Draft Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) (No. 2) Regulations 2019

Jonathan Reynolds Excerpts

Wednesday 23rd October 2019 General Committees

[Jonathan Reynolds (Stalybridge and Hyde) (Lab/Co-op)]

It is a pleasure to see you in the Chair, Mr Bailey. We have read out the title of this statutory instrument twice already, so I will exempt myself from that particular duty.

For the benefit of any new members of the Committee and for the record, my Opposition colleagues and I have strongly objected to the process of passing so-called no-deal SIs since it began a year ago. Secondary legislation is not an appropriate channel for the size and scope of the onshoring project that is being attempted, and does not allow time for the scrutiny that regulations of this magnitude demand. The fact that we are still, at this stage of the process, preparing for no deal is an indictment of the way the Government have handled these negotiations, which has left businesses and the City mired in uncertainty. However, we have had that debate in this room many times; the Minister knows my view, and I know his, so I will move on to the substance of the instrument.

As the Minister described, EMIR is a fundamental piece of pan-European financial markets regulation that emerged in the wake of the financial crisis and as part of a G20 commitment. It relates to building a more robust and transparent trading regime for the sale of over-the-counter derivatives, designed to protect against the type of systemic risk that worsened the freefall in markets after the collapse of Lehman Brothers by using an institution known as a central clearing counterparty.

Ongoing European co-operation is vital to the future stability and effectiveness of that regime, and the UK’s role as a European clearing hub is vital. In the past, our competitors have argued that clearing of euro-denominated instruments should take place in the eurozone, and it is clear that Frankfurt and Paris will continue to try to win clearing volume from London. Therefore, it is of the utmost importance that we get the ongoing regulatory framework right, not just to maintain our competitiveness, but because CCPs are so fundamental to the stability of the financial system across Europe. It is vital that the Government work to secure a more permanent form of recognition from the EU for the UK’s CCPs, for which the FCA has lobbied. Without that, we risk splitting liquidity and migration of contracts by EEA firms, which will be unable to use a UK CCP that is not formally recognised.

In preparing my comments on the instrument, some of the criticisms felt familiar. In particular, the Opposition have raised concerns in the past about the transition of powers from EU institutions to UK equivalents without properly considering the interaction between those institutions. A number of new powers to assess equivalence and recognition of third-country CCPs and trade repositories are being transferred to institutions including the Bank of England, Financial Conduct Authority and the Treasury. However, the relationship between the Bank of England and the FCA, for example, is not the same as that between the European Commission and the European Securities and Markets Authority.

The Opposition are concerned about this attempt to simply port across the Lamfalussy process of rule-making without considering whether it fits the framework that we have in this country. In addition, the secondary legislation process has been so piecemeal that it is challenging to scrutinise properly the allocation of powers to the different bodies. It is unclear how all these elements fit together and how extra responsibilities given to UK regulators will be accommodated in terms of resources.

By my count, this is the fifth statutory instrument that relates to central counterparty clearing, as the Minister mentioned. We were due to leave the EU in March 2019, so the fact that we are still porting across fundamental items of legislation tells us something.

The Minister said that the circumstances in Europe have materially changed, particularly the pension system. I would like him to clarify whether those changes form a new initiative on the European level. Perhaps the most interesting question I could ask is this: had we left in March 2019, would we still be making this change and essentially be choosing a form of voluntary alignment with single market regulations in the financial services sector?

Scrutiny of the instrument is challenging without a proper impact assessment. The explanatory memorandum states:

“An Impact Assessment has not been prepared for this instrument because, in line with Better Regulation guidance, HM Treasury considers that the net impact on businesses will be less than £5 million a year.”

That is a rather generous interpretation of the better regulation framework; it may well comply with the letter of the guidance, but it does not comply with the spirit. The political uncertainty we are in and the seriousness of these regulations mean that we need a proper impact assessment. Trillions of pounds-worth of trades are cleared through UK CCPs every year. We must be sure that we have assessed every possible outcome of change to the framework, particularly in a no-deal scenario in which markets will be volatile.

The FCA has been granted powers to suspend reporting obligations, with the agreement of the Treasury, for a period of up to one year in the event that no registered or recognised UK trade repository is available. Under that arrangement, the FCA will also be able to specify when, once the suspension ends, firms will be expected to report previous trades undertaken during the suspension period. That feels like a worrying step towards deregulation. Under what circumstances does the Treasury envisage that there will be such a cataclysmic failure that no trade repositories in the UK will be functioning? Is this requirement intended to apply solely to EEA firms operating here that are unable to use a UK trade repository because it has not been formally recognised by the EU?

If that is the case, surely the Government’s priority should be to ensure that that recognition process is formalised and given a degree of permanence, as the unavailability of a trade repository suggests that there would be extreme disruption. Equally, allowing the FCA simply to suspend regulations risks creating uncertainty. The value is in a consistent and reliable regulatory regime.

More broadly, I would like to ask the Minister to provide reassurance that the measures will not result in any lighter regulation in market infrastructure. The regulations are a central part of our G20 commitments to prevent the derivatives market ever again inflicting damage to the global economy on the scale of 2008. We must not allow any repeat of those disastrous events.

--- Later in debate ---

[John Glen]

Let me say at the outset that the instrument is needed to ensure that UK firms are able to make use of the new provisions included in EMIR REFIT and that EMIR will function appropriately after exit. Without the instrument, UK pension funds would be required to clear derivatives in a CCP, and that would come at a considerable cost to UK pension schemes and pensioners.

The instrument also ensures that the clearing suspension, a key financial stability tool, operates effectively in the UK. The hon. Member for Stalybridge and Hyde characteristically went through familiar arguments, stating his party’s position on the unsuitability of this process, and I will not go over that again. As he said, we both know where we are on that. He did make some specific points, which I will respectfully try to accommodate.

On the appropriateness of the transition of powers, the Bank of England will be given responsibility for suspending the clearing obligation in exceptional circumstances, with the consent of the Treasury. Both the Bank of England and the FCA will take on the responsibility to set certain binding technical standards that currently sit with ESMA. That is a widely understood common responsibility between them.

The SI does not give any new supervisory responsibilities to UK authorities. No new firms will be subject to supervision by UK supervisors due to the SI. National supervisors across the EU already have responsibility for supervising the users of uncleared derivatives and CCPs, and we are confident that the regulators are appropriately resourced for those roles.

The hon. Gentleman made a point about the wider framework. As he knows, a review is ongoing with respect to what we term air traffic control of regulations. There will be subsequent reviews of the configuration of powers between the Treasury, the FCA and the Bank of England, so the wider point that he made was a fair one, but that will be resolved hopefully after a deal is secured.

The hon. Member for Stalybridge and Hyde mentioned impact assessments. The Treasury has considered the impact of all its financial services SIs. I did not mention it before, but I am happy to say now that the impact of today’s SI was assessed to be below £5 million. When that is the case, Government policy is not to publish a full impact assessment. For previous exit SIs where the impact was assessed to above £5 million, impact assessments were published in advance and could be scrutinised.

The hon. Gentleman made some points about reassurance on the direction of travel of regulation. The context of the SI is that the UK’s pension regime relies on a higher number of defined benefit schemes than the rest of the EU. The way that those schemes need to interact with CCPs is unusual and different, so we have had an enduring dispensation not to participate in the same way. That is not a deregulatory effect, but because the pension schemes would have to hold a large amount of cash, which would be costly and uneconomic for them.

In essence, there has been enduring uncertainty around the conclusion of the process of resolution, but we have actively participated in it, given our historically different pension scheme arrangement. There is no desire not to observe the G20 Pittsburgh obligations on derivatives, and this is not some sort of deregulatory effort.

[Jonathan Reynolds]

It is an entirely reasonable observation that the UK pensions industry is structured differently and requires a different set of regulations and approach, but we have always known that. Is the Minister saying that, if we had not spotted this back then and left the European Union without passing the instrument, our regime would be deficient, or has something changed so that we now need to address it?

[John Glen]

Clearly, had we left on 31 March, the EMIR REFIT regulation would not have come in in July. What happened would have depended on the conditions under which we had left at the end of March and on whether we observed the changes naturally as part of the EU through a transition period, or if, in a no-deal circumstance, we used a different mechanism to consider ongoing legislation into which we had had some input but that was not quite finished. That is a bit of a difficult question to answer fully, but that is my understanding.