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

Lord Bethell Excerpts

Tuesday 1st October 2019 Lords Chamber

Moved by

[Lord Bethell]

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

[Lord Bethell (Con)]

As the House will be aware, the Government had previously made all necessary legislation, under the EU withdrawal Act, to ensure that, in the event of a no-deal exit on 29 March 2019, there was a functioning legal and regulatory regime for financial services from day one. Following the extension to the Article 50 process, new EU legislation will become applicable before 31 October and, under the EU withdrawal Act, this new legislation will form part of UK law at exit. Further deficiency fixes are therefore necessary to ensure that the UK’s regulatory regime remains prepared for exit. The approach taken in this instrument aligns with those financial services exit statutory instruments already approved by Parliament, providing continuity by maintaining existing legislation at the point of exit, but amending where necessary to ensure that it works effectively after exit.

I shall turn to the substance of the instrument. The European Markets Infrastructure Regulation, usually referred to as EMIR, implements the G20 Pittsburgh commitment from 2009 to regulate over-the-counter derivative markets in the aftermath of the financial crisis. EMIR was reviewed by the European Commission in 2015-16, resulting in an update known as EMIR REFIT. EMIR REFIT makes a series of technical changes so that the framework for over-the-counter derivatives, usually referred to as OTC derivatives, applies in a more proportionate way. EMIR REFIT focuses on users of OTC derivatives. It does not make significant changes to the rules for central counter- parties—CCPs. In particular, it provides exemptions from the requirement to clear trades in those derivatives through a CCP, because clearing is not always appropriate for all firms.

As the House will be aware, earlier EU exit legislation was used to address deficiencies in EMIR, as it will form part of UK law at exit. This instrument addresses new deficiencies which will arise as a result of the recent amendments made to EU legislation by EMIR REFIT, which came into force on 17 June 2019. After exit, the UK would be outside the EEA and outside the EU’s legal and supervisory framework for financial services. The EMIR framework that will form part of UK law at exit therefore needs to be updated to ensure that these new provisions continue to work effectively.

This instrument will ensure continuation of the new provisions introduced in EMIR REFIT and will transfer new EU functions to the appropriate UK authorities. Many provisions in EMIR REFIT will continue to work effectively at exit without significant amendments—for example, the exemption for small financial counterparties from the requirement to clear trades through a CCP.

However, there are two key deficiency fixes in this instrument which are necessary to ensure that EMIR REFIT is workable in a UK context. First, this instrument ensures that UK pension schemes will continue to be the exempt from the requirement to clear trades through a CCP. This is an important provision for industry and consumers; an exemption for pension schemes is needed because there is currently no approach to clearing that works without subjecting pension schemes to disproportionate cost, particularly the requirement to pay margin to the CCP. These additional costs would ultimately undermine the ability of pension funds to meet their obligations to pension holders. In the EU, EMIR REFIT currently includes a pension scheme clearing exemption which will last anywhere between two and four years. This instrument provides greater certainty and stability by ensuring that there is no ambiguity about the length of the extension. That extension will now last the full four years in the UK.

This fix is appropriate given the size and nature of the UK pension schemes, the vital role they play in pension provision and their crucial position as long-term investors in the UK economy. This instrument will provide the time to find a solution which balances the interests of pension schemes and CCPs, which will be particularly challenging in the UK context. The instrument enables the Treasury to extend the pension scheme exemption further, for up to two years at a time, if no appropriate solution for the UK market has been found. It also ensures that EEA pension schemes will continue to be exempted in the UK. This means that UK banks will still be able to trade derivatives with EEA pension schemes without using a CCP. Her Majesty’s Treasury committed to this action on 21 February to avoid disruption to UK businesses offering derivatives to EEA pension schemes.

Secondly, the instrument transfers the function to suspend the clearing obligation from the European Securities and Markets Authority and the European Commission to the Bank of England. In EMIR REFIT, ESMA can recommend that the European Commission suspend the clearing obligation in three-month increments for up to 12 months. We believe that the Bank of England is the most appropriate UK authority for this function, in line with the responsibilities that Parliament has already conferred on the Bank for financial stability and CCP supervision. The Bank of England must secure the consent of Her Majesty’s Treasury and inform the Financial Conduct Authority if it needs to suspend the clearing obligation in the UK. The Bank may decide to issue a suspension lasting for any period up to 12 months. Such flexibility will enable the Bank to reduce uncertainty for globally significant clearing members and clients based in the UK in the unlikely event that a suspension is necessary. Finally, this instrument ensures that all references to EMIR are up to date on exit day so that references in UK legislation after that point will refer to the right version.

The Treasury has been working closely with the Bank of England and the Financial Conduct Authority to prepare this instrument. We have also engaged the financial services industry extensively on it. The Treasury published the instrument in draft on 24 July ahead of the Summer Recess, to maximise transparency to Parliament and industry.

This legislation is necessary to ensure that EMIR legislation continues to function effectively in the UK from exit. In particular, it will ensure that UK firms are able to use the new provisions on proportionality introduced by EMIR REFIT, and that the Bank of England is able to take necessary action to safeguard financial stability where necessary. I hope that your Lordships will join me in supporting these regulations. I beg to move.

[Baroness Bowles of Berkhamsted (LD)]

My Lords, I must declare my interest as a director of the London Stock Exchange plc and Prime Collaterised Securities ASBL, as these measures may affect parts of the businesses with which I am involved. As I am sure many noble Lords already know, I also have a personal affinity with these matters having either negotiated them or left them on my to-do list for the European Commission when I ceased to be chair of the Committee on Economic and Monetary Affairs.

On the OTC derivatives and, in particular, the pension funds exemption, I can add a little history. It was a UK issue that came up rather late in the day, so it had to be pulled out of my magic negotiating bag during trialogues to fix it; and because it was a UK issue, there were not necessarily a lot of people who wanted to fix it. One thing that helped me on my way was that I managed to mobilise the defined benefit pension funds that had been taken over by German businesses when they took over some of the car industry. They suddenly decided that they had a workforce that might be concerned. That is just one of the levers that I managed to pull.

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While the Chancellor claims to have a plan in place to mitigate the economic effects of no deal, we know from numerous economic analyses that there would be a significant shock. The Yellowhammer documents confirmed our worst fears—that this shock would be disproportionally felt by the most vulnerable in our society. I therefore urge the Minister—I hope he will respond to this plea—to convey to his colleagues the previously stated view of this House that the Government must avoid a no-deal exit at all costs.

[Lord Bethell]

My Lords, I express my thanks for an informative debate on this technical but incredibly important measure. I give particular thanks to the noble Baroness, Lady Bowles, who gave us a good trot around the history of some of the regulations and described in very honest terms her central role in the background of some of these instruments. I remember well her front-line role in fighting for Britain’s interests in this matter during a very difficult period.

I start by answering her question about whether the clearing suspension can be extended. The instrument allows the Bank of England to suspend the clearing obligation for up to 12 months, with the consent of the Treasury. This means that the Bank can decide to issue a suspension lasting for any period up to 12 months, based on its assessment of the situation. For instance, it may determine that a suspension for six months is the best option, but the suspension cannot be extended. However, if the conditions of the suspension of the clearing operation continue to be met, we would expect the Bank to institute a new suspension if necessary, which would again require the consent of the Treasury.

The question was asked: can the pension scheme clearing exemption be renewed or extended? This instrument allows the Treasury to extend that exemption for up to two years at any time by regulation, if no alternative can be found for the UK market. Importantly, this means that it could be renewed if no solution were to be found.

Will there be a permanent solution to the pension scheme exemption? Currently, requiring a pension scheme to clear trades in a CCP can lead to disproportionate costs, especially the requirement to pay margin on CCP in cash. A technical solution would address this problem: for example, it would involve finding a way for the pension scheme to meet its obligations to the CCP without turning long-term assets into cash. Any solution must not pose a risk to the CCP. However, currently the EU has been unable to find a solution which accomplishes that, and the Government will continue to work with UK CCPs and pension schemes on that important question. This will ultimately be decided according to what the technical solution will look like.

The noble Baronesses, Lady Bowles and Lady Kramer, and the noble Lord, Lord Davies, all raised questions about the Explanatory Memorandum. Their points were well made and the concerns behind them are completely understood, but I reassure the House that the Government remain utterly committed to doing a deal. However difficult that may seem, that remains the commitment, and that includes a deal on financial services. The Explanatory Memorandum continues to reflect the Government’s policy, but of course we should be ready for all scenarios, which is why we are here today.

The noble Baroness, Lady Kramer, raised an important point on the question of divergence. I should like to reassure her on that. This SI aims to ensure continuity—that is its whole ethic and philosophy—and consistency with EU laws. This is not about divergence. I remind the House that the SI has been warmly welcomed by business after a long period of consultation, and if concerns about divergence were still outstanding, I am sure the industry would have voiced them.

The noble Baroness also asked about regulatory arbitrage, about which I should similarly like to reassure the House. Our onshoring approach aims to preserve existing regulation as much as possible. We also want to maintain maximum supervisory co-operation with the EU to avoid regulatory arbitrage of any kind. She also asked whether the trading obligation will be suspended automatically. I should like to reassure the House that in the EU, the trading obligation would not be automatically suspended. For the UK, we have made the trading obligation suspension automatic on suspending the clearing obligation. I hope that is understandable.

The noble Lord, Lord Davies, asked whether the Government will implement the remaining aspect of the EMIR REFIT and how that implementation would happen. The purpose of this SI is to address deficiencies that will arise in UK law if the UK leaves the EU without a deal. It cannot address aspects of the EMIR REFIT which are not in application. We are working with regulators and industry to ensure that the remaining provisions in EMIR REFIT are implemented in an appropriate manner for the UK.

In conclusion, I reassure the House that every effort has been put into the consultation on these important regulations. Industry has lent an enormous amount of support to them and they have been laid before the House for a considerable time. In that spirit, I ask the House to approve these regulations.

Motion agreed.