The EBA has issued an Opinion which sets out a number of recommendations concerning the period prior to the UK’s departure from the EU. While primarily focused on credit institutions, the Opinion is also relevant to other types of financial services providers, including investment firms (see our related briefing here).
The Opinion seeks to provide guidance on supervisory expectations and to address the regulatory and supervisory arbitrage risks that arise in the context of Brexit. It follows on from four earlier Brexit-related Opinions published by ESMA and repeats many of the same messages, in particular regarding the authorisation process and outsourcing arrangements. Specifically, national competent authorities (“NCAs”):
- must apply existing authorisation, registration and/or admission standards without any derogations or exemptions and should not rely on mere confirmations or previous or existing authorisation decisions granted by another NCA; and
- should not allow institutions to outsource activities to such an extent that they operate as “empty shell” companies and should ensure that all institutions have the substance to identify and manage the risk they generate.
However, the Opinion also contains a number of specific recommendations relevant to credit institutions addressing, in particular, authorisations, internal models, back-to-back and intragroup operations, and resolution and deposit guarantee schemes. The Opinion is accompanied by a Report which sets out the EBA’s supporting analysis (“Report”).
Each application for authorisation as a credit institution must be supported by a substantial amount of information evidencing the applicant’s capacity to comply with the authorisation requirements. NCAs should have regard to the draft regulatory and implementing technical standards submitted by the EBA to the European Commission in July 2017, regarding the type and format of information to be presented in applications for credit institutions, notwithstanding that these have not yet been adopted. In addition, the annex to the Report sets out a list of key questions to which an NCA should have regard when assessing authorisation applications.
When evaluating the completeness of an application, the relevant NCA should take into account information that is already in its possession, as well as information that the NCA is able to obtain from another NCA. It should also take into account information that need not be provided because it relates to activities that the applicant does not propose to carry out.
According to the Report, any UK credit institution relocating to the EU that is seeking to acquire a licence, or change an existing license, should make sure that it submits its completed application file before the end of March 2018 so that it can obtain authorisation before the UK leaves the EU.
While permission to use internal models which is based on existing decisions will continue to apply in the EU27 Member States after Brexit, some institutions will need to apply for permissions to use, change or extend existing internal models, while others will need to apply for new permissions. When assessing applications for the use of internal models, or changes or extensions to existing models, NCAs should have regard, where relevant, to previous permissions. This is particularly the case where the relevant permissions were granted on the basis of the regime set out in the Capital Requirements Regulation 575/2013 and the Capital Requirements Directive 2013/36, for the same exposures and portfolios. The Report contains detailed provisions on different scenarios that could arise in the context of Brexit in relation to internal models.
Back-to-back and Intragroup Operations
An EU entity that, post-Brexit, uses back-to-back transactions or intragroup transactions to transfer a part of its risk to a non-EU/EEA entity must:
- have appropriate governance and risk management arrangements to be able to take on identification and management of the risks that it has generated;
- be able to rapidly deploy scaled-up risk management arrangements in the event of a crisis; and
- ensure that the market activity hedged via back-to-back transactions or the credit exposure re-financed or secured via intragroup transactions is not large enough to threaten the continuity of the EU27 entity in the event of the failure of the non-EU/EEA entity. This means that the EU27 entity must have sufficient capital above the Pillar 1 minimum requirement, as well as in-house risk management and operational capabilities, to be able to cover for the material risks stemming from the unhedged portfolio, manage it actively, and, if needed, unwind the positions in an orderly way.
In addition, the relevant NCA must put in place enhanced supervisory cooperation with the supervisor of the relevant non-EU/EEA entity.
Resolution and deposit guarantee schemes
The Opinion lists a number of actions that resolution authorities should take with respect to resolution planning. It also states that institutions and authorities must assess their stock and issuance plans for instruments used to meet the minimum requirements for own funds and eligible liabilities (“MREL”) in the light of Brexit, and in particular their reliance on instruments under English law both as regards newly issued and existing instruments.
In so far as newly issued instruments are concerned:
- resolution authorities must assess the approach to be taken by institutions to ensure that such instruments can be subject to the write-down and conversion powers of EU resolution authorities; and
- institutions that wish to issue new MREL-eligible instruments under English law should at a minimum include clauses in the relevant contracts recognising the eligibility of those instruments to be subject to the write-down and conversion powers of EU resolution authorities. Alternatively, institutions may issue the instruments under EU27 law given that this would entail enhanced legal certainty.
Regarding institutions’ existing stock of MREL-eligible liabilities, resolution authorities should:
- assess the extent to which that stock is governed by English law;
- engage with the relevant institution to replace or renegotiate these contracts to include bail-in recognition clauses where a material proportion of an institution’s existing MREL-eligible liabilities are issued under English law and the relevant resolution authority cannot be satisfied that its resolution powers would be given effect in respect of English law contracts; and
- aim to ensure that non-MREL liabilities issued under English law that might be subject to bail-in as part of the resolution action for an institution can also be credibly written down or converted through the inclusion of recognition clauses, unless the resolution authority is otherwise satisfied that its powers would be given effect in respect of English law contracts.
Deposit Guarantee Schemes should be prepared to ensure that EU27 depositors maintain their protection after Brexit, by assessing, where relevant, the equivalence of the UK’s deposit protection regime at the date of Brexit, and should consider putting in place cooperation arrangements with the UK DGS after that date.