Draft Benchmarks (Amendment and Transitional Provision) (EU Exit) Regulations 2019

Anneliese Dodds Excerpts

Tuesday 19th February 2019 General Committees

[Anneliese Dodds (Oxford East) (Lab/Co-op)]

It is a pleasure to serve on the Committee with you in the Chair, Mr Gray. I am grateful to the Minister for his explanatory remarks.

Once again, the Minister and I are here to discuss a statutory instrument that makes provision for a regulatory framework after Brexit in the event that we crash out without a deal. On each of those occasions, I and my Labour Front Bench colleagues have spelled out our objections to the Government’s approach to secondary legislation. The volume of EU exit secondary legislation is deeply concerning for accountability and proper scrutiny. The Government have assured the Opposition that no policy decisions are being taken. However, establishing a regulatory framework inevitably involves matters of judgment and raises questions about resourcing and capacity.

Secondary legislation ought to be used only for technical, non-partisan, non-controversial changes because of the limited accountability it allows. Instead, the Government continue to push through far-reaching financial legislation via such vehicles. As legislators, we have to get it right. The regulations could represent real and substantive changes to the statute book and they need proper in-depth scrutiny. In that light, the Opposition would like to put on the record our deepest concerns that the process regarding the regulations is not as accessible and transparent as it should be.

I will now pose four questions to the Minister that I hope he will respond to in his later remarks. My first question concerns timing and the relationship between this SI and the legislation recently passed on in-flight financial services legislation. As the Minister referenced in his remarks, we are currently within a transitional period for the benchmarks regulation, with its coming fully into force only from the start of next year. Only after that point will there be an outlawing of benchmarks that have not been approved for use by one of the routes set out in the EU regulation. Why was the regulation not included within the in-flight process? It has clearly been agreed at EU level, but formally speaking is not yet implemented. I thought that such measures were covered by the in-flight process; hopefully, the Minister can illuminate me if I am wrong.

Secondly, I want to press the Minister on a detail related to the transitional period. The regulation, as with other SIs laid by the Government, provides for a system of deemed equivalence for the transitional period. Effectively, it suggests that EU27-approved benchmarks can be used in the UK and will be assumed to be equivalent, as if they had been examined by the UK’s regulator. However, there is a strange aspect to the regulation in relation to the process if an EU27 national competent authority decides to remove a benchmark or if an administrator is removed from the register, or if that is undertaken by the college of regulators that assesses critical benchmarks. This regulation states that even if such a benchmark, or a benchmark administrator, is removed in the EU27, it can still be maintained on the UK list during the transition period if

“the FCA considers that doing so would not be compatible with the FCA’s strategic objective or would have a material adverse effect on the advancement of the FCA’s operational objectives.”

That appears to be beyond the scope of the withdrawal agreement’s empowerments, because continued placement on a benchmark register, or a register for benchmark administrators, is not dependent on whether national competent authorities believe that is compatible with their objectives as regulators—it surely depends only on what is in the benchmark regulation that set out the criteria for the benchmarks to be approved. I do not really understand why such language has slipped into the UK regulation. Will the Minister explain?

Thirdly, I want to question the empowerments for the FCA within the regulation. It gives the FCA, with Treasury oversight, exclusive powers over critical benchmarks—a change that I will go on to talk about in a moment—but that is on top of all the other empowerments within the regulation that the Minister rightly referred to. The FCA will have to keep a register of benchmarks and benchmark administrators, develop a code of conduct and so on.

As I am sure Members are aware, there have already been questions about the FCA’s role in the enforcement of benchmark regulations. In 2017, the complaints commissioner partially upheld cases against the FCA brought by two former UBS traders caught up in the LIBOR-rigging scandal. The commissioner criticised the FCA for serious errors. Indeed, it has been commented that in some cases the junior traders have been the ones who face prosecution rather than those further up the food chain, who were well aware of what was going on. In that context, surely it is important for the FCA’s role to be properly scrutinised.

I want to focus on the arrangements for critical benchmarks, which, as I said, under EU law are undertaken by a college of national regulators under the overall overview of ESMA. This SI removes the UK from such arrangements, and places determinations on criticality entirely under the purview of the FCA, albeit it with reporting obligations to the Treasury. When making those determinations, the FCA must consider whether the benchmarks concerned pass certain thresholds of use. Will the Minister explain a little more about how that process would work? Will the FCA be able, within the time provided, to determine those benchmarks, given that the SI refers to the FCA’s having to review thresholds

“in the light of market, price and regulatory developments and the appropriateness of the classification of benchmarks with a total value of financial instruments, financial contracts, or investment funds referencing them that is close to the thresholds”?

We heard in relation to the markets in financial instruments directive and no-deal regulations that calculating thresholds would require up to four years. That came after a suggestion from Her Majesty’s Treasury that all that was needed for those no-deal preparations was a simple shift in roles and responsibilities from EU to UK actors. A number of us were sceptical about that claim, and we were proved right. Of course, the determination of thresholds for a relatively small set of benchmarks will be much less onerous than that for hundreds upon hundreds of commodities contracts, but some indication of the FCA’s view of the difficulty of the process, or otherwise, would be helpful.

There is likely to be a major shift in the use of critical benchmarks. Members will be aware of the LIBOR scandal, and arrangements for the reporting of interbank rates are changing. The Bank of England will not require banks to submit those rates beyond 2021, and it will therefore not be possible to calculate LIBOR anymore. A whole proliferation of critical benchmarks appear to be on the way, from the eurozone’s euro short-term rate, ESTER, to the UK’s reformed version of the sterling overnight index average, SONIA—they all have interesting acronyms—and some are obviously being developed by the US, Switzerland and Japan. That suggests that the process of assessing different benchmarks, especially critical benchmarks, could become quite onerous for the FCA, with a greater plurality of widely used benchmarks beyond LIBOR. It would be helpful to hear how and whether the FCA is prepared for such an eventuality.

On the point made by my hon. Friend the Member for Wallasey, the use of such benchmarks is incredibly widespread in terms of the people it would affect and the impact it might have on markets. Estimates of the use just of LIBOR vary from between $200 trillion to $370 trillion of financial contracts across the world, particularly with interest rates swap contracts, and the benchmarks are enormously important.

Finally, in regulation 5(9) the statutory instrument provides a definition of “commodity”. The definition seems fine, but I do not believe that it is in the EU benchmark circulation and it would be helpful to know why it has been provided. Is that because there is not the same inter-relationship with other pieces of no-deal legislation as there is with existing EU legislation? It would be helpful to know about that, and it is fine for the Minister to write to me on that point of detail.

--- Later in debate ---

[John Glen]

I am grateful to the hon. Members for Oxford East and for Wallasey for their scrutiny of this measure, and I shall endeavour to answer the points made.

On the general opening remarks of the hon. Member for Oxford East, all I can say to her is that the Government are not taking any powers beyond those that exist within the withdrawal Act. To the points made by the hon. Member for Wallasey, I say that there has been an attempt at every juncture to be thorough in the way that we have examined the optimal way to transition and onshore these powers, that we have engaged with industry and the regulator, and that we have done that with their consent and allowed scrutiny through that process, even in a condensed period.

I will now address the four points that the hon. Member for Oxford East raised. The first one was around the issue of the relationship with the in-flight files and the fact that there are ongoing challenges to this regulation, which is in the process, essentially, of being fully adopted.

There is a European supervisory authorities review file in the in-flight files Bill, but that is separate and additional to this onshoring process; the regulation is in force already, but it is in a transitional phase. Many requirements in the regulation already apply. It is simply the case that some benchmark administrators are not required to apply for authorisation until 2020. However, on the broader issue, if subsequently the ESA file that is in-flight then makes an EU-wide update, then—in a no-deal scenario—we would have to make that decision at a future point.

The second point that the hon. Lady raised was about deemed equivalence of the EU27. I responded to the hon. Member for Wallasey earlier with respect to the publicly available machine-to-machine software, to ensure that at the point of a no-deal moment—not what the Government expect—at the end of March, we would be completely up to date with decisions made across national competent authorities across the EU at that point.

The hon. Member for Oxford East referred in her remarks to a transition period. Well, we would not have that transition period in a no-deal situation, so it would not apply. I sense that she wants to intervene and I am very happy to give way.

[Anneliese Dodds]

I appreciate the Minister’s sincerity in trying to respond to my comments, and I apologise: I do not think I expressed myself clearly. I was referring to the fact that there could be a divergence between the benchmarks still approved in the UK during the 24-month period—I probably used the wrong language to describe that—and what applies in the EU27, because this regulation says that a benchmark can be retained in the UK even if it is not in the EU27, if the FCA considers that taking it off would not be compatible with its strategic objective and so on.

[John Glen]

On the maintenance of benchmarks if they have been dropped from the ESMA register, I was going on to say that this SI enables the FCA to exercise judgment. It does not have to follow ESMA decisions. The FCA objectives are in place to protect UK markets and consumers. In a no-deal situation, that is a function that the FCA would have to take on.

I have set out the transition mechanism for decisions that have already been made, but in a no-deal situation we would absolutely face a very challenging environment. I am sympathetic to the comments of the hon. Member for Wallasey about the resourcing of the FCA in that situation; it would be significant. In this corpus of 53 SIs, I am concerned about making the transition process clear. There would be a lot of legislation to pass and work to be done in a no-deal situation subsequent to this process.

[Anneliese Dodds]

I know that the Minister and his officials are doing the best they possibly can in the extremely difficult situation that they should not have been put in, but I want to press him on this. These regulations are described as putting into practice the EU benchmark regulation; they are not described as dealing with any eventualities that could come out of no deal. In that situation, surely if we are just following the EU benchmark regulation, we should use the criteria that ESMA uses on benchmarks, not other criteria for the FCA’s objectives. That falls outside the scope of these regulations.

[John Glen]

I think, with the greatest respect, that the hon. Lady is getting two things muddled up. At this point, we are onshoring what already exists. We have a 24-month transition period during which, in a no-deal situation, there would be considerable engagement with industry and regulators about how we would adopt the criteria as a national body independent of the European supervisory authorities. If we were in that situation, we would clearly need to develop a new framework altogether for regulation. How we would harmonise with other bodies outside the UK would depend on the basis of that no deal. If the hon. Lady is asking me whether I am setting out in this SI a comprehensive regime for an independent verification of benchmarks over the next two years in a no-deal situation, I should say that no, I am not.

[Ms Eagle]

It is difficult to think of scenarios that we hope will not happen. We all hope that at some stage sense will break out and there will be time to do this disentangling. Will the Minister reassure me that if there is no deal, the regime that these changes will put in place will be in place the day after no deal, and that there will not be large numbers of loopholes through which very rapid trading, which can be instantaneous, can occur, leading to huge profiteering?

[Anneliese Dodds]

rose—

[John Glen]

I am happy to give way to the hon. Lady.

[Anneliese Dodds]

The Minister is being enormously generous in giving way. I appreciate his comments, but I would like this put on the record. What I take from his remarks is that these regulations are hybrid. They are not just about onshoring the existing regime, because if they were they would not include the reference to the FCA deciding on these matters because of its strategic objectives. Rather, they are partially about the creation of a new regime. As such, they depart from what is allegedly the template for these regulations.

[John Glen]

I am grateful for both points. I will first respond to the hon. Member for Wallasey. I assure her that the regulation will onshore and will not create any cliff-edge risks around the loopholes that she refers to. We have worked very closely with the FCA, which provides the technical expertise. I will address her point about the resourcing of the FCA in a moment.

For the record, I do not accept the characterisation of hon. Member for Oxford East of the regulations as hybrid. In a no-deal situation, there would need to be a lot of extra work to create a new permanent regime. In terms of the divergence between the UK and the EU27, the FCA will not necessarily know why a benchmark has been removed from the ESMA register after exit. It is therefore prudent to give the FCA the discretion to make its own assessment so it is able to protect UK markets and consumers. In a no-deal situation, we would be in a world very different from the one we are used to and we take the view that the provision fixes a deficiency caused by our withdrawal.

The hon. Member for Wallasey raised the importance of the benchmarks being regulated, and I absolutely agree. The SI will ensure that the regulatory regime in the UK will operate effectively in a no-deal scenario. I reassure her that the SIs in the programme have passed through the usual quality control procedures and we have engaged extensively with the FCA in drafting them.

Based on my earlier comments about the additional full-time equivalents that the FCA has had this year in preparing effectively to manage the programme, I am confident that it has adequate resources. Regarding the future pressure, the FCA is not funded by the Government but by a levy on industry, so it will be up to the authority to bring that forward in its plan, which it will do shortly for 2019-20.

I note the observations about the familiarisation costs and the mechanism to calculate them. To be clear, the SI has been assessed to result in an estimated one-off familiarisation cost of £8,300, which, shared between the 16 UK benchmark administrators authorised under the regulations, is £518 each.