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Preparing for regulation after Brexit

Preparing for regulation after Brexit

At the same time as the UK government is negotiating for its preferred outcome for financial services under Brexit (as set out in its White Paper and in its framework for a UK-EU partnership in financial services), it is also making contingency plans for what would happen on 29 March 2019 in the event of a “no deal” Brexit.

This contingency planning includes the preparation of a statute book that could function from day one of a “no deal” Brexit. One element of this is a proposed Statutory Instrument covering the Capital Requirements Regulation (CRR) and related EU legislation covering the prudential regulation of credit institutions and large investment firms. As an EU Regulation, the CRR is currently directly applicable in all EU member states, without the need for any national legislation. This would need to be replaced by UK national legislation in the event of a “no deal” Brexit in order to preserve a full set of prudential requirements for UK credit institutions and major investment firms.

This Statutory Instrument would amend the CRR as it is transferred across to the UK statute book under the European Union (Withdrawal) Act 2018.

Implications for firms

There are three main implications for firms here.

First, the “onshoring” approach (as HM Treasury refer to it) of replacing all references to the EU and EU institutions with references to the UK and UK institutions would create some regulatory treatments (for example on consolidated supervision, sovereign exposures and liquidity) that will increase regulatory requirements on UK firms, and are also likely to require firms to change their data and systems to enable the necessary split between UK and EU27 assets, liabilities and market positions.

Second, the proposed Statutory Instrument is a contingency plan to ensure that a full prudential regime is in place from “day one”. Thereafter the UK authorities will have to turn EU Regulations such as the CRR into a combination of UK legislation and provisions in the PRA and FCA Rulebooks. This will be a long process, requiring detailed consultation with the industry.

Third, this proposed Statutory Instrument provides a precedent for how other EU financial services legislation will be carried across in the event of a “no deal” Brexit.

Statutory Instrument

The proposed Statutory Instrument would amend the CRR (and existing UK legislation that implements related EU directives such as CRD4) as it is transferred across to national UK legislation, so that a full prudential regime is in place. In doing so, the Statutory Instrument would makes six main types of change to the CRR:

First, references to “the EU” or “member states” would be replaced with “the UK”. In some places this will make a significant difference to the regulatory treatment of UK-based firms. For example:

  • Current EU banking groups with UK operations would no longer be able to benefit from consolidated liquidity requirements that apply only on a cross-EU basis. Consolidated liquidity requirements would no longer apply to a UK group with EU business, while EU27 groups operating in the UK would become subject to an additional layer of PRA requirements.
  • The current zero risk weighting and exemption from large exposure limits for UK banks of their EU-wide sovereign (and central bank and public authority) exposures denominated in national currency would no longer apply, since these treatments would only apply to UK sovereign, central bank and public authority exposures denominated in sterling.
  • Similarly, some EU-wide asset classes currently eligible to count towards high quality liquid assets in the calculation of the Liquidity Coverage Ratio, and some eligible collateral against real estate exposures, would be narrowed to UK assets and UK collateral.

Second, functions would be transferred from EU institutions to UK authorities. This would include changing the responsibility for issuing technical standards and guidance on “level 1” legislation from the European Supervisory Authorities (in particular the EBA and ESMA) to the PRA and the FCA; and removing the need for the FPC to notify or seek approval from EU institutions for the setting of macro-prudential requirements.

Third, the responsibility for taking third country equivalence decisions would be transferred from the Commission to HM Treasury. HM Treasury would also presumably have to decide whether the EU27 (collectively or individually) would count as an equivalent third country.

Fourth, the binding obligations on UK authorities to cooperate and share information with EEA authorities would be removed. This does not mean that such cooperation would cease - but it would be on a discretionary rather than legislated basis.

Fifth, decisions already taken under the CRR (including on third country equivalence or internal model approvals) would be “saved”, and would continue to apply as if they had been taken by the UK authorities.

Sixth, as an exception to the general approach, the fixed/variable remuneration ratio limits in CRD4 would be replaced from day one by the existing remuneration rules in the PRA and FCA rulebooks (these rules allow a firm to set the ratio between the fixed and variable components of remuneration at up to 200 percent for each material risk taker, if approved by the shareholders or owners or members of the firm).

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