uk

Preparing for Brexit’s Impact on Capital Market Operations in the United Kingdom

 

Overview

The United Kingdom made headlines when it voted to leave the European Union in June 2016. Popularly named “Brexit”, the move began a tumultuous four-year voyage that seemingly came to completion on January 31, 2020 when the UK’s withdrawal became official. However, as many are coming to realise, the nation is just now beginning to face some of its biggest challenges yet.

While the UK may be officially out of the EU, the European Union Withdrawal Agreement Act of 2020 (EUWA) called for a transitory implementation period that will end on December 31st of this year. Until that deadline, the UK will largely be treated as a Member-state of the EU while trade negotiations are underway. However, the agreement period largely prevents an extension beyond the fast-approaching 11-month deadline, making this the country’s last chance at striking a satisfactory trade deal with the EU.

The EUWA currently provides that directly applicable and operative EU laws such as the Market Abuse Regulation, the Transparency Directive, and the Prospectus Regulation will be converted into UK law at the end of the year. However, this does not amount to a workable level of certainty, in that such regulation, once converted, would be exposed to domestic revision or amendment.

Impact on Capital Market Regulation

The potential failure to achieve a trade deal presents particularly significant issues concerning, firstly, the “passporting” system (i.e. the system that enables banks and financial services firms that are authorised in any EU or EEA state to trade freely with minimal regulatory oversight – thereby serving as the foundation of the EU single market for financial services) and, secondly, the creation of a new EU Capital Markets Union, of which the UK has traditionally been a strong supporter.

More specifically, the UK will no longer be a part of the EU’s single-market system and will be treated as a third-party country lacking passporting or equivalence rights in the EU. This could be detrimental to both the EU, who relies on UK’s economic activity to bring revenue into the EU, and for the UK, a hub for international transactions instigated by firms that capitalise on the minimal red-tape requirements made possible by the Capital Markets Union. Abdication of the passporting and equivalence practices in the UK could particularly affect instances where there are lower numbers of retail investors in more than one Member State, as individual approvals would be required in each such Member State due to the absence of said practices.

What Practitioners Need to Know

As it stands, the presumption is that the UK will be considered a third-party country at the end of the implementation period. Consequently, some UK firms with operations in the EU are relocating to EU member-states (or are considering doing so) in order to preserve their passporting rights. EU regulators and supervisors are monitoring this activity, and it is important for professionals at every level to stay updated on the various guidelines and resources released by authorities to assist practitioners during the transition period.

With the potential failure to achieve a free trade deal still on the table, businesses and their advisors need to be prepared to reckon with its consequences. For example, the European Central Bank has been pressuring banks to accelerate their Brexit strategy plans and implement a substantial portion of its policies by the time the withdrawal deadline occurs. If firms cannot rely on regulatory equivalence, firms may have to incur significant costs that could affect their financial stability, hence why they should be considering potential mitigating mechanisms to counteract such effects.

Furthermore, on February 4, 2020, the Statutory Auditors and Third Country Auditors published their regulatory amendments to address deficiencies of retained EU law arising from the withdrawal of the UK from the EU in relation to the regulatory oversight and professional recognition of statutory auditors and third country auditors in the UK. In addition to updating the adequacy standards of nations such as China and South Africa, the amendments also provided an assessment framework for the equivalence of third countries’ audit regulatory frameworks and enabled the audit exemption currently available to subsidiaries of UK and EEA parent undertakings to continue to be available to those subsidiaries where their financial years have already begun.

While players across the board are giving their best efforts to deliver a smooth and fair transition of the UK out of the EU, only time will tell how complicated and contentious the terms of such transition will be. With or without a free trade arrangement, it is especially important for financial professionals, attorneys, and other advisory professionals to be vigilant in their assessment of regulatory developments as they are released.

House of Lords EU Committee Launches Inquiry into Brexit and Financial Services

 

On August 31, 2016, the House of Lords EU Sub-Committee on Financial Affairs published a webpage announcing the launch of an inquiry into Brexit and financial services in the UK. The Sub-Committee will begin its inquiry with two evidence sessions concentrating on the consequences of the referendum result for financial services and potential future arrangements.

The issues to be considered by the inquiry are as follows:

  • The reaction of financial services firms to the outcome of the EU referendum result
  • The possibility of the relocation of financial services firms from the UK
  • Priorities for the UK financial services sector in the withdrawal negotiations and in negotiating a future relationship for the UK with the EU
  • Equivalence rights to access the EU single market for the UK
  • Financial regulatory co-operation between the UK and the EU under different models of EU membership
  • A potential free trade agreement and the UK’s financial sector
  • Potential transitional arrangements
  • The importance of passporting rights for firms operating in the UK
  • Risks for retail customers and investors
  • Considerations for non-EU firms wishing to gain access to the EU through the EU’s equivalence regime

Brexit – What Now For Your Business

So, the UK has voted to leave the EU. Everyone has their own opinion and we’ve all seen the news reports and various viewpoints but what does this result mean for you in practical terms and where do we go from here? Orrick’s EU-UK Working Group is ready and waiting to answer any questions you may have (see contact details at the end of this alert) and in the meantime, here’s our overview of the key issues for your business. READ MORE

U.S. and U.K. Officials Meet to Discuss Key Components for the Resolution of a Global Systemically Important Bank

On October 13, the heads of the Treasuries and leading financial regulatory bodies in the United States and United Kingdom participated in an exercise designed to further the understanding, communication, and cooperation between U.S. and U.K. authorities in the event of the failure and resolution of a global systemically important bank, or G-SIB. The exercise demonstrates the continued commitment of the United States and the United Kingdom since the financial crisis to promote a safer and sounder financial system by cooperating to address issues involved in the orderly resolution of large and complex financial institutions without cost to taxpayers.  Release.

PRA Issues Clarification on Implementation of the Solvency II Directive

On August 29, the UK PRA issued an update on the implementation of the Solvency II Directive (2009/138/EC), which is planned for January 1, 2016. The current PRA Update focuses on:

  • the relationship between the risk margin and the calibration of non-hedgeable risks; and
  • the assessment of the credit risk for matching adjustment portfolios.  PRA Update.

FCA Publishes Report on Hedge Fund Activity in the UK

On March 24, the FCA published a report which sets out its findings from a survey of hedge fund activity in the UK.

Key findings are:

    • 98 percent of total leverage used by hedge funds in the UK is acquired through derivatives.
    • Institutional investors are the dominant investors in hedge funds.
    • The proportion of high net worth individuals investing in hedge funds has declined.
    • Equity strategies are the most popular among the funds in the survey.   Report.

UK Government White Paper on Banking Reform

On 14 June 2012, HM Treasury and the Department for Business, Innovation and Skills (BIS) published a white paper on banking reform setting out the government’s proposals for implementing the key recommendations of the Independent Commission on Banking (ICB) chaired by Sir John Vickers. White Paper.

Key proposals of the White Paper are:

• Retail banking operations will be ring-fenced, with operations core to consumer and small business services separated from investment banking.

• Those ring-fenced operations will face limits on exposures to other banks – they will only be allowed to carry out tasks like facilitating other institutions’ payments and managing liquidity.

• The biggest banks will hold 17% of risk-weighted assets as primary loss-absorbing capital.

• Bail-in bonds will be used to make creditors cover some of the cost of a bank failing, without a full collapse.

• But depositors will still be protected and will have a senior claim to bondholders, as well as a legal guarantee on deposits up to £85,000.

• Banks must comply with Basel III’s 3% tier one leverage ratio.

The deadline for responses to the White Paper is 6 September 2012 with the Government due to publish a draft bill in the autumn. The Government states in the white paper that it is committed to completing all primary and secondary legislation by the end of this Parliament in May 2015. The deadline for banks to comply with all of the ICB recommendations is 2019.

FSA Consultation Paper on Recovery and Resolution Plans

On August 9, the FSA published a Consultation Paper and Discussion Paper regarding the implementation of Recovery and Resolution Plans by systemically important banks and large investment firms in the UK. The goal of the paper is to present proposals on what is expected of a firm in planning for stress events that would require it to take action to recover or, if necessary, wind-down in an orderly manner without putting UK taxpayers at risk of loss. FSA Release. FSA Consultation Paper and Discussion Paper.