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EU-UK Trade and Cooperation Agreement (TCA) – Financial Services

As had been expected and indeed messaged in the latter half of 2020, financial services are only covered in a limited manner in the text of the December EU-UK TCA. In essence, the TCA does not stray much further than WTO ‘most favoured nation’ terms.

Accordingly, the agreement of the TCA did not eliminate the majority of the ‘no-deal’ preparations and arrangements, noted below, that financial services firms had to apply and be in a position to adhere to in order to navigate the new regulatory landscape from 1 January 2021.The next key development that will influence the longer term impact of Brexit on financial services will be the outcome of the discussion the parties committed to continue in relation to establishing structured regulatory cooperation arrangements, with a view to signing a Memorandum of Understanding for this framework by end March 2021. Developments in this regard will be keenly watched and we will keep you informed of what emerges.

In summary the high-level and primarily indirect impacts for financial services firms of the TCA are as follows:

  • While the terms of the TCA do not go as far as those in the EU Canada Free Trade Agreement with respect to financial services; both parties do confirm that they will maintain market access for the provision of financial services by means of establishment i.e. UK or EEA subsidiaries or ‘third country’ branch presence in each other’s territories.
  • The TCA does not repeal or replace the ‘national law’ Brexit measures that were adopted by individual Member States ahead of Brexit. As such, UK firms that have obtained access to EU markets or citizens via these individual Member State measures can continue to do so.
  • Further, the TCA does not prohibit ‘reverse solicitation’, however, there are significant individual National Competent Authority requirements and expectations with respect to the monitoring, control and oversight which should not be underestimated by UK firms.
  • Indirectly (for the moment), financial services firms will be impacted by the following measures adopted in the TCA:
    • Cooperation on cyber-security matters and data-protection;
    • Respective rules on authorisation for the provision of services in each respective territory;
    • Non-discrimination measures for service providers and investors; and
    • Free movement of capital.
  • There are no equivalence measures adopted within the TCA. However, a non-binding political declaration was made alongside the agreement which commits the EU and UK to continue to undertake discussions to establish structured regulatory cooperation arrangements in financial services, with a view to signing a Memorandum of Understanding for this framework by end March 2021.
  • It is contemplated that these cooperation arrangements will allow for:
    • bilateral exchanges of views and analysis relating to regulatory initiatives and other issues of interest;
    • transparency and appropriate dialogue in the process of adoption, suspension and withdrawal of equivalence decisions; and
    • enhanced cooperation and coordination including in international bodies as appropriate.
  • With respect to the granting of EU equivalence, the declaration notes that ‘the Parties will discuss, inter alia, how to move forward on both sides with equivalence determinations between the Union and United Kingdom, without prejudice to the unilateral and autonomous decision-making process of each side.’
  • As noted below, the UK Financial Conduct Authority (FCA) has granted EU financial services firms equivalence with UK law in a number of key areas.

UK’s Financial Services Contract Regime

Further, the UK’s Financial Services Contract Regime (FSCR) ensures that firms can fulfil their existing contractual obligations in the UK for up to five years (15 years for insurance contracts), even if they are outside the Temporary Permissions Regime (TPR), provided it does not amount to new business. It allows EU/EEA firms to run-off contracts made prior to the end of the Transition Period with UK persons (individuals or legal entities). Firms that did not submit a TPR notification, or that are unsuccessful in securing full UK authorisation through the TPR route, automatically enter the FSCR, but have to take certain actions, including compliance with UK rules that did not previously apply to them. 

Specific actions taken by the Irish Government in respect of UK financial services:

These measures were included in the Withdrawal of the United Kingdom from the European Union (Consequential Provisions) Act 2020 (the Brexit Omnibus Act 2020).

  • Settlement finality: Temporary preservation of certainty in settling a range of transactions in shares, securities and other financial instruments including mutual recognition and access to existing clearance systems in line with EU contingency measures. This will apply for a period of 18 months after the Transition Period for UK Central Counterparties (CCPs) and until 30 June 2021 in the case of UK Central Securities Depositories (CSDs).
  • Insurance contract continuity: Measures to ensure Irish policy holders continue to benefit from insurance contracts underwritten by UK insurers for at least 15 years even if they are no longer permitted to conduct new EU business.
  • A number of insurance sector tax changes related to preserving the ability to impose levies on various insurance premia.

Post Brexit Status Overview: Key impacts per financial services sector segment

Capital Markets

UK firms will no longer access EU wholesale financial markets via passporting but access may be possible depending upon the local regulatory regime and the activities performed. Measures have also been put in place to limit the impact of the end of the Transition Period. 

On access to clearing, on 28 September 2020 the European Securities and Markets Authority (ESMA) announced that it will grant temporary third-country recognition to three UK CCPs from 1 January 2021 under the European Market Infrastructure Regulation. The recognition of these three UK CCPs, namely ICE Clear Europe Limited, LCH Limited and LME Clear Limited, means that EU clearing members of these CCPs will be able to continue to access the services and that the CCPs will be able to continue to provide their services in the EU at the end of the Transition Period on 31 December 2020. Recognition of these three UK CCPs will continue to apply while the equivalence decision remains in force, which is for 18 months until 30 June 2022.

The Bank of England has published an interim list of third-country counterparties (CCPs) that UK firms can continue to use for clearing services under the temporary recognition regime (TRR), for up to three years.

As regards trading venues, in the absence of mutual equivalence under the MiFID II share trading obligation (STO), the FCA is using its Temporary Transitional Power (TTP) (To help firms adapt to their new requirements, the UK financial regulators have the power to make transitional provisions to rules, for a temporary period, up to end 2022) to allow UK firms to access an EU trading venue as long as the venue is a UK-Recognised Overseas Investment Exchange, has applied under the TPR or its activities meet all the conditions required to benefit from the Overseas Person Exclusion. ESMA has confirmed that trading of shares with EEA International Securities Identification Number (ISIN) on a UK trading venue in GBP will not be subject to the EU STO.

ESMA has made no announcement regarding the EU derivatives trading obligation (DTO). However, the FCA is using its TTP to allow firms subject to the UK DTO to trade with, or on behalf of, EU clients subject to the EU DTO and to transact or execute those trades on EU venues with the same regulatory status as listed above for STO, provided the firm has taken reasonable steps to be satisfied the client does not have arrangements in place to execute the trade on a trading venue to which both the UK and EU have granted equivalence (e.g. a US venue).

UK firms are allowed to access certain non-UK central security depositaries (CSDs) under the Transitional Regime, until the CSDs are permanently recognised under the UK Central Securities Depositories Regulation (CSDR). EU issuers can continue to use the one UK CSD – Euroclear UK & Ireland Limited - until end June 2021, when the Commission’s equivalence decision expires.

From an Irish perspective, the Migration of Participating Securities Act 2019 was signed into law on Christmas day 2019, and it sets out the mechanism by which relevant listed Irish securities will migrate from CREST to Euroclear Bank in Belgium. The Act contemplates that the migration process will be effected for all relevant Irish securities on the same day, which is likely to be sometime in Q1 2021.

The Act prescribes a number of steps to be taken by issuers prior to the migration of their relevant securities to Euroclear Bank. In particular, it will be necessary for each relevant issuer to pass certain resolutions at its next AGM or at an EGM (convened in advance of the final migration date) consenting to the migration, which could lead to considerable time pressure being applied to issuers to meet that deadline.

Banking services

UK banks may now provide banking services in the EU only if they hold valid authorisation from the relevant EU/EEA supervisory authorities. Where the authorisation process would not be finalised before the end of the Transition Period, EU/EEA supervisory authorities had asked institutions to implement contingency plans setting out alternative actions until they receive authorisations. Where UK financial institutions chose to cease their activities in the EU, they were required to finish the off-boarding of affected customers by end 2020 without causing detriment to consumers.

EU/EEA consumers are permitted to maintain existing bank accounts held with UK financial institutions, subject to the relevant UK legal requirements (and vice versa). However, the deposit protection rules may be different as between the UK and EU/EEA Member States, and if the deposit is held with a bank branch, it may no longer be covered by any scheme.

Banking prudential

The position of EU/EEA banks operating in the UK is covered by the TPR, provided the banks notified before end 2020.

The Prudential Regulation Authority (PRA) has issued guidance on the use of its transitional direction, made under the TTP, relating to firms’ obligations under the Capital Requirements Regulation (CRR). This will delay the impact of some CRR onshoring changes relating to: EU-issued covered bonds, Pillar 1 capital requirements for credit risk, Pillar 1 risk weights for residential and commercial real estate, model permissions, use of credit ratings, securitisation, own funds requirements for CCP exposures and requirements for large exposures, liquidity and reporting and disclosure. 

Pan-EU consolidated supervision and the EU joint decision-making framework have ended, but joint decisions made before end 2020 will continue until different decisions are taken by the PRA or the FCA.

Individual Pillar 2 requirements and PRA buffer and combined buffer requirements are not affected by onshoring changes, therefore transitional relief is not required.

The PRA has designated responsibility for ensuring compliance with group CRR prudential consolidation requirements to PRA subsidiaries of Financial Holding Companies (FHCs) or parent Mixed Financial Holding Companies (MFHCs) until the parent FHC or MFHC’s application for approval or exemption has been determined. This rule will apply to a subsidiary firm controlled by a “parent FHC or MFHC in a Member State” (see also the new PRA Rulebook definition of “UK parent financial (or mixed financial) holding company”).

The PRA’s policy relating to the onshored Bank Recovery and Resolution Directive II (UK BRRDII) includes changes to the existing PRA regime for Contractual Recognition of Bail-In (CROB) and Stays.

The PRA continues to be lead supervisor for UK banks, but where new entities have been set up to manage EU/EEA business, banks will need to meet the requirements of the authorising local regulator. For non-UK banks the PRA will continue to supervise UK-based entities as “host” in cooperation with the home state supervisor. The ECB and UK regulators have agreed a memorandum of understanding that will allow supervisors to continue exchanging information and to coordinate the supervision of cross-border banking groups.

Insurance prudential

For both UK and EEA firms and groups, there are potential implications for the solvency capital requirement (SCR), including the classification of the UK for non-life charges, the unrated reinsurance counterparty charge, the equity charge for AIM stocks and any future sovereign debt change.

For UK-parented European insurance groups, the PRA is no longer the lead supervisor. Absent an explicit equivalence decision, the group supervisor is determined by the largest EEA balance sheet, with EEA group supervision at sub-group level. The PRA has restricted access to College of Supervisor arrangements, but worldwide group supervision could still include reliance on PRA group supervision.

For UK insurers with EEA parents, the relevant national EEA supervisor will continue to be the lead supervisor and the UK insurer will continue to be consolidated into the group’s financial position, but the PRA has restricted access to College of Supervisor arrangements. Also, absent an explicit equivalence decision, PRA approvals under the UK Solvency II Directive (UK SII) will not be recognised and the EU group would need to consolidate the UK insurer on an EU SII basis (rather than permitting inclusion of the UK insurer on a UK SII basis using the deduction and aggregation method).

Generally, insurers have already adjusted their capital positions to prepare for a non-equivalence scenario, but the practical impacts of the change in lead supervisor and supervisory college arrangements will only be seen over time as issues arise.

Asset management and investment funds

For asset managers and funds, the key concern is whether and for how long the UK’s regulatory framework will be adjudged by the EU to be equivalent as regards MiFID II, to enable the continued delegation of portfolio management services from EU entities (including funds) and EU professional clients to UK asset managers. 

Asset managers will also be impacted by any divergence in capital markets regulations (such as the share trading obligations, central counterparties, market abuse and so on) and shifts in market liquidity, not only as between the UK and the EU, but to other markets. Evidence of this has already been seen in the first week of trading in 2021.

Furthermore, some EU professional clients may be constrained in appointing a third-country asset manager, and it is for individual Member States (and the UK) to decide whether they will allow portfolio management service to be provided to retail clients in their jurisdiction by third-country asset/wealth managers. This is a key topic of discussion under the forthcoming review of the Alternative Investment Fund Managers Directive (AIFMD).

UK UCITS funds are no longer UCITS. These funds may no longer be passported into the EU or be eligible assets for EU UCITS. A UK firm is not able to be the Management Company of EU UCITS.

UK Alternative Investment Funds (AIFs) and UK AIF Managers (AIFMs) have lost their EU passports. There is still no sign that the AIFMD non-EU passports will be introduced, so UK AIFMs will need, instead, to use national private placement regimes (NPPRs), which are generally limited to placements with professional clients and do not exist, or are of narrow scope, in some Member States.

The UK’s TPR allows registered EU/EEA asset managers, fund managers and funds to continue to operate or be marketed in the UK for up to three years. Thereafter, EU UCITS and AIFs would be dependent on the UK’s NPPR to market into the UK or to register with the FCA. The UK NPPR is currently the most open of the national regimes for professional investors, but the registration process for third-country funds requires each fund to be considered on a case-by-case basis. The proposed UK Offshore Funds Regime (OFR) will ease this process. The FCA will consider third countries’ fund regimes and judge whether they are equivalent. Funds from countries that receive positive judgements will be able to register with the FCA via a simplified process.

Both EU and UK firms should also factor into their thinking the current debate on delegation and substance. EU entities will need to have increased in-house skills and more experienced staff than may previously have been permitted. Most policymakers recognise, though, that the delegation of portfolio management, both within the EU and to third countries, brings the best knowledge and skills from around the globe, to the benefit of EU investors. 

Retail intermediaries

Note that the EU definition of “retail” is wide and includes many high-net-worth clients of private banks or wealth managers, for example, as well as some institutions, such as local authorities.

It is a matter for individual Member States to decide whether they will allow UK (or any other third country) firms to provide financial services to retail consumers in their jurisdiction. It is also for each Member State to decide what constitutes new business and whether they allow existing client relationships to continue to be serviced.

Therefore, business previously conducted by UK firms under MiFID II or IDD (Insurance Distribution Directive) passports will no longer be permitted unless the customer’s Member State permits it. Furthermore, the continued servicing of existing customers may be problematic. The position needs to be considered for each customer and for each Member State.

UK Equivalence Decisions in respect of the EU / EEA

  • European Market Infrastructure Regulation Equivalence Directions: ‘This decision paves the way for UK entities to seek or apply for an exemption from the requirement to clear through a Central Counterparty (‘CCP’) or meet margin requirements for transactions with an EEA State entity in the same group. Granting this decision means these exposures can qualify as intragroup exposures in the credit valuation adjustment (CVA) calculation, ensuring that UK firms will in many cases not have to capitalise CVA on ‘Over The Counter’ (OTC) exposures to EEA State affiliates.’
  • Capital Requirements Regulation Equivalence Directions: ‘For UK firms, these equivalence decisions will ensure they will not be subject to increased capital requirements as a result of their EEA State exposures.’
  • The Solvency 2 Regulation Equivalence Directions: ‘This direction covers the equivalence decisions on both reinsurance and group capital treatment. A full set of Solvency II equivalence decisions for the EEA States is beneficial for the UK by providing certainty and continuity.’
  • Central Securities Depositories Regulation Equivalence Directions: ‘With equivalence granted, the Bank of England can then assess Central Securities Depositaries (CSDs) in the EEA for recognition (subject to establishing co-operation arrangements with the relevant EU authorities), allowing those CSDs, once recognised, to continue to service UK securities.
  • Benchmarks Regulation Equivalence Directions: ‘This decision determines that benchmark administrators in each EEA State comply with legal requirements which are equivalent to the Benchmarks Regulation which will apply in UK law after the end of the Transition Period and are appropriately supervised in the relevant EEA Member State. This equivalence decision acts as a mechanism to enable such administrators to be added to the Financial Conduct Authority’s (FCA’s) benchmarks register, and to enable them to provide benchmarks to supervised entities in the UK.’
  • Credit Rating Agencies Regulation Equivalence Directions: ‘This means non-systemic credit rating agencies (CRAs) authorised or registered in the EEA States will be able apply to be certified in the UK, subject to certain regulatory requirements. Endorsement also allows for the cross-border use of ratings between the UK and the EU. This allows UK-registered CRAs to endorse credit ratings issued from affiliated EU CRAs which allows them to be used for regulatory purposes by UK firms.’
  • Short Selling Regulation Equivalence Directions: ‘This means that EEA market makers will be eligible to make use of the exemption in Article 17 of the EU’s Short Selling Regulations (which disapplies certain short selling restrictions and reporting requirements) subject to complying with certain regulatory requirements.’
  • Central Counterparties (Equivalence) Regulations: ‘Subject to entry into an appropriate cooperation arrangement between the Bank of England and the relevant national competent authorities of EEA states, and a Central Counterparty (CCP) specific recognition determination by the Bank of England, UK firms will be able to continue using EEA CCPs after the end of the Transition Period. This equivalence decision does not exclude EEA CCPs from the current UK Temporary Recognition Regime (‘TRR’). Until recognition decisions are made, EEA CCPs who meet the relevant eligibility criteria will remain in the TRR, which is due to last until December 2023 and may be extended by the UK Treasury.’
  • Finally, the UK Department for Business, Energy and Industrial Strategy will be laying The Statutory Auditors and Third Country Auditors (Amendment) (EU Exit) (No. 2) Regulations 2020 to grant audit equivalence to the EEA States and approve as adequate their audit competent authorities.

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