approaches to a number of key issues, each of which may be vital to success.

No one-size-fits-all approach

The extent firms will need to respond to increasing fragmentation of regulatory approaches, will depend, among other things, on their legal structures, licensing arrangements, operating models and sector. For many firms, the challenges are likely to arise from increasing, and often significant, divergence between EU and UK standards. This is a result of the UK reviewing and tailoring onshored EU regulatory requirements to better suit, and enhance the competitiveness of, its domestic market.

FS firms or groups operating across borders will be faced with a unique set of cross-border legal and regulatory challenges, particularly from areas impacted by increasing legal and regulatory divergences. These include, but are not limited to:  

  • People / mobility considerations
  • Data transfers
  • Anti-money laundering (AML)
  • Tax considerations
  • Sustainable finance
  • Technology

In addition, firms will need to look at how the EU progresses on a Banking Union and the Capital Markets Union (CMU) as well as monitor the UK reviews aimed at, among others, tailoring the UK Listings Regime, Prospectus Regime, wholesale market regulation, AML framework, Solvency II and the UK’s approach to FinTech.

Taking a holistic approach to sustainable finance

The fast-moving pace of regulatory change related to climate change and, latterly, wider ESG issues, creates a significant challenge for FS firms operating across multiple borders. For example, jurisdictional differences in taxonomies make group-wide definitions and product-level disclosures problematic. Cross-border firms will also need to comply with different data and reporting requirements and supervisory approaches (for example, stress testing).

It is important that firms understand and take a holistic approach to the totality of the sustainable finance-related regulatory requirements, in particular external disclosures, that apply across their locations.

Strengthening position - technology investment

Technology is transforming FS and the regulatory approach is central to where and how firms develop their strategy. Boards will need to understand where diverging or different standards could cause complications.

Areas under the regulatory spotlight, where we see differences in approach emerging, include, but are not limited to: payments, artificial intelligence (AI), RegTech, crypto assets and the cloud. In particular, we expect regulation to evolve rapidly in relation to AI as the use of big data and algorithms clearly concerns regulators. This means cross-border firms will need to monitor AI requirements in the jurisdictions in which they operate, as well as where their clients impacted by those AI systems are located.

The EU digital strategy is also an ambitious strategy that covers a host of topics including crypto assets, another area where we see regulation developing and maturing fairly rapidly. Despite the benefits of technology, FS firms may face difficult choices ahead when deciding where and when to invest large amounts in technology programmes, and how to “future-proof” their decisions in the light of regulatory uncertainty.

The winning formula

The challenge now for FS firms is to review their overall legal entity structure in the UK, the EU and globally, aligned with an examination of business strategy. This will help develop a clear picture of how to operate profitably with acceptable returns, in the context of substantial regulatory change and divergence. It will not be straightforward and will require serious investment and board time. Without that level of monitoring, major operational and strategic decisions become more about luck than skill.

Summary

Deciding the best jurisdictions to locate and invest in has always been a challenge. It is now even more difficult, as divergence increases post COVID-19 and Brexit. The stakes are high, as firms plan around critical areas, such as ESG and technology. They will need to be agile to manage differences in the short-term. Longer term, each FS firm will have to look carefully at the net impact of regulation across its global footprint and decide the best legal structure and strategy. Those that carefully think and plan ahead are likely to emerge as the winners.

About this article

By Andrew Pilgrim

EY UK Government and Financial Services Leader

Expert in public sector engagement and financial services. Worked across political, regulatory and policy issues that shape the sector.

Contributors