The week in outline:

Her Majesty’s Government (HMG) published its first batch of technical notices on a ‘no deal’ Brexit scenario. The note on financial services (FS) (see Document 2 below) confirmed the legislative action being taken under the European Union (Withdrawal) Act 2018 (EUWA) (as explained in previous updates) and included details of the transitional relief which HMG is putting in place. In addition to the statutory instruments (SIs) (under section 8 EUWA) listed in our update for the week ending 10th August, the note confirmed that 6 more SIs will be published (see the areas listed below under Document 2). The note makes clear (as explained in previous updates) that transitional relief is being provided by the UK on a unilateral basis and without any matching commitment from the EU (which so far has refused to provide similar transitional relief for UK firms). The UK measures can only provide relief under UK law, largely to assist EU-27/EEA firms; so UK firms are currently at a severe disadvantage. Meanwhile, the ECB repeated its opposition to ‘back-branching’, i.e. post-Brexit structures where euro-based credit institutions use UK branches for EU business.

In its White Paper of 12 July 2018 on the future EU/UK relationship (the final agreement – FA) HMG adopted a bifurcated approach as between goods and services. For goods, the UK would effectively operate within the single market structure; it would commit to follow current and future EU rules for most goods/agri-products regulation and single market mutual recognition/DRC[1] would continue to prevent friction and border controls. If the EU were eventually to agree to this concept (despite the doubts it has expressed so far), the FA might retain much of the single market (and customs) DRC for goods, at least into the medium term. In contrast, HMG has abandoned any hope of achieving a similar quasi-single market outcome for services/FS under the FA.

This week HMG published a presentation on its proposals for financial services under the FA (see Document 1 below). There were also reports of a speech on this topic by Valdis Dombrovskis (the European Commissioner responsible for FS).[2] The UK has moved a long way from its original proposals for FS and now accepts the EU’s initial position that the UK would be treated by the EU as a third country without preferential access; there now appears to be considerable common ground between the UK and EU in this area:

  • The UK will operate entirely outside the EEA Single Market and all single market DRC/reciprocity (as between the UK and the EU-27/EEA) will be lost/turned off.

  • The UK will not be granted any preferential access to EU-27 markets.

  • The UK will be treated by the EU as a third country (like the US, Japan etc.).

  • EU FS legislation has a large number of provisions which harmonise various aspects of FS regulation relating to third counties[3] but much regulation of cross-border activity between Member States and third countries (including perimeter rules) is un-harmonised and differs from one state to another according to domestic law/regulation. EU FS harmonisation of third country provisions deal with a variety of issues from the capital treatment of EU firms in relation to their third country exposures to the treatment of third country firms, some of which provide limited DRC/market access. These provisions vary from sub-sector to sub-sector and from one directive/regulation to another. Some harmonisation is applicable to all third countries without differentiation; some DRC/market access is only available to firms from a country which the EU has found to have ‘equivalent’ home regulation and this evaluation also dictates the basis on which the EU grants ‘equivalence’/DRC/market access.

  • The EU will only grant any such equivalence/access to the UK under its third county legislation, acting on an ‘autonomous basis’. This means that such access will not be agreed and protected at a treaty level. There will be no on-going treaty rights to such access (or remedies if the access is withdrawn), at a state to state level or for firms to rely upon.

  • DRC/market access for UK firms will be limited to those provisions of EU FS legislation under which market access can be granted to third countries. This suggests that market access/DRC will be no greater than, say Switzerland, which has taken advantage of almost all EU third country provisions and has often gained the highest equivalence status.[4] Would the EU offer the UK the same terms for branches of non-life insurers as Switzerland enjoys under the Swiss-EU insurance agreement?[5] This agreement is a rare example of a bilateral treaty with the EU which extends single market DRC in FS to a third country and where the EU grants access rights on a treaty, and not on an ‘autonomous’, basis.

  • HMG is concerned about the timetable for obtaining equivalence decisions from the EU and is pressing for the UK to have a full set of EU third country equivalence decisions in operation by the end of the transitional period/when the UK leaves the Single Market.

  • As the EU will act autonomously[6] when dealing with the UK in this area, it will follow its own internal processes/EU legislation (rather than any UK/EU treaty) when determining the basis for granting equivalence/DRC/access, when reviewing such decisions and in relation to any withdrawal or limitation of such rights. It will also be free in principle to change EU legislative provisions e.g. to make the basis of equivalence more onerous or to limit, change or withdraw the available DRC/access. The changing nature of such available DRC/access can be seen from the current review by the EU and the proposed changes to the regulation of third country CCPs under EMIR. It seems quite possible that the EU has in mind two possibilities. First, the EU is concerned about the UK watering down its rulebook; hence the current plans to tighten the EU’s equivalence assessment and make it more granular (see the recent comments by Valdis Dombrovskis). Second, the EU may find mutual UK/EU access attractive in the short run (particularly for wholesale/large corporate business) but might see the possibility of reducing access when the euro-area has developed its internal market infrastructure/capacity.

FS equivalence/DRC/access are normally only granted by the EU if the third country grants similar access to EU firms. Often, therefore, there are bilateral arrangements between the EU and third countries relating to these arrangements. These are found in FTAs, such as the most recent EU FTA with Japan, and in memoranda of understanding (MOUs). The former are at a state to state level; the latter are at a regulator to regulator level. These often have mechanisms to facilitate regulatory cooperation and potential DRC. They may also address cooperation and exchange of information for supervisory purposes. They may have structures, such as joint committees, for discussion/cooperation and, in the case of the EU/Japan agreement, even for voluntary mediation. However, these all fall under the description of ‘voluntary cooperation’; they facilitate cooperation and provide a framework for mutual market access but do not fetter, to any significant extent, the autonomous decision making described above. In the case of MOUs, they do not involve any international legal obligations at all.

In conclusion and subject to the points below, the UK would abandon entirely the notion of any substantive treaty basis (even at a state to state level) for DRC/access to EU markets in FS. This is a dramatic climb down from HMG’s original proposals for FS as it essentially accepts the EU’s hard-line that it would not grant the UK, once it left the Single Market, any substantive preferential or treaty-based access rights in financial services.

It is not yet clear whether the UK has any real hope or realistic expectation of securing any substantive treaty rights in FS. It says (in Document 1 below that ‘reliance on informal MoUs would inevitably leave gaps in the oversight of micro and macroprudential risk.’ The FA could provide a bilateral framework/structure for supervisory and regulatory cooperation (covering most of the areas listed for bilateral treatment in Document 1 below); this could involve treaty-based obligations (unlike an MOU) on procedure, process and joint committees etc. but without prejudicing the fundamental notion of ‘voluntary cooperation’, and thus without giving the UK any preferential access or substantive treaty basis for access granted under EU equivalence.

The EU is reviewing its third country FS legislation in the light of Brexit and is clearly intending to strengthen its position. The EU has not, however, rejected the idea of extending the scope of coverage of EU harmonisation of third country treatment; Valdis Dombrovskis is reported to be open to this idea. This could include new access mechanisms in areas that are not currently harmonised – for example a MiFIR style registration mechanism for banks from equivalent third countries to offer wholesale/corporate banking activities on a services basis. However, this would still fall a long way short of single market DRC/passporting. It seems likely that any such new access mechanisms would not be offered to the UK on a preferential basis, but would be open to any equivalent third country; the EU seems to accept the possibility of ‘enhanced equivalence’, whilst rejecting the idea that the UK could be granted ‘super-equivalence’.

Department for Exiting the European Union: Framework for the UK-EU Partnership: Financial Services (Document 1)

The Department for Exiting the EU has now published this presentation (dated 25 July 2018). The slides can be accessed here.

“Once the UK leaves the EU, we will maintain strong and appropriate regulation of our sector, given the exposure of our economy to the fiscal risk it represents.

The UK hosts the world’s most significant financial centre, with markets and products that are often very different from what is found elsewhere in the EU.

These differences mean that ruletaking – in the sense of an open ended commitment to adopt rules without having influenced their formation – will simply not work for this sector

It is important to find a mutually acceptable solution that encourages us to work together constructively, protecting financial stability, and respecting the principle of autonomous decision-making”

Equivalence at the outset

  • UK and EU start with the same rulebook and entwined supervision
  • Initial reciprocal recognition agreed for all third country regimes

Expanded scope of activities permitted cross-border

  • Currently not sufficient for the breadth of interconnectedness between our markets
  • Prioritising the most mutually beneficial activities for the economy, ensuring no unintended consequences or arbitrage

Common principles

  • Agree common principles for the governance of our relationship
  • Include commitments to global norms, and that equivalence is an evidence-based judgement on the equivalence of outcomes

Regulatory & supervisory cooperation

  • Formalised regulatory and supervisory cooperation. Encourages:
    • Regulatory coherence
    • Effective market surveillance
    • Effective cooperation (including in crisis)

Structure withdrawal

  • Consultation and discussion before loss of access to either market
  • Ability to try and find solutions
  • Clear timelines and notice-periods
  • Time for businesses and supervisors to adapt to change on either side
  • Address acquired rights, safeguarding existing obligations to customers if equivalence is withdrawn

Bilateral agreement would include commitments and processes – ensuring transparency, stability and promoting cooperation

Autonomous: Access to market

“Each side’s legislative process and rulemaking would be autonomous, where each of us are answerable to our respective political and judicial frameworks

The criteria for determining if a foreign jurisdiction has equivalent standards and supervision for a given sector would be autonomous

The decision to grant or withdraw equivalence would be an autonomous judgement

There would be no recourse to the EU/UK Dispute Resolution Mechanism for autonomous matters – only for commitments included in the bilateral, Treaty-based agreement”

…with bilateral Treaty-based commitments to provide certainty and stability, not provided for under existing EU equivalence regimes

“Managing the scale of financial services activity occurring in both directions as part of a productive and efficient European market will inevitably demand bilateral engagement. A structure is needed to provide greater clarity about how we will work together.

There are gaps in coverage of the existing third country regimes. For example, there is no third country equivalence regime to support the rights of around 7,000 EEA domiciled funds to market to UK retail customers, who operate under the passport today.

Supervisory cooperation should reflect the level of integration between the UK and EU and provide a clear legal framework which covers micro- and macro- prudential supervision and crisis management. Reliance on informal MoUs would inevitably leave gaps in the oversight of micro and macroprudential risk, while uncoordinated decision-making could lead to conflicting or unenforceable decisions.

Cross-sectoral structured consultation and dialogue on the evolution of rules is essential if we are to maintain compatible regulation across the very broad spectrum of activity taking place. This is not provided for under existing equivalence frameworks.”

“The impossibility of acting unilaterally in relation to major firms and jurisdictions is already well-evidenced – as demonstrated by the EU and US taking decisions together in practice about access to each other’s markets for clearing services, delivered through coordinated announcements.”

“Clarifying and formalising the process of managing cross-border regulation and market access will not limit either Party’s judgement or flexibility, but rather will create greater confidence in and predictability of the process for affected firms and supervisors.”

“We are not proposing an expansion of the third country equivalence regime to all the areas covered by the passport. Instead, we propose that the scope of the relationship should be defined appropriately in relation to mutually economically beneficial global market activity.”

“Guarantees around cooperation, oversight and onsite inspections – which may be difficult for the EU to impose on all third countries without affecting wider EU/third country relationships and “moving the goalposts” for everyone”

HMT: No-Deal planning: Banking, Insurance and other Financial Services/Brexit planning and Analysis (Document 2)

The technical note for banking, insurance and other financial services has been published, which sets out implications for individuals and business customers of UK-based providers, UK-based customers of EEA firms operating in the UK and EEA customers (including UK citizens living abroad) of UK firms operating in the EEA; for financial services firms and funds and FMI. Separately, Philip Hammond has published his response to the TSC request for information on the Government's no-deal Brexit planning and analysis. The guidance can be accessed here and the letter can be accessed here.

In the guidance the following commitments have been made:

“The government will also be bringing forward legislation to deliver transitional arrangements for:

  • Central Securities Depositories
  • Credit Rating Agencies
  • Trade Repositories
  • Data Reporting Service Providers
  • Systems currently under the Settlement Finality Directive
  • Depositaries for authorised funds.”

ECB: Euromoney interview with Ignazio Angeloni (Document 3)

ECB has now published the text of an interview with Ignazio Angeloni. Topics include: Brexit and the SSM and governance issues in the banking sector. The interview can be accessed here.

“For the incoming banks, i.e. those relocating from the United Kingdom to the euro area, the key thing for us is to ensure that they put in place all the structures that are needed to conduct sound banking here. Establishing a legal entity on the continent cannot merely be a formality. They have to have a real structure here; have full control over and responsibility for the business they do; and have the necessary prudential safeguards, as well as high-quality staff, internal controls, risk management, and so on. That’s very important for us, and most of the incoming banks have now understood this need and incorporated it in their plans.

The story is different for the outgoing banks, i.e. euro area banks that access the UK market. Often, they work through branches, some of which are very large. Establishment or restructuring plans have to be authorised by the Prudential Regulation Authority. Our main concern here is “back-branching”, i.e. using a remote branch across the Channel as a springboard to do business in the EU, thus evading supervisory control. We want banks to use branches in the United Kingdom to conduct business in the United Kingdom.”

ECB: The review of prudential treatment of investment firms (Document 4)

ECB has published an Opinion, including proposed changes to the EC draft Regulation.  Specific areas commented on include: classification of investment firms; authorisation and provision of services by third country firms. The opinion can be accessed here.

The opinion comments on the Commission’s proposal to strengthen and further harmonise the MiFID II legislation applicable to branches of 3rd country investment firms. It is suggesting further steps in the development of the 3rd country/equivalence regimes (for further commentary see our update of the week ending 22 June 2018).

Other publications from the RegZone Brexit news feed

Department for Exiting the EU: Article 50 talks

Talks will be held in Brussels on 21-22 August 2018. The agenda can be accessed here.

Department for Exiting the EU: Framework for the UK-EU partnership: open and fair competition

The Department for Exiting the EU has now published this presentation (dated 25 July 2018). The slides can be accessed here.

EC: Statement by Michel Barnier

Michel Barnier's statement following his 21 August 2018 meeting with Dominic Raab, which notes that the EU and UK "agreed that the EU and the UK will negotiate continuously from now on", follows. The full statement can be accessed here.

HMT: Draft Capital Requirements (Amendment) (EU Exit) Regulations 2018

This SI will make amendments to retained EU law, and existing UK law, related to capital requirements to ensure that it continues 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 draft can be accessed here.

Department for Exiting the EU: No-deal planning

The Department for Exiting the EU and other Government departments have published the first batch of technical notes in relation to no-deal planning. The text of Dominic Raab's introductory speech and a general guidance note follow. The guidance can be accessed here, the speech can be accessed here.

DBEIS: No-deal planning – state aid

The technical note for state aid has been published, which states that, in the case of no-deal, CMA will take over state aid regulation within the UK immediately. The new regime would apply to all businesses with operations in the UK. The note can be accessed here.

European Parliament: Covered bonds

The European Parliament has published a draft report on the proposal for a covered bond regulation (that would amend CRR). The draft can be accessed here.

HoC: Brexit and financial services

An updated version of this HoC Library briefing (including a synopsis of the 23 August 2018 financial services technical note) follows. The report can be accessed here.