Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2020

Baroness Penn Excerpts

Thursday 18th June 2020 Lords Chamber

Moved by

[Baroness Penn]

That the draft Regulations laid before the House on 24 March be approved.

[Baroness Penn (Con)]

My Lords, your Lordships will be aware that, since July 2018, HM Treasury has put in place legislation, using powers under the European Union (Withdrawal) Act 2018, as amended by the European Union (Withdrawal) Act 2020, to ensure that the UK has an independent and coherent financial services regulatory regime at the end of this year when the UK leaves the transition period. This SI is part of that programme of work, and the approach aligns with the general approach established by the EU (Withdrawal) Act 2018, providing continuity by retaining existing legislation at the end of the transition period, but amending where necessary to ensure that it continues to function and is effective in a UK-only context.

The SI makes deficiency fixes to a new piece of EU legislation that has recently become applicable relating to the European market infrastructure regulation, hereafter referred to as EMIR. EMIR implemented the G20 Pittsburgh commitments, agreed in the aftermath of the financial crisis in 2009, regulating over-the-counter derivative markets and, in particular, requiring some derivatives to be cleared in a central counterparty, known as a CCP, to manage risk between users of derivative products. EMIR has been effective in increasing the safety and transparency of derivatives markets, thereby reducing the associated risks users may face. UK CCPs play an essential role in reducing systemic risk and ensuring the efficient functioning of global financial markets. Parliament has previously approved several EU exit instruments to ensure that EMIR continues to function at the point of the UK’s withdrawal from the EU.

EMIR was updated by a regulation known as EMIR 2.2 on 1 January this year. This regulation modifies the third-country, or non-EU, CCP supervision framework so that EU authorities have greater oversight over third-country CCPs that are systemically important to the EU. Most of these changes are made to the recognition framework for CCPs outside the EU. Each CCP has to be individually recognised by the European Securities and Markets Authority, known as ESMA.

The Bank of England has already been given the power to recognise non-UK CCPs wishing to operate in the UK via an earlier SI under the EUWA. Because this recognition framework has now been updated, this SI transfers ESMA’s new powers to the Bank of England. That means that the Bank of England will have the power to tier non-UK CCPs according to their systemic importance to the UK. Under the tiering system, tier 1 CCPs will continue to be supervised by their home regulator alone, while systemic CCPs will be recognised as tier 2 and expected to comply with certain requirements in UK EMIR. The power to supervise tier 2 CCPs has also been transferred from ESMA to the Bank. Where a CCP is subject to the supervision of the Bank of England, this SI extends parts of the current supervisory framework for UK CCPs to non-UK CCPs. This is appropriate as this supervisory framework is working effectively in the UK already, and largely mirrors the powers that ESMA will have. For example, both ESMA and the Bank will have the power to issue fines.

EMIR 2.2 also empowers the Commission to adopt delegated acts to specify how the framework will function in practice. This includes tiering, but also how the UK supervisor’s deference to the rules of the non-UK CCPs’ home authorities, referred to as “comparable compliance”, will function. This SI transfers the power to establish those frameworks to the Bank of England. The Bank has existing responsibilities for safeguarding financial stability in general, and managing systemic risk in CCPs in particular. It is therefore appropriate that the Bank can establish the details of the framework to manage the systemic risk posed by some non-UK CCPs in a way appropriate for the UK.

The remaining functions of the Commission are transferred to Her Majesty’s Treasury through this SI. This includes the so-called location policy. Under EMIR 2.2, ESMA can recommend to the Commission that a third-country CCP that is felt to be “substantially systemically important” cannot offer some services to EU clearing members unless those services are offered from inside the EU. The UK did not support the inclusion of this location policy during the negotiation of EMIR 2.2, due to concerns that it could lead to market fragmentation and reduce the benefits provided by the global nature of clearing. However, the powers in the EUWA, under which we are making this SI, extend only to addressing deficiencies arising from withdrawal, and commitments were made during the passage of the Bill that the power would not be used to make significant policy changes.

Therefore, this instrument transfers the power to use the location policy to Her Majesty’s Treasury via a negative regulation, subject to advice from the Bank of England, and appropriate procedural safeguards and transitional provisions. However, I can assure the House that it is hard to foresee a circumstance in which using the location policy would be effective in supporting financial stability in the UK. The UK clearing market sees a large proportion of clearing occur in UK CCPs; it is therefore unlikely to be appropriate ever to use this tool in practice.

EMIR 2.2 also makes changes to the internal EU supervisory and co-operation mechanisms, including creating a CCP supervisory committee inside ESMA and increasing responsibility for EU supervisory colleges. As the UK is no longer part of the EU, these provisions are removed by this instrument.

Finally, the instrument updates the recognition powers set out in the temporary recognition regime. This regime was established by a previous SI to enable non-UK CCPs to continue their activities in the UK while their recognition applications are assessed. This SI updates the recognition requirements in line with the new EMIR 2.2 provisions, helping to provide certainty for non-UK CCPs regarding their recognition within the UK market during the transition period.

The Treasury has worked closely with the Bank of England to prepare this instrument and has engaged with the financial services industry. The draft legislation has been publicly available on the legislation.gov.uk website since 24 February to maximise transparency to Parliament and industry, and the instrument was laid before Parliament on 25 March.

In summary, this instrument will ensure that the UK’s regulatory framework will continue to function effectively in the UK at the end of the transition period. Without an operable regime, the UK’s ability to regulate the financial sector effectively, and manage the financial stability risks posed by some of the largest non-UK CCPs, will be compromised. I hope noble Lords will join me in supporting these regulations. I beg to move.

--- Later in debate ---

[Baroness Penn]

As noble Lords have noted, this is quite a technical debate, and I will do my best to address the points that they have raised. I defer to their greater experience in previous roles, potentially having made some of these regulations as Members of the European Parliament and, as Members of this House, having taken through a large proportion of the regulations in the process of onboarding our financial services regulations in preparation for leaving the EU.

Several noble Lords raised the question of the new responsibilities that this SI gives the Bank of England as the regulator versus the powers that will, for example, come back to Her Majesty’s Treasury. The Bank’s new responsibilities are consistent with its existing responsibility for safeguarding financial stability in general and for managing systemic risks in CCPs in particular. Responsibility for recognising non-UK CCPs was transferred from ESMA to the Bank of England in a previous SI, and EMIR 2.2, which this SI translates into UK law ready for Brexit, transfers the responsibilities for tiering non-UK CCPs in the recognition process.

The Bank has been given two new supervisory powers over tier 2 non-UK CCPs through the extension of the existing supervisory framework and tools that apply in the UK. To ensure that the Bank can fulfil its supervisory obligations, it will be able to sign a memorandum of understanding with non-UK competent authorities of a recognised CCP. The Bank will also have the power to set further technical standards to specify the tiering criteria and establish a framework that allows for comparable compliance where the framework that a non-UK CCP operates under is recognised as comparable to the one that we have in the UK and is therefore satisfactory for regulatory purposes. These powers are going to the Bank rather than to the Treasury because of the Bank’s existing responsibilities for safeguarding financial stability and managing systemic risk in CCPs.

The question of the resources for the Bank to fulfil its obligations was raised by several noble Lords. We are confident that the Bank has made adequate preparations and is effectively allocating resources in order to manage its new responsibilities. Furthermore, it has already been assigned the ability to levy fees to fund the responsibilities arising from its role in relation to non-UK CCPs.

My noble friend Lord Wei asked about the Bank giving away the powers that it will receive under this statutory instrument. It will not be able to give away these powers; it will only be able to enter into supervisory co-operation agreements to manage how it uses those powers in practice.

Several noble Lords asked how we are progressing with the assessment of equivalence. As they noted, there was a commitment in the political declaration to undertake equivalence assessments by the end of June. We are working hard and are focused on fulfilling our obligations and commitment to conclude those assessments. I am afraid that I cannot expand further than that.

As I said, this is a very technical SI to move regulation from the EU to the UK in preparation for the end of the transition period, but several noble Lords asked what the prospects of the further politicisation of this process might be—in particular, with regard to the use of the location policy, about which concerns have been expressed. The UK regards the politicisation of financial services as being in no one’s interests. The financial stability that underpins our and the EU’s economies depends on trust and predictability in regulatory matters. What is more, the potential use of the location policy could result in the fragmentation of the clearing market, which, again, would undermine financial stability and increase costs for those involved.

The noble Lord, Lord German, asked what deal the Government are referring to in their Explanatory Memorandum. The deal is the withdrawal agreement, which this House and the House of Commons have spent a significant amount of time debating and agreeing, and which of course was endorsed by Parliament in January this year.

Several noble Lords asked about parliamentary scrutiny of the powers transferred under this SI. Of course, Parliament has several ways in which to scrutinise both the Government and the Bank of England—through Ministers appearing in this Chamber and through Select Committees.

The noble Baroness, Lady Kramer, asked about the use of the location policy, which I believe I have covered. We have brought in the power to use the location policy but have no intention of doing so.

That brings me to a question asked by several noble Lords—whether, through this SI or the broader process, we would lower our standards. This SI is intended simply to transfer EU powers into UK legislation and to amend any deficiencies that might arise through that process. Therefore, it does not diminish any regulation of the sector, and in fact it provides further protection for consumers by bringing into UK law protections that have been provided for through EU regulation.

The noble Lord, Lord Tunnicliffe, asked how many further SIs we might expect under this process. As he noted, the number is partly dependent on files that might come from the EU Commission during the rest of this year while we remain in the transition period. Therefore, I cannot give him a specific number but I hope I can reassure him that it will be much lower than the number we have seen so far during this process of bringing EU regulation into the UK system.

I do not believe that I have covered all the points raised by noble Lords and I hope that they will forgive me if I write to them on the outstanding matters. To conclude, this instrument is necessary to ensure that existing EMIR legislation continues to function effectively in the UK from the end of the transition period following the updates made by EMIR 2.2. In particular, it will ensure that the UK has an enhanced recognition regime, with the tools necessary to manage the financial stability risks posed by some of the largest non-UK CCPs. I hope that the House has found this afternoon’s debate informative and that it will join me in supporting these regulations.

Motion agreed.