Unfortunately, the days when small jurisdictions with good communications, low tax, imported regulatory talent, and some local expertise could establish a financial services centre are misty memories.

Small financial centres have to attract and maintain the scale, breadth and quality of their regulators. These have to be funded, normally by fees charged for regulatory services. In some jurisdictions, the exchequer may have to contribute to funding through the allocation of tax revenues, but in this case, they have to make the case for the economic and financial benefits of the presence of financial services to the wider economy.

The financial services sector continues to expand, fueled by economic, financial and social factors. Key drivers include:

• Funding national and corporate recovery from the economic devastation of Covid-19, through capital markets, fund-raising, debt and equity.
• Funding the developments required to implement national and international commitments to climate change.
• The rise of enhanced interest in Environmental, Social and Corporate Governance (ESG)issues.
• Financial technology(Fintech) where software and other technologies such as “blockchain” and Artificial Intelligence (“AI”) are used to automate, improve and reduce the costs of services by making them secure and scalable.

Small financial centres are nimble and fleet-of-foot, their thin veneer of Company Law and Corporate Taxation enables them to quickly identify new opportunities and attract investors.

However, such light touches bring disadvantages – light-touch regulation may run contrary to the demands of ESG, and the fragmentation of markets and services in response to new standards and services agreements creates regulatory complexity in trading with other centres.

The latter presents a particular headache for regulators in small financial centres. Financial regulation has increasingly diverged around the world. Key areas of divergence currently include:

• Alignment with non-financial regulations in areas such as fiduciary responsibilities, data privacy, and compliance standards.
• Data privacy, cyber-security and the funding of jurisdictionally proscribed activities such as the funding of, or providing services to cannabis-related enterprises.
• Fintech and other innovative technologies which require new or amended regulation in areas such as “cloud services”, data storage and aggregation and processing of payments.
• Crypto-currency and crypto-asset trading.

This divergence provides problems of coordination, as institutions seek to exploit regulatory arbitrage opportunities, and tends to heighten risk and reduce financial stability. This gives rise to situations such as the criticism of the Lithuanian regulator’s oversight of a local “fintech” company which prosecutors suspect of fraudulent activity in relation to the collapse of Wirecard.

The growing complexity of trade and commercial services agreements among jurisdictions require a wider vision by financial regulators. The major risk is that unless equivalences are agreed, based upon mutual regulatory trust between jurisdictions, market fragmentation occurs. A good example of this fragmentation is the Euro derivatives market where execution has fragmented to three of four markets in the Euro-zone while clearing and settlement continue to operate in London.

So how can smaller jurisdictions address these challenges?

Firstly they can seek deeper specialisation and refinement in areas of financial services where the jurisdiction has demonstrable financial regulatory competence, and where there is a depth and breadth of financial services business accompanied by demonstrable expertise.

Secondly, they should make more extensive use of technology to conduct routine review and oversight in areas of customer on-boarding and due diligence such as identity /AML

Thirdly, through objective evaluation of their own competencies, resources and strategic aspirations, financial regulators, with the support of their Government, should communicate with clarity to prospective and existing regulated institutions, which sectors of financial services business cannot be accommodated either due to lack of expertise, or because accommodating that business type will damage the reputation of the centre.

Finally, they should seek to co-operate with regulators in other jurisdictions to share regulatory skills and experience.

In the slipstream of Brexit, the UK is likely to develop and innovate financial services assisted by technology developments and focus on markets beyond the European Union. The Crown Dependencies and Overseas Territories should seek to co-operate and collaborate with the UK in the development of the finance sector to mutual benefit. A by-product of this could be greater collaboration on financial oversight and regulation.