Taking the Lead: Bank Recovery and Resolution Rules

As in the case of bank capital, elected officials were quick to respond to voter concerns by substantially expanding regulators’ powers over bank recovery and resolution. In response, regulators developed stringent new rules on loss-absorbing capacity (LAC) and ‘living wills’ for banks. However, the financial industry on the whole did not seek to resist the changes. Nonetheless, UK regulators sought to act as pace-setters in this area at the international and EU levels to manage the cross-border externalities generated by bank failures. They were therefore able to exert significant influence in the formulation of new international standards on resolution and LAC, and over the EU’s new Bank Recovery and Resolution Directive. This was achieved by leveraging their substantial regulatory expertise, alliance-building (with the US), and ‘first-mover advantage’.

In Search of Stability: Bank Capital and Liquidity Requirements

Following the financial crisis, UK preferences shifted decisively in favour of trading up bank capital and liquidity requirements. To reassure voters, elected officials intervened in the regulatory process by strengthening the domestic institutional architecture for banking regulation. Financial regulators leveraged this political support to overcome resistance from the financial industry, but also pushed for international/EU harmonization of capital requirements to avoid damaging the UK’s competitiveness. Internationally, UK regulators therefore acted as pace-setters and exerted significant influence over the design of the Basel III Accord. However, at the EU level, the UK was forced to act as a foot-dragger by prolonging negotiations over the Capital Requirements Directive IV (CRD IV) in an attempt to resist Franco-German efforts to water down the rules. But UK negotiators were more successful in leveraging domestic constraints to oppose the Commission’s attempt to impose the ‘maximum’ harmonization of bank capital.

Brexit and the Future UK–EU Relationship

This chapter uses the domestic political economy framework to consider the implications of Brexit for UK financial regulation. It outlines the likely future UK–EU relationship by analysing the preferences, role, and influence of key domestic groups on Brexit, and by assessing the EU’s framework for managing relations with third countries. We argue that elected officials pursued a ‘hard’ Brexit position in response to parliamentary constraints and pressure from financial regulators to avoid becoming rule-takers. The City of London authorities pushed strongly for a bespoke deal based on mutual recognition, although this masked significant intra-industry divisions. The EU’s insistence that the future relationship be based on the existing third-country regime reflected a desire to defend the single market, but also Franco-German incentives to compete for post-Brexit business. However, the coverage of third-country equivalence rules in finance, and the inclusion of financial services in trade agreements, remains limited.

Controversies Over Clearing: Regulation of Derivatives

UK regulators supported more stringent rules regarding the clearing of over-the-counter derivatives through Central Counterparties (CCPs) on financial stability grounds. Minimal resistance to this came either from elected officials, who paid little attention to the issue, or from the derivatives industry, as many viewed reform as desirable. UK regulators were therefore able to pursue the trading-up of OTCD rules and greater harmonization to manage the cross-border externalities generated by derivatives clearing. At the international level, UK regulators acted as pace-setters to secure more prescriptive standards, leveraging their significant market power and regulatory capacity, based on London’s prominent position. But at the EU level, UK negotiators pursued a strategy of foot-dragging in opposition to European Markets Infrastructure Regulation (EMIR) provisions on the scope, access, and location of CCPs. The UK also used legal challenges to block attempts to relocate the clearing of euro-denominated derivatives to the euro area.

Sitting on the Fence: Bank Structural Reforms

The main driver of new, stringent rules on bank structure was not pressure from elected officials, as the two largest UK political parties were ambiguous about the benefits of separating retail and investment banking. Instead, we argue that regulators in the Bank of England pushed strongly for ‘ring-fencing’ to address moral hazard concerns caused by too-big-to-fail banks. Despite fierce opposition from the financial industry, regulators were determined to trade up rules by actively cultivating political support through the Independent Commission on Banking (ICB) and in Parliament. At the international and EU levels, UK regulators acted as fence-sitters on banking reform for two reasons. First, unilateral reform by the US meant that it was not possible to push for an international solution with its traditional ally. Second, resistance to major structural reforms amongst several member states limited the scope for harmonization across the EU.

Introduction

This chapter outlines the theoretical and empirical puzzles that inform the book, its objectives, overall argument, and structure. It sets out to explain the changing preferences and influence of the UK in shaping multi-level financial regulation. In particular, the book addresses two empirical questions. Why has the UK favoured increasingly stringent regulation in certain financial sectors since the crisis, but not in others? Why has the UK led international and EU-level regulatory reforms in some areas, but has resisted these initiatives in other areas? The chapter also outlines the book’s ambition to undertake a preliminary assessment of the impact of Brexit on the future of UK financial regulation, focused on two questions. Why has the UK decided to withdraw from the EU single market in services, including finance? How is Brexit likely to impact on the UK’s regulatory preferences and ability to shape multi-level financial regulation?

Setting the Multi-Level Context

This chapter provides the context for the rest of the book. It first outlines the configuration of the financial system in the UK, and the structural and instrumental power of the financial industry. It then discusses the distinctive institutional structures centered around the City–Bank–Treasury ‘nexus’ prior to the crisis and evaluates how the role and influence of the financial industry has been challenged by institutional reforms following the financial crisis, and more recently by Brexit. The second part of the chapter outlines the international and EU institutional context through which non-binding international standards, and ‘hard’ EU legislation, is developed. Following the crisis, the UK played a leading role in shaping the post-crisis financial regulatory response at both levels. However, the strategies of UK negotiators at the international and EU levels were often differentiated, and the ability of UK negotiators to influence the final outcome was mixed.

Conclusion: The Future(s) of UK Financial Regulation

The concluding chapter begins by recalling the main puzzle and research questions set out at the beginning of the book, and by summarizing the main findings from the case study chapters. The second section details the book’s wider empirical and theoretical contribution to the field, as well as providing recommendations for future research. We focus on three main literatures: the political economy of financial regulation, theories of business power, and theories of new interdependence. The final section assesses the implications of Brexit for the UK’s role in shaping financial regulation in the future. Specifically, we consider how the UK’s withdrawal from the EU is likely to affect the UK’s regulatory preferences (more or less stringency), its regulatory strategy (greater divergence or further harmonization), and its regulatory influence (enhanced or diminished).

State of the Art and Research Design

This chapter reviews the main bodies of literature in international/comparative political economy and public policy, elucidating why existing work has insufficient explanatory power. Second, it then outlines the theoretical framework of the book, its research design, methodology and operationalization, and case-study selection. The analysis employs a two-step approach. The first explains the UK’s financial regulatory preferences (supporting or resisting more stringent rules, i.e. ‘trading up’) as the outcome of the interaction of key domestic actors: elected officials, financial regulators, and the financial industry. In the second step, we explain the UK’s regulatory strategy in international/EU negotiations (as ‘pace setting’, ‘foot dragging’, or ‘fence sitting’) and its influence over regulatory outcomes. By analysing financial regulatory reform as a ‘three-level game’, the domestic political economy approach captures the interdependency of different negotiating arenas over time. The book draws on over sixty in-depth interviews conducted between 2012 and 2019.

Resisting the Push for Tougher Regulation: Hedge Funds

In the wake of the crisis, regulators at the Financial Services Authority (FSA) sought to develop a tougher approach to overseeing hedge funds. But this push for trading-up regulation was opposed by elected officials, together with the financial industry, on the grounds that this would damage the competitiveness of the sector. The FSA’s capacity to resist this pushback was also severely constrained by growing speculation over whether it would be abolished, limiting its regulatory capacity and diminishing its institutional resources. At the international level, the UK allied with the US to act as foot-draggers to ensure that new international standards were broadly compatible with their relatively light-touch regime. However, the UK’s ability to resist the trading-up of EU rules was more limited because it lacked political allies and domestic constraints to exploit as bargaining leverage.