Brexit update for financial services firms – week ending 6 July 2018

United Kingdom

The week in outline:

The week was dominated by domestic UK politics and the cabinet's Brexit 'away day' at Chequers. The cabinet statement (see document 1 below) released on Friday night confirmed the anticipated approach of HM Government (HMG). This high-level document is due to be followed by the publication on 12th July of the Department for Exiting the European Union's white paper. This will set out the UK's proposals for the future EU/UK relationship in greater detail.

HMG has now confirmed that it is seeking a different relationship for industrial goods and agricultural products (on the one hand) and for services (on the other). The former is described as a free trade area (FTA) but appears to be the expected combination of a customs deal (now termed the ‘Facilitated Customs Arrangement’) and quasi-single market membership for goods. This would involve the UK continuing to follow EU legislation in these areas.

In contrast to the proposals on goods, the statement says about services that the proposals will:

“provide regulatory flexibility where it matters most for the UK’s services-based economy, and where the potential trading opportunities outside of the EU are the largest, recognising that the UK and the EU will not have current levels of access to each other’s markets – with arrangements on financial services that preserve the mutual benefits of integrated markets and protect financial stability, noting that these could not replicate the EU’s passporting regimes…”

This provides no concrete information about what HMG is proposing for financial services (FS). Indeed the contrasting emphasis in Friday’s statement in relation to goods, services, and then FS is (no doubt deliberately) confusing as to where HMG stands on FS. The statement highlights the benefits (as HMG now apparently sees them) of moving away from EU standards in services and accepting the loss of market access to EU markets and the 'friction' that this will cause. The wording on FS seems to suggest that any ambition or hope of maintaining extensive mutual recognition/ dual regulation coordination (DRC) has been abandoned in favour of the more pressing issue of the goods sector and the Irish border problem.

The concern is that HMG will limit its objectives in the FS sector, in order to (i) show the EU that it is not seeking full single market access by another name and (ii) show its critics on the Brexit wing that the UK will gain some new freedom to negotiate FTAs (in services) with non-EU countries. As reported in previous updates, there were already strong signs that HMG was not really committed to its public proposals for extensive bilateral mutual recognition in FS. It now seems that HMG may favour a much less ambitious arrangement, perhaps even prioritising the UK’s ability to set its own rules over a robust legal basis for (even) the limited EU market access and DRC available to third countries generally. For analysis of ‘market access’, ‘mutual recognition’, and ‘DRC’ see our April 2017 report.

Hopefully the white paper will provide some greater clarity but it may still be difficult behind the carefully chosen words to judge the real negotiation intent on the part of HMG. We explored the framework for a UK/EU arrangement in FS (and related terminology) in our April 2017 report. The language used by HMG is often vague and not much more than ‘mood music’. When assessing the white paper, we will be trying to unpick various different elements of the proposals for FS:

  1. UK/EU supervisory cooperation arrangements.
  2. GATS/WTO style commitments (e.g. not to impose quantitative type restrictions on access) and FTA style obligations to provide market access undernational treatment (which prohibits a state from favouring domestic products/services over imported products/services),potentially subject to the ‘prudential carve out’ (which allows a state to impose measures to ensure the integrity and stability of its financial system).
  3. The individual DRC arrangements that are being proposed in each area. These are the individual measures which eliminate, or reduce regulatory barriers which block modes of access, and/or create friction and cost in cross-border business (these are the key elements). Presumably the broad scope and scale of single market DRC arrangements will be lost, so much of the current DRC would be turned off at 31/12/20. The Chequers statement, in a nod to the EU, states that any DRC ‘could not replicate the EU’s passporting regimes’. Regulatory barriers will therefore arise to modes of access and to pan-EU operation by UK firms. Modes 1/2, or services business, is most at risk of outright prohibition whereas for mode 3 access via a local establishment, the risks are local requirements to subsidiarise (as the UK imposes for significant retail deposit taking) and the friction of dual authorisation for branches. Current single market DRC is very broad and removes/reduces a huge number of regulatory barriers beyond the simple and obvious barriers to modes of supply. These include many diverse practical barriers to efficient cross-border business/operation (see our April 2017 report).
  4. The basis for maintaining or discontinuing any DRC/mutual recognition arrangements agreed under item 3 above. This DRC might, for example, be agreed only on the memorandum of understanding style basis as the EU does with most third countries. There are reciprocal understandings and GATS obligations but in practice the EU seems able to change its third country regime, as the present review demonstrates. Single market DRC is embedded in a strong legal order which protects UK firms in the FS sectors. HMG originally seemed to favour some sort of objective legal mechanism (if only at a state to state level) to underpin agreed DRC and, perhaps, even a test to determine where divergence justified the agreed DRC being withdrawn. It seems that this is no longer proposed and indeed that policy may now prioritise avoiding arrangements which would be seen as risking the UK becoming a ‘rule taker’ either by tying itself directly to EU rules or where cumbersome arrangements over DRC might make rule divergence difficult in practice.
  5. Whether, under the WTO/GATS regime, the DRC arrangements under item 3 above (i) are agreed on an open access basis and limited to DRC available to other countries under the Most Favoured Nation (MFN) principle, or (ii) go beyond the EU’s third country regime and provide the UK (and the EU) with privileged access under the GATS FTA exclusion from MFN (see our update for the week ending 18 May 2018).

Items 1 and 2 above are likely to be less controversial. HMG has said nothing publicly about its priorities or ambitions on the critical issue of DRC under 3 above. Presumably it is still looking to access any DRC that the EU offers to third countries under open access. As reported previously, the EU is reviewing and taking steps to toughen this regime ahead of Brexit. This would presumably be supported by bilateral arrangements as discussed under items 1 and 4 above. What further DRC is HMG looking to secure in order to ‘preserve the mutual benefits of integrated markets and protect financial stability?’

Irrespective of whether and when we get a better understanding of HMG’s priorities, it may be some time before FS firms get any concrete information on agreed DRC measures that they can rely upon after the transitional period (or any transitional measures for DRC that will be withdrawn at the end of that period). Despite HMG’s assurances, it seems that this clarity may, under the current timetable, come very late in the day.

On the morning of Monday 9th July CMS held a Brexit client event with Dominic Greave, Stephen Kinnock and Tom Brake. Chatham House rules applied but the predominant message was that the political uncertainty would continue for some time yet. In the cold light of the Monday morning after the Chequers 'break thorough' (but before the resignation of Boris Johnson), it was difficult to see how HMG’s approach could lead, within the current timetable, to a negotiated agreement with the EU that would also command support at Westminster. Nobody knew how this political impasse would be resolved. The outcome of this highly volatile crisis remained very uncertain.

The current negotiations concern the wording of a non-binding Political Declaration (on the framework for the future UK/EU relationship) which is to be annexed to the Withdrawal Agreement. Against this background, might the EU and HMG see a common interest in a vague ‘apple pie’ Political Declaration, in the hope that this would allow the Withdrawal Agreement to be approved and take effect, whilst leaving the substantive issues on the future relationship to be negotiated after Brexit? This would ‘kick the can down the street’ and increase the danger of a second ‘no-deal’ scenario/‘cliff edge’ at the end of the transitional period on 31/12/20.

HM Government Chequers Statement

It sets out the Government's position on the future relationship with the EU. It is noted that preparations would be stepped up to address potential outcomes, including the possibility of "no deal". The full statement can be accessed here.

BoE: recording of fpc meeting

BoE has now published the record of the FPC’s 19 June 2018 meeting. The full record can be accessed here.

Ensure a UK legal and regulatory framework is in place

“Much of the UK’s legal and regulatory framework for financial services is derived from EU law. Directly applicable EU law would need to be brought into UK law. Changes would need to be made to the resulting legal framework to make it workable when the UK was no longer a member of the EU. UK regulatory authorities would also need to make changes to their own rulebooks to reflect the new legislation. Shortly after the FPC’s meeting, the EU (Withdrawal) Act had been passed by Parliament. HM Treasury had started publishing draft secondary legislation, and intended to lay the first financial services statutory instruments (SIs) shortly after Royal Assent. SIs establishing the temporary permissions and recognition regimes would be amongst the first laid. The Bank and the Financial Conduct Authority (FCA) expected to consult on rule changes shortly afterwards. The FPC judged that the risk to the UK was at a medium level, and that the passing of the EU (Withdrawal) Act would mean that there had been a reduction in risk since March.”

Clearing services

“In the absence of an agreement or recognition by the European Securities and Markets Authority of UK CCPs (see above), EEA clearing members and their clients currently using UK CCPs would need to find new arrangements for future clearing services with CCPs authorised or recognised by EU authorities. The UK Government had committed to legislate, if necessary, regarding the recognition of non‑UK CCPs, including a temporary recognition regime, so that these CCPs would continue to be able to provide clearing services to UK clearing members and clients in order to avoid disruption. Once this legislation was passed, risks to UK clearing members and clients would be mitigated. In light of this, and since the FPC’s meeting in March, the Bank had written to non-UK CCPs on 28 March 2018 to explain these CCPs could plan on the assumption that they would only need recognition by the end of the implementation period. The FPC judged that the risk to the UK remained at a medium level and the risk to the EU remained at a high level.”

Banking services

“Banks would need the necessary permissions and structures in place to continue providing services to customers on a cross-border basis. Some UK-based banks were in the process of undertaking restructuring and obtaining necessary regulatory permissions for EU subsidiaries. The UK Government had committed to legislate, if necessary, for a temporary permissions regime that would enable EEA banks to continue to operate pending authorisation. Once this legislation was passed, risks to UK customers would be mitigated. In light of this, and since the FPC’s meeting in March, the PRA had written to EEA banks on 28 March 2018 to explain that these banks could plan on the assumption that they would only need PRA authorisation by the end of the implementation period. The FPC judged that the risk to the UK and to the EU remained at a medium level.”

Asset management

“Restrictions on cross-border portfolio delegation could require disruptive changes to asset managers’ business models. To avoid this, EU national competent authorities would need to enter into co‑operation agreements with the FCA. Asset managers and their funds would also require authorisation to continue to market retail funds across borders. To enable funds domiciled in the EEA to continue to be marketed to investors in the UK, the UK Government had committed to legislating for a temporary permissions regime if necessary. Since the FPC’s meeting in March, the FCA had said that affected firms and funds did not need to submit an application for authorisation at this point. The FPC judged that the risk to the UK and to the EU remained at a medium level.”

Personal data

“Financial companies’ ability to carry out new and existing financial services might be impaired by barriers to the cross-border flow of personal data between the UK and EEA. This could be mitigated if the UK and EU were to recognise each other’s data protection regimes as ‘adequate’. The UK Government had indicated it is pursuing this via an EU-UK agreement. Companies could also take steps to mitigate this risk by, for example, introducing new clauses into contracts that permit data transfer. But this may not be comprehensive or completely effective. The FPC judged that the risk to the UK and to the EU remained at a medium level.”

Other publications from the RegZone Brexit news feed

HoL: Brexit: UK-EU Relations

On 2 July 2018, HoL debated the EU Committee's report. The transcript can be accessed here.

HoC Exiting the European Union Committee: The progress of the UK’s negotiations on EU withdrawal: data

The Committee's report urges the Government to start the process to secure a Data Adequacy Decision from the EU as soon as possible to maintain data flows between the UK and the EU after 29 March 2019. It suggests that the UK should seek a treaty, rather than a one-way adequacy decision made by the EC. The full report can be accessed here.

EC: Report by Donald Tusk to the European Parliament

Text of this statement given on 3 July 2018 follows. Topics include: Brexit and the completion of the Banking Union. The full statement can be accessed here.

The European Union (Withdrawal) Act 2018 (Commencement and Transitional Provisions) Regulations 2018/808 (C63)

These Regulations bring into force various provisions of the European Union (Withdrawal) Act 2018. The full report can be accessed here.

TSC: Brexit impact analysis – FCA/BoE

TSC has published letters sent to FCA and BoE asking for their commitment to publishing an analysis of the impact of the Withdrawal Agreement and future framework (once it has been negotiated) on their ability to meet their objectives, in good time before Parliament comes to make its key decisions. The letter to the FCA can be accessed here and the letter to the BoE can be accessed here.

EBA: Interview with Pentti Hakkarainen

Text of a Bloomberg interview with Pentti Hakkarainen on 29 June 2018 has now been published. Topics include: the banking sector and Brexit. The full interview can be accessed here.

Department for Exiting the EU: Speech by Robin Walker: Securing the future of mutual recognition of professional qualifications

This speech was given on 3 July 2018 to industry representatives on the future of mutual recognition of professional qualifications. The full speech can be accessed here.

HoC: Brexit - the exit bill

This HoC library briefing on the Brexit "divorce bill" includes a synopsis of June-December 2017 negotiations. The full briefing paper can be accessed here.

HoC European Scrutiny Committee: 33rd Report of Session 2017-19

Section 6 of the report looks at a proposed Directive with regard to improving cross-border law enforcement access to financial information and details the latest ministerial responses to the Committee’s specific concerns (including with regard to Brexit). This matter is still under scrutiny by the Committee. Access the full report here.

CMS RegZone publishes weekly updates (available via email, on-line and via Twitter) 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). Links to publications are contained in each update; publications released before the updates commenced in April 2018 can be found in a bibliography here. CMS RegZone publication ‘Where we stand’ provides an overview of the current position in a single report; this is updated regularly to take account of the key developments from the weekly updates.