Brexit update for financial services firms - week ending 15 June 2018

The week in outline: The week was dominated by the debates in the HoC and amendments to the EU (Withdrawal) Bill. UK Parliamentary committees continue to raise issues in the FS sector. In our last update, we looked at the UK’s position during the proposed transition period under the draft Withdrawal Agreement. The UK will cease to be represented within EU institutions. It will, however, remain a rule-taker, implementing new EU legislation and regulation. Another concern is that although the UK will cease to be represented within the ESAs (and will only be able to attend meetings where it is invited and without voting rights), EBA, ESMA and EIOPA will continue to have jurisdiction in the UK during the transition period. They will continue to supervise a few UK firms directly and to exercise their current roles and powers in relation to the UK; indeed current proposals would increase the role and powers of the ESAs. Questions continue to be asked about whether the UK will remain a member of SEPA post-Brexit and the implications of UK membership as a non-EU member (like Switzerland).

HMT: European System of Financial Regulation

HMT has updated the HoC European Scrutiny Committee with regard to the possibility of the UK being represented in the ESAs during the Brexit implementation period negotiations. It also discusses the April 2018 ECB Opinion on the ESFS omnibus proposal. The full letter can be accessed here.

UK representation in the ESAs

In its report (HoC European Scrutiny Committee’s 13th Report), the Committee concluded that “the Minister has not been able to offer any reassurance in this regard, saying only that the issue of representation is subject to negotiations with the EU. We ask him to write to us again when the negotiations on the transitional period are concluded, with his assessment of the implications for the ability of the UK’s NCAs to be represented within the ESAs during this period.”

In its letter HMT refers to Article 123 of the draft Withdrawal Agreement which states that the UK may, upon invitation, exceptionally attend meetings or parts of meetings of agencies, provided that:

1. “The discussion concerns individual acts to be addressed during the transition period to the United Kingdom or to natural or legal persons residing or established in the United Kingdom; or
2. The presence of the United Kingdom is necessary and in the interest of the Union, in particular for the effective implementation of Union law during the transition period.”

The letter notes that “the UK’s presence at such meetings would be limited to agenda items fulfilling either of the conditions above, and the UK would not have voting rights.” It says “the UK will continue to engage with and work alongside the ESAs during the Implementation Period. The exact nature of this engagement is a matter for further discussion with the European Commission.”

Commentary: HMT now seem to accept that UK participation in the ESAs during the transition period will be governed by the text of Article 123. The UK will have no voting rights and will only be able to attend when invited to do so by the EU (as discussed in last week’s update). It seems that, despite the UK’s non-participation, the jurisdiction of EIOPA, EBA and ESMA will continue to cover the UK during the transitional period. The ESAs will exercise their current roles and powers in relation to UK firms, products and regulation. The extent of this role and their powers is explained in our RZ report on ‘’The supervision of financial institutions”; for example, the ESAs have the power, in certain circumstances, to overrule national authorities.

The new powers of the ESAs

The European Commission’s ESFS proposal was considered by the HoC European Scrutiny Committee’s 5th Report and subsequently their 13th Report; the letter from HMT above summarised the recent ECB opinion (which casts doubt on some aspects of the proposal) – with which HMG broadly agrees. There appears to be some doubt as to whether the proposal will now remain on the agenda for the June ECOFIN meeting.

There were two areas of concern about the new ESA powers - how those powers might impact the UK as a single market member during the transition period and as a third country thereafter. The HoC European Scrutiny Committee’s 5th Report explains that under the European Commission’s proposal “all three Supervisory Authorities will gain additional powers to ensure supervisory convergence and coordination between NCAs [national competent authorities]. In addition, EIOPA and ESMA would become able to publish firm-specific results on stress testing of financial institutions within their remit (as the EBA already can)” For instance, “ESMA will acquire new direct supervisory responsibilities for a number of investment products and services covered by EU law in the context of the Capital Markets Union, and EIOPA will play a more substantial role in NCA’s assessment of the internal models of insurers under Solvency II.” There is also the issue of “increasing the responsibilities of ESMA, in particular the expansion of its direct supervisory powers to certain alternative investment funds” and “the financial implications for the UK sector of the new industry levy to fund the ESAs’ operations”

The report states (in relation the UK as a third country) “the ESAs will play a larger role in supervising access of non-EU firms active on the EU market, in particular by assessing the equivalence of their countries’ regulatory regimes with EU sectoral legislation on an on-going basis” As explained in the Committee’s 13th Report the main concerns in this area are “the implication of new powers of the ESAs in relation to certain financial products –including prospectuses and benchmarks – offered by non-EU firms to EU-based customers (which will become relevant once the UK becomes a “third country” vas-a-vis the Single Market).”

House of Commons European Scrutiny Committee 30th Report of Session 2017-2019

Section 13 of the report considers proposals with regard to SEPA and the cost of cross-border money transfer post-Brexit. The Committee has requested a response from HMT with regards to specific concerns. The full report can be accessed here.

The report states that according to the Economic Secretary to the Treasury “the UK‘s “broadly supportive” of the new Regulation because it would “make financials services more affordable”. In regards to the implications of the UK’s withdrawal from the EU the Committee quotes the Secretary saying “the applicability of the proposed Regulation will depend on the future relationship [with the EU].”

The Committee notes “that the Regulation is due to become applicable in early 2019. It is therefore expected to apply to the UK for the duration of the post-Brexit transitional arrangement, pending formal ratification of the UK’s Withdrawal Agreement under Article 50 TEU.”

In its report the Committee argues that “SEPA is, in principle, open to non-EEA countries. Switzerland is the only member that is neither in the Single Market nor a user of the euro as its domestic currency. However, it is our understanding that – as the UK’s current participation in SPEA results legally from its membership of the EU – continued and uninterrupted UK membership as a non-EEA country would have to be approved by the European Payment Council and the European Commission.” As discussed in one of our previous updates the European Payment Council has elaborated that there are many ways in which the UK could remain a member post-Brexit.

The Committee report also stresses that “even if the UK remained part of SEPA but stayed outside the Single Market (like Switzerland), it is unclear whether the Regulation to equalise fees for cross-border euro payments with domestic payments in sterling would apply to British banks, or whether such restriction pricing would need to be introduced separately for the UK by Parliament or the Financial Conduct Authority.”

The Committee concludes by stating “given the uncertainty around Brexit and the future of the UK’s participation in the Single European Payments Area, we ask the Minister to write to us by 22 June 2018 to:

• Confirm whether it agrees that the UK’s exit from the Single Market will by default result in the end of its current membership of the Single European Payments Area at the end of the transition and what it estimates the cost of that would be for UK businesses and consumers.
• If so, clarify if it is indeed the Government’s intention to ensure that the UK’s membership of SEPA is preserved beyond that point so that British payment services provides can continue to interact with counterparts in other SEPA countries on current terms.
• Clarify in what way the EU’s regulatory measures on cross-border payments, with respect to the limits on charges for euro-denominated payments and the upcoming transparency requirement for currency conversions, would apply to the UK if it remained in SPEA after it leaves the Single Market in a manner similar to Switzerland.”

BoE: Annual Report and Accounts 1 March 2017-28 February 2018

BoE’s report includes a review of work undertaken in 2017/18, including an overview with regard to PRA and FPC. Access the full report here.

When talking about the UK’s withdrawal from the EU the report notes “While financial institutions from overseas bring great benefits, they also bring risks. That is why we have proposed an updated approach to authorising and supervising foreign banks and insurers. This approach will reflect how important (or systemic) individual foreign banks and insurers are to the UK, and how similar the foreign regulatory regime is in meeting international standards. Importantly, the approach will also assess the level of co-operation with the institution’s home supervisor.”

This approach is reflected by the Supervisory Statements SS1/18 and SS2/18 (following the Policy Statements PS3/18 and PS4/18 which are based on the Consultation Papers CP29/17 and CP30/17). They set out the PRAs approach to branch authorisation and supervision for international banks and insurers. The only change that was introduced between the Consultation Papers and the Policy Papers is that the FSCS-protected liabilities threshold has been increased from £200 million to £500 million in PS4/18.

The PRA’s policy is explained in more detail in the accompanying press release to the Consultation Papers. The PRA is to “take into account how ‘systemic’ their activities are in the UK. Specifically, the types and amounts of business undertaken will determine the intensity of the PRA’s approach to supervision. If the branch is important for the resilience and stability of the UK financial system as a whole, the PRA will place greater emphasis on the degree of influence and visibility that it has over the firm. For example, in making its assessment of whether a branch is systemic, the PRA will take into account a number of factors, including size (whether the firm’s UK footprint is larger than £15 billion in total assets), and inter-connectedness with the UK financial system.”

“In terms of where firms are from, the PRA’s approach is based on an assessment of the degree of equivalence of the home state regulatory regime in meeting international standards, and, importantly, the level of cooperation with the home state supervisor. Where sufficient supervisory cooperation and assurance on resolution exists, a firm may apply to operate as a branch.”

At the same time the PRA also stresses that it “does not expect the new approach to affect the current operations of any of the non-EEA international banks and insurers currently operating in the UK as branches. This is because we already have an appropriate level of third country supervisory cooperation with their home state supervisors in light of the systemic importance of the relevant firms.”

In regards to the future relationship with the EU the report states: “Consistent with our long history of co-operation with our counterparts in the EU and our commitment to an open financial system, we currently continue to presume that a high degree of co-operation with EU supervisors continues following Brexit.”

Finally the Bank of England also emphasised that they “have also worked to mitigate potential disruption to the provision of FMI services resulting from EU withdrawal. This encompasses: ensuring the new UK legal and regulatory framework for FMIs is in place for exit day; that UK FMIs and their members have made appropriate contingency plans; that the Bank is ready for any new responsibilities (for example, relevant responsibilities currently undertaken by EU bodies); and that the impact on services provided to UK clients by foreign FMIs has been appropriately addressed.”

The policy has come into force on 29 March 2018, exactly one year before the Brexit date.

Commentary: The PRA policy concerns mode 3 access and the question of whether foreign firms can operate via a UK branch of an overseas entity, whether such a branch is subject to branch specific requirements to protect UK customers or whether the foreign firm is required to establish a UK incorporated subsidiary. In the case of insurers the PRA must also continue to meet the EU’s minimum requirements in Solvency II for the authorisation of branches of third country insurers.

There is currently no EU equivalence regime which entitles third country banks or insurers to operate via mode 3 branches. The UK and EU might agree new mode 3 access/DRC/mutual recognition arrangements for branches; these might, for example, involve the host state ‘deferring to’ or ‘recognising’ the home state authorisation, so that no local/host state authorisation is required (as under the current single passport) or it might involve some lesser form of DRC which enables the foreign firm to establish a locally authorised branch without any requirement for a local subsidiary.

The PRA has reserved its position by saying that the new policy is relevant to EEA banks and insurers seeking UK branch authorisation post-Brexit, but of course, in that context, the new policy would operate subject to any agreed EU/UK deal. As explored in previous updates, it seems UK regulators would not wish to see DRC arrangements (after the UK leaves the single market) which enabled EU/EEA banks to conduct UK retail deposit taking (above de minimis levels) via a mode 3 branch - asthey are currently entitled to do under the single passport.In the new supervisory statement, PRA explains the current limitations on its regulation of incoming EU banks and the steps available to it as a host state regulator.

Department for Exiting the EU: Framework for the UK-EU partnership company law (accounting and audit)

This presentation sets out the UK Government's vision for the future UK-EU Partnership in the area of company law. The full presentation can be accessed here.

The slides set out the main issue regarding accounting and audit. “The corporate reporting framework and audit regulation facilitates UK and EU companies to list securities across borders, and whether and how audit firm registrations are recognised across borders. Cross border regulatory cooperation assures compliance.”

The slides then go through the different third country regimes that currently exist under EU law. First for accounting: “Holding companies from third countries that list equity on EU markets must prepare accounts for the relevant Member State either using EU adopted IFRS or standards that have been determined as equivalent by the Commission. This enables those companies to access investment and capital on EU markets.”

Then for audit regulatory equivalence: “Companies from third countries that list securities on EU markets must be audited by EU statutory auditors or by auditors from the third country that have registered in the relevant Member State. Work on these audits by registered third country auditors must be inspected unless the third country is deemed equivalent.”

And finally for competent authority adequacy: “EU competent authorities may only transfer audit working papers and investigation reports to a third country competent authority that is deemed adequate. This enables joint inspections and investigations to maintain audit and accounting quality and ensure consistent standards of auditor independence”

The UK government suggests that they “will introduce a full UK corporate reporting and audit framework which will be transparent and will be policed by the UK’s independent regulator, the Financial Reporting Council (FRC). We will transpose the EU-adopted IFRS, and have already transposed the Accounting and Audit Directives in full.”

In terms of the future partnership between the EU and the UK the presentation concludes “third country regimes for accounting and audit equivalence and adequacy exist in some areas. Existing third country regimes do not guarantee sufficient stability of coverage by the end of the Implementation Period. UK and EU companies and enforcers need early assurance that our accounting and audit standards will be equivalent, especially given our unique starting point and complete convergence on day one of exit. They also do not provide sufficient stability that equivalence will continue to be provided. Companies and enforcers would benefit from greater confidence that equivalence will not be withdrawn without undue notice. Existing third country regimes do not cover all accounting and audit issues, notably corporate reporting and audit requirements, and audit firm registrations. We would be interested in exploring the mutual benefits of agreeing provisions on these issues.

Commentary: While the UK Government has highlighted the issues regarding accounting and audit post Brexit it does not seem to suggest more than “interest in exploring the mutual benefits of agreeing provisions on these issues” without offering any concrete proposals.

Where we stand in outline: The draft Withdrawal Agreement makes no provision for financial services but it does provide for a transition period from 29/03/19 to 31/12/20 during which the EU single market legislation (including in FS), and its dual regulation coordination (DRC)/mutual recognition, would continue to apply to the UK. The UK would, however, cease to vote and participate in EU institutions, whilst these institutions continued to have jurisdiction in the UK. The agreed framework for the future relationship (post-transition) is due to be recorded in a political declaration annexed to the Withdrawal Agreement. The timetable for the negotiations has slipped again and they are now expected to continue until late in the year, with ratification thereafter. The risk that the UK leaves the EU without a transition period (because of a break-down inthe negotiations) will therefore continue until late in the day. The UK has announced unilateral plans to assist EU firms in that scenario (with a temporary permission regime) but the EU has not reciprocated or addressed UK concerns about contract continuity in that scenario. It seems increasingly unlikely that any detailed agreement of specific DRC/mutual recognition in FS would be agreed in the political declaration this year; presumably any such negotiations would take place after Brexit. The UK has proposed (see Philip Hammond's speech of 7 March) that after the transition period, the EU/UK relationship in financial services should be a bespoke bilateral arrangement for DRC and mutual recognition of each side’s rules, based on international standards and equivalent outcomes (without requiring identical rules on each side). The rationale is that the EU and UK will start with fully aligned regulatory regimes (because the UK is transposing all EU regulation into the UK domestic regime) and DRC should therefore continue, until there is divergence in the regulatory regimes. This would provide much greater access for UK firms than the EU’s current regime for third country mutual recognition/DRC. The EU position is that market access will be granted under mode 3/via local establishment (and not for services business) and this will be subject to host state regulation. This will offer the UK no more than is available to other third countries - regulatory cooperation on a voluntary basis and DRC limited to (unilateral and revocable) decisions by the EU under its third country “equivalence” legislation. The EU is toughening its third country policy in order to deal with the UK as a third country. Under this scenario, UK firms will face differing national perimeter rules (in many areas)for services businessunder modes 1 and 2. Our report on Brexit and FS in April 2017provides detailed analysis of the potential for mutual recognition/DRCunder an EU/UK agreement. Until it is known what DRC arrangements are to be agreed, the important issue of transitional measures and the mechanics/practicalities of turning off current DRC, as the UK leaves the single market at the end of 2020, cannot be addressed (e.g. via phased implementation and grandfathering).

Other publications from the RegZone Brexit news feed

EIOPA: Annual Report 2017

EIOPA has published its annual report, which includes details of its work over the period (including Brexit-related Opinions), and notes issues it intends to focus on in 2018, including digitalisation and InsurTech. The full report can be accessed here.

HoL European Union (Withdrawal) Bill: Commons considerations of Lords amendments

This HoL library briefing was prepared in advance of consideration of Commons amendments on 18 June 2018. The full paper can be accessed here.

HMT: Speech by Philip Hammond

HMT has published the text of a speech given by Philip Hammond at the German Family Business Conference 2018 on 8 June 2018. The full speech can be accessed here.

EC: Temporary Customs Union

The EC has published slides and an infographic with regard to the UK’s technical note. The slides can be accessed here and the infographic here.

HMT: Speech by John Glen: TheCityUK Conference 2018

Text of a speech given on 13 June 2018 follows, in which John Glen discusses the UK financial services sector. The full speech can be accessed here.

EU (Withdrawal) Bill - debates

Links to the Hansard transcripts for 12-14 June 2018 follow. These are the links for the 12th, the 13th and the 14th of June.

EU (Withdrawal) Bill - amendments

A document containing HoC amendments in lieu, amendments to amendments and reasons has been published. The full document can be accessed here.

BoE: Speech by Anil Kashyap: Come with me to the FPC

Text of this speech, given on 13 June 2018 follows, in which Anil Kashyap discusses FPC's work. The full speech can be accessed here.

HMT: Speech by John Glen: TheCityUK Congerence 2018

In his speech at the Annual Conference John McFarlane, Chairman of TheCityUK, talks about the industry’s value to the economy, what Brexit needs to deliver for UK trade, and the long term future of industry. The full speech can be accessed here.

CMS RegZone publishes weekly updates on Brexit developments for financial services firms. These provide analysis and commentary on significant developments during the week in question. A daily digest of Brexit news (without analysis or commentary) is also available by email here and online via the RZ news wizard here (both of these can be filtered using the Brexit topic).