Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018
(Limited Text - Ministerial Extracts only)
Read Full debate
Lord Bates
That the draft Regulations laid before the House on 17 October be approved.
Relevant document: 3rd Report from the Secondary Legislation Scrutiny Committee (Sub-Committee B).
The Minister of State, Department for International Development (Lord Bates) (Con)
My Lords, these draft regulations have been laid under the European Union (Withdrawal) Act 2018 as part of government preparations for a scenario in which the UK leaves the EU without a deal. As with other instruments, this does not intend to make policy changes other than to reflect the UK’s position outside the EU in that eventuality. This instrument addresses legal deficiencies in the markets in financial instruments regulation, the markets in financial instruments directive and in related domestic financial services legislation and EU delegated regulations, which I shall collectively refer to from here on in as MiFID II.
MiFID II regulates the buying, selling and organised trading of shares, bonds, and complex financial instruments. It governs the practices of investment banks, exchanges and portfolio managers, among others. MiFID II came into effect on 3 January 2018. These regulations are essential to the financial services sector, and key parts of legislation would be inoperable without them.
In its report of 21 November, Sub-Committee B of the Secondary Legislation Scrutiny Committee drew this instrument to the special attention of your Lordships’ House. The SLSC focused on the SI’s approach to the transparency regime, which I will address specifically.
MiFID II requires buyers and sellers on financial markets to disclose specified data, such as price information for their trades, which brings transparency to price formation in financial markets. It also provides exemptions from these transparency requirements in several cases. Formulas are used to calculate whether a trade may qualify for an exemption to these transparency requirements. Generally, these formulas are calculated using pan-EU trading data.
In a no-deal scenario, the UK is not expected to have access to the pan-EU trading data, which is necessary for calculating these thresholds. This instrument therefore grants the Financial Conduct Authority a set of temporary powers that will allow it some controlled flexibility over how the MiFID II transparency regime operates in the UK. These powers will operate during a transitional period of up to four years. If the Treasury feels that the FCA can fulfil its transparency functions before the end of the transitional period, the Treasury may end this period by the issue of a direction.
In addition to temporary powers, the FCA is also provided with some longer-term flexibility to reflect the fact that it may be necessary to use reliable trading data from other countries in calculating transparency thresholds after exit. The four-year transitional period for the FCA’s temporary powers is necessary to give the FCA time to adjust its IT systems and gather relevant market data so that it can administer an effective transparency regime in a no-deal scenario.
In its report to the House, the Secondary Legislation Scrutiny Committee mentions the adequacy of FCA resourcing to carry out its new responsibilities. The Treasury has worked closely with the FCA to deliver MiFID II, and the FCA is confident that it will have sufficient resources to operate the transitional transparency regime. Before exit day, the FCA will publish a statement of policy on how its temporary powers will be used. The Treasury can refuse to approve the FCA’s policy statement on specified grounds. The ability for the Treasury to object to such a statement by the FCA was raised by the Secondary Legislation Scrutiny Committee in its report, which noted Parliament’s interest in understanding the reasons for an objection, should one be made.
Provisions have been included so that the Treasury may refuse to approve an FCA statement should it potentially prejudice any international agreement that the UK hoped to reach, or the Treasury believes that the statement is incompatible with international obligations. In a no-deal scenario, it is important that the Treasury can manage international negotiations effectively, and this mechanism is a sensible way of ensuring this. The FCA supports this approach. Parliament will also be able to scrutinise and question Treasury Ministers and the regulators on its approach to the use of these temporary powers, as Parliament does now.
The Secondary Legislation Scrutiny Committee also noted that it would have been helpful if the FCA’s policy statement on its use of these powers could have been made available before the debate. This was not possible, as the FCA needs sufficient time to consider the drafting of such a statement. The FCA has provided assurance that a statement of policy will be ready at least four weeks before exit, if the UK leaves the EU without a deal. I turn to other issues contained in this SI.
Certain functions under MiFID II are carried out by EU authorities, principally the European Commission and the European Securities and Markets Authority, known as ESMA. The Commission and ESMA will not carry out these functions once the UK leaves the EU. This instrument therefore—consistent with other SIs—transfers the functions of the Commission to the Treasury, and ESMA’s functions to the FCA and the Bank of England. The instrument also transfers responsibility for making binding technical standards from ESMA to the FCA, the Bank of England, or the Prudential Regulation Authority. This is in keeping with the approach set out in the Financial Regulators’ Powers statutory instrument, which was debated in your Lordships’ House on 17 October 2018.
This instrument also deletes provisions that will become redundant when the UK leaves the EU, such as requirements regarding automatic recognition of an action by an EU body. In addition, this instrument removes obligations on UK authorities to share information with EEA authorities’ obligations, although this does not preclude UK authorities from co-operating with the EEA; it can do so on a discretionary basis.
A key set of provisions of concern will be the treatment of third-country regimes. Under MiFID II, a third-country regulatory regime may be determined by the European Commission to be equivalent to the requirements of MiFID II. So that MiFID II equivalence regimes operate effectively in the UK after exit, the Treasury will take on the Commission’s function of making equivalence decisions for third-country regimes. Existing Commission equivalence decisions will also be incorporated into UK law and will continue to apply to these third countries.
The Government have introduced a temporary permissions regime, as set out in the EEA passport rights regulations 2018 made on 6 November. This will enable EEA firms and funds operating in the UK through a passport to continue their activities in the UK for a limited period after exit day and allow them to apply for UK authorisation or transfer business to a UK entity as necessary. This instrument makes provisions for EEA firms operating in the UK under the temporary permissions regime, by ensuring that they will not be deemed in breach of the UK’s MiFID II rules if they can demonstrate that they have complied with corresponding provisions in the EU’s MiFID II rules.
Without these provisions, such firms would be faced with possible conflicts of law and duplicative regulatory regimes, which would impede their operations in the UK. This provision will apply only to certain provisions of MiFID II during the temporary permissions regime, and only where the EEA MiFID II requirement has equivalent effect to the UK MiFID II requirement.
This instrument also includes transitional arrangements for data reporting service providers which report transactions to regulators and publish transparency data. Under the transaction reporting regime in MiFID II, investment firms must submit a report to their national regulatory authorities following a trade. These reports are used by regulators to detect market abuse. Under the regime, UK branches of EEA firms do not send transaction reports to the FCA but to their home regulator, and this information is then shared between EU regulators. As automatic sharing of information will no longer occur, this instrument will require UK branches of EEA firms to report to the FCA. The instrument also provides that firms will continue to be required to report on trades in financial instruments admitted to trading, or traded, on trading venues in the UK and the EU. This maintains the FCA’s existing scope for the monitoring of markets.
The Treasury has been working closely with the FCA, the Bank of England and industry bodies in respect of this instrument. It was published in draft form, with an Explanatory Note, on 5 October 2018, to maximise transparency to Parliament, industry and the public ahead of laying. Regulators and industry bodies have generally been supportive of this statutory instrument.
This Government believe that the proposed legislation is necessary to ensure that MiFID II continues to function appropriately if the UK leaves the EU without a deal or an implementation period. I hope noble Lords will join me in supporting these regulations. I commend the regulations to the House and I beg to move.
Lord Tunnicliffe (Lab)
My Lords, I thank the Minister for presenting the instrument and I thank both noble Baronesses for the variety and depth of their questions. I tried to understand the instrument—I put quite a lot of effort into it—and I thank Treasury staff for helping us to do so. I came across a clear need for the maintenance of MiFID II in our law; I accept entirely the general direction of the instrument towards preserving it. Fortunately, I did not come into contact with the entire 900 pages, which is probably the only reason I can claim for still being sane.
I came across some of the concerns that have been expressed. The most worrying area, at least to me, is the temporary powers that the FCA is to have. Why has the SI not been delayed until we have sight of the FCA’s statement of policy on the use of temporary powers? No matter how expert one may be, we do not have a clear view of what powers we are giving away and what impact that may have. If that is not possible—clearly, that is the Government’s position—surely the statement of policy should be brought before Parliament. Its impact will be as big as that of granting the concept of temporary powers.
Can the Minister assure us that in those four years, the temporary powers will not be used to water down MiFID II? That seems an important step towards transparency in these intricate markets. I can see why the industry would want those watered down. It is crucial that the Government be able to assure us they will resist that, and that the temporary powers will not be used to water it down.
Finally, I would like to come back to the FCA having sufficient resources. In the past, the most detail the Minister has given is to say “it will have sufficient funds because it will be able to pre-set the industry, so funds are not a problem”. The noble Baroness hit the nail on the head: it is not about funds but available pools of talent. In the letter the Minister will undoubtedly write concerning this instrument, could we have some clarity, direct from the FCA, on why—in this very highly paid industry, where there is strong competition for talent—it is so confident it will be able to access the available talent to do the task required for this SI and the others considered today?
Lord Bates
My Lords, at this hour a letter is an attractive proposition. I counted some 27 questions, which is a pretty respectable ratio from the three distinguished speakers in this debate. I will try to deal with as many as I can in the time available. Clearly, I will have to read the Official Report with officials to see if there are any points we need to write on; I suspect there will be. Therefore, if we run out of time, I will include other answers in that communication.
The noble Baroness, Lady Bowles, asked why the amended thresholds which appear in Article 5(1)(a) and 5(1)(b) of the Commission of Delegated Regulation 2017/567—thresholds for determining which equity instruments are liquid—have not been changed. However, replacing references to Union data with UK market data in the legislation would change which instruments were classed as being liquid for UK market participants.
On the FCA not having the data, it needs sufficient time to build systems to analyse market data independently from ESMA. It estimates that this will take four years. As noted, the Treasury can end this period earlier if the transparency regime cannot operate earlier. The FCA does not have all the data relating to firms in the UK, as EU firms currently report back to their own competent authority and not to the FCA.
Baroness Bowles of Berkhamsted
Does not this very regulation enable that, within the transition period, the FCA will collect that data? That is one of the other provisions. Although it might not have it now, after Brexit, as soon as we are into the transition period, it will have it.
Lord Bates
Of course, in the event of a deal, that would be the case, and that is what we would expect to happen. On the transitional period that the noble Baroness, Lady Bowles, asked about, it took approximately four years to develop the detail of the current transparency system and put it in place. On her point about the FCA being held accountable, and what parliamentary oversight of the FCA’s decisions there would be—a point also raised by the noble Baroness, Lady Drake, and the noble Lord, Lord Tunnicliffe—the powers being granted to the FCA are necessary to uphold market stability. These powers will generally be constrained to situations where their use is necessary for the advancements of the FCA’s integrity objectives. The FCA will be held accountable in two ways. First, it will be required to publish a statement of policy explaining its approach; the policy statement could come into effect only if the Treasury did not raise objections. Secondly, Parliament will be able to further scrutinise and question Treasury Ministers; if the Treasury objected, the FCA would need to revise its statement.
The noble Baroness, Lady Bowles, asked about the transitional powers. Without these powers—
Baroness Bowles of Berkhamsted
I am sorry to interrupt again, but I think that the noble Lord just said that Treasury officials would interrogate the FCA about its policy and that it would have to change it if they did not like it. However, my understanding of the regulation is that they can do that only with regard to either international standards or if it would interfere with some international negotiation. The provision does not appear to have been put into the legislation as an all-round general policy; indeed, I think that the whole idea is that the Treasury is not supposed to interfere with what the FCA does. So I am not sure that this line from the Treasury—“We’re going to make sure it’s all right”—fully stands up.
Lord Bates
That is a good one for the letter. We will certainly address that point; it is a legitimate question to ask.
The noble Baroness, Lady Bowles, asked whether the FCA consultation was timed to come out after the debate should have occurred. No, the FCA operates completely independently of the Treasury. She also asked whether we had considered keeping the post-trade transparency even if pre-trade transparency is suspended. Simply replacing references to EU market data with UK market data in the legislation will result in significantly different calculations and thresholds for market participants. The FCA can use the data available to it. The intention is to maintain the outcomes of the transparency regime. Transparency will continue to operate during the temporary period.
The noble Baroness, Lady Drake, said that the instrument should not set bad precedents. It has been drafted in accordance with Section 8 of the EU withdrawal Act, and some policy changes are an unavoidable result of addressing deficiencies. We have sought to maintain the intended policy outcome of the legislation. She asked whether a sudden change in the requirement would be hard for firms to deal with. We have announced plans to grant the regulators temporary powers to phase in new requirements that would apply to firms in a no-deal exit. Those powers must be exercised by the regulators in accordance with their statutory objectives, as set by the FSMA. This is a sensible measure to ensure that firms have the time needed to adjust in an orderly way.
The question about whether the FCA has enough human capital to carry out its functions and responsibilities is interesting, I undertake to feed that point back to it, and it may feel better placed to respond. The FCA has reported to the Treasury that it is confident that it will have sufficient resources to operate the transitional transparency regime, due to the preparations that it is making. As it set out in its 2018-19 business plan, a significant proportion of its resources are already focused on the forthcoming exit.
The noble Baroness, Lady Drake, asked about the Secondary Legislation Scrutiny Committee report saying that the powers could have been made available to the House before the debate. Unfortunately this was not possible because the FCA had given priority to making regulatory rules fit for purpose in a no-deal scenario, to avoid significant disruption of financial markets. It would also be unusual for the FCA policy to be ready prior to the passing of legislation to which it relates. She also asked about the scale of what was covered—
Lord Tunnicliffe
In my experience it is not unusual for enabling legislation to be accompanied certainly by draft regulations. Often the House has demanded that, to give it proper comfort that it is right to give those powers.
Lord Bates
We are not talking about the secondary legislation; we are talking about the statement—but I take on board the noble Lord’s point.
The noble Baroness, Lady Drake, asked how many firms would be directly impacted by the SI. The answer is approximately 3,300 UK firms and 1,650 EEA firms. The FCA estimates that changes to reporting requirements and IT processes will affect approximately 1,500 branches of EEA firms, and that this will result in a one-off cost to business of £8.75 million.
The noble Baroness, Lady Drake, asked whether the statement would be ready. We have said quite specifically that it will be ready at least four weeks before exit. On views expressed by stakeholders, the Treasury has engaged with a wide range of stakeholders, representing large international firms as well as smaller UK businesses.
The noble Lord, Lord Tunnicliffe, asked whether the SI makes policy changes. The UK is putting in place all necessary legislation via the EU withdrawal Act to ensure that there is a functioning legal regime in the event of a no-deal exit in March 2019. He asked whether the FCA will have adequate resources. I covered that point in response to the noble Baronesses, Lady Bowles and Lady Drake. He also asked about the temporary permissions regime that applies for a limited period and who would decide when it ends. The length of the temporary permissions regime is determined in accordance with the EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018, made on 6 November.
In a previous debate, the noble Lord, Lord Tunnicliffe, asked why the Treasury is solely responsible for the equivalence decisions, which relates to this debate. Across all financial services statutory instruments, the Commission’s functions are transferred to the Treasury. The transferral of equivalence powers is in keeping with this approach. Equivalence decisions are made by the issue of Treasury regulations. Regulations are issued by statutory instrument and subject to parliamentary scrutiny.
Again in a previous debate, the noble Baroness, Lady Bowles, asked whether the impact assessment is accurate given the cost to firms and how extensive MiFID is. The estimated costs of familiarisation have been calculated using the formula given at the end of the impact assessment and relate only to the cost of reading and understanding the instrument. Of course, affected firms will also need to familiarise themselves with a number of materials that are already published.
The noble Lord, Lord Tunnicliffe, asked a further question about whether temporary powers would water down MiFID II. The temporary powers are included to try to preserve outcomes for transparency. Without these flexibilities there would be a cliff-edge risk as to how the transparency regime operates. It would create uncertainty for firms and business, which we are trying to avoid.
With those responses, and the undertaking to study in detail the Official Report and to write on the specific questions raised, I beg to move.