The UK/EU deal
After much uncertainty throughout the Brexit transition period that any UK/EU deal was going to be possible, the Trade and Co-operation Agreement was finally reached at the last minute on 24 December 2020.
As widely anticipated, agreement in relation to financial services is minimal and effectively leaves firms in a ‘no deal’ scenario with the loss of passporting and minimal equivalence decisions reached by both sides. The door has, however, been left open for further discussion and negotiation through the accompanying Joint Declaration (among others) on financial services under which both parties have agreed, by way of Memorandum of Understanding concluded at the end of March 2021, to establish structured regulatory co-operation on financial services with the aim of establishing a ‘durable and stable’ relationship. Among other aspects, it importantly provides for ‘transparency and appropriate dialogue’ on the adoption, suspension and withdrawal of equivalence decisions.
This is a positive step and does avoid an abrupt end to the UK-EU financial services relationship, but it remains to be seen what further equivalence decisions can be reached by both sides and by when. The decisions reached by both sides before the end of the transition period very much focused on addressing financial stability risks that the immediate loss of market access might cause and, for the UK, to support open liquid markets and effective risk management. Both sides indicated subsequently that they would not make further decisions until they had further clarity on the other side’s intentions and potential future divergence.
That said, there is mounting pressure on the European Commission, including from EU regulators and banking firms, to reach an equivalence decision on the MiFIR derivatives trading obligation. This is reportedly starting to hurt EU firms, whose UK clients wish to remain on UK venues, as much as it has hurt UK firms whose EU clients have transferred significant trade volumes to EU venues. Lobbying on other legislation, including the MiFIR share trading obligation, may follow.
Building presence without passporting
Many banking groups headquartered in the UK and EU with operations in eachother’s jurisdictions took steps well in advance of the original exit day (29 March 2019) to ensure business continuity post-Brexit, primarily through the creation of new subsidiaries or branches, or increased authorisation of existing ones. Understandably, some banking firms did not make these entities fully operational or capitalised pending the outcome of the UK/EU negotiations. This is now the focus for such firms, particularly given some counterparties are reporting challenges in dealing, and doing business, with them given their small size. The ECB is also maintaining pressure on these firms, with its Chair stating in February 2021 that ‘the bank continues to closely monitor UK firms’ progress on relocating…their European businesses’. It estimates that approximately €810bn of capital market assets still need to move to EU entities.
EU banking firms, if they have not already done so, have slightly more time to achieve fully fledged UK entities given the existence of the UK’s minimum three-year Temporary Permissions Regime. It permits such firms to continue operating for the Regime’s duration provided they apply for full authorisation from the UK regulators before its end.
The UK regulators have also been turning their attention to their supervision of internationally headquartered banks, not simply those headquartered in the EU, with the aim of maintaining the UK’s position as a preeminent global financial centre. The UK's Prudential Regulation Authority (PRA) estimates that a fifth of global banking activity is undertaken in the UK and almost 50% of UK banking assets are held by international banks.
The UK's Financial Conduct Authority (FCA) published its ‘Approach to international firms’ in February 2021 following consultation, which sets out its approach to the authorisation and supervision of international firms and the circumstances in which they may need to establish a UK subsidiary rather than a branch. The FCA indicates that relevant banks (and insurers), as dual-regulated firms, should consider the document as it (the FCA) will provide consent to any authorisation applications that they submit to the PRA.
The PRA is in the process of consulting on an update to its Approach document, originally published in March 2018, which it intends to make applicable in Q2 2021. It has made clear that, among other aspects, it will expect detailed information on banking firms’ or groups’ profitability, the market risk they pose (which will depend on their potential impact on UK financial stability), the degree of intra-group interconnection, as well as the existing requirement of equivalent home state regulation particularly in relation to the bank’s capital requirements and applicable resolution regime.
Both parties have agreed [an MoU] to establish…regulatory co-operation..[aimed at] establishing a ‘durable and stable’ relationship.