EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018
Considered in Grand Committee
That the Grand Committee do consider the Central Counterparties (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018 and the EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018.
Relevant document: 1st Report from the Secondary Legislation Scrutiny Committee (Sub-Committee B)
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.
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 Committee.
My Lords, I would like to intervene briefly to ask my noble friend a couple of questions. Although we all hope for a deal scenario, not a no-deal scenario, nevertheless the practical approach to these matters should perhaps be thought through a little more. My first point is a procedural one relating to the statutory instrument—I refer particularly to the EEA passport rights matter. I spent some years—not many, thank goodness—as a member of the Select Committee on Statutory Instruments in the House of Commons, which was chaired by the late Bob Cryer. He was scrupulous about determining the nature of approaches towards statutory instruments.
I am concerned that we have, effectively, a hybrid—an affirmative resolution, but nevertheless with the prospect of a negative procedure in the event of any extension of time, for registration of the various bodies that may need registration in due course. I find that rather concerning. I would like my noble friend to confirm that we are not getting dangerously close to a ban on negative approaches. Clearly that could happen when the affirmative approach is required but where there is a fee involved for a function which a UK public authority would exercise.
I believe the registration itself must by implication—although it is not revealed in this document—carry with it some financial implications; some fees will have to be paid, although they are not referred to here. If that is the case, would it not be more appropriate for affirmative resolution to be carried through to those extensions as well as to the rest of the item? That is my first point.
My second point is that while the FCA seems capable of handling quite large numbers of registrations for companies under EEA processes, the Prudential Regulation Authority does not. That is a deep concern. So far, the PRA seems able to manage only 10 or 12 applications per year. It has already indicated that it expects that there will be between 100 and 200 applications in the event of a no-deal scenario under these proposals. How does my noble friend believe this can be dealt with, without some form of massive increase in resources or powers, particularly in the hands of the PRA? I would be grateful if he would allow that.
I come to my third and final point. He has talked about the extension of the extension, which requires six months’ notice from either the PRA or the FCA as to the needs arising. To my mind, that is an almost indefinite process; we would see these extensions going on ad infinitum, or certainly for a considerable time. Surely that must be a disadvantage to the entities applying for registration and, indeed, to the position of this country in relation to the financial services in which it is at present so pre-eminent. Can he assist with that? I am grateful to him for his introduction.
My Lords, I thank the Minister for his introduction and I concur with him that these are necessary instruments. I declare my interests as in the register and, in particular, as a director of the London Stock Exchange.
Starting with the EEA passport rights regulations, I fully understand the need for temporary or deemed permissions and some flexibility, but in the longer term there are risk and competitiveness issues to consider, so I shall explore further the time periods and how the policy surrounding them might operate. There are two time periods: two years from exit before a formal application for authorisation has to be made, and three years from exit, extendable, within which the relevant regulator makes a determination. Supervisors can require a formal application to be made before the two-year period is up, and presumably that could be exercised for a variety of reasons, such as phasing in for size or complexity of entity or for other risk-based reasons. As the Minister has already mentioned, the two-year period is also potentially useful to EEA firms trying to decide what to do, getting used to UK supervision and having time to organise themselves before having to seek authorisation. It can also be that the two years is simply a waiting room until the regulators have the capacity to carry out the authorisation determinations. How is it envisaged that the two-year period will operate? What is the policy? Is it a phasing mechanism? Will the regulators be controlling that phasing? Is it wholly in the hands of the firms that want their passports replaced? Is it expected that everyone will have two years and then there will be a sudden rush of applications; or, as I asked before, will there be some kind of risk-based assessment about which applications must be brought forward in time?
I now turn to supervision, because the entities in the temporary regime will come under supervision. Can the Minister assure us about the regulator’s capacity to supervise and that significant supervision will take place? If it is envisaged that there may be an unmanageable, or at least long, queue for authorisations because of capacity issues, what is the capacity situation with supervision?
Does two years really mean a fixed two years that cannot be extended? I cannot find anything to say that it could be, and there is nothing in the Explanatory Memorandum. But just in case I might have missed something, will the Minister clarify whether the construct of the regulation stating that “Section 55U” of FiSMA “has effect as if” is a good way of keeping the two years unamendable by any power to make changes that might be embedded in FiSMA or anywhere else? I am still learning the tricks of some of the parliamentary drafting that goes on here, and that is quite a good one to remember.
As to the three-year limit allowed for determination of applications, it can be extended, as has already been said. How necessary that is might in part be determined by the policy over the preceding two years. Is extension available only if the regulators do not have the capacity to conclude within three years? I think that is what the Minister said. Has three years been set assuming a rush of applications at the two-year stage, or will an extension be inevitable if that two-year rush happens?
As the noble Lord, Lord Kirkhope, said, it would clearly not be appropriate for the extension to be used on a rolling basis to allow businesses that might not measure up to full UK authorisation standards to continue to operate in a temporary regime because there had been no determination of their application. That is one of the reasons why I share the view expressed by the Secondary Legislation Scrutiny Committee that there is a good case for an extension requiring the affirmative procedure. I do not agree with the reply from the Treasury Minister John Glen in the correspondence. It is not satisfactory to say that some affirmative permission somehow flows from this SI so that the negative procedure is enough at the time of the extension. That might have been the case if the policy on these time periods had been more clearly elaborated, but it was not. In fact, it seems to be in the hands of the regulators, and if that is the case, then I cannot see how avoiding affirmative procedure is the right way to go. If the Government had set the policy and embedded it in here, that would be different, but this does not include the policy on how it is going to be used.
A positive case for extension somehow has to be made to Parliament. An important part of the extension process is the report under Regulation 27, made by the relevant regulators to the Treasury six months ahead of expiry of the time period. What arrangements are there for that report to be made available to Parliament in a timely way, not just as background once the regulation has been laid and it is too late? For example, will at least all the relevant Select Committees be briefed?
There are undeniable risks if temporary measures drag on too long, and it could mean unfair competition with domestic entities. It is one thing for UK companies to have to absorb the cost of seemingly more strenuous conditions being applied to them in EU countries, and quite another if there is somehow a lighter-touch temporary regime here at home for competing EU-based companies. I am sure noble Lords will see that there is a prospect for a double whammy to UK companies if they lose out on both sides of that for a significant period.
I will move on now to the central counterparties regulation. The temporary regime has some parallels with the passport regulation, and covers making the Bank of England the regulator and the EMIR recognition and equivalence regime. I acknowledge the wisdom of saying that the Treasury and the Bank of England can get ahead in the recognition and equivalence. That is very important. I repeat the concerns on time limit extension. There is good reason why that should have been made using the affirmative procedure. In some ways, I see even less reason for extending it here because central counterparties are relatively few—they may be important and systemic when they are large, but there are not huge numbers of them. Will the Minister tell me what reasons are envisaged for not being able to get out of the temporary regime and needing an extension? It might be that, despite the best endeavours, the necessary co-operation arrangements have not been put in place for whatever reason.
I am also slightly puzzled by the fact that Regulation 12 says that an application has to be submitted before Brexit, but Regulation 19 says that the game is up if you have not made one by six months after Brexit. Either there is some discontinuity there or I have missed something—which is not impossible when going through lots of these things very quickly.
The final point I want to make is not a question that can be easily answered. One of the criticisms that was constantly made against the EU equivalence regime in the various Brexit reports that came out was that it could be withdrawn with little notice—in fact, they feared that could happen under political influence of the Commission. Can the Minister explain whether such criticism could also be made against the UK regime in due course, bearing in mind that it basically follows the EMIR regulation, or have the conditions in Regulation 19(7)—that the Bank of England can withdraw only because of financial stability; although that can obviously be used very widely—made it in some way more binding?
Finally, when the Commission was making equivalence decisions under EMIR, it was sometimes quite difficult to fit within the wording of EMIR Article 25(2)(b) because some countries simply do not have regulation and authorisation provisions. These are not the major countries, but nevertheless there may be CCPs. Due to the capital charges that apply to other bodies if a CCP is not recognised, there is an incentive for recognition of CCPs in what one might call less-developed countries in the financial services sense. It then became necessary for the Commission to consider comparable mechanisms and use a very flexible interpretation of the language of the legislation. Indeed, it had to resort to things like looking at the rules of the exchangers that were using the CCPs, with that replacing, if you like, the legal provisions. It raises the question of whether there is any language in the way equivalence is to be done that is drawn so tightly in this statute that it will become inflexible and you will not be able to recognise some of those types of CCPs, particularly where you are referencing the legal constructs that are available in the country. Those legal—in legislative terms—constructs simply may not be there, and you are looking for something else that you have to use to replace them.
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?
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.
I have only one or two small questions on the instrument, if my one-line précis is substantially accurate. First, some of these foreign firms are covered by the Financial Services Compensation Scheme—the FSCS. Customers of those firms in the United Kingdom therefore have that protection. Can I be assured that with a temporarily—and subsequently fully—authorised firm, such protection as consumers now have will continue uninterrupted as we go through exit day into, perhaps, a temporary period and a more permanent period? Again, the instrument seems silent as to what happens if a firm, having been in a period of temporary authorisation, is subsequently denied it permanently if it is found to be lacking in some way. What would be the consequence for UK customers? Would they in fact find that their investments or trades, or whatever services are provided by these financial firms, are in some way at risk?
The sequence of events if there is no deal, which we all hope will not happen, will in some bizarre way end up as an audit of passporting because its concept, as I understand it, is that each member nation of the EU has equivalent and appropriately powerful rules for regulation. Those rules and regulations can be accepted by other members of the EU as sufficient to allow trading across borders. This would imply that any firm trading in the UK now through a passport ought to be trading at such a standard that it would, beyond reasonable doubt, expect to be authorised. I would value any comments that the Minister might have on that concept.
Other noble Lords have spoken about the extension being for 12 months at a time. I am sure the Minister will try to assure us that these extensions will happen only in exceptional circumstances, but they always are exceptional circumstances. I suspect that those from the 17th century, when the Army went from being a standing army to being authorised every year by a vote in Parliament, would be surprised to find the practice still happening today—which it does, because I have to vote on it every year. I fear that “12 months at a time” could go on for many years. For that reason, I support the general request that this should be under an affirmative procedure, not a negative one.
The question about regulators’ resources is also very valid. I believe that in a year, the PRA makes authorisations that are in single figures and, although I cannot remember the figure I have been given, that the number of firms that might be under its purview could be something like 70.
My other concern is about the Bank of England. My understanding of the instrument is that the Bank of England will have supervisory responsibilities towards these firms from exit day. I assume that will include supervision of what I think is called the reform and resolution regime—that is, how you manage a bank that is going broke. I know that the Bank of England has a significant directorate that looks after that for UK banks. Presumably it would pick up a similar responsibility. Can the Minister assure us that all features of supervision for which the regulator has immediately become responsible, as I understand it, will be properly resourced?
I do not know whether I am getting this wrong, but this seems to me to be the most significant SI in the financial sector that we have had so far and that it is not likely to be overtaken by a more significant one. It says that in a no-deal situation the UK capitulates on the matter of international financial services. It creates a regime where EU and EEA firms carry on trading more or less as if nothing had happened and it implies that the UK cannot trade in Europe as it does today. As far as I can see, there are no mechanisms to allow it to trade. I hope that I am wrong, that out of the hat comes a rabbit and that the Minister will say there is a WTO rule or something like that, but I do not believe that is so. I think the situation is catastrophic. Perhaps I am over-exaggerating. Perhaps it is really not a big problem. Lots of eminent politicians for whom I do not have natural sympathy have expressed how wonderful no deal would be. I think this is the classic example of where no deal would be really bad for the industry. What is the Government’s estimate of the effect of no deal on financial services in terms of employment, tax revenue and the health of the economy? Aside from these instruments, because presumably the Government are, as we speak, working flat out to secure a better deal for financial services, what is the Government’s aspiration in this area? What position do they hope to reach to make up for the lack of reciprocity in this deal? Will it be a fully reciprocal situation where UK firms will have the same privileges as EU firms have trading in the UK?
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.
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.
The noble Baroness, Lady Bowles, asked what organisational preparations are being made by the FCA and the PRA for the challenges of supervising new firms. As the CEO of the Prudential Regulation Authority, Sam Woods, explained to the Treasury Select Committee, the PRA has significantly increased the number of staff working on these issues and has reprioritised its activities to ensure that the right resources are focused on its authorisations work. The FCA stated in its 2018-19 business plan:
“A significant proportion of our resources are already focused on the forthcoming exit, including arrangements to implement the change”.
I am confident that the PRA and the FCA are making adequate preparations and are effectively allocating resources ahead of March 2019 and the start of the temporary permissions regime.
The noble Baroness, Lady Bowles, asked whether there is a contradiction between Regulations 12 and 19 about when the application needs to be made. The central counterparties may apply before exit day but are not required to. They have up to six months after exit day to apply for full recognition.
Regulation 12 states:
“A central counterparty established in a third country”,
“intends to provide clearing services … on and after exit day”,
has to make an application and that the application “must” be submitted before exit day. I do not think that is quite what the Minister said. I realise that time is short now, and there are quite a few things that the Minister has had to gloss over. I hope he will review what I have said, and I would welcome a written response.
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.
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.