My Lords, HM Treasury is currently undertaking the necessary preparations to ensure that, in the event that no deal is agreed when we leave the EU in March 2019, a functioning legislative and regulatory regime will continue to be in place for financial services. The aim of the work is to maintain continuity at the point of exit as far as possible. The European Union (Withdrawal) Act 2018 will transfer existing EU legislation on to the UK statute book at the point of exit. It also gives Ministers powers to amend this legislation to ensure that it will operate properly in a UK context. The Treasury is laying the necessary statutory instruments to complete this work for financial services legislation. This is the third debate in this Committee as part of this programme of work and there will be many more over the coming months.
Last December, the Treasury announced that legislation would be brought forward to establish a temporary permissions regime enabling EEA firms operating in the UK to continue their activities in the UK for a time-limited period after withdrawal. At the same time, it was also announced that a temporary regime would be brought forward in relation to non-UK central counterparties. The two SIs being debated today deliver on these commitments. They are both extremely important to the financial services sector, as they make a key contribution to our aims of maintaining service continuity at the point of exit.
The EEA passport rights regulations deal with references to the EEA financial services passport in UK law and establish a temporary permissions regime to provide for continuity once the UK leaves the EU and passporting no longer operates in the UK. Many will be familiar with the passporting system, which allows firms in an EEA state to offer services in another EEA state on the basis of the authorisation granted by their home state regulator. In a no-deal scenario, the UK would be a third country outside the EU financial services framework and therefore outside the passporting system, meaning that any references to EEA passport rights in UK legislation would become deficient at the point of exit.
The Government therefore need to repeal provisions in the Financial Services and Markets Act 2000 that implement the EEA financial services passport. This would mean that any EEA firms currently operating in the UK via a passport would no longer be able to do so from exit day, just as UK firms would no longer be able to passport into other EEA states. EEA firms would then need to obtain authorisation from the UK’s regulatory authorities if they wished to continue doing business in the UK. In such a scenario, the volume of applications received by the UK regulators would increase significantly as many hundreds, perhaps thousands, of EEA firms submit applications for UK authorisation. This will include applications from large and complex businesses with a substantial UK presence.
The need for a large number of firms to submit these lengthy applications for authorisation before exit day, and have the UK regulators process them in time, therefore poses a substantial cliff-edge risk for firms and regulators. Ultimately, this would affect UK individuals and businesses who rely on services from passporting EEA firms and cause disruption to them. To mitigate those risks, in line with the Government’s commitment on 20 December last year, the Treasury has therefore put forward this legislation to establish a “temporary permissions regime”. This regime would enable EEA firms operating in the UK via a passport to continue their activities in the UK for up to three years after exit day, allowing them to obtain UK authorisation or transfer business to a UK entity as necessary.
To alleviate the potential scenario where some EEA firms cannot be authorised within the three-year period, this SI also gives the Treasury the power to extend the regime. This could be done only where it is “necessary” to do so, and it could be extended by only 12 months at a time. Any extension would need to be based on a robust assessment from the FCA and the PRA regarding the effects of extending and not extending the period. The instrument that would extend the regime would be subject to the negative procedure, which was drawn to the special attention of the House of Lords by Sub-Committee B of the Secondary Legislation Scrutiny Committee in its report published on 18 October. The Treasury judges this choice of procedure appropriate given that the power to extend the regime is conferred by this instrument, which itself is subject to the affirmative procedure. I assure Members that we take parliamentary scrutiny seriously. Although this affirmative instrument introduces a power to make regulations via the negative procedure, the Treasury believes that if a like provision were to be made by an Act of Parliament, it would also be via the negative procedure because the power is so tightly drawn.
The temporary permissions regime would ensure, first, that firms can continue servicing UK businesses and consumers for a temporary period after exit day and, secondly, that firms will have appropriate time to prepare for and submit applications for UK authorisation and complete any necessary restructuring. Finally, the PRA and the FCA can manage the expected applications for UK authorisation from EEA passporting firms that were previously operating in the UK via a passport in a smooth and orderly manner.
This SI is a pragmatic response to a complex issue. It is necessary to minimise disruption to users and providers in the UK financial services sector in a no-deal scenario. I note that the Secondary Legislation Scrutiny Committee report acknowledged the importance of these regulations in achieving this objective.
It is with similar considerations for minimising disruption and enabling the UK’s regulators to manage a no-deal scenario in an orderly fashion that I turn to the second of these SIs, which covers central counterparties. Central counterparties are central to the UK and global financial system. They reduce risk and ultimately improve the efficiency and resilience of the system as a whole. They stand between counterparties in financial contracts, becoming the buyer to every seller and the seller to every buyer. They guarantee the terms of trade even if one party defaults on the agreement, reducing counterparty risk. UK firms currently receive services from non-UK central counterparties under the framework set out in the European Market Infrastructure Regulation, known as EMIR.
Under EMIR, non-UK central counterparties are permitted to provide services to UK firms if they are either located in the EU and authorised by their home regulatory authority or located in a third country deemed equivalent by the Commission and recognised by the European Securities and Markets Authority. In a no-deal scenario, when the UK leaves the EU and is no longer within the single market for financial services, those non-UK central counterparties would be unable to provide services to UK firms until they were recognised under the UK’s domestic regime. Such a sudden dislocation in the provision of services would introduce substantial risks to UK firms, many of which rely on non-UK central counterparties to provide clearing services and for mitigating transaction risks. By extension, this could impact on customers of those UK firms. Day one disruption to these services would pose risks to UK firms, as well as stability risks to the broader financial system.
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The central counterparties SI therefore provides a number of measures to mitigate these risks, and ensure that a day one scenario can be properly managed. First, the SI establishes a UK framework for recognising non-UK central counterparties, while maintaining the same regulatory criteria for non-UK central counterparties to provide services in the UK. The Treasury will take on the European Commission’s responsibility for determining whether a third-country jurisdiction’s regulatory and supervisory framework is equivalent in respect of EMIR. The Bank of England will take on functions relating to the recognition of individual central counterparties located in third countries, which up until now has been the responsibility of the European Securities and Markets Authority.
Secondly, the SI makes it possible for the Bank of England to take the necessary steps to recognise non-UK central counterparties as soon as possible following exit day. This is done by providing powers to the Bank of England to consider recognition applications ahead of exit day, as well as to enter into supervisory co-operation arrangements with non-UK authorities.
Finally, the SI establishes a temporary recognition regime for central counterparties, in a similar fashion to the temporary permissions regime provided by the EEA passport rights SI. Subject to certain conditions, the regime provides temporary recognition for a period of three years to non-UK central counterparties that notify the Bank of England of their intention to continue to provide clearing services in the UK. The purpose of temporary recognition is to allow additional time for applications to be processed and equivalence decisions to be made by the Treasury. While non-UK central counterparties are encouraged to engage with the Bank of England as early as possible, the temporary recognition regime will ensure the continuity of services if it happens that a recognition decision cannot be made ahead of exit day. As with the EEA passport rights SI, this SI would give the Treasury the power to extend the regime for 12 months at a time if it is satisfied that an extension is necessary and proportionate to avoid disruption to financial stability.
The measures in both these SIs are, we believe, a pragmatic response to ensuring service continuity for the UK on leaving the EU without a deal. The importance of their provisions is reflected in the announcement last December, which made it clear to the industry well in advance of exit day that the Treasury would put forward legislation to deliver these regimes. The regulators are now in the process of consulting industry to ensure that these regimes are properly applied in the UK when it leaves the EU. Further information has been made available to firms through dedicated sections of the regulators’ websites. The Treasury has continued to engage the financial services sector on issues relating to no-deal legislation and will continue to do so.
These SIs are an important part of the work to provide a functioning financial services regime in the event of a no-deal scenario. It is important to stress that if, as expected, we enter an implementation period when we leave in March 2019, the access to each other’s markets would remain the same during that period: passporting will remain in place and non-UK central counterparties that meet the current requirements will continue to be able to provide services to UK banks. However, these SIs should provide reassurance to Parliament and, more importantly perhaps, to the UK financial services sector as a whole that the UK is prepared for all possible outcomes. The City’s success is based on being the most open and dynamic financial centre in the world. Ensuring that EEA financial services firms and non-UK central counterparties can continue to operate here after exit day will help to maintain this status, protect jobs and preserve tax revenues to fund our vital public services, while also preserving an efficient and resilient financial system. I hope noble Lords will join me in supporting these regulations and I commend them to the House.