Britain has started evaluating whether the EU’s offshore financial centres are fit to oversee the more than £2tn of UK investors’ cash held there, amid concern that Europe is not moving fast enough on appropriate safeguards.
The extent of the UK’s exposure to offshore centres was highlighted in September, when turmoil at pension fund vehicles largely based in Ireland and Luxembourg forced the Bank of England into an emergency intervention to halt a sharp fall in government bond prices.
As part of its Brexit deal, the UK agreed to treat the EU’s fund regulation as “equivalent” to its own until the end of 2025. This means EU-based funds can continue to use so-called passports to sell to UK investors as if Brexit had not happened.
But if equivalence ended, EU fund managers would no longer be able to use the bloc’s licences to sell to British investors. This would create a range of new regulatory hurdles that could prompt some fund managers to use UK-based investor structures, or to stop offering some products in Britain because they would become too expensive.
Money market funds, which invest in short term government bonds and bank deposits, have emerged as an early flashpoint between the UK and the EU, as watchdogs prepare to take different paths to implementing global recommendations on regulation. UK investors hold about £280bn in these funds, most of which are offshore.
British watchdogs recently wrote to their peers in some EU countries including Ireland and Luxembourg with a series of questions about the standards they hold their funds to, in what marks the first step of a review of whether the UK and the bloc have equivalent regulatory regimes, according to people familiar with the situation.
Bank of England governor Andrew Bailey hinted at UK-EU tensions last week. He told MPs that while the UK was working on ways to improve the resilience of money market funds, their cross-border structure meant “we need the EU to do it and they have not done it yet”.
The EU has indicated it will not be in a position to begin work on proposals to improve the resilience of money market funds by the Financial Stability Board, an international body that makes recommendations about the global financial system, until the next European Commission mandate, which begins in 2025, said people briefed on the situation.
“The FSB has a long list of recommendations, not all are relevant for the EU market,” said an EU official. The Commission declined to comment.
One person familiar with the discussions about the Financial Stability Board’s recommendations said it was “fine” for UK investors to largely use funds in Ireland and Luxembourg before Brexit, when common regulation was in place and changes were made jointly.
The UK now sees potential risks “if you have investors investing in deposit-like assets that are not regulated in a way that can ensure financial stability”, added this person.
If the UK forced EU-based funds to relocate some activity, something that would most likely happen gradually to avoid disruption, the impact would be mostly keenly felt in Ireland and Luxembourg. This is where more than £2.2tn of UK investors’ cash is “primarily” domiciled, according to research from the Investment Association, a trade body.
Another person briefed on the discussions involving UK and EU regulators said Britain’s actions stemmed mostly from policymakers’ growing awareness of potential systemic risks to Britain from overseas fund structures, as highlighted in September’s pension crisis.
The Financial Conduct Authority, the UK watchdog which has sent out questionnaires on regulatory equivalence to EU counterparts, declined to comment. One person familiar with the regulator said the exercise was to “support its process for providing advice” to the UK Treasury, which would determine the scope of the equivalence review.
The Treasury did not comment specifically on the review, but said: “We are working closely with UK regulators, our international partners and the EU to improve the resilience of money market funds.”
Esma, the European markets regulator, said it was helping to “co-ordinate and centralise the interaction with” the UK Financial Conduct Authority.
The Central Bank of Ireland, which regulates funds based in the country, declined to comment. The CSSF, Luxembourg’s markets regulator, did not respond to requests for comment.
