Brexit update for financial services firms - week ending 18 May 2018


The UK government (HMG) announced that it will provide further details of its proposals (see below) for EU/UK mutual recognition in financial services (as part a broader white paper to be published next month). Public statements to date have been high level and lacked any detail. UK parliamentary committees continue to express concern about the "disconnect” between HMG's proposals and the position of the EU (see below).


The latest committee to report expects that, despite opposition from the UK, Sweden and the US, some form of the new “location policy” powers will be maintained in the final EMIR/ECB legislation (proposed by the EC last year). “The main unresolved issue, therefore, is the exact requirements that must be fulfilled before the location policy could be invoked against British (and other non-EU) CCPs.”


The EU/UK negotiation topics for this week (to 25th May) include alternating sessions on outstanding issues under the Withdrawal Agreement and on the framework for the future relationship (which is due to be recorded in a political declaration annexed to the Withdrawal Agreement).


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 agreed framework for the future relationship is due to be recorded in a political declaration annexed to the Withdrawal Agreement. 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 than the EU’s current regime for third country mutual recognition/DRC. The EU position is that market access will be granted under mode 3/via local establishment (and not for services business) and this will be subject to host state regulation. This will offer the UK no more than is available to other third countries - regulatory cooperation on a voluntary basis and DRC limited to (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.


David Davis announces white paper to be published in June


David Davis has confirmed that HMG will publish a white paper on its proposals for the future UK/EU relationship. This will cover a range of areas including financial services and regulatory divergence. It will be published in June ahead of the European Council meeting. The previous white paper was published in February 2017. The section on financial services in that document said nothing of substance about the UK’s proposals to replace single market DRC/mutual recognition; speeches since then have referred to the mutual recognition proposals described above but these have been brief and lacked any detail. UK regulators have had to speculate about the extent of DRC which the UK may be seeking.


EC: Slide on the EU/UK possible framework for the future partnership


This slide was presented by Michel Barnier to the General Affairs Council (Article 50) on 14 May 2018 and to the European Parliament Brexit Steering Group on 15 May 2018.


The power point highlights the EU's traditional approach to its relationship with the UK after the UK leaves the single market. It shows a block for the bilateral relationship, which has a governance framework and then divides the relationship into four areas - one of these is a CETA style free trade agreement. The bilateral FTA is divided into 4 areas including market access and regulatory cooperation.


Beneath and underpinning the bilateral relationship but clearly outside the black line perimeter, the slide has a further block “EU autonomous measures e.g. 3rd country equivalences in financial services, adequacy decisions on data protection”. According to this approach, market access is looked at primarily in FTA/WTO/GATS terms as we explained (in chapter 2 of our April 2017 report) and mutual recognition/deference/DRC on the EU side is only available via the third country framework. This framework is “open access” and is open for all third countries to seek to negotiate comparable arrangements if they meet the necessary standards, in accordance with the multi-lateral Most Favoured Nation Treatment (MFN) obligations under GATS.


In very crude terms, market access is about ensuring you can do business at all (under local regulation/national treatment and subject to the prudential carve out), whilst deference/DRC enables firms to conduct business in a more efficient mode (for example without having to establish a local subsidiary), with less local regulation and thus reduced “friction”.


The UK proposals appear to envisage a very different relationship (to that envisaged by the EU) with extensive bilateral EU/UK deference/mutual recognition/DRC providing broader and deeper market access and friction reduction. This would presumably operate under the GATS exemption for multi-sectoral free trade agreements which allows more favourable treatment to be agreed without offering 'open access'/the same benefits to other countries who meet the same criteria under MFN. A party to an FTA may, however, have given individual MFN commitments in other FTAs, which could be triggered as between the parties to those FTAs but see our article here about the extent of such commitments applicable to the EU/UK.


ECB: Supervision Newsletter (May 2018)


The newsletter includes an article that looks at the Brexit transition period and how it affects what ECB expects of banks. Click here to access the article.


In its May newsletter, the ECB published an article on “Brexit and the potential impact of the transition period”. The ECB refers to the EC's notices of 8 February 2018, which requires banks to have contingency plans for a no deal/no transition scenario. Applications for authorisation in the Euro-area are required by Q2 2018 at the latest. The ECB says "banks should not use a possible transition period to delay planning, but rather to implement their Brexit plans and adapt their operations to the new framework that would result from the UK becoming a third country”. There is no sign (yet) of the EU assisting UK firms by following the UK which has announced a temporary permission regime to mitigate no deal risks and assist incoming EEA firms in avoiding unnecessary implementation of their contingency plans. The UK is calling for EU action to mitigate no deal risks and has proposed joint action to protect on-going derivative and insurance contracts. Again the tone from the ECB is that these risks must be addressed by firms without any legislative assistance from the EU (although it is hoped that the UK will continue to press the EU for new EU/UK cooperation - see our update for week ending 27 April 2018). The article also refers to the impact of Brexit on the prudential treatment of third party exposures. ECB is providing certain flexibility within its supervisory expectations; during a so called “build-up period”, banks may be allowed more time to meet certain supervisory expectations - “local risk management capabilities and governance structures, and to move to an adequate and balanced business organisation within the euro area”. The article concludes, however, “The arrangements should in no case endanger robust internal governance and sound and effective risk management, or mean that capabilities and controls are running behind the business”.


EIOPA: Opinion on the solvency position of insurers in light of the withdrawal of the UK and the EU


EIOPA’s Opinion calls upon national supervisory authorities to ensure that all risks to the solvency position of insurers arising from the UK becoming a third country are properly addressed. It sets out 14 areas where the determination of the solvency position of insurers will change, including the risk-mitigating impact of derivatives, the recognition of ratings from UK rating agencies and the regulatory treatment of credit risk exposures situated in the UK. Click here to access the Opinion.


This follows a series of similar publications by the EC, ESAs and the ECB on the impact of Brexit on firms. EIOPA sets the scene for this opinion on the basis that EU-27 insurers (to whom it is addressed) cannot yet rely upon a transition period and must consider, in that context, the effects of the UK becoming a third country and ceasing to be covered by Solvency II legislation (with effect from on 30/3/19). The opinion looks at the impact on EU-27 insurers – not in connection with their UK business under the single passport – but in relation to their solvency position under Solvency II. It looks at 14 examples of negative impacts on the insurers’ solvency calculations from less favourable treatment of UK assets, liabilities and exposures (including the use of UK credit rating agencies) following Brexit. EIOPA says that the objective of the opinion is ‘to call upon national supervisory authorities to ensure that these risks are properly identified, measured, monitored, managed and reported’.


The areas covered include –

  • risk mitigation via derivatives in the SCR calculation as a result of loss of MiFID passport of UK banks/investment firms (where pre-Brexit impacts are identified);
  • use of ratings of UK ratings agencies in default, market, and spread risk calculations in the standard SCR calculation – such ratings will be impacted by the deregistration of UK ratings agencies at Brexit;
  • impact on technical provisions and recoverable amount due to inability of UK reinsurers to service reinsurance held by EU-27 reinsurers after Brexit;
  • impact on matching adjustment and volatility adjustment to the risk-free interest rate – UK government bond spread and the use of ratings by UK rating agencies which will cease to be ECAIs;
  • reliance on letters of credit or guarantees issued by UK credit institutions which may fall out of tier 2 or cease to qualify at all after Brexit;
  • SCR (risk charge for spread risk and market risk) for exposures to UK central government, UK central bank and 3 UK regional governments may increase;
  • Less favourable treatment of exposures to UK insurers and reinsurers under SCR for market risk concentrations and counterparty default risk and capital requirements;
  • Less favourable treatment of risk mitigating effect of reinsurance held with UK reinsurers;
  • Less favourable recognition of risk transfer of UK SPVs;
  • Change in group supervision for EU-27 insurers with UK parents and subsidiaries; and
  • Danger that group internal models will no longer be available for EU-27 insurers with UK parents and they would have to use the standard formula.


HoC European Scrutiny Committee: 27th Report of Session 2017-19


Sections 4 and 5 of the report consider proposals with regard to EU supervision of UK-based CCPs in the light of Brexit and the law applicable to assignment of claims in capital markets and detail the latest ministerial response to the Committee’s specific concerns. These matters are still under scrutiny by the Committee. Click here to access the report.


The Committee says that that there has been no indication from the EU that it is willing to consider the UK’s proposals for mutual recognition in financial services. They quote Michel Barnier's speech of 26 April 2018: “The EU cannot accept mutual market access without the common safeguards that underpin it. This is needed to maintain financial stability, investor protection, market integrity and a level playing field. This objective would not be reached if financial institutions could operate in the EU, or serve clients in the EU, based on an authorisation by the supervisors of a third country, subject to the rules, supervision and enforcement mechanisms of this third country alone”. The Committee highlights that Barnier has “insisted the UK could seek ‘equivalence’ decisions under EU financial services legislation—including EMIR—during the post-Brexit transitional period to take effect immediately afterwards” and repeats his comment that “The 21-month transition period that we have proposed could be useful to prepare for the new relationship. That transition will also allow the EU to consider the adoption of equivalence decisions.”


On the EMIR/ECB proposals the committee says – “As the Bank of England and its Financial Policy Committee have repeatedly emphasised, the UK’s withdrawal from the EU poses problems for derivatives contracts involving an EU counterparty cleared using a UK-based CCP. Brexit means that EMIR’s provisions on restricting non-EU CCPs from performing a clearing function in the EU will automatically apply to British clearing houses and the status of existing clearing contracts still outstanding becomes uncertain. In the immediate aftermath of 29 March 2019, those effects will be obviated by the proposed post-Brexit transitional period. From March 2019 until December 2020, the UK would stay bound by EU law (including EMIR) and effectively remain in the Single Market. However, the transitional arrangement only postpones the crunch moment of the UK becoming a ‘third country’. At that point, the scope of the 'equivalence’ regime under EMIR (as affected by the recent proposals) is therefore likely to be crucial. Equivalence is the only legal mechanism currently available for British CCPs to continue servicing EU-based counterparties in the derivatives market after the UK leaves the Single Market. The Commission and European Central Bank proposal would add additional hurdles for British CCPs to obtain recognition from ESMA under the equivalence regime, and in extreme cases effectively force relocation of the company to the EU if it wants to continue servicing EU counterparties. We have taken note of the Minister’s comments on the deliberations on this aspect of the proposals within the Council. It appears likely that some form of the new ‘location policy’ powers for the European Commission and the European Central Bank will be maintained in the final legislation despite opposition from the UK, Sweden and the US. The main unresolved issue, therefore, is the exact requirements that must be fulfilled before the location policy could be invoked against British (and other non-EU) CCPs.'”


Other publications from the RegZone Brexit news feed


HoL: European Union (Withdrawal) Bill


Click here for a link to Hansard record of the third reading which took place on 16 May 2018. The link also includes a document that sets out amendments made by HoL. HoC will consider the amendments. Earlier in the week, prior to the third reading, a HoL library briefing, which set out a summary of amendments made to the Bill at report stage, and a debate pack were published– click here to access the briefing and here to access the debate pack.


EC: Speech by Michel Barnier


Click here to access the text of Michel Barnier’s speech given on 14 May 2018.


FCA: Speech by Andrew Bailey: The FCA’s Business Plan and priorities


In this speech, given on 16 May 2018, Andrew Bailey considers aspects of Brexit in relation to the insurance sector. Click here to access the speech.


CMA: Speech by Michael Grenfell: A view from the CMA: Brexit and beyond


Michael Grenfell’s speech of 16 May 2018 discusses aspects of CMA’s work in relation to Brexit, including the scope for UK divergence from EU law precedent and wider implications, such as state aid. Click here to access the speech.


HoC European Scrutiny Committee: Dispute resolution and enforcement in the draft Withdrawal Agreement


The Committee has launched a short inquiry on how the relevant provisions of the draft Agreement relate to each other (both during the proposed transition/implementing period and afterwards) and to the rest of the withdrawal agreement (in particular the financial settlement), their practical effect, and their conformity with international and EU norms. Written submissions are invited, which must be received by 8 June 2018.




CMS RegZone publishes weekly updates 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).