The week in outline:

Her Majesty’s Government (HMG) published its long awaited White Paper ‘The future relationship between the United Kingdom and the European Union’ on July 12. In summary, and as expected, HMG announced a major policy change with a new bifurcated approach to the trading relationship:

  • HMG now proposes that the UK should effectively remain in the Single Market for goods (including agri-food) via a tariff free UK/EU ‘free trade area’ with the UK committed to EU rules as a ‘rule-taker’ (except where a lack of harmonisation would not lead to border checks) and with an EEA style process for adoption of new EU rules by the UK parliament. This Single Market solution is at odds with previous policy. HMG suggests that this new approach, together with a complex ‘Facilitated Customs Arrangement’, would remove the need for customs borders and checks and resolve the Northern Ireland/Ireland border problem.

  • HMG is now taking the opposite approach for services business, including financial services (FS). HMG now proposes that when the UK leaves the Single Market/EEA it should become a third country with only an FTA style relationship in financial services with the EU. It appears to accept the EU opening position as the starting point for negotiations, i.e. that the EU would treat the UK as a third country without preferential access to EU markets.

This represents a big change in HMG’s position on FS. HMG had previously proposed a bilateral mutual recognition treaty in FS with preferential access, freedom for rules divergence and a flexible outcome based equivalence assessment to determine when divergence would trigger a loss of mutual recognition. The new regime was intended be an entirely new bilateral approach which was to be much more ambitious in terms of DRC than the EU’s relationship with other countries under its third country legislative provisions (which was the basis proposed by the EU). (For detailed analysis of mutual recognition, DRC, bilateral arrangements and the regulation of third country firms – see our April 2017 report).

It is clear that HMG now accepts that when FS Single Market DRC is terminated at the end of any transitional period there will be no general replacement with bilateral DRC arrangements. It also accepts that the UK/EU relationship should be based on the EU’s regulation of third country firms. This volte face is summarised in vague language in the White Paper as -

new economic and regulatory arrangements for financial services, preserving the mutual benefits of integrated markets and protecting financial stability while respecting the right of the UK and the EU to control access to their own markets – noting that these arrangements will not replicate the EU’s passporting regimes;”

The White Paper signals a major change of policy and a switch to what some have called ‘plan B’ or ‘enhanced equivalence “The EU has third country equivalence regimes which provide limited access for some of its third country partners to some areas of EU financial services markets” and the White Paper suggests that these can be built on to deliver the new relationship in FS. The additions are broadly to cover regulatory and supervisory coordination (relatively easy goals), enhanced DRC, and transitional measures to smooth the switching off of Single Market DRC.

There is no indication, however, of the scale of additional DRC that HMG is proposing nor does the White Paper give any specific examples. It merely says “As part of this, the existing autonomous frameworks for equivalence would need to be expanded, to reflect the fact that equivalence as it exists today is not sufficient in scope for the breadth of the interconnectedness of UK-EU financial services provision. A new arrangement would need to encompass a broader range of cross-border activities that reflect global financial business models and the high degree of economic integration. The UK recognises, however, that this arrangement cannot replicate the EU’s passporting regime.” To give an example, it is presumed that this will include DRC to enable banks to provide certain banking services (e.g. wholesale/large commercial business) on a services basis, i.e. without having to establish a local branch or obtain local authorisation. As mentioned in our April 2017 report a similar system is already in place under MiFIR whereby “[…] TCFs [Third Country Firms] from equivalent jurisdictions (as explained in detail in Annex E) will register with ESMA and can then provide cross-border services and deal with counterparties in any EU country. This only covers crossborder supply in investment services/activities and is limited to [certain] professional clients and eligible counterparties.”

The White Paper envisages that this ‘enhanced equivalence’ relationship would be delivered via

  • what it calls (confusingly) the “autonomous frameworks for equivalence” (i.e., on the EU side, its legislative provisions which provide a harmonised treatment for third country firms with home country rules/regulation which are ‘equivalent’ to those of the EU[1]); and

  • via a “bilateral framework of treaty treaty-based commitments” – with the latter being subject to the UK’s proposals for dispute settlement in chapter 4 of the White Paper.

This is the mechanism used in other EU/third country arrangements (including in Free Trade Agreements); the reciprocal bilateral arrangements are consistent with and implemented by the EU via its pre-existing third country legislative provisions. In this case, however, it is not clear how HMG proposals would be achieved. What would be implemented (on the EU side) by enhancing the EU third country legislative provisions (i.e. by changing the current basis of the provisions and adding new DRC) to make the improved access terms available to all third countries and what would be unique to the UK/EU relationship?

It seems that HMG envisages that the additional DRC measures/market access would be available to third countries generally; see the extract above where HMG says that the “existing autonomous frameworks for equivalence would need to be expanded”. HMG’s original proposal was for preferential access for the UK alone; in one sense it is a ‘bigger ask’ to expect the EU to expand its third country legislative provisions (to suit the UK), to provide third countries generally, and on Most Favoured Nation principles, with opportunities for greater market access/DRC. Presumably this reflects the limited DRC/access that HMG is now expecting to achieve under ‘enhanced equivalence’. To some extent there are gaps in the current regime which may have arisen partly because of the history of EU harmonisation/legislation in different sectors, but there are obvious difficulties in the UK negotiating with the EU to open up its markets in this way, for the benefit of other third countries.

In paragraph 70 of the White Paper (set out below) HMG proposes that there should be a more secure basis for DRC granted under the equivalence framework; otherwise firms have little protection against DRC being withdrawn at short notice. It proposes a transparent assessment methodology for equivalence assessment, a structural process to govern DRC withdrawal and long-term stabilisation of DRC/access rights. These desirable objectives may be something of a hang-over from HMG’s original proposal; it is not clear whether HMG envisages these measures flowing through to the EU’s third country regime or being ‘UK only’. In the latter case, would the EU need to introduce new flexibility in its legislative provisions to provide for different equivalence processes depending on the third country concerned?

Previously Philip Hammond had said: “We must have the ability, if necessary, to deliver an equivalent outcome by different means….. At first glance, this may appear to point to a solution based on the EU’s established third-country equivalence regime. But that regime would be wholly inadequate for the scale and complexity of UK-EU financial services trade. It was never meant to carry such a load.”[2]The White Paper clearly takes a very different approach, but it is unclear whether the UK now accepts the basis of the EU equivalence assessment or whether HMG is still looking for great flexibility - the White Paper reads "As established in many existing EU provisions, this approach would be based on an evidence-based judgement of the equivalence of outcomes achieved by the respective regulatory and supervisory regimes."

The EU is, of course, currently moving in the opposite direction to that proposed by HMG in the White Paper; it is preparing for Brexit by ‘enhancing’ its ‘autonomous frameworks for equivalence’ (and other harmonisation of third country regulation) not to improve market access for third countries, but to provide better protection for EU firms and markets (see previous updates). The EU is also changing the regulation of EU firms/markets to improve their competitive position vis a vis the UK after Brexit (see document 3 below) and taking a hard line on how UK groups restructure for Brexit, to increase pressure on relocation to the EU-27.

This is the first time that HMG has acknowledged the need for transitional arrangements for the end of the transitional period (as distinct from a ‘no-deal’ scenario) and they also refer to the idea of ‘acquired rights’ in this context. Unsurprisingly HMG is proposing that full third county DRC should be available and in operation at the end of the planned transitional period on 31/12/20. This has been a relevant factor in FS firms planning from the outset, but the extent of any new/enhanced DRC remains an unknown. It may be that the Political Declaration to be annexed to the Withdrawal Agreement may provide some comfort that at the end of the transitional period the UK will be treated as equivalent and enjoy the DRC available under the EU’s current third country provisions but the question of additional DRC (or of specific additional DRC measures) may be unresolved and left to be negotiated after 29/3/19. As noted in our last update, the short timetable and interests of some parties suggest that much will be left to be negotiated during the transitional period.

If HMG’s proposals are agreed by the EU, UK firms and markets will face a complicated matrix of:

  • EU harmonised third country requirements which apply to all third country firms (e.g. Solvency 2 requirements in relation to EU branches);

  • EU provisions which provide for differentiated treatment (hopefully enhanced to provide broader/additional DRC as HMG suggest) for third countries which (on one basis or another) have equivalent rules to the EU; and

  • A mass of differing national rules and requirements and DRC/access provisions of each of the EU-27 states in the many areas of third country regulation (and perimeter rules) which will remain un-harmonised.

HMG's White Paper has been published. Section 1.3.4 sets out the proposals with regard to the financial services sector.  It is proposed that there should be reciprocal recognition of equivalence under all existing third country regimes to take effect at the end of the implementation period. It is proposed that the new arrangement should include provisions through the bilateral arrangement for common principles for the governance of the relationship; extensive supervisory cooperation and regulatory dialogue; and predictable, transparent and robust processes. The full paper can be accessed here.

“60. As the UK leaves the EU and the Single Market, it recognises the need for a new and fair balance of rights and responsibilities. The UK can no longer operate under the EU’s “passporting” regime, as this is intrinsic to the Single Market of which it will no longer be a member.”

“61. In addition, given the importance of financial services to financial stability, both the UK and the EU will wish to maintain autonomy of decision-making and the ability to legislate for their own interests. For example, in some cases, the UK will need to be able to impose higher than global standards to manage its financial stability exposure. In other areas, the UK market contains products and business models that are different to those found elsewhere in the EU, and regulation would need to reflect these differences. The decision on whether and on what terms the UK should have access to the EU’s markets will be a matter for the EU, and vice versa. However, a coordinated approach leading to compatible regulation is also essential for promoting financial stability and avoiding regulatory arbitrage.”

“62. The EU has third country equivalence regimes which provide limited access for some of its third country partners to some areas of EU financial services markets. These regimes are not sufficient to deal with a third country whose financial markets are as deeply interconnected with the EU’s as those of the UK are.”

“64. This new economic and regulatory arrangement would be based on the principle of autonomy for each party over decisions regarding access to its market, with a bilateral framework of treaty-based commitments to underpin the operation of the relationship, ensure transparency and stability, and promote cooperation. Such an arrangement would respect the regulatory autonomy of both parties, while ensuring decisions made by either party are implemented in line with agreed processes, and that provision is made for necessary consultation and collaboration between the parties.”

“65. As part of this, the existing autonomous frameworks for equivalence would need to be expanded, to reflect the fact that equivalence as it exists today is not sufficient in scope for the breadth of the interconnectedness of UK-EU financial services provision. A new arrangement would need to encompass a broader range of cross-border activities that reflect global financial business models and the high degree of economic integration. The UK recognises, however, that this arrangement cannot replicate the EU’s passporting regime.”

The UK proposes a new framework:

“66. As the UK and the EU start from a position of identical rules and entwined supervisory frameworks, the UK proposes that there should be reciprocal recognition of equivalence under all existing third country regimes, taking effect at the end of the implementation period. This reflects the reality that all relevant criteria, including continued supervisory cooperation, can readily be satisfied by both the UK and the EU. It would also provide initial confidence in the system to firms and markets.

1. Common principles for the governance of the relationship

“68. As established in many existing EU provisions, this approach would be based on an evidence-based judgement of the equivalence of outcomes achieved by the respective regulatory and supervisory regimes. The UK and the EU would set out a shared intention to avoid adopting regulations that produce divergent outcomes in relation to cross-border financial services. In practice, as the UK and the EU have since the financial crisis, the UK will continue to be active in shaping international rules, and will continue to uphold global norms. To reflect this, the UK-EU arrangement should include common objectives, such as maintaining economic relations of broad scope, preserving regulatory compatibility, and supporting collaboration – bilaterally and in multilateral fora – to manage shared interests such as financial stability and the prevention of regulatory arbitrage.”

2. Extensive supervisory cooperation and regulatory dialogue

“69. a) Regulatory dialogue: for equivalence to be maintained over the long term, the UK and the EU should be able to understand and comment on each other’s proposals at an early stage through a structured consultative process of dialogue at political and technical level, while respecting the autonomy of each side’s legislative process and decision-making.”

“69 b) Supervisory cooperation: in a close economic relationship between the UK and the EU financial services sectors, it would be necessary to ensure close supervisory cooperation in relation to firms which pose a systemic risk and/or that provide significant cross-border services on the basis of equivalence. It will be essential for the UK and the EU to commit to reciprocal and close cooperation to protect consumers, financial stability and market integrity with codified procedures for routine cooperation and for coordination in crisis situations. This should include appropriate reciprocal participation in supervisory colleges, which are coordination structures that bring together regulatory authorities involved in the supervision of banks and other major financial institutions – as well as other supervisory structures, including information exchange, mechanisms for consultation over decisions affecting the other party, and arrangements for the supervision of market infrastructure.”

3. Predictable, transparent and robust processes

“70. To give business the certainty necessary to plan and invest, transparent processes would be needed to ensure the relationship is stable, reliable and enduring. The UK envisages that some of these processes would be bilaterally agreed and treaty based; others would be achieved through the autonomous measures of the parties.

  1. Transparent assessment methodology: the process for assessing equivalence should be based on clear and common objectives; make use of consultation with industry and other stakeholders; and include the possibility of using expert panels.
  2. Structured withdrawal process: if circumstances arise that cause either party to wish to withdraw equivalence, there should be an initial period of consultation on possible solutions to maintain equivalence. Either party may also indicate to the other that it no longer seeks equivalence in a certain area. There should then be clear timelines and notice periods, which are appropriate for the scale of the change before it takes effect. There should also be a safeguard for acquired rights to avoid risks to financial stability, market integrity or consumer protection from sudden changes to the regulatory environment.
  3. Long-term stabilisation: in accordance with WTO principles, there should be a presumption against unilateral changes that narrow the terms of existing market access regimes, other than in exceptional circumstances. This would mean each side trying to avoid future changes that assess equivalence in entirely new ways that could destabilise an established relationship. Existing equivalence decisions should only lapse after a new decision has been taken.”

EC: Speech by Michel barnier

Text of Michel Barnier's speech of 10 July 2018 follows in which he discusses various aspects of Brexit, including with regard to the financial services sector. The full speech can be accessed here.

“That being said, I think that we should have a close relationship with the UK, also in financial services.

This is our common interest. I see a number of ways to achieve this.

First, the EU Single Market is open to third countries, in general, to the US, and also to the UK. And it will remain so. In the EU, free movement of capital is open to third countries. As regards market access to provide financial services, the European Council made clear that our future Free Trade Agreement with the UK should include the right of establishment, with EU rules applying.

Secondly, the EU has a long history of relying on the regulation and supervision of third countries. This is what the G20 calls deference, what you call in the US substituted compliance, and what we call in the EU equivalence. To date, the EU has adopted more than 200 so-called equivalence decisions covering more than 30 foreign jurisdictions, including of course the US. This integrates financial markets and facilitates the work of financial operators in the EU and the foreign jurisdiction. Today, to be very clear, we are in the EU the most open jurisdiction in the world for financial services. Why would this equivalence system, which works well, including for the US industry, not work for the UK? Why?

Thirdly, in order to draw lessons from the financial crisis and limit the risks in the future, EU countries collectively developed more effective financial regulation and supervision. And we were very happy to do this hand-in-hand with the UK.

I can personally testify it: for five years, I was in charge of financial services for the Commission and all these regulations, but two – short selling and banker bonuses – have been adopted in full agreement with the UK. We need to keep this joint regulatory effort in mind, and be ready to exchange our ideas for future rules in the context of close and voluntary regulatory cooperation. Here also, we have a regulatory dialogue with the US. We could build on this experience with the UK.

Fourthly, we will of course cooperate with the UK – as we do with the US – in international fora such as the Financial Stability Board and the Basel committee.

The world of finance is global and interdependent. We have a mutual interest in working together, not separately.”

ESMA: Amendment to Commission Delegated Regulation (EU) 2017/588 (RTS 11)

ESMA's consultation proposes amendments to the MiFID II tick size regime, particularly with regard to third countries. Responses are required by 7 September 2018. The full consultation paper can be accessed here.

ESMA is concerned that Swiss markets have benefited from increased market share on stocks traded both in the EU and in Switzerland because of smaller tick sizes. It is concerned that UK markets may enjoy a similar advantage as a third country post-Brexit and it is therefore suggesting a change in the relevant MiFID requirements.

Other publications from the RegZone Brexit news feed

HoC European Scrutiny Committee: 34th Report of Session 2017-2019

Sections 4 and 5 of the report look at the Motor Insurance Directive and SEPA (cost of cross-border money transfers) respectively and detail the latest ministerial responses to the Committee’s specific concerns (including with regard to Brexit). These matters are still under scrutiny by the Committee. The full report can be accessed here.

HoC: Brexit and financial services

This HoC library briefing has been updated. The full briefing paper can be accessed here.

Department for Exiting the EU: Dispute resolution and enforcement after Brexit

This paper comprises the Government's response to the May 2018 HoC EU Committee report, which includes comment on each of the recommendations made by the Committee. The full paper can be accessed here.

FMLC: Issues of legal uncertainty arising in the context of the establishment of an EU insurer in another member state

FMLC's report looks at the distinction in the freedom of establishment and the freedom to provide services, with particular regard to the differences in the formalities for establishment as set out in the EC's Interpretive Communication, published in 2000, and Solvency II.  It considers the impact of these uncertainties on (re)insurers planning for Brexit and recommends that HMG request guidance on the conditions for establishment in the course of their negotiations with the EU. Access the full report here.

FSB: Interest rate benchmark reform: overnight risk-free rates and term rates

FSB has published this statement on reforms to interbank offered rates and the development of overnight risk-free rates and term rates.  FSB notes a forthcoming ISDA that contemplates fall backs for certain derivative contracts based on overnight RFRs. Access the full statement here.

FMLC: Legal uncertainties relating to insurance business

FMLC has published its letter of 12 July 2018 to the Department of Exiting the EU setting out issues of legal uncertainty which arise in relation to insurance business in the context of Brexit and requesting that HMG raises the need for further guidance on this issue with the EC and provides similar guidance to foreign firms which might want to access the UK market after Brexit. Access the full letter here.

ESMA: Amendment to Commission Delegated Regulation (EU) 2017/588 (RTS 11)

ESMA's consultation proposes amendments to the MiFID II tick size regime, particularly with regard to third countries. Responses are required by 7 September 2018. The full consultation paper can be accessed here.

ESMA: Timely submission of requests for authorisation in the context of the UK withdrawing from the EU

ESMA notes that it has issued this statement in order to raise the awareness of all market participants on the importance to prepare for the possibility of a hard Brexit and urges entities wishing to relocate to the EU27 to submit their application for authorisation as soon as possible to allow it to be processed before 29 March 2019. The full publication can be accessed here.

TSC: Solvency II

TSC has published a letter it has sent to PRA commenting on the regulator's current work on various aspects of Solvency II and suggesting, in light of Brexit, that " it may be sensible to remain as closely aligned as possible with other EU countries. At the same time, we believe it is important to identify where there is a lack of fit with the needs of UK consumers and industry, and the options for achieving better outcomes. The Committee would like the PRA to be proactive in this regard and to work with the industry in developing future policy". The full letter can be accessed here.

HoC Procedure Committee: Scrutiny of delegated legislation under the European Union (Withdrawal) Act 2018

The Committee has published its final report on HoC's scrutiny of the detailed process of incorporating EU law into UK law to prepare for Brexit. The full report can be accessed here.

EBA: Report on the peer review of the regulatory technical standards on passport notifications

EBA has published this report with regard to information to be notified when exercising the right of establishment and the freedom to provide services for credit institutions. The report showed that competent authorities have developed consistent and robust procedures to comply with the requirements and includes suggestions for best practice. The full report can be accessed here.

HoC: Leaving the EU

The Hansard transcript of the 9 July 2018 debate in HoC follows. Theresa May stated "on services, we want to be free to ensure that we are able to put in place what we believe is necessary to maintain our key position in services, not least in financial services. The global financial centre of the City of London needs to be maintained into the future, and we will continue to do that". The full transcript can be accessed here.