With UK/EU deal negotiations in the balance and a no-deal scenario still possible, a panel of experts from Herbert Smith Freehills, the Financial Conduct Authority and McCann FitzGerald (for the Ireland perspective) will review the current state of play on Brexit and what comes next for the regulation of cross-border financial services. Continue reading
On 27 March 2020, the House of Lords EU Financial Affairs Sub-Committee published a letter from its Chair, Lord Sharkey, to the Chancellor of the Exchequer, Rt Hon. Rishi Sunak MP, emphasising the importance of the UK remaining actively engaged in shaping the future relationship with the EU in financial services.
In the letter, Lord Sharkey calls on the Government to establish a structured dialogue between the UK and the EU to support cross-border financial services and manage any future divergence. The key message from Lord Sharkey is as follows:
“While the Government is quite rightly currently focussing on the coronavirus pandemic, at some point it will need to return to considering the future of the UK’s financial services sector and negotiating its relationship with the EU.
“When it does, it should pay particular attention to how it will work with the EU to support cross-border financial services and manage any future divergence.”
The letter also sets out the following key points and recommendations which were reached by the Committee during its review of financial services after Brexit:
- while the UK is currently fully aligned with the EU, there is a risk that the EU’s equivalence decisions will be politicised and could be withdrawn at very short notice. There should be regular and structured dialogue to provide a forum for discussion and resolve any possible disagreements;
- the Government should delegate more powers to the financial regulators after Brexit, to give the UK’s regulatory regime more flexibility and increase its ability to respond to changes. This will require increased parliamentary oversight of the financial regulators’ activities; and
- the UK may wish to make some targeted adjustments to ensure that the regulatory regime is fit for purpose. The UK should take a leadership role in promoting international cooperation in financial services after Brexit by promoting global standards.
The letter also includes a longer annex highlighting key findings from the inquiry from various government, regulatory and industry sources. While much of this will be familiar territory to market participants that have remained engaged in the discussion on this area, the annex is a useful round-up of key perspectives on equivalence and the shape of the future UK-EU relationship.
It was confirmed yesterday by HM Treasury (HMT) in a statement to Parliament that it will retain the UK regulators’ “Temporary Transitional Power” (TTP), which was introduced as part of the UK Government’s no-deal contingency planning legislation, and shift its application such that it is available for use by the regulators for a period of two years from the end of the Transition Period.
HMT’s statement reminded Parliament that:
- while, in general, the same laws and rules [as apply presently in relation to financial services] will apply at the end of the Transition Period, HMT recognises it will be important, irrespective of the agreement that is reached between the EU and UK, for the regulators to have the flexibility to smooth any adjustments to the UK’s regulatory regime for financial services at the end of the Transition Period; and
- the purpose of the TTP is to allow the Bank of England (BoE), the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) to phase in changes to UK regulatory requirements so that firms can adjust to the UK’s post-Transition Period regime in an orderly way, in line with the objectives already set by Parliament.
While this outcome is in line with market expectations, it is nonetheless reassuring for UK firms and other market participants to have confirmation, at a time of particular uncertainty, that the UK regulators will retain this flexibility for the medium term. There is no indication of any extension to the separate Temporary Permissions Regime (TPR) for EU financial institutions currently passported in/into the UK.
This post was first published on our Digital TMT and Sourcing Notes blog.
On 4 March 2020 the Financial Conduct Authority published a short set of findings from its review of outsourcing in the UK life insurance sector. Despite the review’s narrow scope, the FCA’s findings are readily applicable to other outsourcing contexts, so regulated firms outside the life insurance sector should be aware of these. Continue reading
The Chancellor of the Exchequer delivered the 2020 Budget to Parliament on 11 March 2020. This includes a package of related policy documents, many of which highlight planned reforms to the financial services sector.
Of particular note for banks and investment firms is the policy statement on prudential standards published by HM Treasury, which confirms the government’s intention to implement:
- CRD V and the related Basel III banking standards through powers in the forthcoming Financial Services Bill, including the more recent “Basel 3.1” reforms not incorporated within the EU CRR II regulation; and
- an updated prudential regime for investment firms in the UK. The policy statement notes the instrumental role played by the UK Government in developing the EU prudential regime for investment firms (ie the Investment Firms Directive and Regulation), although there is no specific commitment to closely mirror the EU regime, or indeed the CRR II rules.
The possibility of divergence in approach is also hinted at in the closing comments, which note that HM Treasury is conducting a review to determine how the regulatory framework will need to adapt to the UK’s position outside of the EU, including examining the ongoing allocation of regulatory responsibilities between Parliament, HM Treasury and the regulators. Both the Government and the regulators will consult on proposals to implement the various prudential reforms “in due course”.
Two years after MiFID II and MiFIR started to apply, the MiFID review process has begun, with both the European Commission and the European Securities and Markets Authority (ESMA) having recently published consultations on the framework.
European Commission consultation
The European Commission has launched a public consultation on the review of the MiFID II/MIFIR regulatory framework. This consultation uses a questionnaire format divided into two main sections. The first section covers general questions on the overall functioning of MiFID II/MiFIR, with the second section covering specific questions on “priority” and “non-priority” topics (see below). Continue reading
The sections on financial services in the UK’s approach document are set out below:
Chapter 16: Financial Services
- The Agreement should promote financial stability, market integrity, and investor and consumer protection for financial services, providing a predictable, transparent, and business-friendly environment for cross-border financial services business.
- The Agreement should include legally binding obligations on market access and fair competition, in line with recent CETA precedent.
- The Agreement should also build on recent precedent, such as the EU-Japan EPA and international best practice, by establishing regulatory cooperation arrangements that maintain trust and understanding between our autonomous systems of regulation as they evolve. This could include appropriate consultation and structured processes for the withdrawal of equivalence findings, to facilitate the enduring confidence which underpins trade in financial services.
Equivalence in Financial Services
- The UK and the EU have committed to carrying out unilateral equivalence assessments for financial services, distinct from the CFTA. The fact that the UK leaves the EU with the same rules provides a strong basis for concluding comprehensive equivalence assessments before the end of June 2020.
Unsurprisingly, these are brief and outcomes-focused in nature, reflecting the Government’s approach more generally and the desire for “autonomous systems of regulation” (as preserved under the EU-Japan Economic Partnership Agreement) rather than close alignment. The comments on equivalence do serve as a reminder to the EU that the UK will nonetheless be starting from a position of close alignment, but as ever, there are no guarantees that this challenging deadline for completing assessments will be achieved.
On the same date, the European Commission has also published a speech delivered by Michel Barnier, the EU’s chief negotiator on its future relationship with the UK, addressing the potential for UK/EU co-operation post-Brexit. The tone of the speech is characteristically challenging of the UK’s perceived desire to preserve sovereignty and regulatory autonomy while maintaining access to EU markets. Mr. Barnier’s discussion of equivalence indicates the lack of appetite from the EU to develop a more extensive and durable form of equivalence for cross-border market access, as explained in the following extract:
[Equivalence in financial services]
“… The EU will have the possibility to grant equivalences. We will do so when it is in the interest of the EU; our financial stability; our investors and our consumers. But these equivalences will never be global nor permanent. Nor will they be subject to joint management with the UK. They are, and will remain, unilateral decisions.
I read in the Financial Times recently that London must retain its primacy as a hub for wholesale financial markets without becoming a rule-taker of European regulation. As a former Commissioner in charge of financial services, allow me to question that. Why should we accept that the profits stay in London while the EU carries the risks?
The UK may not want to be a rule-taker. But we do not want to be the risk-taker. When the next financial crisis strikes, who will foot the bill? I doubt the UK will foot it for the EU. That is why the EU must take the responsibility for its financial regulation, supervision and stability.”
The FCA this week published two template ‘Dear CEO’ letters, one to asset managers and one to alternative investment firms, highlighting the FCA’s views on the key risks posed to customers and markets, and setting out its supervision strategy for the coming months.
The FCA’s asset management portfolio comprises firms that predominantly directly manage mainstream investment vehicles, or advise on mainstream investments (excluding wealth managers and financial advisers), whilst its alternatives portfolio is comprised of firms that predominantly manage alternative investment vehicles (such as hedge funds or private equity funds) or alternative assets directly, or advise on those types of investments of investment vehicles.
The FCA’s key concern is that standards of governance in both sets of firms are below what it expects, and progress is needed in both sectors to protect the best interests of customers.
The ‘Dear CEO’ letters make it clear that the FCA will be very active in the asset management and alternatives sectors in the coming months, and firms should expect increasing scrutiny. It will be important for firms to look at the areas identified by the FCA and consider any changes they need to make.
The FCA’s supervision strategy addresses the key issues in each sector, with specific priority areas set out below. Whilst the areas of focus are split between the two sectors, the FCA recognises that there will be overlap between the two.
The asset management supervision strategy will focus on the following key areas:
- Liquidity management – Authorised Fund Managers (AFMs) are responsible for ensuring effective liquidity management in funds but the FCA warns that there can be a liquidity mismatch in open-ended funds between the terms at which investors can redeem and timescales needed to liquidate assets. The FCA expects firms to take necessary action following recent publications from the FCA and the Financial Policy Committee. This has been a continuing theme in light of the issues experienced by some real estate funds after Brexit and the collapse of the Woodford fund.
- Firm’s governance – Following the extension of SMCR at the end of 2019, the FCA expects firms to have refreshed their approach to governance and taken the steps necessary to improve it in line with SMCR requirements. The FCA intends to carry out work in H1 2020 focussing on the implementation of SMCR across asset managers.
- Asset Management Market Study (AMMS) remedies – The FCA published its AMMS Final Report in June 2017 and the consequential rule changes are now in force, including requirements around governing body structure and value assessment on funds. In H1 2020, the FCA plans to undertake work on how effectively firms have undertaken value assessments, with more work envisaged in the future given the breadth of the AMMS reforms.
- Product governance – Following the introduction of new product governance requirements under MiFID II, the FCA has begun reviewing how effectively these requirements have been implemented by asset managers, and expects to complete this work in early 2020. In parallel, the FCA is also reviewing arrangements whereby funds are managed by ‘host’ Authorised Corporate Directors (ACDs) (AFMs that are not within the group structure of the delegate investment manager), as there are concerns that the ‘host’ ACD may not be undertaking their responsibilities effectively in some cases.
- LIBOR transition – The FCA is currently gathering information from some asset management firms to enhance its understanding of business models, including their specific exposure to LIBOR risk, and intends to provide further communications on its expectations for LIBOR transition in due course.
- Operational resilience – Operational resilience remains an area of focus for the FCA for financial services firms as a whole. In the asset management sector specifically, the FCA is conducting technology reviews and ad-hoc reviews of firms’ arrangements and expects to undertake further proactive work in this area. The FCA reminds firms of their obligations under Principle 11 to notify it of any material technology failures or cyber-attacks. For more information on operational resilience in the asset management sector, please see our blog post here.
- EU withdrawal – With the UK’s exit from the EU approaching, the FCA expects firms to consider how the end of the implementation period will affect both the firm and its customers, and take action to be ready for 1 January 2021.
Alternative Investment Firms:
For alternative investment firms, the FCA’s supervisory priorities are as follows:
- Investor exposure to inappropriate products or levels of investment risk – Significant levels of investment risk are inherent in alternative investments, so the FCA expects firms in this sector to carefully consider the suitability or appropriateness of these investments for their target investors. Where investors are allowed to ‘opt-up’ to elective professional client status, firms should robustly assess the client’s suitability to be opted-up. The FCA plans to review retail investor exposure to alternative investment products offered by alternatives firms, with a particular focus on firms being aware of who their clients are and acting in their clients’ best interests.
- Client money and custody asset controls – As part of the retail investor exposure, the FCA also plans to assess whether firms which have client money or asset custody permissions are exercising them in accordance with the Client Assets Sourcebook (CASS) rules.
- Market abuse – In the FCA’s view, market abuse control across the alternatives sector has “significant scope for improvement”. To that end, the FCA has recently conducted an assessment of the adequacy of market abuse controls in the sector and may invite firms to participate in a similar exercise in future. The FCA reminds firms that it may consider enforcement action for those firms which are found not to comply with Market Abuse Regulation (MAR).
- Market integrity and disruption – With scope to take significant investment risk in managing their products (ie. credit risk and market risk), the FCA expects alternatives firms to operate robust risk management controls to avoid excessive risk-taking and effectively mitigate against potential harm or disruption to markets. The FCA may choose to undertake in-depth assessments of firms’ controls in future.
- Anti-money laundering and anti-bribery and corruption – Alternatives firms face a risk of being used to facilitate fraud, money laundering, terrorist financing and bribery and corruption. The FCA intends to review firms’ systems and controls to mitigate this risk, with particular focus on the risks of money laundering and terrorist financing.
- EU withdrawal – As above, the FCA expects firms to take steps to be prepared for the UK’s exit from the EU at the end of the implementation period on 1 January 2021.
The third episode of Regulation in Focus, our podcast series of short, sharp insights into regulatory issues that matter to you, features Katherine Dillon and Emma Reid from our non-contentious financial services regulatory practice in London, discussing the role that equivalence might play in accessing EU markets post-Brexit.
European Commission Vice President Valdis Dombrovskis announced in a speech at the Guildhall in London last week that, ‘as the risk to financial stability has not yet been fully removed, because industry has not so far fully prepared’, he intends to renew the temporary equivalence decision for UK central counterparties (CCPs) beyond the current expiry date of 30 March 2020. No further details of the extension have as yet been published.