An update from the IA on a major announcement from the Chancellor Tuesday on the future of FS regulation post-Brexit.
In a Written Ministerial Statement submitted to Parliament on Tuesday 23rd June, Chancellor of the Exchequer Rishi Sunak set out for the first time - in detail - how HM Treasury intends to regulate the UK financial services sector post-Brexit. In his statement, the Chancellor identified the key principles HM Treasury will now apply when considering whether to align, or diverge from, the EU on key financial services files and confirmed a number of reviews or reforms to take place both before and after, the end of the Brexit transition period.
In light of the ongoing Brexit negotiations, we wanted to provide a summary of the critical elements of the Chancellor’s statement, implications for equivalence, and next steps concerning reviews or consultations as announced by the Chancellor. While the announcement provides some clarity about the UK’s legislative plans for updating prudential requirements, maintaining sound capital markets, and managing future risks post-Brexit, the statement did not clarify the UK’s approach on other areas of importance to members, such as the implementation of the Sustainable Finance Disclosure Regulations in the UK – due to enter into force in March 2021.
In the coming weeks, we will be speaking directly to members through our senior and technical policy committees about HM Treasury’s post-Brexit plans as articulated in the Chancellor’s statement, how they may affect the industry, and additional areas where further clarity would be welcome in addition to the detailed supplementary policy statements submitted alongside the Chancellor’s own statement. We also invite members to engage fully in the coming months with HM Treasury as it undertakes several critical reviews on various legislative measures affecting our industry.
Background to the Chancellor’s Statement:
In preparation for the UK’s eventual departure from the EU, in 2019 HM Treasury launched the Financial Services Future Regulatory Framework Review to look at how the UK’s regulatory framework could adapt in the future to enhance the UK’s position as a world-leading financial services centre, and in particular to the UK’s position outside of the EU. The Chancellor’s statement is a key milestone as part of this review process, although the Chancellor did note that some action was already being taken in coordination with industry as a result of this Review. In particular, the Chancellor noted that in the Queen’s Speech of December 2019 the Government had announced its intention to bring forward a Financial Services Bill to ensure the UK maintains its world-leading regulatory standards and remains open to international markets. Specifically, members will recall that this bill will deliver long-term market access between the UK and Gibraltar for financial services firms based on shared, high standards; and a simplified process which will allow overseas investment funds to be sold in the UK.
Scope of reviews/reforms announced by the Chancellor:
In discussing specific policy reviews or planned reforms as part of the Review, although relatively light on detail, the Chancellor justified many of the proposed changes because ‘rules designed as a compromise for 28 countries can no longer be expected in every respect to be the right approach for a large and complex international financial sector such as the UK’. Now that the UK has formally left the EU, the Chancellor was keen to highlight that the EU has already started making decisions on amending its current rules ‘without regard for the UK’s interests’ (for example on the MiFID Review and related Quick Fixes). As a result, it was right for the UK to now also see how it could tailor its approach to ensure that it better suits the specific needs of the UK market outside the EU.
In general, the HM Government intends to implement immediate legislative reforms in line with current expectations of the industry and the approach of the EU and other international partners ‘where relevant’. According to the Chancellor, ‘naturally, there will be some defined areas where it is appropriate for the UK – as a large and complex financial services jurisdiction - to take an approach which better suits our market’, but we understand that members should expect that the UK will do so in a manner consistent with international standards. As we set out below, there are several areas where the UK Government intends on taking action in the coming months, or in the immediate period after the end of the transition period as follows:
We understand that the FCA will launch a full consultation taking into account the feedback later in 2020, but this discussion paper focuses on the technical details that are for the most part currently being defined through EBA/ESMA RTS at the EU level. Most importantly, the paper highlights the UK could diverge in the following areas:
- NCA discretion to allow firms to ‘opt-in’ to CRR/CRD – the UK would not replicate this IFR discretion which allows firms with assets under EUR 15bn to opt-in the application of CRD/CRR framework if they belong to a banking group.
- Staff under scope or ‘risk takers’ – the FCA stresses that it will consult on the definition of the staff under scope for remuneration purposes, possibly taking into account the draft EBA RTS published recently while adapting them to the UK.
- Alternative arrangements for variable remuneration – the FCA states it will replicate the IFR discretion given to investment firms to issue ‘alternative arrangements’ if they do not issue instruments which could be used in variable remuneration.
- MS discretion to disapply exemption – the UK would not apply the MS discretion to disapply the exemption for individuals whose annual variable remuneration is EUR 50,000 or less, and represents 25% or less of that individual’s total annual remuneration.
We understand that HM Government will introduce updated prudential standards ‘in a flexible and proportionate manner’ and intends to do this by delegating responsibility for firm-level requirements to the relevant regulator – the Prudential Regulation Authority (PRA) or the Financial Conduct Authority (FCA) – subject to an ‘enhanced accountability framework to ensure that the regulators have regard to competitiveness and equivalence’ when making rules for these regimes. Critically, we understand that this reference is in direct response to calls from the IA and others for regulators to have international competitiveness as a direct statutory objective post-Brexit. However, at this point HM Treasury is unable to provide further detail on what such a framework would involve. Both the PRA and the FCA will set out further information on the substance of the proposed regimes in due course.
The UK Government and the Regulators also propose to introduce the new Investment Firms Prudential Regime (IFPR) and updated rules for credit institutions in line with the intended outcomes of the EU’s Investment Firms Regulation and Directive, and the second Capital Requirements Regulation respectively. For the IFPR, we understand that as part of this new regime, the PRA will not require PRA-designated investment firms to re-authorise as credit institutions, unlike the EU regime. We also know that the FCA will not require FCA-regulated investment firms to comply with the requirements of the Fifth Capital Requirements Directive (CRDV) in the period until the new IFPR applies. A consultation on our transposition of CRDV will take place in July.
During the Transition Period, and under the terms of the Withdrawal Agreement, HM Government confirmed that it would implement EU legislation that requires transposition before the end of 2020. This includes the transposition of the Fifth Capital Requirements Directive (CRDV), and the Bank Recovery and Resolution Directive II (BRRDII) by Dec 28 2020. BRRDII makes amendments to the original 2014 Bank Recovery and Resolution Directive (BRRD) provisions, to update the EU’s resolution policy and Minimum Requirements for Own Funds and Eligible Liabilities (MREL) framework. However, we understand that HM Treasury is still considering how best to implement aspects of files that do not come into force until after Dec 31 2020. Given some of these changes do not come into force until the UK has left the Transition Period, the Chancellor statement notes that ‘it is right that the UK exercises its discretion when implementing these files’.
We also understand that the Government will also now bring forward a review of certain features of Solvency II to ensure that it is properly tailored to take account of the structural features of the UK insurance sector which has long been a sticking point in the context of equivalence discussions with the EU. These will include but are not limited to, the risk margin, the matching adjustment, the operation of internal models and reporting requirements for insurers. We understand from the Chancellor’s statement that the Government expects to publish a Call for Evidence in Autumn 2020.
As part of the Chancellor’s statement, HM Treasury also published a further written ministerial statement relating to LIBOR transition. The statement sets out detail on HM Government’s approach to legislative steps that could help deal with ‘tough legacy’ contracts that cannot transition from LIBOR before end-2021. In particular, HM Government will use the Financial Services Bill to introduce amendments to the Benchmarks Regulation 2016/1011 as amended by the Benchmarks (Amendment) (EU Exit) Regulations 2018 (the ‘UK BMR’), to ensure that FCA powers are sufficient to manage an orderly transition from LIBOR.
In addition to these major policy statements, also of note to members is that the UK will not be implementing the EU’s new settlement discipline regime, as set out in the CSDR, which is due to apply in February 2021. The Chancellor’s statement notes that UK firms should instead continue to apply the existing industry-led framework, with any future legislative changes in the UK developed through dialogue with industry, with a reassurance that sufficient time will be provided to prepare for the implementation of any new future regime.
Additionally, the UK will not be taking action to incorporate into UK law the reporting obligation of the EU’s Securities Financing Transactions Regulation for non-financial counterparties (NFCs), which is due to apply in the EU from January 2021. In doing so, HM Treasury notes that given that systemically important NFC trading activity will be captured sufficiently through the other reporting obligations that are due to apply to financial counterparties, it is appropriate for the UK not to impose this further obligation on UK firms.
We also note the following items for members’ information as part of the Chancellor’s statement:
- Amendments are expected to the Benchmarks Regulation to ensure continued market access to third-country benchmarks until end-2025. HM Treasury will publish a policy statement in July 2020;
- Amendments are expected to the Market Abuse Regulation to confirm and clarify that both issuers and those acting on their behalf must maintain their own insider lists and to change the timeline issuers have to comply with when disclosing certain transaction undertaken by their senior managers (‘Persons Discharging Managerial Responsibilities’);
- Legislation is expected to improve the functioning of the PRIIPs regime in the UK and address potential risks of consumer harm in response to industry and regulator feedback. HMT will publish a policy statement July 2020; and
- Legislation is expected to complete the implementation of the European Market Infrastructure Regulation (REFIT) to improve trade repository data and ensure that smaller firms can access clearing on fair and reasonable terms.
We will update members in more detail once we have further details on each of these points and HM Treasury’s proposed approach.
Impact on Brexit negotiations and equivalence
At the end of the Brexit transition period, it is clear from the Chancellor’s statement that the UK is keen to make full use of its newfound powers to make its own laws separate of EU institutions, with Tuesday’s statement the first significant intervention by the Chancellor about how the UK will look to both regulate financial services in the years to come, and manage its relationship with the EU moving forward - its largest export market for financial services.
While making clear that the future financial services regime for the UK may not be the same as that of the EU27, the Chancellor was at pains to stress that ‘an enduring future relationship with the EU would help complement the UK’s leading global role in financial services’ and that it was still in the interests of both sides to continue working closely together on financial services regulation, given the extent of activity and interconnectedness between the two markets. In particular, the Chancellor reiterated his belief that ‘comprehensive mutual findings of equivalence between the UK and the EU were still in best interests of both parties’, and that the UK remained committed to continuing dialogue with the EU about their intentions in this respect.
However, the statement also made clear that the UK was now prepared to take the lead in financial services regulation vis-à-vis the EU, especially where it is not directly connected to a third country regime or equivalence. Placing considerable emphasis on the importance of international standards and the role of the UK as a major global financial centre, the Chancellor was keen to explain that in the future decisions about staying aligned or otherwise to the EU will be made on a case by case basis, taking into account what was best for the UK financial services industry as a whole.
Of note is that this statement, its content relating to future possible regulatory divergences, and importantly its timing, point to potential complications in the wider Brexit negotiations. While HM Treasury are keen to downplay the impact Tuesday’s statement might have on the equivalence process currently underway with the EU, the fact that both sides were meant to assess each other as technically equivalent this month as per the Political Declaration cannot be ignored. In fact, all indications are this will no longer occur by the end of June as agreed. Instead, we understand that announcements about equivalence may now come after any wider FTA is agreed later this year, assuming an agreement can be reached before the end of the transition period.
Critically, if they didn’t before, both sides now view equivalence, and its ongoing maintenance, arguably in a different light. The UK’s position is that over the past 24-months it has onshored all of the EU acquis and therefore granting equivalence should be a relatively straightforward process. Even if not under its preferred ‘outcomes-based’ model and instead under a technical and granular line-by-line assessment, the UK considers itself to be ‘super-equivalent’ on Jan 1 2021, with possible future divergence then being handled on a case-by-case basis through a Joint Financial Services Committee. From the UK’s perspective, there is no legal reason as to why it couldn’t be found equivalent by the EU – but as we all know, equivalence is as much a political process as a technical one. If the EU isn’t prepared to grant equivalence based on the onshoring of the EU acquis, the UK appears to be taking the view that there is little benefit to signalling continued alignment on new legislative files post-Brexit.
For the EU, the question is, however, how to prevent the UK from competing in an unfair or unstainable manner. The EU is concerned that without appropriate safeguards, it could be faced with a major financial centre operating in close geographic proximity to the Single Market without any control over its regulation, or supervision of market participants. In the context of Brexit, it also important for the EU that the UK is seen not to benefit in the same way as if it were still a member of the Single Market. If it is free to truly make its own rules, but retain considerable market access, this could become a major strategic threat to the EU and the wider European project itself in the longer-term. It should be noted, however, that the EU is yet to respond to the statement by the Chancellor formally, and it is yet to be seen how the statement will change its view regarding equivalence for UK financial services. In several areas, for example on CSDR and even potentially PRIIPS, the UK’s approach could potentially force a rethink within EU institutions along similar lines.
According to the Written Statement, members should expect a number of policy review to take place before the end of the year as follows:
- Jul 20 – HMT to publish policy statement on BMR
- Jul 20 – HMT to publish policy statement on PRIIPS
- Aug 11 20 – Deadline for comments on consultation on BRRDII implementation
- H2 20 – HMT consultation on next phase of Financial Services Future Regulatory Framework Review
- Autumn 20 – Call for evidence on Solvency II review
- Sep 25 20 – Deadline for comments on a discussion paper on the UK implementation of the IFR/IFD rules
The IA are participating in webinar with the Chancellor on Tuesday, where they hope to receive further detail. They are also hosting a webinar with Katharine Braddick, Director General of Financial Services at HM Treasury, on 13th July at 2pm, where Board and Advisory Council members will be able to ask questions on the Chancellor’s statement and its implications for the industry directly. If you have further questions or feedback on the above, please do send them to Dave McCarthy (David.email@example.com). We will will also be discussing next steps at our next International and European Policy Committee.