Many EU and U.K. financial institutions have been waiting with bated breath for (and commencing their contingency plans without) a clear picture of what post-Brexit U.K.-EU financial services will look like. In this note we consider some recent significant developments that help piece together what could lie ahead post March 2019, namely: (i) what the expanded equivalence model outlined in the Government’s recent White Paper means for financial institutions; and (ii) what the U.K. is doing to ensure the continuity of cross-border financial services.
After Her Majesty’s Government concluded its meeting at Chequers on 6 July 2018 it released its proposal for the United Kingdom’s future relationship with the European Union (the “White Paper”). Notably, the White Paper proposes an “expanded equivalence” model for the future of EU-U.K. financial services business. In this note, we briefly summarise what that means and how it could take place.
In the White Paper the U.K. Government acknowledges that the current passporting arrangements are not to be replicated in any future EU-U.K. financial services agreement. The passporting model is premised on a harmonised rulebook of standards for financial institutions to comply with and, ultimately, a convergence of supervisory approaches overseen by a supranational EU regulator. However, the EU and the U.K. differ in terms of markets, business models and financial stability exposures, and it is in their respective interests to have the ability to legislate independently. The supranational premise of passporting would clearly impinge on regulatory autonomy for the EU and the U.K.—as well as including a “cherry picking” of one of the four freedoms, which the EU has said will not be allowed. Instead, the Government advocates expanding the EU’s financial services framework that currently allows cross-border financial services business to be carried out despite being governed by an independent non-EU regulatory framework. In the White Paper, the Government states that “the existing autonomous frameworks for equivalence would need to be expanded, to reflect the fact that equivalence as it exists today is not sufficient in scope for the breadth of interconnectedness of U.K.-EU financial services provision.” Furthermore, it is stated that the proposed new EU-U.K. arrangements for financial services must include:
All of these outcomes are achievable under the “enhanced equivalence” model for EU-U.K. financial services, developed by Barnabas Reynolds of Shearman & Sterling LLP. This enhanced equivalence proposal for financial services consists of a bilateral EU-U.K. agreement for financial services, the provisions of which would include:
It is possible to deliver the White Paper’s objectives under the enhanced equivalence proposal and to craft the best solution for EU and U.K. financial institutions while still respecting both jurisdictions’ negotiating principles and regulatory autonomy. The enhanced equivalence model recasts the existing equivalence framework by adding treaty-based improvements and protections on top of the existing legislative framework which the EU and U.K. regulators are familiar with. Much will depend on how comprehensive an agreement the EU and the U.K. are able to agree upon. However, a great deal can be expected of an ambitious agreement on financial services that builds on the existing equivalence framework that the U.K. and EU already use today.
Continuity for Financial Services Business
We discuss here the U.K.’s legislative proposals for the continuity of cross-border financial services business in the U.K., namely: (i) a temporary permissions regime for EU firms passporting into the U.K.; and (ii) a temporary recognition regime for non-U.K. CCPs (“Third-country CCPs”). There is also HM Treasury’s (HMT) proposed FMI designation regime which will ensure that non-U.K. FMIs providing services in the U.K. can benefit from the insolvency law protections of the U.K.’s Settlement Finality Regulations (SFRs). Draft legislation onshoring the EU short selling and deposit guarantee scheme (DGS) legislation have also been published.
HMT intends to lay all of these draft regulations before Parliament in autumn 2018 and the regulations will, for the most part, apply from Exit Day. The U.K. financial services regulators are expected to consult in the autumn on how changes will be made to their rules in these and other areas. Further draft financial services legislation is expected to be published in the lead up to Brexit.
All of the draft regulations are made under the provisions of the European Union (Withdrawal) Act 2018 to address failures of retained EU law to operate effectively and other deficiencies arising from Brexit. The regulations do this by changing necessary cross references, replacing EU regulators with U.K. equivalents and making consequential amendments. HMT refers to this process as “onshoring.” For example, the Financial Services and Markets Act 2000 (FSMA) sections and schedules on passporting and EU Treaty rights will be excised on Exit Day and powers of the European Commission under the European Market Infrastructure Regulation (EMIR) will be transferred to the Bank of England.
HMT, the Bank of England, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) have previously stated that the approach for financial services post-Brexit would be to ensure that regulated firms would only need to obtain additional U.K. authorisation if U.K. regulated activities are carried out after the end of the post-Brexit transitional period. On 24 July 2018, HMT released the draft EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018 (TPR SI). The TPR SI functions as follows:
HMT has also published guidance and a draft statutory instrument for non-U.K. third country CCPs - The Central Counterparties (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018 (the “CCP Recognition SI”). The CCP Recognition SI has a number of functions:
The draft Short Selling (Amendment) (EU Exit) Regulations 2018 (U.K. SSRs) were published on 9 August 2018. These regulations onshore the EU Short Selling Regulation (EU SSR) and make amendments to the existing U.K. Short Selling Regulations. The explanatory guide to the U.K. SSRs states that changes for firms with shares admitted to trading on a U.K. venue should be minimal. The procedure for notifying U.K. instruments to the FCA will be kept and instruments admitted to trading on U.K. venues will continue to have the same restrictions applied to them. The FCA will continue to have powers to restrict short selling in the event of a significant fall in the price of a share or in response to a threat to U.K. financial stability or market confidence.
Changes made by the draft U.K. SSR include:
The draft Deposit Guarantee Scheme and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018 were published on 15 August 2018. The key changes proposed are:
HMT has separately announced its intention to legislate to ensure, after U.K. withdrawal from the EU, the continuation of U.K. settlement finality protections currently provided under the Settlement Finality Directive (SFD) and implemented in the U.K. by the SFR. The SFRs establish various insolvency carve-outs for designated market infrastructure systems and also legislate for finality of transactions within such systems. However, only EU systems are in scope.
The SFD requires Member States to notify ESMA of information concerning the national systems (and the respective system operators) they have designated to be included within the scope of the SFD protections. Member States must also designate the national authorities that must be notified when insolvency proceedings are opened against a participant or a system operator. Under the protections afforded by the SFD, transfer orders which enter into designated systems within certain deadlines are guaranteed to be finally settled, regardless of whether the sending participant has become insolvent or transfer orders have been revoked in the meantime. The legislation also effectively results in settlement finality for holdings in central securities depositories in clearing systems, such that these records cannot be unwound at the behest of insolvency officials. Finally, certain insolvency law protections are established in favour of system operators to enable such systems to carry out their default management functions and to realise the collateral that they hold.
Under the SFD, each Member State automatically recognises systems that have been designated by other Member States. However, the U.K. will fall outside the SFD’s automatic recognition framework. Therefore, without more, upon Brexit, U.K. systems would cease to benefit from SFD protections in insolvency proceedings relating to EU participants and EU systems would cease to benefit from carve-outs from U.K. insolvency laws. The HMT proposals address the latter scenario. HMT will bring forward legislation to allow designations, under domestic law, of non-U.K. FMIs, including FMIs outside the EU. It also proposes to give the Bank of England functions and powers to grant permanent designation to non-U.K. FMIs.
This proposed new legislation is noteworthy in that it is another example of post-Brexit legislation that not only addresses Brexit issues but arguably promotes the U.K. Government’s vision of a “global Britain.” Settlement systems around the world will potentially be capable of being afforded the same insolvency law and finality protections under U.K. laws as are afforded to EU systems—something that the EU has omitted to achieve, despite this being a widely-known deficiency. Furthermore, the proposed legislation will provide for a temporary SFD designation regime that will enable EU systems currently designated under the SFD to be easily grandfathered into benefitting from SFD protections upon Brexit, in advance of a permanent designation being granted.
The EU has, to date, omitted to take positive steps to address any of these issues. Instead, its regulators have focused on making the case for regulated financial institutions to relocate businesses to the Eurozone and apply for new regulatory authorisations under existing laws. The lack of any EU-wide steps in relation to the SFD issue has resulted in some Member States, notably the Netherlands, proposing new national legislation that would enable the designation of non-EU systems for local purposes.
 “The future relationship between the United Kingdom and the European Union,” Her Majesty’s Government, CM 9593, 12 July 2018.
 Paragraph 66-67, White Paper.
 For full details of the enhanced equivalence proposal see: “A Template for Enhanced Equivalence: Creating a Lasting Relationship for Financial Services Between the EU and the U.K.,” Barnabas Reynolds, Politeia, July 2017; and “EU-U.K. Financial Services After Brexit: Enhanced Equivalence—A Win-Win Proposition,” Barnabas Reynolds, New Direction and Politeia, 2018.
 Note that the White Paper proposes that at the end of the transitional period (31 December 2020) reciprocal recognition of equivalence under all existing third-country regimes should take effect. The ability to agree, at the least, temporary or transitional recognitions provides greater flexibility to ensure that reciprocal recognitions are put in place.
 The Financial Markets and Insolvency (Settlement Finality) Regulations 1999. The regulations implement the EU Settlement Finality Directive (Directive 98/26/EC).
 A post-Brexit transitional period from 29 March 2019 to 31 December 2020 has been agreed in principle between the U.K. and the EU whereby Union law will continue to be applicable in the U.K.
 Available here.
 The TPR SI establishes a temporary permissions regime for firms using passporting rights only, i.e.: firms authorised under section 31(1)(b) or (c) of FSMA immediately before Exit Day (i.e. the types of EEA firms referred to in Schedule 3 and 4 of FSMA: credit institutions, financial institutions, investment firms, insurers, reinsurers, insurance intermediaries, reinsurance intermediaries, UCITs management companies, emissions allowances auction participants, alternative investment fund managers and mortgage intermediaries. Statutory instruments for firms regulated to carry out financial services activities (e.g. payment institutions, electronic money institutions and funds marketed into the U.K.) are to follow.