How prepared is the financial services industry for Brexit?
The Financial Conduct Authority (FCA) has been proactive in planning for the UK’s departure from the EU. But how have financial services firms responded?
FCA chief executive Andrew Bailey spoke at an industry conference on 16 September, and outlined the preparation financial services firms had made to date.
The sector has made good progress over the course of the year, he believes, but there is no room for complacency, and more work still to do – both by the EU, by the FCA and by the firms it regulates.
How is the FCA helping firms to prepare for Brexit?
Bailey told delegates that the regulator is continuing ‘to prepare for a full range of possible outcomes and scenarios’.
Central to its approach is the Authority’s ‘strong commitment to open global financial markets’, and Bailey stressed that ‘There is no reason to believe that Brexit should restrict access to financial markets’.
Preparation carried out by the FCA to date has seen close working with its counterparts worldwide, and particularly within the EU.
Underpinning its work to prepare for the UK’s departure from the EU is a focus on what Bailey calls ‘best execution for clients’; the assurance that users will get the best terms available, wherever the users or markets may be located. Effective competition is a central tenet of this.
This ‘best execution’ requires the integrity of markets – ensuring which is one of the FCA’s three statutory objectives.
Bailey was keen to point out that this ‘transcend[s] any particular set of rules’ – in other words, is not impacted whether the UK is inside or outside of the European Union – and that the UK market currently meets high standards on this.
As long as all players in the market meet these levels of integrity, a healthy degree of competition can continue, something the regulator wants to see.
Bailey was also at pains to point out that the FCA and its EU counterparts will be working to ‘mitigate any disruption to markets, and thus do what we need to do to preserve integrity’.
How is the UK financial services sector preparing for Brexit?
No deal planning must necessarily form a significant – possibly the largest – part of both the FCA’s and the industry’s plans. Bailey reported that ‘Firms in the UK have stepped up their preparations, the authorities in the UK have made good progress, and in the EU authorities have mitigated risks of material disruption to cleared derivative markets’.
Because of the progress made towards no-deal planning over the last year, the Bank of England believes the impact of a no-deal scenario has lessened over the course of recent months.
The FCA itself has taken a proactive stance. It published two consultation papers last October, with another launched in November and two more published on 8 January this year.
On 28 February, it published its near-final rules and guidance covering the UK’s financial services industry in the event the UK leaves the EU without an implementation period. Those proposals were based on feedback from the consultations.
And then in June, the FCA published its final instruments and guidance that will apply in the event that the UK leaves the EU without a deal or an implementation period.
This week, the regulator updated draft directions under its Temporary Transitional Power. The TTP gives the FCA flexibility in applying post-Brexit requirements, allowing firms to transition to a new UK regulatory framework, and the directions published this week would only come into effect on exit day if the UK leaves the EU without an implementation period.
He did warn though, that although the ‘worst case scenario’ was less bad than it had once been, ‘a worst case scenario remains just that…we cannot provide the assurance that there will be none’. The global financial crisis has given the regulator experience in dealing with unforeseen circumstances – but nonetheless (or maybe because of lessons learned during that crisis), the FCA is not complacent about the possible implications of a no-deal Brexit.
What are the key developments in the FCA’s Brexit preparation?
Bailey summarised the main developments to date:
Legislation and the Temporary Transitional Power
As we outlined above, the FCA this week issued draft directions relating to its Temporary Transitional Power.
It has also done significant work on legislation, working with the Treasury and Bank of England to onshore EU financial services legislation by the exit date. To date, this has involved the creation of over 50 statutory instruments. Amendments have been made in tandem to the FCA Handbook and to Binding Technical Standards made in the EU.
In Bailey’s words, this has led to some ‘hefty consultation documents – monsters even by our standards’.
Memoranda of Understanding
New co-operation agreements with EU markets and insurance and banking authorities have been drawn up. These would take effect in a no-deal situation. The MoUs enable firms to share confidential information; enable outsourcing or delegation between UK and EU firms; and support issues around market access and equivalence.
Changes to the FCA role
Once the UK leaves the EU, the FCA will take on several functions for the UK which are currently performed by ESMA at EU level. These include the regulation of Credit Rating Agencies and Trade Repositories, and responsibilities in respect of MiFID II.
Other changes involve: switchover for the Market Data Processor (MDP); updating the Financial Services Register to take account of the Temporary Permissions Regime (TPR); and changes to the Handbook website to accommodate onshoring changes and new materials.
The FCA’s Brexit webpages are a good source of additional information on all impacted areas.
Bailey also pointed out a number of issues that still require more action – among them:
- The Share Trading Obligation (STO). A rule in EU law that requires EU MIFID firms to trade certain shares only on EU venues, systematic internalises or equivalent third country trading venues. There is still work to be done here to ensure that market liquidity is not damaged for certain groups of shares.
- The Derivatives Trading Obligation (DTO), which requires EU firms to trade some classes of OTC derivatives on EU or equivalent third country Trading Venues. Here, work is needed to ensure firms are not caught by both the EU and UK DTOs.
- Clearing. The UK and EU authorities have already done significant work to mitigate the risks around continued access to UK and EU clearing services. However, temporary recognition for UK CCPs would expire in March 2020, and without greater clarity on the regulatory status of UK CCPs after this date, the contracts that EU members clear with UK CCPs will need to be closed out or transferred by then – a process that would need to begin by the end of this year. Further action may therefore be necessary to prevent this being required.
- Uncleared derivatives. Here, UK activity to allow firms to service existing uncleared derivatives between UK and EU counterparties has not been reciprocated by the EU. This means that individual Member States have to act to prevent disruption to contract continuity. Uncertainty remains about the scope of current or proposed legislation, in some jurisdictions, and in some cases additional action needs to be taken by regulators before firms can avail themselves of the regimes.
- Data exchange – here again, UK legislation is not reciprocated by the EU. UK legislation will allow the free flow of personal data from the UK to the EU in a no-deal scenario, but EU rules currently limit the flow of personal data from the EU to the UK. This could restrict EU households and businesses accessing financial services from, and continuing contracts with, UK financial service providers. The FCA believes that ways need to be found to continue this flow of information.
- Progress on contract repapering – where progress, in Bailey’s words, has been ‘gradual’. The majority of UK firms have confirmed that they plan to maintain existing products and services to their customers resident in the EU – but without repapering, their ability to deliver this may be limited.
What happens next?
Although there is more to do, Bailey expressed satisfaction with the progress made to date. However, he also acknowledged that there are ‘issues still to be resolved and uncertainly to be dealt with’.
He promised a ‘pragmatic’ approach from the FCA in tackling future issues as they arise, and in maintaining market integrity and protecting consumers and market uses.
The regulator will work with firms to ensure their contingency plans are executed effectively, and engage with its EU counterparts to derive solutions to the yet-unresolved issues.
Summarising, Bailey said that ‘we have made considerable progress, but we do not underestimate the task ahead’. It’s a stance that firms, too, might take; they can be pleased with progress to date, but should remain realistic and proactive about the challenges that remain.
Keep pace with a changing regulatory landscape
Brexit is a good example of the constantly-changing financial services regulatory environment. Keeping pace with the terminology, jargon and acronyms used in the sector is one essential step in ensuring you can understand and meet evolving legislative requirements.