Central Counterparties (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018

Lord Tunnicliffe Excerpts

Tuesday 30th October 2018 Grand Committee

[The Earl of Lindsay (Con)]

My Lords, I want to ask my noble friend a couple of questions on the CCP side to clear up any confusion, in my own mind at least. The first refers to the requirement in the Explanatory Memorandum for,

“non-UK CCPs (including CCPs established in the European Union)”,

to apply to the Bank and receive recognition from the Bank in order to continue their activities after Brexit day. The paragraph thereafter refers to the opportunity for temporary recognition, and there it refers only to third country CCPs. I assume that third country CCPs include CCPs established within the European Union, but the slightly different terminology used in those two paragraphs left a doubt in my mind as to whether there was some distinction. If indeed the temporary recognition is not available to CCP establishment within the European Union, what is the reason for that? From the way the memorandum is written, it could conceivably be that the term “third country CCPs” does not apply to European Union-established CCPs.

My second question, which reflects a question raised by the noble Baroness, Lady Bowles, is about the length of the temporary recognition timeline. If I understand it correctly, it is set initially at three years and can be extended by 12-month intervals. Is it envisaged that a non-UK CCP can, at the end of three years, still be operating under a temporary recognition regime and can continue thereafter to enjoy 12-month extensions to its—as it were—permitted activities in the United Kingdom?

[Lord Tunnicliffe (Lab)]

My Lords, I will speak to these two instruments in the order they appear on the Order Paper. I found these two instruments difficult to understand and therefore have consumed considerable intellectual effort in actually understanding them, which has left very little effort in reserve to produce an elegant speech. I would like to thank two officials: Greg Stump, for his tutorial on the CCPs, and Richard Lowe-Lauri, for his tutorials on the passporting. I have to say that the disadvantage of having an excellent tutorial is that all the questions I could have asked have largely been answered, so I will not be making a very long speech.

One of the biggest problems in understanding the instruments is that they, particularly the one on passporting, refer frequently to the Financial Services and Markets Act, which we all know as FiSMA. I do not have available a fully amended version of it to refer to so I want to ask the Minister something; I definitely do not want a reply because he will have to take this back to the ranch. Some years ago, a precedent was established when a 50-page Bill came from the Commons and left the Lords 150 pages long—it involved introducing bail-ins, et cetera—and the Treasury was good enough to provide an electronic copy of FiSMA, fully amended. That made understanding what the revisions of the instruments were doing much easier. I request formally that the Treasury does that again. Clearly the Government have a fully amended copy of FiSMA available on their machines because otherwise the creation of the instruments would be virtually impossible.

The regulations on passporting seem very simple. Basically, they say that an EEA CCP can continue trading in the UK, initially under a temporary recognition before moving into permanent recognition. It is as simple as that. As I understand it, this cannot be done unilaterally because moving CCPs into a full recognition environment will be dependent on memoranda of understanding with the host nations of those CCPs. I would value confirmation of that if it is true. Even in an extreme no-deal scenario, there will still need to be international understandings between nations in that situation.

There is no reciprocity in the instruments, as I read them. We have a situation where we are saying to EU CCPs, “Please carry on as before”, and to UK-based CCPs, “We have secured nothing to allow you to continue your business in Europe”. In the case of CCPs, not continuing on a reciprocal basis will be very difficult for both Europe and ourselves. I believe that there is some discussion in Brussels about there being reciprocity, even in a no-deal situation. I would value any news the Minister may have on the development of such a reciprocal understanding.

In the event of a loss of recognition by a foreign-based CCP, it is not clear what the enforcement mechanism would be. For instance, would the loss of recognition mean that trade contracts would become ultra vires or lead to a very messy situation? The statutory instrument contemplates the loss of recognition but does not set out how that would be managed. I would value anything that the Minister might be able to tell me about what would happen.

Equally, my understanding of the passporting instrument is, once again, that it is extraordinarily simple. It means that EEA firms can carry on trading in the United Kingdom on virtually the exact same terms as they do now. In other words, a no-deal situation has no negative consequences for non-UK firms because the mechanism for a more or less automatic granting of temporary authorisation, and then the transition to permanent authorisation, is set out in this instrument. The converse is not there; as far as I can see, it does nothing for UK firms. The Minister may put me right on this but, as far as I know, there are no effective World Trade Organization rules for services that would allow UK firms to trade in Europe.

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[Lord Bates]

I thank noble Lords for participating in this debate. It has lasted for 46 minutes, of which my introductory remarks were 13 minutes. In the 33 minutes, noble Lords have, by my calculation, managed to generate 24 questions which I will attempt to work my way through. I simply flag that up for colleagues on the Front Bench who are waiting for immediate business.

These are crucial issues. Noble Lords are quite right to raise them and seek further clarification. I commence by saying that I agree with the noble Lord, Lord Tunnicliffe, in this respect: this is not the outcome we are seeking or that we want or desire. It is not the outcome that we expect. We expect to secure a deal that will allow us to continue to have a good trading relationship in financial services with the European Union. We believe that that is in the interest of not only the UK but the EU as well. We are working very hard to secure that.

[Lord Tunnicliffe]

I want to explore that question a little bit further. Surely the test would be whether this is, in its elements, reciprocal to the privileges that EU firms will have as a result of this instrument.

[Lord Bates]

I will come on to that.

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[Lord Tunnicliffe]

I am sorry.

[Lord Bates]

I do not want a 25th question; I will keep it at 24 and work my way through to that one. I have some remarks to address that particular point.

The noble Baroness, Lady Bowles, asked whether there could be a scenario in which a firm cannot be authorised within three years, which would extend the time limit. The answer is yes. The position is that although the PRA and the FCA have credible working estimates of the number of EEA firms that will apply to them for authorisation, there is an unavoidable degree of uncertainty about this process. That, coupled with the varying degrees of complexity in some of these firms’ applications, means that a power to extend the length of time is necessary. This will be crucial to mitigate the potential scenario in which some EEA firms cannot be authorised within three years from exit day, which could force the regulators to reject authorisation for the firms’ applications. Clearly, we do not seek that outcome.

The noble Baroness also asked whether there is enough flexibility to make equivalence decisions for CCPs. The powers in the EU withdrawal Act limit the fixing of deficiencies to retain EU law when the UK leaves the EU. It does not allow for policy changes beyond this element. The aim is to provide certainty to non-UK CCPs and their UK users during the period immediately following withdrawal from the EU. The criteria for recognition of non-UK CCPs will remain unchanged and will be onshore. This would allow recognised non-EU CCPs to resubmit the application used for EU recognition.

The noble Baroness then asked about the process for the joint assessment by the regulators. As set out in the statutory instrument, the PRA and the FCA would need to submit to the Treasury a joint assessment outlining the effect of extending or not extending the time period on the regime, on firms in general, on the UK financial system and on the ability of the regulators to discharge their functions in a way that advances their statutory objectives. That assessment would need to be submitted to Her Majesty’s Treasury no later than six months before the end of the regime. The Treasury would then make regulations to extend the duration of the regime only if it considers them necessary on the basis of the assessment.

The noble Lord, Lord Tunnicliffe, asked what protections would be available following exit day to UK customers who currently have access to the Financial Services Compensation Scheme. No one should lose FSCS protection as a result of this SI. If a UK customer is currently protected by the FSCS, they will be protected as long as the firm enters the temporary permissions regime.

The noble Lord also asked about the consequences for UK customers if a firm is denied authorisation. Any firms in the temporary permissions regime that are denied full UK authorisation by the UK regulators will lose their temporary permissions. Further legislation will be laid before Parliament at a later date to enable such firms to wind down their UK-regulated activities in an orderly manner. This legislation will ensure that the existing contractual obligations of these firms with UK customers can continue to be met. UK customers would no longer be able to enter into new contracts with these firms unless the firms had successfully reapplied for authorisation from UK regulators.

The noble Lord then asked what a firm being denied authorisation says about the passport regime and whether it suggests that it is not equitable, let alone equivalent. The EEA passport regime system is underpinned by the co-operation of EEA member states’ competent authorities. Each member state’s competent authorities supervise the activities of firms under its jurisdiction, even if those activities take place elsewhere in the EU. Once we leave the EU, we cannot rely on this co-operation continuing. We are therefore making these preparations.

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[Lord Bates]

We may have misunderstood the point that the noble Baroness was making. I am very happy to undertake to write to her on that specific point and copy it to members of the Committee.

The noble Baroness asked why a CCP might not have been recognised within the initial period. While the Bank of England has credible working estimates of the number of CCPs that will apply to it for recognition, there is an unavoidable degree of uncertainty about this.

My noble friend Lord Lindsay asked whether third-country CCPs includes EU CCPs. EU CCPs will be treated as third-country CCPs post-exit. EU CCPs and third-country CCPs will be eligible for the temporary recognition regime if they were permitted to operate prior to 29 March 2019.

My noble friend Lord Kirkhope asked whether the regime could be extended continually each year. It is in everyone’s interest for firms to transition from the current system of EEA passporting rights to full UK authorisation as quickly and efficiently as possible. There would be no circumstances in which it would be desirable for the regulators or the Treasury to extend the length of the regime on a continuous basis. He also asked whether the negative procedure is an appropriate instrument. I respect the work of the Secondary Legislation Scrutiny Committee, whose report we have before us today. I addressed this in my opening remarks. We believe that the choice of procedure is appropriate, given the overall powers being scrutinised now through this affirmative instrument. The negative procedure would just be an extension of that. The power to extend the time period is not a provision which relates to fees and so would not, if made alone, attract the affirmative procedure under Section 8 of the Act, to which my noble friend referred. He also spoke about the process for registration with the PRA and its ability to deal with the volume of applications. I reiterate what I said to the noble Baroness, Lady Bowles: I am confident that the PRA and the FCA are making adequate preparations to deal with the scale of the challenge which they face, but it is a significant challenge.

The noble Baroness, Lady Bowles, asked whether the regulators may ask firms to apply for authorisation sooner than the two-year deadline set out in the statutory instruments if they so choose. The EEA Passport Rights (Amendment, etc., and Transitional Provision) (EU Exit) Regulations will give regulators the ability to direct firms to make an application for authorisation during a specified period within two years from exit day if they have not already applied for authorisation. This will help regulators manage the flow of applications in a smooth and orderly manner. I draw the Committee’s attention to the FCA’s recent consultation paper published on 8 October, in which it set out its intention to allocate each firm a three-month landing slot within which that firm will need to submit its application for UK authorisation. It plans to issue a direction shortly after exit day setting out which firms have been allocated to which landing slot.

The noble Baroness, Lady Bowles, asked how the two-year application period will operate. I dealt with that earlier but I did not cover one specific point: the two-year deadline for applications to be received cannot be extended.

The noble Lord, Lord Tunnicliffe, asked whether this is a one-sided arrangement and whether there will be any reciprocation. The Government are only able to take legislative action in relation to EEA firms’ passport rights to the UK; they cannot through unilateral action influence the status of UK firms. That is why we are seeking to agree a deep and special partnership with the EU, as well as an implementation period, so that important preparations can take place in an orderly manner.

The noble Lord asked what the impact on the financial services sector would be if there is a no-deal exit. Reaching a deal is in the mutual interests of both sides. We are focusing on the negotiation of the right future partnership based on a proposal published in the White Paper on 12 July. That White Paper outlined the Government’s position on financial services and Brexit. We propose a framework for financial services that will provide stability for the EU-UK ecosystem, preserving mutually beneficial cross-border business models and economic integration for the benefit of businesses and consumers in the UK and the EU.

The noble Lord asked what it says about the regime if a firm is denied authorisation. Once we leave the EU we cannot rely on this co-operation continuing and therefore we are making these preparations. It is important that these regulations go ahead so that consumers in this country have confidence in the financial services put forward here.

I have addressed the Financial Services Compensation scheme and I will now deal with one or two points relating to central counterparties. The noble Lord, Lord Tunnicliffe, made a point on the memorandum of understanding with the host state. Yes, there are a number of necessary steps for a non-UK CCP to be recognised in the UK. These include that the Treasury must determine that the relevant third country’s regulatory and supervisory framework is equivalent to EMIR; the bank must agree supervisory co-operation agreements or memorandums of understanding with relevant competent authorities of the CCP applicant; and the non-UK CCP’s application for recognition to be assessed by the bank must include information on its financial resources, internal procedures and various other relevant information.

The noble Lord asked what would happen if the central counterparty is not recognised. If a non-UK CCP were to continue to provide clearing services to UK firms without recognition, it would be in breach of a general prohibition under the Financial Services and Markets Act, which prohibits anyone carrying out a regulated activity unless they are authorised or exempt. The CCP would be guilty of an offence and subject to a fine or imprisonment. However, further legislation will be laid at a later date to enable such firms to wind down their activities in an orderly manner by being treated as being recognised for a short period.

I hope that has addressed many of the questions.

[Lord Tunnicliffe]

In the unlikely event that the Minister has missed anything, will he review his answer and, if he has missed the odd point, send a letter covering it?

[Lord Bates]

I am happy to give an undertaking to do that. We are in uncharted territory here—we have not been through this process before. The Economic Secretary to the Treasury, John Glen, is being incredibly diligent in engaging with the regulators on a regular basis and being guided through this process. That is why the announcement was made in December. We will continue to keep this under review. The noble Baroness, Lady Bowles, made a suggestion about how we might keep the House informed of developments and made particular reference to perhaps involving the Select Committees. If I may, I will take that back to the Economic Secretary to the Treasury because, in some of these areas, once we know the lay of the land—we hope it will not come to that but if it does—then we will clearly need to review these provisions. I am happy to take that suggestion back and include it in my answer to the noble Lord, Lord Tunnicliffe, which I will copy to my noble friends Lord Lindsay and Lord Kirkhope.