Brexit update for financial services firms - week ending 25 May 2018


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.


Department for Exiting the EU: Framework for the UK-EU partnership – Future Economic Partnership


The Department for Exiting the EU has released the slides on the UK's proposal for the future economic partnership between the EU and the UK. These slides come as part of a series of presentations which so far have covered Security, Data Protection and Science, Research and Innovation. This article will focus on the aspects relating to services and financial services in particular. The full set of slides can be accessed here.


This presentation appears to put previous UK statements about HMG’s proposals for a new EU/UK relationship into the form of a Power Point. It repeats much of the high-level statements and phraseology such as ‘a new, deep and special partnership with the EU’ and ‘a broad, deep and balanced relationship’. It envisages two core parts - an economic partnership and a security partnership. These would sit along cross-cutting areas such as data protection.


The presentation says virtually nothing about HMG’s proposals for financial services (see above). It says that the UK wants mutual market access based on equivalent outcomes and cooperation in order to benefit both businesses and consumers in the UK and the EU. Even the minimalist statements in the speeches of the Prime Minister and the Chancellor say more than this. The phrase ‘mutual market access based on equivalent outcomes’ is odd, and avoids any reference to the critical issue of mutual recognition/deference/DRC measures. However, there is a general reference, under the heading ‘regulatory cooperation’, to ‘methods to demonstrate that our rules are substantially similar – identical or equivalent in outcomes’. This implies that alignment would be checked to ensure ongoing DRC should remain in place.


Regarding the structure of the agreement the presentation reemphasises that the UK Government intends to leave both the single market and the customs union and that rights and obligations will need to be held in a new and different balance.


The presentation suggests that the UK will transpose the EU state aid rules and principles in full through the EU Withdrawal Bill and that HMG will consider keeping in-step with the EU's state aid rules and competition regime thereafter – a commitment that would go beyond standard FTAs and would only be given for commensurate levels of market access.


Further Analysis on Mutual Recognition/deference/DRC


Whilst appearing before the House of Commons Exiting the European Union Committee (see our update for the week ending 4 May 2018), Andrew Bailey was asked about the HMG’s proposals for financial services (see above) and the extent of mutual recognition/DRC that the UK was offering/seeking. There appears to be no public statement from HMG which addresses this point. Philip Hammond’s speech on 7th March seemed to imply that the UK might be seeking full single market DRC at the outset - or perhaps, more realistically, as much DRC as it can get - (with the possibility that, at a later stage, DRC might reduce if rulebooks diverged). Andrew Bailey did not know what HMG proposed but doubted that it would offer or seek full single market DRC; he cited the example of retail banking. Given the UK’s domestic ring-fencing regime, he did not think it would make any sense to maintain current DRC under the single passport and enable EEA banks to conduct substantial retail deposit taking in the UK via non-ring-fenced entities.


This provides an interesting practical example of the rather simplistic debate about mutual recognition/DRC and divergence (see further analysis in our report of the week ending 4 May 2018) and we now unpick this example a little further. The single passport enables EEA banks to access the UK market on a cross-border services basis (GATS modes 1 and 2) or via a local branch (under GATS mode 3). Post-crisis the UK introduced a major reform of UK banking via the new ring-fencing regime. EU legislation in this area came later and was much less prescriptive; there is no EU requirement for ring-fencing.


HMG makes the point that at the outset the UK will be fully compliant with all EU requirements; discussion then focuses on the possibility that the UK may subsequently decide either to move away from existing EU requirements or might fail to follow new EU legislation after 31/12/20. The question of difference is, however, more complex.


Intra-member state rulebook divergence/difference: Current single market DRC is set out in EU legislation; it provides for harmonisation (minimum or maximum) and related DRC (such as the single passport). The scope of EU level harmonisation/DRC is broad but not universal. In many harmonised areas, the harmonisation is on a ‘minimum’ basis, permitting differing national rules, like ring-fencing. So although there is no divergence between the EU and UK requirements, there is currently a significant degree of difference between, for example, UK rules and those of any other member state.


Higher or more prescriptive UK standards: There has been speculation about the UK seeking to move away from EU standards when it leaves the single market and concerns, on the EU side, that this might involve less stringent regulation which would put EU based firms at a competitive disadvantage. The UK has often objected to new EU rules and been out-voted, so logically it might wish to remove these from the UK rulebook (eg the bonus cap or certain controversial aspects of Solvency 2 for annuity business), but it also has a long record of maintaining domestic regulation which goes beyond EU harmonisation (sometimes via gold platting or super-equivalence) – ring-fencing is one example and individual responsibility and the SCMR another.


The question of divergence (after the UK leaves the single market) is not, therefore, a one way street. Future divergence (UK versus EU harmonisation) may arise from the UK pursuing more stringent regulation than EU harmonisation, as well as from the UK not following new EU harmonisation or departing from existing harmonisation. In some cases the rules may differ/diverge but in practice the outcome, risk and protection may be much the same (which reflects HMG’s ideas about outcome based equivalence).


Logically one could argue that as the UK will be fully EU compliant on leaving the single market, full single market DRC should continue until there is divergence between the UK and EU rules. In the context of UK retail banking, there would be no rulebook change at that point, so no reason to change the single market rights of EEA banks to conduct retail banking in the UK via local branches of un-ring-fenced entities. However, this is not what Andrew Bailey and the Bank of England have in mind; they would not offer continuing DRC in retail banking – because of pre-existing intra-member state divergence – and would require a local UK regulated subsidiary to be used under mode 3.


Taking this example further, the UK retail banking policy above could differentiate between member states, with the UK offering to defer to some member states but not others. The UK would defer only to any member state with equivalent domestic ring-fencing and grant their banks DRC rights to use mode 3 branches or mode 1/2 cross-border services. UK regulators already have some scope to differentiate DRC treatment depending on their assessment of the regulation in a given country, but it remains to be seen whether the UK/EU relationship might encompass this DRC differentiation at a member state level.


As we explained in our April 2017 Report, strong DRC is more difficult to achieve in the retail sector, so it is perhaps not surprising that the Bank of England should assume that the UK would not seek, or offer to maintain, the retail banking passport.


HoC Scrutiny Committee: 28th Report of Session 2017-19


Most of the report is not relevant to the financial services as it deals with unfair trading practices in the food supply chain, law enforcement access to electronic evidence, new EU partnership with Africa, the Caribbean and the Pacific, EU trade defence instruments, equal pay and the gender gap and the European agency for safety and health at work. However the report also deals with banking reform, more precisely “Risk Reduction Measures” (RRM). These proposals would bring the current legal framework of the Capital Requirements Directive and Regulation and the Bank Recovery & Resolution Directive in line with the most recent international standards. The Committee is concerned about the impact of the legislation on third countries, which the UK will be post Brexit. Click here to access the report.


The report considers the potential impact of the legislation in the context of Brexit. “The [UK] Government has also actively opposed a proposed new requirement for large non-EU banks and investment firms with operations in more than one Member State to create an intermediate, independently-capitalised EU based parent undertaking (IPU) to facilitate group supervision and resolution. This would have a direct impact on UK banks, whose operations within the Single market would require a larger (and therefore more costly) presence in the EU after the UK loses its ‘passporting’ rights for financial services when it becomes a “third country” (either on 29 March 2019 or at the end of the post-Brexit transition period).”


Treasury research has shown that “16 to 17 UK-based banking groups, based on their existing structures would be caught under the current IPU proposals as drafted"; however, "roughly half of these UK-based banking groups already have an established holding company in another EU Member State."


Until the amendment to the Capital Requirements Directive is formally adopted, it is also unclear when exactly non-EU banks within the scope of the new IPU requirement would have to establish a holding company within the EU. Under the terms of the Council's approach, this would not become a binding obligation until seven years after the new legislation is adopted.


The Committee concluded that despite the Minster’s reassurance about the speedy adoption of legislation, the Committee is “concerned that any delays in the process could push back formal adoption of the RRM legislation until after the UK loses its vote within the Council in March 2019.”


HoC Exiting the EU Committee: The progress of the UK’s negotiations on EU withdrawal (March to May 2018)


The Committee has released a report discussing the progress of the negotiations on the UK withdrawal from the EU. It has commended both sides for prioritising the protections of citizens’ rights and welcomed the progress that has been made on the Withdrawal Agreement. However, they believe that still a lot of work has to be done, in particular in regards to dispute resolution and the future trade deal, which will be discussed in more detail here. Click here to access the report.


The Committee has stated that “it is highly unsatisfactory that nearly two years after the referendum, Ministers have yet to agree, and set out in detail, what kind of trading and customs arrangements they wish to seek in negotiations with the European Union.” It also argues that “trade in goods currently regulated through the Customs Union is not the only challenge that must be resolved in order to secure frictionless trade. Significant elements of intra-EU trade are also regulated through Single Market legislation that sits alongside the Customs Union.” This is, of course, particularly relevant for the trade in services.


In regards to the transition period the Committee has stated: “during the transition/implementation period the UK will continue to be fully subject to the jurisdiction of the CJEU. Despite this, Article 6 of the Draft Withdrawal Agreement, which seems to have been agreed, provides that the term of office of British judges on the CJEU will cease on 29 March 2019. On the understanding that nothing is agreed until everything is agreed, we urge the Secretary of State for Exiting the European Union to address this anomaly before the Withdrawal Agreement is finalised."


Furthermore “it is likely that different types of dispute resolution bodies will be needed to enforce the provisions in the Withdrawal Agreement. We agree that the CJEU should not be the final arbiter after the transition/implementation period is concluded. However, we do not see how dispute resolution can be left to the Joint Committee for technical and political arbitration alone. The only pragmatic and acceptable solution is a final arbiter whose composition is balanced between representatives from the UK and the EU’s institutions. We recommend that the Government urgently publish an update to its August 2017 position paper which sets out its preferences for dispute resolution, both across all of the relevant provisions in the draft Withdrawal Agreement and in respect of the future partnership.”


Other publications from the RegZone Brexit news feed


EBA ESMA EIOPA Joint Committee Annual Report


Click here to see the Annual Report. In terms of Brexit, the focus is on possible implications on the provision of financial services, the continuity of contracts, and on ensuring consistent EU approach to oversight of cross-border banking groups, including possible relocation. The two Joint Committee Risk reports published in spring and autumn convey the ESA’s preliminary analysis on the issue.


HMT Speech by Philip Hammond


Click here to access the text of Philip Hammond’s speech given on 23 May 2018. He mentioned that in terms of services they have the opportunity to establish a broader agreement than ever before, including continued recognition of professional qualifications and a labour mobility framework that enables travel to provide services to clients in personal, and an opportunity to seek a bespoke partnership in financial services that will enable the ongoing delivery of cross-border financial services in both directions, while protecting financial stability and maintaining fair competition.


European Commission: Compromise proposals in relation to CRR/CRD


Presidency compromise texts have been published with regard to (i) the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and (ii) exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures. Similar to the RMM reform mentioned above these legislations would increase the burden on non-EU member states. See full texts here and here.


HM Government Technical Note: Exchange and Protection of Classified Information


The note sets out the UK’s position on the technical arrangements necessary for the exchange and protection of classified information between the UK and the EU.


House of Commons Library Briefing paper Brexit: Parliament's role in approving and implementing agreements with the European Union


This HoC library briefing looks at issues around Parliament's role in approving the agreements secured under Article 50; the Withdrawal Agreement and Implementation Bill and the political declaration on the framework for the future relationship.


House of Lords EU Financial Affairs Sub-Committee: Uncorrected Oral Evidence Contractual Continuity Post-Brexit


Discussing the possible implications of Brexit on contractual continuity it was argued that for the most part contracts are unlikely to be frustrated, but the issue would depend on the law of each relevant member state. There is also general agreement that the transition period is beneficial for the financial services industry, while at the same time only delaying the issues. Click here to access the report.


House of Lords EU Financial Affairs Sub-Committee Uncorrected Oral Evidence: Data sharing post Brexit


The Committee has published a transcript of the hearing held on 23 May 2018 at which legal experts discuss issues surrounding data sharing in the financial sector post-Brexit.


BoE Speech by Mark Carney: Guidance, contingencies and Brexit


Text of Mark Carney’s speech, given on 25 May 2018, follows, in which he discusses potential paths for monetary policy during the next phase of Brexit, and notes steps taken by HMT and BoE on “cliff edge” risks.