Wallace is tied second with Frenchman Julien Guerrier on five under, while Fleetwood carded a five-over 77.
Fleetwood said he endured a “nightmare” on the greens in windy conditions.
Only 15 of the 124 players left in the field were under par in their second round at Walton Heath, with Denmark’s Lucas Bjerregaard delivering the best mark of the day, carding five under to move to three under for the tournament.
A handful of players – including Guerrier tied in second – will need to conclude their closing holes from round two on Saturday morning as play was suspended for darkness shortly after 18:00 BST on Friday.
No PGA Tour and no fear for Eddie
Pepperell, who produced a hole-in-one and an eagle in his first round, wiped out two bogeys in round two with five birdies – one courtesy of chipping in from off the green on the third hole.
The Oxford-born player is averaging under 70 strokes per round on the European Tour this season for the first time in his career. A win at the Qatar Masters and a second-place finish at the Scottish Open in July have lifted him to 50th in the world rankings.
He said: “I’m really excited because I do think I can really improve my long game over the weekend and if I can do that then I want to take the mindset of dominating the event, because why shouldn’t I?
“I’ve got to be aggressive, keep trying to play the shots and I don’t think there is anything to be afraid of, for sure.”
A win on Sunday would take Pepperell into the world’s top 35 but he insists he is not keen on following other successful Britons in moving from the European Tour to America’s PGA Tour.
“I’m not interested in playing over there in a full-time capacity for certain,” he added. “I’m really happy where I’m at. I get to see America five, six times a year and I think that’s perfect. And that’s meant as a compliment as much as anything else because I want to enjoy it for what it is.”
Fleetwood said he “played fine” despite struggling to a 77 containing five bogeys and no birdies. A 78 in the third round of the US Open is the only time he has posted a higher score this season.
“I just had a nightmare on the greens really,” he said. “I actually played all right. I basically three-putted 11, 12 and 13 and literally had no idea what the break was going to do or the wind. I never once got it right.
“It was so difficult. I holed my fair share yesterday but I was so far out today on the greens. I can easily think of shots to save and get it round in level par.”
Eddie Pepperell shot a spectacular hole-in-one on the opening day of the British Masters as he shared the first-round lead with fellow Englishmen Tommy Fleetwood and Matt Wallace.
Pepperell’s ace came at the ninth, the 27-year-old’s tee-shot spinning back into the cup after hitting the flag.
He followed it with a birdie on the 10th and an eagle on the 11th, eventually finishing on five under.
“It was a bizarre shot from where I was standing,” he said.
“It looked like it pitched in the hole, jumped up and looked like it was going long because of the height it came out, and obviously went in.
“I played awfully in the pro-am on Wednesday – probably the worst I have in a while – and I wouldn’t say I played great today but I had that really hot run and it’s great to be at the top with Matt and Tommy.”
Fleetwood, part of Europe’s victorious Ryder Cup team earlier this month, also produced a freak shot on the opening day.
The 27-year-old’s tee-shot on the par-three 17th finished in a cup holder in a buggy which had been parked to the left of the green.
He said: “Luckily it didn’t go in the beer in the other cup holder because it would have ruined a drink and the golf ball.”
Fleetwood’s Ryder Cup team-mate and Race to Dubai rival Francesco Molinari is six shots behind, while England’s Richard McEvoy is among a pack of five on four under.
Justin Rose – the competition’s host this year and the 2002 winner – finished his opening round on two over, alongside fellow Englishman Lee Westwood.
Three-time major winner Harrington, 47, is the favourite to succeed Dane Bjorn for the matches in two years’ time.
Westwood, Europe’s fifth-highest Ryder Cup points scorer, was thought to be the Irishman’s main rival but instead has his eyes on the 2022 matches at Marco Simone near Rome.
‘Harrington is the favourite’
The European captain is selected by a panel featuring European Tour chief executive Keith Pelley, a member of the Tour’s players’ committee and the previous three captains, which this time will be Bjorn plus Irishmen Darren Clarke and Paul McGinley.
Bjorn, who will play alongside Harrington and Westwood in the first two rounds of this week’s British Masters at Walton Heath, has suggested Harrington is now the front-runner for 2020.
“There’s a process to go through and I think you’ve got to look at whether we are covering all bases,” he said.
“But I’ve always said when you’ve got somebody that’s a three-time major champion and has the pedigree Padraig has and holds the respect of the players that he does, it would be difficult to see him not doing it at some stage.
“If he wants it this time around, it’s difficult to get around that he is very much the favourite to get the job.”
The selection panel is to meet in December to discuss Europe’s next captain.