Shearman And Sterling

London, Brexit

August 20, 2018

More Pieces of the Brexit Puzzle: Enhanced Equivalence, Transitional Regimes


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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.

The White Paper

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”)[1]. 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.

Expanded Equivalence?

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:

  • “common principles for the governance of the relationship;”
  • “extensive supervisory cooperation and regulatory dialogue;” and
  • “predictable, transparent and robust processes.”[2]

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[3]. This enhanced equivalence proposal for financial services consists of a bilateral EU-U.K. agreement for financial services, the provisions of which would include:

  • cross-border access for a comprehensive range of financial services activities based on each jurisdiction’s autonomous regulatory frameworks achieving a set of agreed outcomes;
  • “filling in the gaps” to cover sectors lacking an equivalence regime;
  • an ability to establish transitional, temporary and permanent equivalence recognitions for different sectors, depending on what is negotiated;[4]
  • a structure to facilitate and encourage extensive regulatory dialogue in developing new regulatory standards, with equivalence recognitions;
  • extensive supervisory cooperation procedures to protect consumers, financial stability and market integrity, such as codified procedures for U.K. and EU regulators to cooperate in routine supervisory and authorisation matters and for crisis situations. The level of interconnectedness of the U.K. and the EU’s financial services sectors requires reciprocal participation in supervisory colleges, close information exchange, mechanisms for consultation over decisions affecting the other party and arrangements for supervision over crucial U.K.-EU financial market infrastructure (FMI), such as central counterparties (CCPs), payment systems and trading venues;
  • treaty-based procedural safeguards that will protect agreed equivalence recognitions (and the financial institutions that rely on them) from being affected by abrupt withdrawals or suspensions, with longer notice periods. Structured withdrawal processes would be in place so that if either party wishes to withdraw equivalence in a particular area, consultation, timelines and notice periods apply. Safeguards would need to be in place for acquired rights of financial institutions and their customers to avoid risks to financial stability, market integrity and consumer protection;
  • common principles for governance of the enhanced equivalence relationship, such as commitments to assess the equivalence of each jurisdiction’s regulatory regime objectively (and by comparison with relevant international norms), commitments not to operate in a manner which interferes with the agreed intended purpose of the agreed equivalence recognitions and to supporting collaboration (bilaterally and in multilateral fora). The overall objective would be to ensure financial stability and to prevent regulatory arbitrage; and
  • judicial review proceedings in the event of a breach of the bilateral agreement or internal procedures on equivalence.

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).[5] 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.[6]

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.

Temporary Permissions for Passported Firms

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.[7] On 24 July 2018, HMT released the draft EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018 (TPR SI).[8] The TPR SI functions as follows:

  • The TPR SI will enable EEA firms currently using passporting rights[9] to carry out financial services business in the U.K. to apply and obtain authorisation under a temporary permissions regime. This will allow regulated activities to be carried out by EEA in the U.K. up to the end of the post-Brexit transitional period. Both the FCA and HMT have issued separate statements on the TPR.[10] Notifications can be made by EEA firms before Exit Day and, upon being authorised under the temporary permissions regime (TPR), such firms will be authorised to carry out the regulated activities that they were authorised to carry on immediately before Exit Day under their passport. The temporary permissions regime will be in place for a maximum of three years from Exit Day, during which EEA firms will be required to apply for authorisation to continue to operate in the U.K. A notification procedure will be put in place by the FCA and PRA for EEA firms to submit a notification to benefit from the time-limited TPR.
  • The TPR SI extends a similar temporary approval regime for regulators to treat individuals to whom the Senior Managers Regime applies as having approval from a time stated in a notice until the individual’s firm comes out of the temporary permissions regime.
  • EEA firms with U.K. establishments will be required to join the Financial Services Compensation Scheme (FSCS) (with consequential annual contributions to the scheme).

Temporary Recognitions for Non-UK Third Country Central Counterparties

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”).[11] The CCP Recognition SI has a number of functions:

  • It transfers to HMT the European Commission’s function of making equivalence determinations under EMIR. An equivalence determination for a third-country jurisdiction is a necessary precondition for CCPs from that jurisdiction to obtain recognised status. The draft Regulations revoke Commission Implementing Acts that relate to third-country equivalence under EMIR. This aspect of the draft SI has been criticised by some industry participants who are of the view that the existing equivalence determinations should be grandfathered. However, the expectation is that third countries already declared equivalent by the European Commission for the purposes of EMIR are likely to be re-designated as equivalent under the U.K.’s post-Brexit EMIR law.
  • It empowers the Bank of England with the functions, currently held by the European Securities and Markets Authority (ESMA), of recognising third-country CCPs. Bank of England recognition will enable third-country CCPs to provide these services to U.K. clearing members and trading venues.
  • It creates a temporary recognition regime, designed to act as a backstop in the event of a “no deal” scenario, in which the transition, or “implementation” period (29 March 2019 to 31 December 2020) agreed in principle between the U.K. and the EU is not ratified under the Withdrawal Agreement that is currently under negotiation. Under the temporary regime, CCPs providing clearing services in the EU by virtue of recognised status under EMIR would be deemed to have recognised status and be able to continue their activities in the U.K. for a limited period after the date of the U.K. withdrawal, subject to prior notification to the Bank of England. The temporary regime would remain in place for three years, subject to a power for HMT to extend the regime’s duration by increments of 12 months.
  • It gives power to the Bank of England to charge fees to non-U.K. CCPs that are providing services in the U.K.

UK Short Selling Regulations

The draft Short Selling (Amendment) (EU Exit) Regulations 2018 (U.K. SSRs)[12] 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 U.K. SSR will only cover instruments admitted to trading on U.K. trading venues and U.K. sovereign debt and will not cover instruments admitted to trading or traded on an EEA trading venue or the sovereign debt of EEA governments.
  • The FCA will assume ESMA’s responsibility for collating and publishing the list of shares principally traded in a third country, including shares which have their principal trading venue outside the U.K. This relates to the EU SSR exemptions from the reporting requirements, the buy-in regime and restrictions on uncovered short selling for shares which are principally traded in a third country. To ensure continuity, the FCA may recognise ESMA’s existing list for up to two years following Exit Day.
  • Provision to ensure that notifications by market makers of their intention to use the exemption available under the EU SSR made to the FCA before Exit Day will remain valid. European market makers will be required to join a U.K. trading venue and submit a notification to the FCA at least 30 days ahead of Exit Day to benefit from the exemption.
  • Provision to ensure that U.K. firms can continue to use U.K. sovereign CDS to hedge correlated assets or liabilities issued by issuers located outside the U.K. anywhere in the world, instead of only in the EU. This is an example of the “global Britain” agenda, and builds on the separate proposals relating to settlement finality designation (discussed below).

Deposit Guarantee Schemes

The draft Deposit Guarantee Scheme and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018 were published on 15 August 2018. The key changes proposed are:

  • Transferring the power to review, adjust and set the coverage level from EU bodies to the PRA, with approval from HMT.
  • Removing the cooperation arrangement under which the U.K. FSCS administers compensation payments to depositors at U.K. branches of EEA banks on behalf of an EEA DGS. A transitional provision will allow the FSCS to continue after Brexit to accept instructions and funds from EEA DGS should an EEA firm operating in the U.K. fail immediately before Exit Day.

Temporary Designation Regime for Continuation of UK Settlement Finality Protections

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 Position

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.


[1] “The future relationship between the United Kingdom and the European Union,” Her Majesty’s Government, CM 9593, 12 July 2018.
[2] Paragraph 66-67, White Paper.
[3] 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.
[4] 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.

[5] The Financial Markets and Insolvency (Settlement Finality) Regulations 1999. The regulations implement the EU Settlement Finality Directive (Directive 98/26/EC).

[6] Developments relating to Brexit can be followed here. Further resources are available from our Brexit Resource Center, here.

[7] 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.

[8] Available here.

[9] 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.

[10] See HMT’s statement here and the FCA’s statement here.

[11] See the draft instrument here and explanatory memorandum here.

[12] See the draft U.K. SSRs here and explanatory memorandum here.

Authors and Contributors

Barnabas Reynolds


Financial Institutions Advisory & Financial Regulatory

+44 20 7655 5528

+44 20 7655 5528


Thomas Donegan


Financial Institutions Advisory & Financial Regulatory

+44 20 7655 5566

+44 20 7655 5566


Sandy Collins

Professional Support Lawyer

Financial Institutions Advisory & Financial Regulatory

+44 20 7655 5601

+44 20 7655 5601