Wednesday 10 February 2021 2:00 pm

Brexit: Restoration of common law principles gives financial services the tools to be innovative

Barnabas Reynolds is a partner at the global law firm Shearman & Sterling

Now that the UK has left the EU, it is time that we re-set the legal framework of our financial services. 

This is not the emotional reaction of a Brexit optimist – although I do believe that there are many advantages to our leaving the European Union – but rather a pragmatic assessment based on the very different ways in which EU and UK law operates. 

UK law is based on common law and Scots law. As a result, our legal reasoning is cautious, iterative and pragmatic, placing its reliance on independent judges. No single group is treated as omniscient.  Parliament tops up the law on specific policy matters.  

By contrast, EU law, based on rationalist and scientific German and French methods that were developed in the nineteenth century, seeks to impose grand, codified schemes. Those framing the law seek to find answers in advance of every problem. The system operates to exert control over individual and business activity, ensuring it serves interests that are centrally determined.

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If we look specifically at the EU law regime for financial services, we can see that it illustrates perfectly the uncomfortable tension between the integrationist EU project and our values in the UK.

Since the 1990s the EU has introduced a blanket of financial services law across all parts of the sector.  

The main rollout was started in 1999 and continued in earnest after the financial crisis of 2007-2008, led by the then Financial Services Commissioner, Michel Barnier. 

In justifying the EU’s supplanting of the UK regime, he (and others in the EU) pointed the finger at the UK over the crisis, with the narrative that it occurred because of a flaw in Anglo-Saxon capitalism and its methods of regulation. 

Yet this proposition was fundamentally flawed. In fact, the crisis arose from a lack of management of financial systemic risk by central banks and regulators around the world, including the ECB. The predominant theory of the time had been the “efficient market hypothesis”, which held that the market would root out bad practices – a belief that turned out to be very wrong. The error did not however arise from the UK’s way of doing things, and the UK and the EU have since then introduced measures to manage systemic risk. 

But the deluge of EU law then led to unnecessary uncertainty arising for the UK regime. Given the nature of EU law and the code-based approach, the EU has adopted a predominantly “purposive” approach to interpretation. This gives EU regulatory officials the ability to assert the purposes behind particular provisions. The voluminous single rulebook provides a rich seam of purposes to be identified.  

The scheme also operates to the detriment of the UK in that highly dangerous EU rules treat Eurozone risk as of lesser significance than international norms would require. This leads the UK to impose top-up costs on businesses here – costs which the EU chooses not to apply itself.

Markets Nervous Amid Fears
The global financial crisis in 2008-9 saw a host of new regulations imposed, many of which critics argued targeted the wrong issues (Photo by Cate Gillon/Getty Images)

Now the UK has left the EU, we can revert to our traditional approach to the law. This will involve removing the undesirable elements of the EU scheme and redrafting the provisions that remain, along common law lines. It will also mean increasing the use of case law precedent.

We then need to look afresh at the role of our high quality regulators.  

Within the EU regime, they were left to work the system as best they could, filling the gaps in the EU’s framework through vague regulator “Principles”, to avoid adding more complexity to an already Byzantine system. In many cases they were reduced to being arbiters of fact as to whether EU legislative rules were broken. Poor EU drafting added uncertainty to the mix. In addition, since the 2007-2008 financial crisis there has been an increased level of challenge from the regulators to financial firms.  

However, this was not accompanied by an equivalent level of challenge to the regulators themselves. When the regulators acquire more rulemaking and supervisory authority under the reordered UK system, further checks and balances are required.

It is important that Parliament and the courts are now put in a position to exercise adequate oversight. 

This means defining more specifically the regulators’ powers and objectives, including the need to achieve clarity and predictability in their rulemaking and supervision.  It also means allowing financial firms to challenge the regulators in court, for which the US system provides useful parallels.  

Finally, it involves the Treasury Select Committee appointing a sub-committee which draws on an expert panel, including lawyers, exercising powers under the Standing Orders of the House of Commons to gather evidence and investigate instances of regulator conduct raised by the industry. 

The prize in sight is a highly predictable legal and regulatory system that empowers the financial industry to innovate. So long as the law ensures customer funds are protected and any failures can be managed, the UK regulators’ more predictable approach to rulemaking and supervision can release businesses to innovate.

Barnabas Reynolds is a partner at Shearman & Sterling and the author of Restoring UK Law: Freeing the UK’s Global Financial Market, published yesterday with Politeia.

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