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Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2020

Volume 803: debated on Thursday 18 June 2020

Motion to Approve

Moved by

My Lords, your Lordships will be aware that, since July 2018, HM Treasury has put in place legislation, using powers under the European Union (Withdrawal) Act 2018, as amended by the European Union (Withdrawal) Act 2020, to ensure that the UK has an independent and coherent financial services regulatory regime at the end of this year when the UK leaves the transition period. This SI is part of that programme of work, and the approach aligns with the general approach established by the EU (Withdrawal) Act 2018, providing continuity by retaining existing legislation at the end of the transition period, but amending where necessary to ensure that it continues to function and is effective in a UK-only context.

The SI makes deficiency fixes to a new piece of EU legislation that has recently become applicable relating to the European market infrastructure regulation, hereafter referred to as EMIR. EMIR implemented the G20 Pittsburgh commitments, agreed in the aftermath of the financial crisis in 2009, regulating over-the-counter derivative markets and, in particular, requiring some derivatives to be cleared in a central counterparty, known as a CCP, to manage risk between users of derivative products. EMIR has been effective in increasing the safety and transparency of derivatives markets, thereby reducing the associated risks users may face. UK CCPs play an essential role in reducing systemic risk and ensuring the efficient functioning of global financial markets. Parliament has previously approved several EU exit instruments to ensure that EMIR continues to function at the point of the UK’s withdrawal from the EU.

EMIR was updated by a regulation known as EMIR 2.2 on 1 January this year. This regulation modifies the third-country, or non-EU, CCP supervision framework so that EU authorities have greater oversight over third-country CCPs that are systemically important to the EU. Most of these changes are made to the recognition framework for CCPs outside the EU. Each CCP has to be individually recognised by the European Securities and Markets Authority, known as ESMA.

The Bank of England has already been given the power to recognise non-UK CCPs wishing to operate in the UK via an earlier SI under the EUWA. Because this recognition framework has now been updated, this SI transfers ESMA’s new powers to the Bank of England. That means that the Bank of England will have the power to tier non-UK CCPs according to their systemic importance to the UK. Under the tiering system, tier 1 CCPs will continue to be supervised by their home regulator alone, while systemic CCPs will be recognised as tier 2 and expected to comply with certain requirements in UK EMIR. The power to supervise tier 2 CCPs has also been transferred from ESMA to the Bank. Where a CCP is subject to the supervision of the Bank of England, this SI extends parts of the current supervisory framework for UK CCPs to non-UK CCPs. This is appropriate as this supervisory framework is working effectively in the UK already, and largely mirrors the powers that ESMA will have. For example, both ESMA and the Bank will have the power to issue fines.

EMIR 2.2 also empowers the Commission to adopt delegated acts to specify how the framework will function in practice. This includes tiering, but also how the UK supervisor’s deference to the rules of the non-UK CCPs’ home authorities, referred to as “comparable compliance”, will function. This SI transfers the power to establish those frameworks to the Bank of England. The Bank has existing responsibilities for safeguarding financial stability in general, and managing systemic risk in CCPs in particular. It is therefore appropriate that the Bank can establish the details of the framework to manage the systemic risk posed by some non-UK CCPs in a way appropriate for the UK.

The remaining functions of the Commission are transferred to Her Majesty’s Treasury through this SI. This includes the so-called location policy. Under EMIR 2.2, ESMA can recommend to the Commission that a third-country CCP that is felt to be “substantially systemically important” cannot offer some services to EU clearing members unless those services are offered from inside the EU. The UK did not support the inclusion of this location policy during the negotiation of EMIR 2.2, due to concerns that it could lead to market fragmentation and reduce the benefits provided by the global nature of clearing. However, the powers in the EUWA, under which we are making this SI, extend only to addressing deficiencies arising from withdrawal, and commitments were made during the passage of the Bill that the power would not be used to make significant policy changes.

Therefore, this instrument transfers the power to use the location policy to Her Majesty’s Treasury via a negative regulation, subject to advice from the Bank of England, and appropriate procedural safeguards and transitional provisions. However, I can assure the House that it is hard to foresee a circumstance in which using the location policy would be effective in supporting financial stability in the UK. The UK clearing market sees a large proportion of clearing occur in UK CCPs; it is therefore unlikely to be appropriate ever to use this tool in practice.

EMIR 2.2 also makes changes to the internal EU supervisory and co-operation mechanisms, including creating a CCP supervisory committee inside ESMA and increasing responsibility for EU supervisory colleges. As the UK is no longer part of the EU, these provisions are removed by this instrument.

Finally, the instrument updates the recognition powers set out in the temporary recognition regime. This regime was established by a previous SI to enable non-UK CCPs to continue their activities in the UK while their recognition applications are assessed. This SI updates the recognition requirements in line with the new EMIR 2.2 provisions, helping to provide certainty for non-UK CCPs regarding their recognition within the UK market during the transition period.

The Treasury has worked closely with the Bank of England to prepare this instrument and has engaged with the financial services industry. The draft legislation has been publicly available on the website since 24 February to maximise transparency to Parliament and industry, and the instrument was laid before Parliament on 25 March.

In summary, this instrument will ensure that the UK’s regulatory framework will continue to function effectively in the UK at the end of the transition period. Without an operable regime, the UK’s ability to regulate the financial sector effectively, and manage the financial stability risks posed by some of the largest non-UK CCPs, will be compromised. I hope noble Lords will join me in supporting these regulations. I beg to move.

I declare my interests as in the register as a director of the London Stock Exchange plc.

I have forgotten how many of these Treasury statutory instruments I have done, but it must be around a half-century innings so far. With each one my past flashes before my eyes and, although EMIR 2.2 was done after my time in the European Parliament, the content is familiar.

I support the UK taking an open stance on location policy, at least for now. I successfully negotiated away attempts at its introduction in the original EMIR because it was then intended to be used in a protectionist way to undermine the financial single market, and the European Court agreed. Brexit changes that protection for the UK. Now that we are on the outside, it comes down to balancing fear and retaliation—fear that massive moving of contracts is itself a systemic risk, fear of extra costs to industry, and perpetual EU pressure on decisions and location of key personnel. Maybe, in the end, it will be the attractiveness of London and London business that wins out—as it has done for the Unilever listing—but no one should underestimate the effort that involves.

Do I object to one of the Commission powers being given to the Bank of England rather than the Treasury? No, that is where the skill lies—although anyone following exchanges between me and Mark Carney on the Economic Affairs Committee will know that I think it has been overoptimistic about how its regulatory relationships will win over EU demands. I do not dispute the good relationships or technical correctness, but this issue has political overtones.

I hugely regret that there is no way that this Parliament gets a say anything like that which the European Parliament has, particularly at primary level. Everything is delegated away from accountable objectivity or the ability for Parliament to steer or understand our largest industry.

Finally on this instrument, look at the mess of it: if it were the olden days, when we had long exchanges in the Moses Room, I might have challenged the Minister to a game of hunt the provisions. It can pass now, but it is a travesty of democracy to have such an entanglement of legislation that no person—not even the Treasury—knows where everything is.

My Lords, I declare my interests as in the register. I broadly welcome this instrument; it comes in extraordinary times, and we do not really have enough time to debate it, but we are at a critical point in our negotiations with the EU during the transition period. This is an incredibly technical instrument, and I am glad to be among the notable Peers who have far more expertise than I do on this matter.

In the limited time, I will focus on questions of sovereignty, because a lot of this has been picked off by our exiting the EU. I have had some contact with both the financial services industry and this area of derivatives, which, though often castigated in public, is crucial to our future as a financial hub. It is a growth sector and, as the world becomes riskier, we need to cement our position in this kind of trading globally to help reduce risk for businesses, organisations and markets around the world.

I have a couple of concerns for my noble friend the Minister to address. She may not have time to fully answer them all, so I would be happy to have a letter placed in the Library in response. My concerns are about sovereignty and how governance may shift over time, particularly in the course of our negotiations—and if they perhaps break down—and post this transition period. As mentioned, we are giving quite a bit of leeway to the Bank of England. What provision has been made, or what guidelines exist, to ensure that the Bank of England does not give away any powers during this period, given the freedoms it has around regulating and bringing in third parties to that regulation?

My second question is on human rights. We are obviously in a period when financial services are being pulled into discussions about past slavery and practices within supply chains. I would be interested to know how the sovereignty in this instrument works with third parties and the question of who decides about human rights. This could very much complicate these markets, which are huge.

Finally, and this is perhaps more of a speculation, but what thought has been given to the provisions in this instrument and decisions that might be made in the Bank of England? Should our relationship with the EU turn sour—I hope it will not—and the EU choose to impose further protectionist measures against us, this could somehow undermine our position in discussions. I look forward to hearing the rest of the debate, but I would welcome some answers from the Minister.

My Lords, at one level these regulations could be seen as a technical set to see us through to the end of the year in order to be compliant during transition. However, they raise some very substantive issues which set a pathway with much greater significance.

What we are legislating for here is derived precisely from the legislation which the EU will use in dealing with the United Kingdom from 1 January next, onwards. Unless there is some major shift in governing policy, the EU form of these regulations will be the rules which govern the activities of UK entities within the 27 member states of the European Union. All of the tightened EMIR 2.2 regime rules on the over-the-counter derivatives market will be applied to us a third country. In the context of the Government’s aim not to be within the single market, a primary concern must be whether our regulatory regime will be regarded as equivalent by the 27 member states of the EU next year.

It is through this lens that we must assess the adequacy of these regulations. I am afraid that all the signs of what will happen next year to our relationship with the EU look increasingly gloomy. As written, the Explanatory Memorandum is either very misleading or incredible in its paragraph 7.1, depending on your view of its literal meaning. Its opening words state:

“The UK has left the EU with a deal”,

yet the EU, as we know, has said that we are not even negotiating effectively on the agreement—the political declaration which the UK reached at the end of last year. What was achieved was leaving with an agreed declaration on the future issues to be negotiated. I suspect that the terms of this bald statement in paragraph 7.1 of the EM refer to a much narrower arrangement than the one currently cited by all sides and the media, including our own Prime Minister, as leaving with a deal. Can the Minister tell the House what deal the Government are referring to in this statement, and which terms of that deal are relevant to these regulations?

According to the political declaration, the UK is required to conclude its equivalence assessments in 12 days’ time. These regulations are part of that exercise. How much more needs to be concluded in these coming days, or will we require an extension of some weeks or months to finish the exercise?

Turning to the regulations themselves there is a considerable increase, as noble Lords have said, in the powers and role of the Treasury and the Bank of England. What level of scrutiny do the Government envisage over the use of these powers? The only reference to Parliament is in relation to Regulation 21 of this instrument. As the Minister said, it uses the most limited form of parliamentary scrutiny, the negative procedure; additionally, this regulation is the one most likely never to be used. As we seek to provide regulatory equivalence and, I hope, avoid a cliff edge at the end of the year, I am bound to reflect that none of this can replace the market access we currently enjoy.

My Lords, you should be able to see me. I thank the Minister for and congratulate her on the clear way in which she introduced this statutory instrument. I have three questions. First, have the FCA and the Bank of England identified to Treasury Ministers any specific systemic risks that the House should be aware of? Secondly, are there any ongoing concerns within the FCA and the Bank of England over inter-trade repository reconciliations? Thirdly, does the power remain to suspend reporting obligations for 12 months and, if so, what criteria will the Treasury use to enact it? Can this power be rolled over for a further 12 months, beyond the initial 12?

My Lords, I support this statutory instrument. I welcome it and congratulate my noble friend on her introduction. It is of course important that derivatives are increasingly cleared through CCPs since the lessons that we learned in 2009. The security of global derivatives markets is vital to the functioning of the financial system and the stability of institutions such as pension funds and insurers, which use derivatives widely nowadays in their risk management processes.

Extending the Bank of England’s supervision of domestic CCPs to global CCPs is necessary as we depart the EU; likewise, ensuring that it can continue to maintain its responsibilities for safeguarding financial stability and systemic risk is important. However, does my noble friend feel that the Bank of England has sufficient resources to deal with these wide-ranging new responsibilities and technical standards, especially if we leave the EU without any formal agreement or continuation of the transition, should that be necessary at the end of this year?

I also welcome the fact that the Treasury will take responsibility for location policy, because that is where such responsibility should rightly lie in the post-Brexit environment. I do not believe that the Bank of England would be the appropriate place, especially given all its other extra duties. Has consideration been given to the concerns expressed that this may become a political issue, with a trade-off of competing interests? Finally, what scrutiny will Parliament have over this broad extension of powers to the Treasury and the Bank of England? It seems of concern, as other noble Lords have suggested, that this is to be subject to the negative procedure should changes be made. I did hope that Parliament would have more of a say.

My Lords, it is a pleasure to speak on these regulations and I join other noble Lords in congratulating my noble friend on the way in which she introduced them. Making the complex clear is no mean feat, given the number of acronyms in them. I am sure she would agree that we have a world-leading financial services sector in the City of London, given its ecosystem, geography and regulator.

I note—other noble Lords have commented on this—the shift in responsibility for CCPs to the Bank of England. Does my noble friend believe that the Bank has the breadth of experience to make decisions on CCPs? I am sure that it has the specific, narrow understanding but, in wanting the decisions to be made in line with broad government policy, what discussions have the Government had with the Bank of England on this issue? Can she also say something about discussions with the Bank over the level of resourcing that she believes it currently has to exercise this task?

As has already been said by other noble Lords, the regulations are required for compliance at the end of this year. Post that, does my noble friend believe that these regulations will enable not only compliance but optimisation? Does she believe that, post-Brexit, more could be done to ensure that we have an optimised OTC derivatives market in the UK?

Finally, on the role of the Bank of England—which, again, is wider than these regulations—I ask the Minister to update the House, in writing if necessary, on the current progress on a central bank digital currency. She talked, quite rightly, about financial stability. If a social media platform launched a cryptocurrency that took hold in any nation state, that could have a significantly detrimental effect on financial stability. Can she update noble Lords on the Bank’s current discussions and consultation on CBDC?

My Lords, I congratulate my noble friend on introducing the regulations and thank her for the opportunity to consider them. I have a number of queries.

I share the concern of the noble Baroness, Lady Bowles. If it is difficult for the Treasury to know where all the instruments are, how on earth are industry and investors expected to keep on top of all the changes as a result of our exiting the European Union? I make particular reference to paragraph 2.15 of the Explanatory Memorandum. Can my noble friend explain why the functions previously held by the European Commission have been split between the Treasury and the Bank of England? It would be helpful to know the thinking behind that.

Derivatives are perhaps the most complex area of financial services. We have moved a great deal away from passporting or equivalence. In this regard, what will the status of industry and investors be going forward? Will we enjoy the same protections in the UK under the statutory instrument set out today as if we were still a member of the European Union? Also, what will be the impact of the location policy described by my noble friend on the City of London and its ability to compete on equal terms and on a level playing field with its erstwhile partners and competitors in the European Union?

Finally, can my noble friend put my mind at rest that, while it might suit the industry to have a weaker overview and oversight of the regulations, the protections for consumers and investors in these instruments will be safeguarded? I would like an assurance on that.

My Lords, I recognise that adopting this SI is sensible and technical. The underlying questions, however, are totally political.

Can the Minister tell us where we stand on equivalence negotiations with the EU on clearance? As the noble Lord, Lord German, reminded us, we are 12 days away from the deadline. The EU, on quite legitimate grounds of financial stability, may well decide to take back into the EU 27 a significant portion of the clearing of euro-denominated derivatives—something it would likely do slice by slice as the 27 build their capabilities. As the Minister pointed out, these regulations in their EU form enhance the power over changing that location. If the EU does so, we lose not only that business but many other wholesale financial market activities that typically collocate. That would be a devastating blow to financial services here in the UK, with knock-on effects on our tax take and public spending.

However, keeping a dominant role in derivatives clearance, with over $30 trillion in exposure in the form of open contracts, is a high risk, frankly—a risk that the EU 27 could legitimately argue that it need not share with us in future. The risk has always been scarily high, but it has increased exponentially with Covid because of the deterioration in the quality of the collateral that stands behind those contracts and is the primary protection against that risk. In her reply, will the Minister address collateral quality and how the deterioration over the past few months as a result of the global economic crisis will be addressed so that we will still be in a reasonable position to manage the exposure created by the major CCPs in London?

My Lords, I am grateful to the Minister for her introduction of this measure, which is the latest in a long line of statutory instruments to amend EU-derived legislation so that it continues to function correctly following the conclusion of the transition period at the end of December. With the events of the past few months, I had forgotten just how many Treasury SIs we dealt with as part of the Brexit process. Indeed, paragraph 6.2 of the Explanatory Memorandum lists a dozen relating to this area alone.

As the Minister outlined, this SI expands the UK’s existing supervisory framework for central counterparties to cover third-country CCPs, to ensure that the Bank of England is able to undertake the necessary supervisory responsibilities required under the EMIR 2.2 framework. It transfers a number of functions currently carried out by the European Commission to domestic bodies, including the Treasury and the Bank, and makes minor amendments to deficiencies in other Brexit financial services SIs.

My right honourable friend Pat McFadden MP asked the Commons Minister a number of questions during the debate there on this measure, including whether the Government think that they can achieve an equivalence decision in the timeframe envisaged in the political declaration. Mr Glen simply said that the Government were “working through” the process. I hope that the noble Baroness the Minister can go into slightly more detail today.

We remain deeply concerned about the future impact of our changing relationship with the EU on the success of this country’s financial services sector. Financial services contribute significantly to Britain’s exports. In 2016, they were worth about £61 billion, with a surplus of £51 billion over imports. More than 300 firms in Britain have opened EU hubs to ensure single-market access, while £1 trillion of City assets and 7,000 banking jobs have been transferred to the eurozone. London has been supplanted by New York as the world’s leading financial centre in the Global Financial Centres Index and is close to being overtaken by Hong Kong. EU officials have insisted that at the end of the transition period the UK, as a third country, must abide by equivalence—a guarantee that its financial regulations meet European standards—and there are additional risks to access, as equivalence status can be revoked at any time.

While we cannot and must not rely on financial services to bring home the bacon, they will have an important role to play in returning the economy to growth once the coronavirus pandemic has been brought under control. We on this side accept that negotiations with the EU are ongoing. I hope that the Minister will note that our concerns have been heard and are shared.

Finally, can the Minister indicate how many further SIs are expected before the end of the transition period? This may be dependent on the number of open legislative files in Brussels but, as I have said on previous occasions, financial services regulation is complicated enough without multiple measures being brought forward to correct deficiencies in instruments that themselves amend other regulations. I trust officials at the Treasury, the Bank of England and the Financial Conduct Authority to ensure that we have a functioning statute book on exit day. However, given the challenging times we find ourselves operating in, I hope that Ministers will do their best to make officials’ lives and the work of your Lordships’ Secondary Legislation Scrutiny Committee as straightforward as possible.

As noble Lords have noted, this is quite a technical debate, and I will do my best to address the points that they have raised. I defer to their greater experience in previous roles, potentially having made some of these regulations as Members of the European Parliament and, as Members of this House, having taken through a large proportion of the regulations in the process of onboarding our financial services regulations in preparation for leaving the EU.

Several noble Lords raised the question of the new responsibilities that this SI gives the Bank of England as the regulator versus the powers that will, for example, come back to Her Majesty’s Treasury. The Bank’s new responsibilities are consistent with its existing responsibility for safeguarding financial stability in general and for managing systemic risks in CCPs in particular. Responsibility for recognising non-UK CCPs was transferred from ESMA to the Bank of England in a previous SI, and EMIR 2.2, which this SI translates into UK law ready for Brexit, transfers the responsibilities for tiering non-UK CCPs in the recognition process.

The Bank has been given two new supervisory powers over tier 2 non-UK CCPs through the extension of the existing supervisory framework and tools that apply in the UK. To ensure that the Bank can fulfil its supervisory obligations, it will be able to sign a memorandum of understanding with non-UK competent authorities of a recognised CCP. The Bank will also have the power to set further technical standards to specify the tiering criteria and establish a framework that allows for comparable compliance where the framework that a non-UK CCP operates under is recognised as comparable to the one that we have in the UK and is therefore satisfactory for regulatory purposes. These powers are going to the Bank rather than to the Treasury because of the Bank’s existing responsibilities for safeguarding financial stability and managing systemic risk in CCPs.

The question of the resources for the Bank to fulfil its obligations was raised by several noble Lords. We are confident that the Bank has made adequate preparations and is effectively allocating resources in order to manage its new responsibilities. Furthermore, it has already been assigned the ability to levy fees to fund the responsibilities arising from its role in relation to non-UK CCPs.

My noble friend Lord Wei asked about the Bank giving away the powers that it will receive under this statutory instrument. It will not be able to give away these powers; it will only be able to enter into supervisory co-operation agreements to manage how it uses those powers in practice.

Several noble Lords asked how we are progressing with the assessment of equivalence. As they noted, there was a commitment in the political declaration to undertake equivalence assessments by the end of June. We are working hard and are focused on fulfilling our obligations and commitment to conclude those assessments. I am afraid that I cannot expand further than that.

As I said, this is a very technical SI to move regulation from the EU to the UK in preparation for the end of the transition period, but several noble Lords asked what the prospects of the further politicisation of this process might be—in particular, with regard to the use of the location policy, about which concerns have been expressed. The UK regards the politicisation of financial services as being in no one’s interests. The financial stability that underpins our and the EU’s economies depends on trust and predictability in regulatory matters. What is more, the potential use of the location policy could result in the fragmentation of the clearing market, which, again, would undermine financial stability and increase costs for those involved.

The noble Lord, Lord German, asked what deal the Government are referring to in their Explanatory Memorandum. The deal is the withdrawal agreement, which this House and the House of Commons have spent a significant amount of time debating and agreeing, and which of course was endorsed by Parliament in January this year.

Several noble Lords asked about parliamentary scrutiny of the powers transferred under this SI. Of course, Parliament has several ways in which to scrutinise both the Government and the Bank of England—through Ministers appearing in this Chamber and through Select Committees.

The noble Baroness, Lady Kramer, asked about the use of the location policy, which I believe I have covered. We have brought in the power to use the location policy but have no intention of doing so.

That brings me to a question asked by several noble Lords—whether, through this SI or the broader process, we would lower our standards. This SI is intended simply to transfer EU powers into UK legislation and to amend any deficiencies that might arise through that process. Therefore, it does not diminish any regulation of the sector, and in fact it provides further protection for consumers by bringing into UK law protections that have been provided for through EU regulation.

The noble Lord, Lord Tunnicliffe, asked how many further SIs we might expect under this process. As he noted, the number is partly dependent on files that might come from the EU Commission during the rest of this year while we remain in the transition period. Therefore, I cannot give him a specific number but I hope I can reassure him that it will be much lower than the number we have seen so far during this process of bringing EU regulation into the UK system.

I do not believe that I have covered all the points raised by noble Lords and I hope that they will forgive me if I write to them on the outstanding matters. To conclude, this instrument is necessary to ensure that existing EMIR legislation continues to function effectively in the UK from the end of the transition period following the updates made by EMIR 2.2. In particular, it will ensure that the UK has an enhanced recognition regime, with the tools necessary to manage the financial stability risks posed by some of the largest non-UK CCPs. I hope that the House has found this afternoon’s debate informative and that it will join me in supporting these regulations.

Motion agreed.

Sitting suspended.