Draft Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, Etc., and Transitional Provision) (EU Exit) Regulations 2018
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The Economic Secretary to the Treasury (John Glen)
I beg to move,
That the Committee has considered the draft Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018.
It is a pleasure to serve under your chairmanship, Sir David. As part of our contingency preparations for a no-deal scenario, the Treasury has been undertaking a programme of legislation to ensure that if the UK leaves the EU without a deal or an implementation period, there will continue to be a functioning legislative and regulatory regime for financial services in the UK. To deliver that, we are laying statutory instruments before the House under the European Union (Withdrawal) Act 2018. A number of those instruments have already been debated in this place and in the House of Lords. The draft regulations are part of that programme.
The draft regulations will fix deficiencies in UK law to ensure that regulations on over the counter derivatives, central counterparties and trade repositories continue to operate effectively post exit, following an approach that aligns with that of other instruments laid under the 2018 Act: providing continuity by maintaining existing legislation at the point of exit, but amending it where necessary to ensure that it works effectively in a no-deal context. They are the last of three sets of regulations to address deficiencies in the European market infrastructure regulation—EMIR—and ensure that an effective regulatory framework is in place for over the counter derivatives, central counterparties and trade repositories in a no-deal scenario. They follow two instruments that have already been debated and made: the Central Counterparties (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018 and the Trade Repositories (Amendment and Transitional Provision) (EU Exit) Regulations 2018.
EMIR is Europe’s response to the G20 Pittsburgh commitment made in 2009 to regulate over the counter derivative markets in the aftermath of the financial crisis. It imposes requirements on all types and sizes of entities that enter into any form of derivative contract, including those not involved in financial services, and establishes common organisational, conduct-of-business and prudential standards for central counterparties and trade repositories. It places three main requirements on entities that enter into any form of derivative contract: reporting to a trade repository every derivative contract that they enter into, implementing new risk mitigation standards for uncleared derivative contracts, and clearing through a central counterparty those over the counter derivatives that are subject to a mandatory clearing obligation.
A derivative is a financial contract linked to the fluctuations in the price of an underlying asset or basket of assets. Common examples of assets on which a derivative contract can be written include interest rates instruments, equities and commodities. Over the counter derivatives, which make up the vast majority of the derivatives market, are derivatives that are privately negotiated and not traded on an exchange. Central counterparties stand between counterparties in financial contracts, becoming the buyer to every seller and the seller to every buyer. By guaranteeing the terms of a trade, even if one party defaults on the agreement, they reduce counterparty risk. Trade repositories centrally collect and maintain the records of derivatives and play a key role in enhancing the transparency of derivative markets and reducing risks to financial stability.
In a no-deal scenario, the UK would be outside the European economic area and outside the EU’s legal, supervisory and financial regulatory framework. The draft regulations will therefore address deficiencies in EMIR and related UK legislation to ensure that the UK continues to have an effective regulatory framework for over the counter derivatives, central counterparties and trade repositories in a no-deal scenario.
First, they will provide for a continuation of the key requirements set out in EMIR and transfer the relevant EU functions to UK authorities, ensuring that the UK remains compliant with its G20 commitments and maintains a safe and transparent derivatives market. Those requirements include the clearing obligation—the requirement that certain derivatives contracts be cleared through authorised or recognised central counterparties—and the reporting obligation, which is the requirement that firms report details of their trades to an authorised or recognised trade repository. They also include the margin requirements—the provisions in EMIR that dictate that derivative contracts not cleared through a central counterparty should be subject to higher margin requirements.
The margin requirement compels firms to put forward money to cover the costs associated with trades. To have a framework in place to facilitate these requirements, the relevant functions are transferred from the European Securities and Markets Authority to the UK regulators, namely the Financial Conduct Authority, the Prudential Regulation Authority and the Bank of England.
The responsibility for drafting binding technical standards relevant to EMIR is also transferred to UK regulators. The Bank of England will take responsibility for specifying which classes of over the counter derivatives should be subject to the clearing obligation, and will set the phasing in of new clearing obligations for firms regulated by the PRA, with the FCA setting the phasing in for all other firms. The FCA will assume new supervision and enforcement powers for UK trade repositories and the ability to suspend the reporting obligation for firms for up to a year, in the unlikely scenario where no trade repository services are available. The PRA will take on the function of specifying the over the counter derivative margin requirements for those financial counterparties that are authorised by the PRA, with the FCA responsible for setting the requirements for all other cases.
Secondly, the draft regulations transfer the power of granting equivalence decisions for non-UK trade repositories from the European Commission to the Treasury, and transfer functions for recognising non-UK trade repositories from ESMA to the FCA. They also remove from the equivalence process the requirement for an international data agreement, to take into account the UK position outside the EU financial services framework.
Thirdly, the draft regulations create a temporary intra-group exemption regime. Under EMIR, intra-group exemptions may be granted to allow parts of corporate groups to be exempt from the clearing obligation and certain requirements of the risk management obligations, such as the margin requirements, when trading with each other. In a no-deal scenario, after exit day certain cross-border exemptions granted before exit day will no longer apply to the UK. The regime will ensure that intra-group transactions that are exempt from the EMIR requirements before exit day or currently will continue to be so after exit day, to avoid any unintended additional cost and burden on UK firms. The regime will last three years from exit day to allow time for the FCA to determine a permanent exemption, and can be extended by the Treasury if necessary. Under the MiFID II—the second markets in financial instruments directive—legislation, there is an exemption from clearing and margining for certain energy derivative contracts and this exemption is maintained in the draft regulations.
Finally, changes are made to ensure that redundant EU processes that will no longer apply after exit, are removed and replaced with relevant UK processes. Under EMIR, EU trade repositories are authorised and supervised by ESMA and follow the EU's processes of appeal. However, following the transfer of functions from the trade repositories SI, it will be the FCA rather than ESMA who will authorise and supervise trade repositories operating in the UK after exit. EU central counterparties are supervised by colleges, which are groups of EEA regulators that oversee the jurisdiction in which central counterparties and their members are based. After exit day, the UK will be independent from EU jurisdiction and will no longer be required to comply with the EU college system; that regulatory oversight will instead be provided by the Bank of England.
Provisions relating to obligations of member states to share information with ESMA will also be omitted as after exit the UK will no longer be part of the EU supervisory framework. That will not preclude the regulators co-operating with each other in future, as appropriate.
The Treasury has been working closely with the FCA, the Bank of England and industry bodies. The statutory instrument was published in draft form, with an explanatory policy note on 5 December 2018, to maximise transparency to Parliament, industry and the public ahead of laying. Regulators and industry bodies have generally been supportive of, and welcomed, the provisions in this SI. The Government believe that the proposed legislation is essential for ensuring the UK continues to have an effective regulatory framework for over the counter derivatives, central counterparties and trade repositories if the UK leaves the EU without a deal or an implementation period. I hope that colleagues will join me in supporting the draft regulations and I commend them to the Committee.
John Glen
I thank the hon. Members for Oxford East, for Aberdeen North and for Garston and Halewood for their clear questioning. I shall try very hard to answer the points raised.
I hear the frustration on the volume and the time that this scrutiny process is taking. All of the 63 statutory instruments we are bringing forward are under the terms of the European Union (Withdrawal) Act that we have previously debated.
The hon. Member for Aberdeen North referred to the issue of equivalence and what would happen with respect to the EU’s assessment of the UK. Clearly we cannot determine that unilaterally. We have as deep a dialogue as we can, but these are provisions for no deal. We have sought to engage deeply with the industry and all the different industry players to achieve an outcome that is as optimal as can be in the circumstances. That is why I put on record my absolute commitment to ensuring that we get a deal. I feel very keenly the frustration of the speeches on the process, and I acknowledge that it is not as it would be under normal circumstances.
In terms of the consultation with industry, we have engaged with stakeholders, including the financial services industry, while drafting the SIs. They are strictly limited by the enabling power, and therefore have limited policy choices within them. In some of the areas I cannot go further than what I said in my opening remarks, which is that we are transferring things over and dealing with deficiencies. However, I shall in a moment address the points raised.
We published a document in June, which set out the approach. We have been publishing draft legislation in advance of laying it to maximise transparency, and securing industry knowledge from TheCityUK and others along the way. We discuss EU exit preparations regularly with industry, which has helped us to understand the impact of the SI. We shared a draft version of the SI to allow stakeholders to familiarise themselves with aspects of it.
As to the key question raised in all three Opposition speeches, about impact assessment, I am conscious of the need to publish the relevant impact assessments as soon as possible and want to reassure the Committee that I am doing everything I can to make that happen. I met officials last week and this morning to try to expedite that and complete the necessary clearance processes. We will publish it as soon as possible.
Maria Eagle
Why does the explanatory memorandum say that it has been published?
John Glen
Because at the time it was printed it was anticipated that it would have been published by then.
As ever, I must stress that some firms would incur some costs adjusting to the changes made by the SIs, if they come into effect, but those costs are significantly outweighed by the benefit that is provided by ensuring that the legislation transferred by the European Union (Withdrawal) Act operates effectively after exit. Without the amendments made by the SIs firms would face far greater disruption to their businesses.
Anneliese Dodds
The Minister is being generous with his time and none of us doubts his commitment to ensuring that the process works properly, but will he enlighten us as to the blockages that are preventing that? Is it a matter of resources or policy issues that have to be dealt with? It would be helpful for us to understand, because although it is wonderful to hear he is trying so hard to get it sorted out, the Committee needs more.
John Glen
I am happy to give clarification. Essentially the process of gaining approval for the impact assessment demands that we share certain information and provide it in an adequate form. Because of the unusual nature of the process and the volume of material, it is difficult to line up. As I said to the hon. Lady in the last Committee in which we served opposite each other, we submitted a group of SIs together, and are working as hard as we can to resolve that.
As Miles Celic, the chief executive of TheCityUK, said in a letter in November, these are exceptional circumstances, which require a unique response. We are doing everything to reach that, but I would not want the process to be truncated. We have not yet had an impact assessment that does not give us a green rating, and I want to make sure that that is how things will end up. However, I fully accept that the situation is not an optimal one. I take on board the observations of all three hon. Ladies, and all that I can say is that I am doing everything I can. I understand that that is inadequate in itself, and wish I could give a date, but it is not possible.
Maria Eagle
Given that it has not proved possible to do what the explanatory memorandum says has been done, why has not the Minister republished and corrected it?
John Glen
Because I wanted the opportunity to explain face to face in the Committee and, given the need to secure the SIs for industry, as I made clear in the quotation from TheCityUK, it is not the perfect process. [Interruption.] I understand the point that the hon. Lady makes but I think I have responded to it as reasonably as I can.
Kirsty Blackman
Lastly, although the Minister has not said it, it appears to me that the issue might be with the Regulatory Policy Committee not getting through the impact assessments that are sent to it. Given that we are going to have an awful lot of SIs and, presumably, an awful lot of impact assessments, that is likely to become more of a problem. Is it necessary for the assessment to go to the Regulatory Policy Committee? Is there a way we could see it without it going to the RPC?
John Glen
The responsibility rests ultimately with me and my officials, and I have to take it on board. It is for me to be accountable for the impact assessments—I am not blaming anyone else. I will continue to do everything I can over the coming hours and days.
The hon. Lady mentioned impact. The draft regulations will not place new regulatory burdens on UK firms. We expect a one-off familiarisation cost for legal experts to examine the draft regulations, which we estimate will have an impact on just over 400 firms and cost £350,000 in total.
The regulatory requirements for trade repositories as defined in title VII of EMIR, will remain largely unchanged. The FCA has been given the power to supervise trade repositories against those requirements, but it has been in close engagement with trade repositories to ensure that their transition is as smooth as possible. Trade repositories will have to familiarise themselves with changes to the supervision and enforcement procedures under the UK regime, but we do not anticipate that that will be burdensome or that the familiarisation costs will be high.
The hon. Member for Oxford East asked how likely the FCA is to use the power to suspend the reporting obligation. It is almost certain that it will not need to use that power because the trade repositories regulations enable it to process advance applications for new trade repositories, or convert authorisations for existing UK trade repositories, to ensure that the UK has operational trade repositories from exit day.
Sir John Hayes (South Holland and The Deepings) (Con)
As I read it, part 2 makes it clear that, should the obligations be suspended, the FCA will retain the power to decide when any trades conducted through the period of suspension are made known. The a priori assumption that businesses should retain information and be willing to report it during the period of suspension provides considerable reassurance.
John Glen
I concur.
The hon. Member for Oxford East asked whether the regulator has adequate resources to cope with its new powers to supervise trade repositories. The Treasury has worked closely with the regulator to prepare the legislation, and we are confident that it is making adequate preparations ahead of exit day and that it has the resources to manage its task. I should point out that, at the end of December 2018, the FCA had a total of 158 full-time employees working on Brexit—an increase from 28 in March 2018. It will publish its 2019-20 plan in the spring, setting out its work for the coming year. When I met Andrew Bailey, head of the FCA, for an hour last week, he did not raise the matter—he has the resources in place.
The hon. Lady asked what would happen in a scenario in which the Treasury provided a temporary regime for intra-group transactions that was not reciprocated by the EU. The Government can address only deficiencies in UK firms, not the issues for EU-based entities—that is why we want to get a deal and get the equivalence process signed off six months before the end of the implementation period, as was set out in the political declaration. The Commission has adopted a temporary equivalence decision for UK CCPs, and in the central counterparties regulations we put in place a reciprocal temporary recognition regime in the UK for EU CCPs.
The hon. Member for Garston and Halewood made a point about the publication of appropriate documents for the Committee. I can only apologise to her. I will examine immediately whether our approach needs to change.
The hon. Member for Oxford East asked why the EMIR provisions on trade repository appeals, fines, supervisory fees and penalties are being replaced with provisions in the Financial Services and Markets Act. The current EU provisions on those matters will no longer be effective under a UK regime, so it is appropriate to replace them. The FSMA provisions that currently apply to FCA supervision of authorised persons will be applied, with appropriate modifications, to its supervision of trade repositories. The new provisions on trade repositories will be equivalent to those to which they are currently subject.
The hon. Member for Aberdeen North asked whether the draft regulations will apply in a no-deal scenario only. This legislation is being implemented to ensure that in the event of no deal we have a fully functioning regime. It will not come into effect in March 2019 in the event of an implementation period on securing a deal, which would be delivered through a separate piece of legislation—the EU withdrawal agreement Bill. However, it could be amended to reflect an eventual deal on the future relationship or a no-deal scenario at the end of the implementation period.
I think I have dealt with all the points raised. I believe that the draft regulations are essential to ensuring that the UK continues to have an effective framework in place for over the counter derivatives, central counterparties and trade repositories if the UK leaves the EU without a deal or an implementation period. I hope the Committee has found this afternoon’s sitting informative and will support the draft regulations.
Question put and agreed to.
Resolved,
That the Committee has considered the draft Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018.