Where we stand: The draft Withdrawal Agreement provides for a transition period from 29/03/19 to 31/12/20 during which the EU single market legislation, and its dual regulation coordination (DRC)/mutual recognition, would continue to apply to the UK. 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 (possibly full single market DRC) than the EU’s current regime for third country mutual recognition/DRC. The EU position is that it will offer the UK no more than is available to other third countries - regulatory cooperation on a voluntary basis and DRC via (unilateral and revocable) decisions by the EU under its third country “equivalence” legislation. In our report on Brexit and FS in April 2017 we provide detailed analysis of these two regimes and the extent of mutual recognition/DRC under each proposal.

News in the week ending 4 May was dominated by the goods sector and the debate about future customs arrangements, particularly in the context of Ireland. Reports from UK parliamentary committees continue to highlight difficulties in the financial services sector.

HoC European Scrutiny Committee: 25th Report of Session 2017-19

Many of the issues considered in this report are relevant to the whole financial services industry, including implementation of new EU legislation before the UK leaves the EU; the practical implications of mutual recognition/DRC ceasing when the UK leaves the EU and the need for transitional measures; the policy difficulties facing government in trying to negotiate a bespoke deal for FS (and not promoting equivalence); and the possible development of the EU’s current third party regime to deal more appropriately with the UK. We analyse each of these issues in our commentary below.  The report itself specifically considers proposals with regard to the regulation of covered bonds and the new EU regulatory framework in respect of crowdfunding and peer-to-peer lending and the latest ministerial response to the Committee’s specific concerns. These matters remain under scrutiny by the Committee. Click here to access the report.

The report considers the potential impact of the legislation in the context of Brexit.

Our commentary: The committee’s Brexit analysis is interesting at several levels. Our commentary below explores some of the issues raised –

  • The report looks at two examples of the “pipeline” of EU legislation, which may fall to be implemented during the transition period/after the UK has left the EU – “… we do not know whether, and if so for how long, the UK and its crowdfunding industry might be covered by the new ECSP regime. Although it is unlikely the Regulation will take effect before early 2020, there is a distinct possibility that the ECSP regime will be binding on the UK during the transitional/implementation period.”
  • The report explores the practicalities of “switching off” mutual recognition/DRC when the UK leaves the single market. For example, the report highlights the practical difficulties for firms where new EU legislation/DRC takes effect shortly before the UK leaves the single market. During the transitional period, EEA institutions would get preferential treatment when holding covered bonds issued by UK banks, but covered bonds issued by the same bank after 31/12/20 would not qualify. During the transitional period, EEA institutions could include UK assets in their covered pool for their covered bonds but after 31/12/20 the EU legislation would not apply and the position would depend on the national legislation of the EEA bank. Similarly, some crowdfunding platforms might have to obtain ESMA authorisation during the transitional period but reorganise and/or obtain different authorisation to continue operating after the transitional period when the legislation ceases to cover the UK.
  • The report highlights the uncertainty about the need for transitional measures when single market DRC is switched off at the end of the transitional period. It is not clear whether EEA banks that had included UK assets in their cover pools before 31/12/20 would be able to keep such assets in the pool on the same basis after that date. The European Commission has recognised the potential need for grandfathering when the Covered Bonds legislation takes effect but of course, the same issue may arise when the UK exits the single market. (The need for grandfathering and other transitional measures is considered in our report on Brexit and FS in April 2017). This is just one very small example of the transitional issues that will arise at the end of the transitional period where single market DRC ceases to operate. Single market DRC is extensive, complex and operates across the full canon of EU FS legislation. Whatever the long-term EU/UK DRC arrangements may be, there will be an over-riding need for agreement of extensive transitional measures (including grandfathering) to deliver a smooth transition from the single market DRC to the new arrangements. Such arrangements can only be considered and agreed once the detail of the new DRC is agreed and known; firms would need to have details of both the transitional arrangements and new DRC arrangements well in advance of the single market DRC being switched off. In the case of a “no deal” scenario (either on 29/3/19 or at the end of the transition period on 31/12/20), firms must hope that there would be sufficient last minute emergency legislation on both sides (see our update for week ending 27 April). If there is an agreement covering DRC thereafter, it is to be hoped that it will provide extensive transitional arrangements and sufficient lead-time for firms. The potential difficulties of achieving this under the current negotiation timetable have been considered in various contexts (see for example another committee report).
  • The report demonstrates the policy difficulties for Her Majesty’s Government in dealing with new EU proposals whilst there is no agreement on the post-single market regime. HMG is carefully avoiding promoting third country equivalence provisions in the new legislation for fear, no doubt, that that would be seen as abandoning hope of achieving its bespoke bilateral DRC/mutual recognition deal. Such provisions, however, could be of great potential importance to UK firms if HMG is not successful. The report states (on covered bonds) – “… the Minister only “notes the Commission’s openness to develop a third country equivalence framework in the future”, but does not indicate whether the Government will push for the inclusion of an equivalence regime at this stage”. On crowdfunding, it states – “We also ask the Minister to clarify whether the Government intends to push for the inclusion of an equivalence regime under the Regulation, so that the UK—if necessary—could apply to stay part of the ESCP regime after it leaves the Single Market (if such market access cannot be secured through a bilateral trade agreement).”
  • Brexit has brought a new dimension to EU policy in relation to third country DRC in financial services. We believe that the EC is interested in developing the EU’s current third country DRC arrangements to put it in a better position to deal with the UK as a third country. The UK is, of course, a major exporter of financial services to the EU and the City of London is Europe’s most important wholesale financial centre; existing third country DRC was not established with such a third country in mind. The report highlights EU discussion of a “reviewed and improved equivalence frameworks to form the basis for any EU-UK agreement on financial services”. Development may involve –
  • Tightening up or restricting DRC which may be seen as too generous/open for dealing with the UK (see EMIR proposals for regulating CCPs)
  • Including/adding/extending new third country DRC frameworks - in proposed legislation (see above) and possibly in existing legislation where third country DRC is limited/absent. This may include DRC perceived to benefit the EU and could include other DRC which the UK is seeking and which the EU might intend to offer in the negotiations.
  • The EU may be keen to offer DRC on a voluntary basis and with conditions in the legislation that enables it to withdraw DRC in due course. Withdrawal might not only be on more objective grounds, such as divergence in EU/UK rulebooks, but also for more subjective reasons - for example, when EU infrastructure has developed to the point that it is less reliant on the City of London.
  • The Committee seems doubtful about the UK’s proposals, commenting - “There has been no substantive indication from the European Commission or the remaining Member States that they would contemplate such a radical departure from the existing case-by-case “equivalence” approach to preferential treatment of non-EEA financial services providers within the Single Market. It would fundamentally alter the regulatory ‘perimeter’ that separates those states subject to Single Market legislation from those states that are not, and likely create friction with the EU’s other trading partners that either commit to applying EU law to secure market access (such as Norway, Iceland, Ukraine) or rely on the ‘equivalence’ process (for example Canada, the US, and Japan)”. The report also suggests that if the EU were to agree substantive bilateral DRC, it would require close harmonisation rather than the flexibility in rule making sort by HMG.
  • The report demonstrates the difficulties for the UK in dealing with the EU when third country DRC is only partially harmonised at the EU level and access is therefore often dependent on the differing national regimes of member states. (In the case of the crowdfunding and covered bonds proposals, harmonisation is only partial and much will still depend on national rules – neither proposal currently includes harmonised third country frameworks.) When single market DRC is switched off, the default position for UK firms in most cases would depend, not on EU regulation, but on these differing national regimes. UK firms will face a mix of EU level DRC/requirements and differing national rules. For example, mode 1 supply - for cross border services business – will often depend on national rules; these national rules often prohibit such supply and are much more restrictive than the UK’s liberal regime for incoming firms under its “overseas persons” exclusion. Where DRC cannot be agreed (on a bespoke/bilateral basis or under the EU’s equivalence framework), then these differing national rules of member states will dictate UK access.

ECB: Speech by Ignazio Angeloni: ECB supervision at five: re-charting the route

Text of this speech, given on 2 May 2018, follows, in which Ignazio Angeloni discusses aspects of ECB's supervision, present and future. He also comments on the effect of Brexit on banking supervision. Click here to access the speech.

Points from the speech: Brexit will make cross-border banking and financial activities between the United Kingdom and the Continent 'more complex, more costly and, at least initially, more uncertain'. He refers to Brexit driven reorganisation and to the role of the ECB as the supervisor of banking operations, which are transferring from the UK/City of London.  The loss of single market mechanisms for UK/EU cooperation will make supervision more difficult. There will therefore be a greater need for cooperation and collaboration between EU and UK regulators (and this will have to be achieved by different mechanisms).

Commentary: The speech clearly promotes the EU’s position on Brexit and FS. It seems that a distinction is being drawn between supervision, where the EU advocates close cooperation, and DRC/mutual recognition of rules where the EU rejects the UK’s proposal for special bilateral arrangements.

EC: Speech by Michel Barnier

Click here for the text of Michel Barnier's speech of 30 April 2018.

Michel Barnier continues to press the EU position on the Irish border.

Commentary: This requires north/south regulatory alignment for goods but no alignment for services. This suits the EU trade position and reflects the EU negotiating guidelines. They propose that regulatory cooperation in services should only be on a voluntary basis and without special UK/EU mutual recognition arrangements (see our update for week ending 27 April). This provides pressure for maintaining single market harmonisation in goods (where the EU is a substantial net exporter to the UK) but not in financial services (where the UK is a substantial net exporter to the EU).

HoL EU Committee: Post-Brexit UK/EU relations

Click here for a transcript of the hearing attended by academics held on 18 April 2018, which includes some discussion of the financial services sector and regulation.

The discussion about financial services is of limited interest.

They also discussed the proposed Political Declaration/Withdrawal Agreement and the question of the anticipated level of detail in these documents about the future EU/UK relationship (post transition). The experts expected agreement in detail in some areas, such as transport, where there were “copy and paste” options available, but not in areas (such as financial services) where the UK was seeking ambitious novel arrangements without existing precedent.

Department for Exiting the EU: Topics for discussions on the future framework at forthcoming meetings

The UK and EU negotiating teams have jointly published a list of topics for discussions on the future framework, which includes financial services.  Click here to access the list.

This is a very short one page list of topics (which includes financial services) to be discussed at forthcoming meetings. It is headed discussions ‘on the future framework’ for the EU/UK relationship. This echoes the wording of Article 50. See above and below as to what may be agreed and included in the Withdrawal Agreement/Political Declaration about the future EU/UK relationship.

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

Transcripts of the hearings held on 19 and 25 April 2018 attended by UK financial services regulators and others and by David Davis have been published – click here and here to access these.

David Davis presented an optimistic picture of the timetable for the negotiation of the future UK/EU relationship. He said the aim was to have the substance agreed for the European Council decision/political declaration in October and for the Withdrawal Agreement. He thought this would enable the full treaty to be drafted before the start of the transition period.

Commentary: There is much to be agreed about the framework for the end-state relationship – see topics in the above list - such as governance, dispute resolution, non-compliance and structure - it is not yet clear whether there will be one treaty or several treaties (and how these might inter-relate in terms of negotiation and after they take effect). There are 40 to 50 areas of negotiation. In financial services, the UK has proposed novel principles on outcome based equivalence, divergence and mutual recognition and many of these concepts are still quite vague. The UK has yet even to articulate the scope of the DRC arrangements it is seeking (see further below). So far, the UK’s proposals have been firmly rejected by the EU. Even if the UK can get the EU to agree to its proposals on financial services within this timescale, we doubt whether specific individual DRC arrangements across all FS sectors/legislation will be agreed by that stage. Firms will need precise details of how each of the many current DRC arrangements will be replaced or phased out. The negotiation of transitional measures, grandfathering, etc. can only take place once the detailed DRC arrangements are known. Of course, if the UK were to accept at an early stage that DRC would be limited to the EU’s existing third country framework, then the position could be settled at an earlier stage. In his evidence, Andrew Bailey discussed some of the issues (covered in his later speech on 24th April (see our Brexit update for the week ending 27th April). The following topics covered by UK regulators were of interest –

  • The suggestion that the UK would not seek full DRC; for example - given the current ring-fencing policy, the UK would not seek/offer DRC that enabled retail banking to be offered without local authorisation. (The single passport DRC enables retail banking to be provided without local authorisation either on a services or branch basis).
  • The work on domesticating retained EU law was in hand (see our update for week ending 27th April re powers to be given to the UK regulators under the European Union (Withdrawal) Bill). However, he described the public/parliamentary work on the bill as the tip of the iceberg compared to the much larger domestication project itself.
  • Reference was made to three levels of response to the problems of servicing of OTC derivative contracts and outstanding insurance policies (in the event of a no deal scenario). First, the most desirable solution was for coordinated action by the EU and UK to provide a ‘fix’ via legislation (similar to the fix for contracts included in the Euro legislation). Failing this, there could be unilateral action of the kind that HMG has announced for temporary permissions – but a Memorandum of Understanding would be needed between UK and EU/national regulators for ongoing supervision of firms. Finally, there was the possibility of firms taking action to resolve the problem themselves, but this was very difficult. There are about 38 million customers within EU-27 countries with insurance policies with UK insurers. It was not plausible that one could safely transfer (by Part VII transfers) all these books of business - even by 31/12/20.
  • PRA had received 29 applications from EU-27 banks and insurers for authorisation and expected a further 120. This was demanding for PRA but doable.

Other publications from the RegZone Brexit news feed

HoL EU Committee: Dispute resolution and enforcement after Brexit

The report calls on the Government to propose an effective system for dispute resolution and enforcement with regard to the proposed Withdrawal Agreement and the future UK-EU relationship. It sets out proposed options, but concludes "there is no ‘one-size-fits-all’ solution to dispute resolution after Brexit. … None of them provides a complete solution”. Click here to access the report.

HoL: European Union (Withdrawal) Bill

Transcripts of the fourth and fifth report stage of the Bill have been published and are available here. Amendments discussed covered clauses 9-11 of the Bill. A sixth day of report stage is scheduled for 8 May 2018.