Brexit update for financial services firms - week ending 17 August 2018

The week in outline:

Her Majesty’s Treasury (HMT) published another draft statutory instrument (SI) under section 8 of the European Union (Withdrawal) Act 2018 (EUWA)[1]. This brings the number of published draft financial services SIs under section 8 to nine.[2] The Draft Deposit Guarantee Scheme and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018 (see Document 2 below) deals with the changes to the Deposit Guarantee Scheme (DGS) regime as onshored/ported into domestic law by the EUWA. It makes both permanent and temporary/transitional changes to domestic law. Changes are required because the DGS operates under the EU’s Deposit Guarantee Schemes Directive 2014/49/EU (DGSD) which, as well as prescribing national requirements for deposit guarantee schemes, also has elements of single market DRC[3]/reciprocity which would no longer be relevant.

The EUWA changes propose to maintain the current regime but would:

• transfer the power to set DGS limits from EU bodies to UK institutions – the Prudential Regulation Authority (PRA) will have the power to review, adjust and set limits with the approval of HMT;
• remove arrangements for cooperation between the Financial Services Compensation Scheme (FSCS) and EEA deposit guarantee schemes, whereby the FSCS administers compensation payments to depositors at UK branches of EEA credit institutions on behalf of an EEA DGS. However, a temporary/transitional measure allows the FSCS to continue to act as an intermediary where the EEA firm fails shortly before Brexit;
• make technical changes where FSMA provisions refer to the Alternative Dispute Resolution Directive (which relates to the Financial Ombudsman Scheme);

Further consequential changes, at a rulebook level, will be made by section 8 SIs to be drafted by the Financial Conduct Authority (FCA) and the PRA under their new Brexit powers to propose changes at a rulebook and BTS (Binding Technical Standards) level (see our update for the week ending 20 July 2018)[4].

Settlement finality is another area where modifications will be required, presumably under section 8. HMT announced that it would bring forward secondary legislation to deal with settlement finality, in the context of the onshoring of retained EU law under the EUWA. The Bank of England (BoE) also published a dear CEO letter on 24th July (listed in our update for the week ending 27 July 2018) in which they explain their policy under the revised/UK regime. The FMLC had previously published a report which examined the securities settlements systems directive (SFD)[5] and Brexit in the context of the other 2 related pieces of EU legislation: the Recast European Union Insolvency Regulation (EUIR)[6] and the Directive on financial collateral arrangements (FCAD)[7]. The Recast EUIR sets out rules for courts of Member States to determine the jurisdiction and the applicable law for cross-border insolvency proceedings and provides for mutual recognition of those proceedings and judgments.

The SFD is implemented in the UK through the Financial Markets and Insolvency (Settlement Finality) Regulation 1999 (SFR). It is restricted to settlement systems that are governed by the law of a Member State. As the FMLC report explains “the SRF allows payment and settlement systems to apply for certain protections against adverse effects of normal insolvency law insofar as it applies to transfer orders entered into the system and the operation of the rules of the system.” This ensures that creditors can rely on the transfer order and do not need to worry that it will be revoked at a later stage under insolvency proceedings in their jurisdiction or in any other member state.

When discussing the effect of Brexit on SFD the FMLC notes:

“Once the U.K. ceases to be an E.U. Member State, the insolvency courts of the remaining E.U. states will not be required to recognise SFD protections in so far as they are afforded by the SFRs in the context of insolvency proceedings opened against a participant in a U.K. designated system. […] These issues cannot be ameliorated or mitigated by the retention of the SFRs under the European Union (Withdrawal) Bill because the issue is the loss of reciprocity rather than a potential lacuna in the U.K. legal framework.”

The domesticated UK settlement finality regime is being established on a unilateral basis (as the FMLC pointed out above). It will provide protection for designated financial market infrastructure (FMIs) only from UK insolvency law/proceedings. When the UK leaves the Single Market and the SFD ceases to apply to UK FMIs, they will no longer be protected from insolvency proceedings in EU-27 Member States under the SFD.[8]

In contrast, in the UK the BoE will be given new powers (as a permanent part of the domestic system) to grant designation to non-UK, including EU, systems that are not governed by UK law. This will enable EU systems to obtain protection from insolvency proceedings in the UK (which they currently enjoy by virtue of the SFD). In addition there will be a temporary/transitional relief for these EU systems (currently covered under SFD); this will provide temporary recognition under the UK system whilst permanent designation is obtained. To participate in the temporary designation regime the EU systems would have to notify the BoE of its intent to submit an application for designation.

While the final shape of the UK regime is subject to the legislative process, the BoE anticipates that UK domestic law requirements for the designation of systems not governed by UK law will in essence be the same as the requirements for designation of systems governed by UK law, as set out in the schedule to the SFR. The BoE does not envisage that it will be a requirement of UK law for a non-UK system to have any form of UK SFD designation in order to have UK participants.

This is another example of the UK preparing for a no-deal scenario and the operation of the UK regime outside the EU Single Market without any bilateral DRC/reciprocity arrangements with the EU. In this case the UK is acting on a unilateral basis to provide protection for EU systems on a permanent basis and also transitional relief to resolve their difficulties arising from the uncertainty about the outcome of the EU/UK Brexit negotiations[9]. In stark contrast, the EU is currently offering no reciprocal protection for UK FMIs in a no deal scenario. In that event, the lack of reciprocal EU measures would ‘mean that EU customers will present higher risks to these [UK] FMIs and may no longer be able to access their services.’ [10] As a result of the UK legislation and the designation of EU-27 FMI, UK customers would not pose a similar risk to these EU systems.

ECB: Supervisory newsletter

ECB has published the latest edition of its newsletter. Topics include: Brexit planning; ECB's approach to supervising governance; recovery planning; building a common supervisory approach for smaller banks and an interview with Ed Sibley (Deputy Governor of the Central Bank of Ireland and ECB Supervisory Board member on the importance of diversity to the governance, culture and risk profile of banks. All articles may be downloaded individually via the following link.

“At the core of this is the ECB’s communication to both incoming and outgoing banks to prepare for all contingencies – including a no-deal scenario – and to counter the idea floated by several banks of setting up “empty shell” institutions.”

“Even if an agreement is reached, the UK’s relationship with the EU will no longer be that of a Member State. This is especially relevant given the UK government’s current stance, i.e. that it does not expect to retain the current levels of access to the EU’s market for services (see the UK’s White Paper from July 2018 “The future relationship between the United Kingdom and the European Union”). For that reason, all banks affected by Brexit should act before March 2019 to mitigate the risk associated with losing access to the EU single market.”

“Banks should not expect public sector solutions to help them with the challenges they are facing. As communicated before, banks may use a limited and clearly defined build-up period to meet certain supervisory expectations if this has been previously agreed with the ECB and national supervisors. However, this does not affect the requirement that core capabilities need to be located in the euro area from day one (30 March 2019) and that the build-up to the target operating model needs to be finalised in good time, consistent with supervisory expectations.”

"The ECB will continue to closely follow banks’ preparations and will counter any effort by them to establish empty shells in the euro area. Supervisors have made effective use of the time since the UK decided to leave the EU and continue in their preparations for the post-Brexit era. Now it is up to the banks to speed up their work and complete their preparations during the final count-down to Brexit.”

Deposit Guarantee Scheme and Miscellaneous Provisions (Amendment) (EU EXIT) Regulations 2018 (Draft)

This SI will make amendments to retained EU law related to deposit protection, FOS and certain inquiries and investigations to ensure that they continue to operate effectively in a UK context once the UK leaves the EU, in any scenario. An explanatory policy note has also been published. HMT intends to lay this SI before Parliament in the autumn. The SI and the accompanying explanatory note can be accessed here.

The explanatory note says - “Deposit Guarantee Schemes (DGS) are an important mechanism for ensuring financial stability and confidence in credit institutions (e.g. banks, building societies and credit unions). DGS support orderly resolution and timely pay out of DGS-covered deposits to depositors. This is especially important during periods of financial stress where depositors can be sure that the money in their bank accounts is covered up to a certain limit, even if their bank, building society or credit union fails.”

“The Financial Services Compensation Scheme (FSCS) is the UK’s DGS and is responsible for paying compensation to depositors when an authorised UK credit institution has failed. The FSCS also provides compensation to customers of certain other types of firms e.g. insurers and investment firms. EU exit related changes to FSCS membership and rules are being made in the EEA Passport Rights (Amendment etc., and Transitional Provisions) (EU Exit) Regulations 2018 and UK regulators’ rulebooks.”

“The UK transposed the Deposit Guarantee Scheme Directive (DGSD) through the Deposit Guarantee Schemes Regulations 2015, amendments to the Financial Services and Markets Act 2000 (FSMA) and via the Prudential Regulation Authority (PRA) rulebook.”

“The Financial Ombudsman (FOS) is the UK’s alternative dispute resolution provider for the financial services industry. The policy intent behind the establishment of the FOS was to provide consumers with a free, independent service that enabled the fair, prompt and informal resolution of disputes with financial firms. It is designed as an alternative to resolution of cases through the courts, which can be expensive for consumers and delay redress. The FOS also satisfies the legal requirement for an alternative dispute resolution entity under European Law (ADR Directive).”

“The FOS is provisioned for in FSMA. More detailed rules on how the FOS operates, including the details of its jurisdiction, are determined by the FCA and the FOS and set out in the FCA Handbook.”

“Schedule 17 to FSMA contains references to EU legislation (the ADR Directive 2013/11/EU). Part 2 of this SI amends these references to ensure they continue to function post-exit.”

“Part 3 of this SI transfers coverage level setting power from EU institutions to UK institutions. The PRA will have the power to review, adjust and set the deposit coverage level with approval from HMT.”

“This part of the SI also removes the arrangement whereby the FSCS administers compensation payments to depositors at UK branches of EEA credit institution on behalf of an EEA DGS (in essence, the FSCS will no longer serve as an intermediary). However, the SI also includes a transitional provision allowing the FSCS to continue after Exit to accept instructions and funds from EEA DGS in the event that an EEA firm operating in the UK fails immediately before the UK’s exit from the EU.”

“This SI removes the requirement on the PRA to notify the EBA each year of the amount of deposits in the UK which are covered by the FSCS and the funding available to the FSCS. The PRA will also no longer have to notify the EBA of any agreements between the FSCS and other EEA DGS.”

“This SI also amends EU references and removes arrangements which will no longer be appropriate after withdrawal. For example, references to incoming EU firms in domestic legislation.”

“The PRA and FCA will be updating their rulebook and handbook respectively to reflect the changes introduced through this SI, and to address any deficiencies resulting from the UK leaving the EU. The PRA and FCA have confirmed their intention to consult on these changes in the autumn.”

“This SI does not include provisions that may be necessary to ensure Gibraltarian financial services firms’ continued access to UK markets in line with the UK government’s statement in March 2018, and other provisions dealing with Gibraltar more generally. Where necessary, provisions covering Gibraltar will be included in future SIs.”

Other publications from the RegZone Brexit news feed

HMT: Financial stability report – record of meeting

HMT has now published the record of the meeting between Philip Hammond and Mark Carney on 4 July 2018. Topics include: FPC’s latest assessment of financial stability risks; Brexit; cyber risk and LIBOR. The report can be accessed here.

FCA: Regulation round-up

The latest edition of FCA's regulation round-up has been published. This includes details of recent publications and forthcoming events as well as noting forthcoming changes to the Connect application system. The report can be accessed here.

DBEIS/Department for Exiting the EU: Business Secretary Meetings

This press release notes meetings held by Greg Clark with ministerial counterparts and businesses in Austria and Finland to discuss the Chequers white paper and future economic relationships post Brexit. The press release can be accessed 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.

[1]See our update for the week ending 27 July 2018.

[2]The EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018 (Draft),The Central Counterparties (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018, The Financial Regulators’ Powers (Technical Standards etc.) (Amendment etc.) (EU Exit) Regulations 2018, The Consumer Credit (Amendment) (EU Exit) Regulations 2018, The European Union (Definition of Treaties Orders) (Revocation) (EU Exit) Regulations 2018, Draft Deposit Guarantee Scheme and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018, The Short Selling (Amendment) (EU Exit) Regulations 2018, The Building Societies Legislation (Amendment) (EU Exit) Regulations 2018 and The Friendly Societies (Amendment) (EU Exit) Regulations 2018.

[3] Dual recognition coordination as explained in chapter 1 of the April 2017 Report. DRC is a broad term to cover a variety of techniques such as “mutual recognition”, “home state recognition/supervision”, “deference”, “substituted compliance” and “passporting”.

[4] The Financial Regulators’ Powers (Technical Standards etc.) (Amendment etc.) (EU Exit) Regulations 2018

[5] Directive 98/26 on settlement finality in payment and securities settlement systems

[6]Regulation (EU) 2015/848 on insolvency proceedings

[7]Directive 2002/47/EC on financial collateral arrangements

[8]The situation for FCAD is less severe. As the FMLC explains: “The same issues do not arise under the FCAD. The implementing measures of E.U. Member States, if they follow the scope of the FCAD, are not expressly limited to the protection of collateral arrangements affecting collateral situated in a Member State, although this is often a prerequisite for enforcement proceedings in the courts of that state, or benefitting only collateral-takers and collateral-providers located in a Member State. Thus, U.K. collateral-takers and collateral-providers will not automatically fall out of scope when the U.K. withdraws from the E.U.”

[9] (The UK is also providing transitional relief (against loss of authorisation/recognition) for EEA FS firms/CCPs under its temporary permissions/recognition regime - see our update for the week ending 27 July 2018).

[10] HM Treasury, “Guidance: Banking, insurance and other financial services if there’s no Brexit deal"