Central Counterparties (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018
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Lord Bates
That the Grand Committee do consider the Central Counterparties (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018 and the EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018.
Relevant document: 1st Report from the Secondary Legislation Scrutiny Committee (Sub-Committee B)
The Minister of State, Department for International Development (Lord Bates) (Con)
My Lords, HM Treasury is currently undertaking the necessary preparations to ensure that, in the event that no deal is agreed when we leave the EU in March 2019, a functioning legislative and regulatory regime will continue to be in place for financial services. The aim of the work is to maintain continuity at the point of exit as far as possible. The European Union (Withdrawal) Act 2018 will transfer existing EU legislation on to the UK statute book at the point of exit. It also gives Ministers powers to amend this legislation to ensure that it will operate properly in a UK context. The Treasury is laying the necessary statutory instruments to complete this work for financial services legislation. This is the third debate in this Committee as part of this programme of work and there will be many more over the coming months.
Last December, the Treasury announced that legislation would be brought forward to establish a temporary permissions regime enabling EEA firms operating in the UK to continue their activities in the UK for a time-limited period after withdrawal. At the same time, it was also announced that a temporary regime would be brought forward in relation to non-UK central counterparties. The two SIs being debated today deliver on these commitments. They are both extremely important to the financial services sector, as they make a key contribution to our aims of maintaining service continuity at the point of exit.
The EEA passport rights regulations deal with references to the EEA financial services passport in UK law and establish a temporary permissions regime to provide for continuity once the UK leaves the EU and passporting no longer operates in the UK. Many will be familiar with the passporting system, which allows firms in an EEA state to offer services in another EEA state on the basis of the authorisation granted by their home state regulator. In a no-deal scenario, the UK would be a third country outside the EU financial services framework and therefore outside the passporting system, meaning that any references to EEA passport rights in UK legislation would become deficient at the point of exit.
The Government therefore need to repeal provisions in the Financial Services and Markets Act 2000 that implement the EEA financial services passport. This would mean that any EEA firms currently operating in the UK via a passport would no longer be able to do so from exit day, just as UK firms would no longer be able to passport into other EEA states. EEA firms would then need to obtain authorisation from the UK’s regulatory authorities if they wished to continue doing business in the UK. In such a scenario, the volume of applications received by the UK regulators would increase significantly as many hundreds, perhaps thousands, of EEA firms submit applications for UK authorisation. This will include applications from large and complex businesses with a substantial UK presence.
The need for a large number of firms to submit these lengthy applications for authorisation before exit day, and have the UK regulators process them in time, therefore poses a substantial cliff-edge risk for firms and regulators. Ultimately, this would affect UK individuals and businesses who rely on services from passporting EEA firms and cause disruption to them. To mitigate those risks, in line with the Government’s commitment on 20 December last year, the Treasury has therefore put forward this legislation to establish a “temporary permissions regime”. This regime would enable EEA firms operating in the UK via a passport to continue their activities in the UK for up to three years after exit day, allowing them to obtain UK authorisation or transfer business to a UK entity as necessary.
To alleviate the potential scenario where some EEA firms cannot be authorised within the three-year period, this SI also gives the Treasury the power to extend the regime. This could be done only where it is “necessary” to do so, and it could be extended by only 12 months at a time. Any extension would need to be based on a robust assessment from the FCA and the PRA regarding the effects of extending and not extending the period. The instrument that would extend the regime would be subject to the negative procedure, which was drawn to the special attention of the House of Lords by Sub-Committee B of the Secondary Legislation Scrutiny Committee in its report published on 18 October. The Treasury judges this choice of procedure appropriate given that the power to extend the regime is conferred by this instrument, which itself is subject to the affirmative procedure. I assure Members that we take parliamentary scrutiny seriously. Although this affirmative instrument introduces a power to make regulations via the negative procedure, the Treasury believes that if a like provision were to be made by an Act of Parliament, it would also be via the negative procedure because the power is so tightly drawn.
The temporary permissions regime would ensure, first, that firms can continue servicing UK businesses and consumers for a temporary period after exit day and, secondly, that firms will have appropriate time to prepare for and submit applications for UK authorisation and complete any necessary restructuring. Finally, the PRA and the FCA can manage the expected applications for UK authorisation from EEA passporting firms that were previously operating in the UK via a passport in a smooth and orderly manner.
This SI is a pragmatic response to a complex issue. It is necessary to minimise disruption to users and providers in the UK financial services sector in a no-deal scenario. I note that the Secondary Legislation Scrutiny Committee report acknowledged the importance of these regulations in achieving this objective.
It is with similar considerations for minimising disruption and enabling the UK’s regulators to manage a no-deal scenario in an orderly fashion that I turn to the second of these SIs, which covers central counterparties. Central counterparties are central to the UK and global financial system. They reduce risk and ultimately improve the efficiency and resilience of the system as a whole. They stand between counterparties in financial contracts, becoming the buyer to every seller and the seller to every buyer. They guarantee the terms of trade even if one party defaults on the agreement, reducing counterparty risk. UK firms currently receive services from non-UK central counterparties under the framework set out in the European Market Infrastructure Regulation, known as EMIR.
Under EMIR, non-UK central counterparties are permitted to provide services to UK firms if they are either located in the EU and authorised by their home regulatory authority or located in a third country deemed equivalent by the Commission and recognised by the European Securities and Markets Authority. In a no-deal scenario, when the UK leaves the EU and is no longer within the single market for financial services, those non-UK central counterparties would be unable to provide services to UK firms until they were recognised under the UK’s domestic regime. Such a sudden dislocation in the provision of services would introduce substantial risks to UK firms, many of which rely on non-UK central counterparties to provide clearing services and for mitigating transaction risks. By extension, this could impact on customers of those UK firms. Day one disruption to these services would pose risks to UK firms, as well as stability risks to the broader financial system.
Lord Bates
I thank noble Lords for participating in this debate. It has lasted for 46 minutes, of which my introductory remarks were 13 minutes. In the 33 minutes, noble Lords have, by my calculation, managed to generate 24 questions which I will attempt to work my way through. I simply flag that up for colleagues on the Front Bench who are waiting for immediate business.
These are crucial issues. Noble Lords are quite right to raise them and seek further clarification. I commence by saying that I agree with the noble Lord, Lord Tunnicliffe, in this respect: this is not the outcome we are seeking or that we want or desire. It is not the outcome that we expect. We expect to secure a deal that will allow us to continue to have a good trading relationship in financial services with the European Union. We believe that that is in the interest of not only the UK but the EU as well. We are working very hard to secure that.
Lord Tunnicliffe
I want to explore that question a little bit further. Surely the test would be whether this is, in its elements, reciprocal to the privileges that EU firms will have as a result of this instrument.
Lord Bates
I do not want a 25th question; I will keep it at 24 and work my way through to that one. I have some remarks to address that particular point.
The noble Baroness, Lady Bowles, asked whether there could be a scenario in which a firm cannot be authorised within three years, which would extend the time limit. The answer is yes. The position is that although the PRA and the FCA have credible working estimates of the number of EEA firms that will apply to them for authorisation, there is an unavoidable degree of uncertainty about this process. That, coupled with the varying degrees of complexity in some of these firms’ applications, means that a power to extend the length of time is necessary. This will be crucial to mitigate the potential scenario in which some EEA firms cannot be authorised within three years from exit day, which could force the regulators to reject authorisation for the firms’ applications. Clearly, we do not seek that outcome.
The noble Baroness also asked whether there is enough flexibility to make equivalence decisions for CCPs. The powers in the EU withdrawal Act limit the fixing of deficiencies to retain EU law when the UK leaves the EU. It does not allow for policy changes beyond this element. The aim is to provide certainty to non-UK CCPs and their UK users during the period immediately following withdrawal from the EU. The criteria for recognition of non-UK CCPs will remain unchanged and will be onshore. This would allow recognised non-EU CCPs to resubmit the application used for EU recognition.
The noble Baroness then asked about the process for the joint assessment by the regulators. As set out in the statutory instrument, the PRA and the FCA would need to submit to the Treasury a joint assessment outlining the effect of extending or not extending the time period on the regime, on firms in general, on the UK financial system and on the ability of the regulators to discharge their functions in a way that advances their statutory objectives. That assessment would need to be submitted to Her Majesty’s Treasury no later than six months before the end of the regime. The Treasury would then make regulations to extend the duration of the regime only if it considers them necessary on the basis of the assessment.
The noble Lord, Lord Tunnicliffe, asked what protections would be available following exit day to UK customers who currently have access to the Financial Services Compensation Scheme. No one should lose FSCS protection as a result of this SI. If a UK customer is currently protected by the FSCS, they will be protected as long as the firm enters the temporary permissions regime.
The noble Lord also asked about the consequences for UK customers if a firm is denied authorisation. Any firms in the temporary permissions regime that are denied full UK authorisation by the UK regulators will lose their temporary permissions. Further legislation will be laid before Parliament at a later date to enable such firms to wind down their UK-regulated activities in an orderly manner. This legislation will ensure that the existing contractual obligations of these firms with UK customers can continue to be met. UK customers would no longer be able to enter into new contracts with these firms unless the firms had successfully reapplied for authorisation from UK regulators.
The noble Lord then asked what a firm being denied authorisation says about the passport regime and whether it suggests that it is not equitable, let alone equivalent. The EEA passport regime system is underpinned by the co-operation of EEA member states’ competent authorities. Each member state’s competent authorities supervise the activities of firms under its jurisdiction, even if those activities take place elsewhere in the EU. Once we leave the EU, we cannot rely on this co-operation continuing. We are therefore making these preparations.
Baroness Bowles of Berkhamsted
Regulation 12 states:
“A central counterparty established in a third country”,
that,
“intends to provide clearing services … on and after exit day”,
has to make an application and that the application “must” be submitted before exit day. I do not think that is quite what the Minister said. I realise that time is short now, and there are quite a few things that the Minister has had to gloss over. I hope he will review what I have said, and I would welcome a written response.
Lord Bates
We may have misunderstood the point that the noble Baroness was making. I am very happy to undertake to write to her on that specific point and copy it to members of the Committee.
The noble Baroness asked why a CCP might not have been recognised within the initial period. While the Bank of England has credible working estimates of the number of CCPs that will apply to it for recognition, there is an unavoidable degree of uncertainty about this.
My noble friend Lord Lindsay asked whether third-country CCPs includes EU CCPs. EU CCPs will be treated as third-country CCPs post-exit. EU CCPs and third-country CCPs will be eligible for the temporary recognition regime if they were permitted to operate prior to 29 March 2019.
My noble friend Lord Kirkhope asked whether the regime could be extended continually each year. It is in everyone’s interest for firms to transition from the current system of EEA passporting rights to full UK authorisation as quickly and efficiently as possible. There would be no circumstances in which it would be desirable for the regulators or the Treasury to extend the length of the regime on a continuous basis. He also asked whether the negative procedure is an appropriate instrument. I respect the work of the Secondary Legislation Scrutiny Committee, whose report we have before us today. I addressed this in my opening remarks. We believe that the choice of procedure is appropriate, given the overall powers being scrutinised now through this affirmative instrument. The negative procedure would just be an extension of that. The power to extend the time period is not a provision which relates to fees and so would not, if made alone, attract the affirmative procedure under Section 8 of the Act, to which my noble friend referred. He also spoke about the process for registration with the PRA and its ability to deal with the volume of applications. I reiterate what I said to the noble Baroness, Lady Bowles: I am confident that the PRA and the FCA are making adequate preparations to deal with the scale of the challenge which they face, but it is a significant challenge.
The noble Baroness, Lady Bowles, asked whether the regulators may ask firms to apply for authorisation sooner than the two-year deadline set out in the statutory instruments if they so choose. The EEA Passport Rights (Amendment, etc., and Transitional Provision) (EU Exit) Regulations will give regulators the ability to direct firms to make an application for authorisation during a specified period within two years from exit day if they have not already applied for authorisation. This will help regulators manage the flow of applications in a smooth and orderly manner. I draw the Committee’s attention to the FCA’s recent consultation paper published on 8 October, in which it set out its intention to allocate each firm a three-month landing slot within which that firm will need to submit its application for UK authorisation. It plans to issue a direction shortly after exit day setting out which firms have been allocated to which landing slot.
The noble Baroness, Lady Bowles, asked how the two-year application period will operate. I dealt with that earlier but I did not cover one specific point: the two-year deadline for applications to be received cannot be extended.
The noble Lord, Lord Tunnicliffe, asked whether this is a one-sided arrangement and whether there will be any reciprocation. The Government are only able to take legislative action in relation to EEA firms’ passport rights to the UK; they cannot through unilateral action influence the status of UK firms. That is why we are seeking to agree a deep and special partnership with the EU, as well as an implementation period, so that important preparations can take place in an orderly manner.
The noble Lord asked what the impact on the financial services sector would be if there is a no-deal exit. Reaching a deal is in the mutual interests of both sides. We are focusing on the negotiation of the right future partnership based on a proposal published in the White Paper on 12 July. That White Paper outlined the Government’s position on financial services and Brexit. We propose a framework for financial services that will provide stability for the EU-UK ecosystem, preserving mutually beneficial cross-border business models and economic integration for the benefit of businesses and consumers in the UK and the EU.
The noble Lord asked what it says about the regime if a firm is denied authorisation. Once we leave the EU we cannot rely on this co-operation continuing and therefore we are making these preparations. It is important that these regulations go ahead so that consumers in this country have confidence in the financial services put forward here.
I have addressed the Financial Services Compensation scheme and I will now deal with one or two points relating to central counterparties. The noble Lord, Lord Tunnicliffe, made a point on the memorandum of understanding with the host state. Yes, there are a number of necessary steps for a non-UK CCP to be recognised in the UK. These include that the Treasury must determine that the relevant third country’s regulatory and supervisory framework is equivalent to EMIR; the bank must agree supervisory co-operation agreements or memorandums of understanding with relevant competent authorities of the CCP applicant; and the non-UK CCP’s application for recognition to be assessed by the bank must include information on its financial resources, internal procedures and various other relevant information.
The noble Lord asked what would happen if the central counterparty is not recognised. If a non-UK CCP were to continue to provide clearing services to UK firms without recognition, it would be in breach of a general prohibition under the Financial Services and Markets Act, which prohibits anyone carrying out a regulated activity unless they are authorised or exempt. The CCP would be guilty of an offence and subject to a fine or imprisonment. However, further legislation will be laid at a later date to enable such firms to wind down their activities in an orderly manner by being treated as being recognised for a short period.
I hope that has addressed many of the questions.
Lord Tunnicliffe
In the unlikely event that the Minister has missed anything, will he review his answer and, if he has missed the odd point, send a letter covering it?
Lord Bates
I am happy to give an undertaking to do that. We are in uncharted territory here—we have not been through this process before. The Economic Secretary to the Treasury, John Glen, is being incredibly diligent in engaging with the regulators on a regular basis and being guided through this process. That is why the announcement was made in December. We will continue to keep this under review. The noble Baroness, Lady Bowles, made a suggestion about how we might keep the House informed of developments and made particular reference to perhaps involving the Select Committees. If I may, I will take that back to the Economic Secretary to the Treasury because, in some of these areas, once we know the lay of the land—we hope it will not come to that but if it does—then we will clearly need to review these provisions. I am happy to take that suggestion back and include it in my answer to the noble Lord, Lord Tunnicliffe, which I will copy to my noble friends Lord Lindsay and Lord Kirkhope.