Brexit Watch #1: Impact of No Deal and Other Regulatory Issues
French investment companies advised to transfer contracts to an EU member state
The French Ministry of Finance has issued a guidance directed at French companies with substantial operations in the UK containing measures they must now consider as a matter of urgency.
For French financial services with investment management arms; the ministry has recommended firms to transfer their financial contracts to entities established in the territory of a Member State of the European Union in light of the fact that new contracts cannot be honoured in the even of a no-deal scenario.
The main recommendation to all French companies with substantial operations in the UK is to perform a self-diagnosis to identify all the impacts — be they “legal, HR, suppliers [or] distributors, costs, location of activities, data, contracts etc”.
In a similar move, the UK’s Brexit secretary, Dominic Raab, told cabinet colleagues that Whitehall departments needed to step up their efforts and move “from warning businesses to telling them to act”. [Source[1]]
The UK Government favours legislation to give continued access to financial services
The UK government is taking forward legislation that will allow UK households and businesses to continue to access financial services provided by EU companies. That legislation needs to be passed by Parliament prior to Brexit to be effective.
The Financial Policy Committee (FPC) has been monitoring risks of disruption that could arise in the absence of an implementation period or any other agreement as the UK exits the EU. The UK banking system lies at the core of the UK financial system. Reflecting the substantial increase in its resilience over the past decade, the UK banking system now has the capacity to absorb, in addition to a disorderly, cliff-edge Brexit, further misconduct costs and stresses that could arise from intensifying trade tensions and a further sharp tightening of financing conditions for emerging markets.
While there has been considerable progress in the UK to address these risks, there has been only limited progress in the EU. In the limited time remaining, it is not possible for companies on their own to mitigate fully the risks of disruption to cross-border financial services. The need for authorities to complete mitigating actions is now pressing.
An implementation period would reduce the risks of disruption to the supply of financial services to UK and EU households and businesses as the UK exits the EU, according to the Bank of England (BoE). [Source[2]]
£41 trillion worth of derivatives at risk if no agreement is reached soon
EU-based firms have OTC derivative contracts with a notional value of £69 tn at UK clearing houses, £41 tn of which matures after March 2019 when the UK is due to leave the EU would be at risk if no agreement is reached soon, says the BoE in its latest statement.
The movement of a large volume of contracts in a short time frame would be costly to, and disrupt the derivatives positions of, EU businesses and could strain capacity in the derivatives market. In addition, fragmentation of central clearing would raise costs for EU businesses. Industry estimates suggest that every single basis point increase in the cost of clearing interest rate swaps alone could cost EU businesses around €22 bn per year.
The BoE’s latest warning was echoed by the International Swaps and Derivatives Association, which lobbies for the derivatives industry. The group called on the EU to prepare new authorisation to come into force the day after Brexit. [Source[3]]
Applying for ROIE status post-Brexit
Once the UK leaves the EU, passport rights will no longer apply to MiFID II EEA market operators seeking to facilitate the participation of the exchange in UK markets. Also, in the eventuality of a no deal, any temporary recognition regime for EEA market operators may not be upheld. So, in September the FCA published a direction pursuant to the Financial Services and Markets Act 2000 (FSMA) regarding how an overseas market operator can apply to be a recognised overseas investment exchange (ROIE). EEA market operators who currently make use of passport rights are advised to make a formal application to be recognised as a ROIE post-Brexit. [Source[4]]
Preparing for a no Brexit deal and protection of consumer rights
HM Treasury (HMT) issued a series of technical notices in August setting out information that gives financial services firms and their customers an understanding of how they can prepare for a ‘no deal’ scenario, which is part of the government’s approach to ensuring that the UK has a functioning financial services regulatory framework in any scenario.
The government wants, in particular, to minimise disruption and avoid material unintended consequences for the continuity of financial services provision, protect the existing rights of UK consumers, as well as ensure financial stability.
Also on the subject of consumers, the Autorité de Contrôle Prudentiel et de Résolution (ACPR), within the scope of its competences regarding customer protection, points out that the contracts concluded by EEA establishments before the exit of the United Kingdom of the European Union with establishments and organizations of the United Kingdom remain valid and must be performed in good faith. [Source[5]]
Amendments to Capital Requirements Regulations
On August 21, 2018, HMT released another draft statutory instrument in preparation for Brexit, the Capital Requirements (Amendment) (EU Exit) Regulations 2018—the draft Capital Requirements Regulations (CRR).
This draft Regulations will amend the CRR to ensure that it continues to operate effectively when the UK leaves the EU. The domestic legislation implementing the Capital Requirements Directive (CRD) is also amended to ensure that it continues to function as intended. The Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) will be responsible for amendments to the technical standards and for updating their rulebooks.
CRR provides for consolidated liquidity requirements for EU banking groups on a cross-EU basis only (i.e., the requirements do not also apply at national level). The result is that UK sub-groups with an EU parent do not currently have a UK level of consolidated liquidity supervision.
The CRR specifies the level of capital and liquidity that firms must hold against different types of exposures, for example, to CCPs or central banks. EU assets, and those of third countries deemed equivalent by the European Commission, are given preferential (generally 0%) treatment and no capital needs to be held against such exposures. After Brexit, EU27 sovereign and CCP exposures which do not benefit from an equivalence decision will no longer receive preferential capital treatment under the UK’s capital framework.
The UK regulators will maintain their existing powers to address macroprudential or systemic risk and the Financial Policy Committee will undertake its role as the macroprudential authority for the UK. [Source[6]]
ECB advises on contingency plans for multiple Brexit scenarios
The European Central Bank (ECB) has advised both incoming and outgoing banks, to prepare for all contingencies – including a no deal scenario. The ECB states that a relatively small percentage of banks lack detailed plans about their future set-up in the euro area, or have not shown sufficient progress in their relocation activities. This approach raises concerns as time is limited and uncertainty over reaching a final political agreement remains. In the possible absence of a Withdrawal Agreement ratified on time by both parties, banks should be prepared for all contingencies, including the possibility of there being no transition period but rather an abrupt end to the UK’s access to the EU single market.
On the supervisory side, the ECB and national supervisors have continued their dialogue with the banks in scope and – where applicable – with their home supervisors in third countries. Supervisors are thoroughly assessing both incoming banks’ Brexit plans and their licensing applications. This process includes horizontal analyses and benchmarking to ensure consistency and a level playing field.
On the 25 June 2018, the EBA warned both the EU27 and the UK financial institutions about their lack of preparation for a hard Brexit without any ratified Withdrawal Agreement nor transition period. The EBA urges financial institutions to assess the implications this worst-case scenario may have on them and set up assessment guidelines to do so.
In particular, financial institutions shall identify potential risk channels and assess the associated impacts on their business model, solvency and liquidity. In doing so, they shall consider whether they have to or are willing to maintain a continued market access to the UK or the EU27.
Implications of their decisions shall be carefully examined, in particular regarding their obligations towards their customers and the regulatory permissions they shall seek. Institutions shall also assess the legal implications by identifying all contracts that could be potentially affected by the hard Brexit scenario and start considering mitigation actions if necessary.
Data management, in particular, data storage and transfer, shall be envisaged consistently with the EU’s General Data Protection Regulation’s requirements. Financial institutions shall also consider the impact on their wholesale funding and identify other sources of funding if necessary. If applicable, they shall consider the Brexit implications of their compliance with the Bank Recovery and Resolution Directive. [Sources[7]]
Plans for EEA Passport Rights
A Temporary Permissions Regime (TPR) put forward by HMT proposes allowances for EEA financial services firms to continue normal operations in the UK for a limited period of time after Brexit while they seek authorisation in the UK. To be eligible for entry into the temporary permissions regime, EEA firms must be authorised to carry on regulated activities in the UK under the EU passporting regime. This includes EEA firms passporting under the EU Single Market Directives who qualify for authorisation under Schedule 3 to the Financial Services and Markets Act 2000 (‘FSMA’). So-called “Treaty firms”, those who exercise EU Treaty rights to do business on a cross-border basis in the absence of passporting rights, who qualify for authorisation under Schedule 4 to FSMA, are also eligible for the temporary permissions regime.
However, EEA firms do not automatically qualify to exercise the TPR and have to provide relevant applications and notifications to the PRA and FCA. In addition, the Treasury will not uphold the TPR in the event of a no-deal Brexit. [Source[8]]
HMT sets out its approach to onshoring financial services legislation
HMT set out its approach to onshoring financial services legislation under the European Union (Withdrawal) Act (EUWA) in June. This is intended to ensure that there is a complete and robust legal framework for financial regulation in the UK, whatever the outcome of negotiations between the EU and the UK, when the UK withdraws from the EU. HMT plans to lay a number of Statutory Instruments (SIs) to make the legal changes required to achieve this aim. HMT has said this is necessary as a contingency against a scenario in which the implementation period, which has been agreed in principle as part of the UK’s Withdrawal Agreement with the EU, does not take effect on 29 March 2019. [Source[9]]]
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[1] http://francobritishchamber.com/brexit-hub/
[5] https://www.gov.uk/government/publications/banking-insurance-and-other-financial-services-if-theres-no-brexit-deal/banking-insurance-and-other-financial-services-if-theres-no-brexit-deal) (https://acpr.banque-france.fr/sites/default/files/medias/documents/20180629_2publication_brexit.pdf