knowledge 22 February 2019 |

Financial Services: Preparations for a ‘No-Deal’ Brexit

Settlement Finality

The Settlement Finality Directive (“SFD”), as transposed in Ireland by the European Communities (Settlement Finality) Regulations 2010 (the “SFR”), reduces the disruption caused to inscope payment and securities settlement systems by the insolvency of participants by protecting the finality of settlement of payment and security transfer orders entered in such systems prior to a participant’s insolvency and related netting and collateral arrangements.

The SFD operates on the basis that systems designated by each EU member state for SFD purposes are automatically recognised and afforded SFD protections under the laws of each other EU member state. Once the UK leaves the EU, any relevant systems located in the UK will no longer be automatically recognised, or afforded protections, by EU member states under the SFD.

Part 7 of the Withdrawal Bill empowers the Minister for Finance to designate certain UK systems, one or more of the participants in which is Irish, for the purposes of the SFR, subject to certain conditions. The effect of such a designation will be to extend the protections of the SFR in respect of payments and transfers made by Irish participants through such systems, if the UK becomes a third country.

The Central Bank of Ireland must undertake an equivalence assessment of the applicable UK laws governing the system and assess the system’s rules for compliance with SFR requirements. However, Part 7 also provides a means for the temporary designation, for up to nine months, of systems designated by the UK for SFD purposes immediately prior to Brexit, one or more of the participants in which is Irish.

The provisions in the Withdrawal Bill regarding settlement finality complement an EU decision to support continued access to the EU market by UK Central Securities Depositories (“CSDs”). Under the Central Securities Depository Regulation 909/2014, in order to provide services in the EU, a CSD established in a third country must be recognised by the European Securities and Markets Authority (“ESMA”). On 19 December 2018, the European Commission adopted Commission Implementing Decision 2018/2030 determining the equivalence of the regulatory framework applicable to CSDs in the UK for the purposes of EU law, for a 24 month period, until 30 March 2021.  This paves the way for UK CSDs to be become recognised third country CSDs, and to continue providing services in the EU.

Ireland is the only EU member state which does not have a CSD and most trades in Irish corporate securities are settled in the UK-based CSD, Euroclear UK & Ireland Limited, which operates the CREST securities settlement system. The combined effect of the equivalence decision for CSDs and Part 7 of the Withdrawal Bill mean that it should be possible to continue to settle trades in Irish corporate securities in CREST for a 24 month period following a 'no-deal Brexit'.

Insurance/Insurance Distribution

If the UK leaves the EU without a deal in place that maintains some or all of its current passporting arrangements, then UK financial service providers, including insurers and insurance intermediaries, will no longer be able to passport into the EU.  While insurance contracts concluded before that date by UK insurance undertakings in the remaining member states (the “EU27”) may remain valid after that date, the insurance undertakings would no longer be authorised to carry out insurance activities with regard to these cross-border insurance contracts.

Part 8 of the Withdrawal Bill is designed to ensure that Irish policyholders that hold existing life and non-life insurance policies with insurance undertakings or through insurance intermediaries, operating in Ireland from the UK or Gibraltar, will not be affected by those undertakings losing their right to passport into Ireland.

In this respect, the Withdrawal Bill provides for a temporary run-off regime, which, subject to a number of conditions, will enable insurance undertakings and intermediaries to continue to fulfil obligations contracted prior to Brexit to their Irish customers for a period of three years after the date of the UK’s withdrawal from the EU.

However, those insurers/intermediaries will no longer be able to write new insurance contracts or continue insurance distribution in respect of new insurance contracts in Ireland until they obtain a relevant authorisation under the EU insurance supervisory regime.

EU Measures for a Hard Brexit

The measures contained in Parts 7 and 8 of the Withdrawal Bill are being taken against the backdrop of a limited number of additional measures that have been taken at EU level to prepare for a 'no-deal Brexit', in addition to the European Commission’s Implementing Decision recognising the equivalence of UK CSDs mentioned above. In particular, the European Commission has taken a number of measures relating to the rules governing derivatives, which are set out in the European Markets Infrastructure Regulation 648/2012 (“EMIR”). In addition, ESMA and national regulators have entered into memoranda of understanding (“MoUs”) with the UK’s Financial Conduct Authority (“FCA”).

EMIR

Under EMIR, certain types of over-the-counter (“OTC”) derivatives transactions must be centrally cleared by Central Counterparties (“CCPs”) that are either established in the EU or “third country CCPs”, recognised by ESMA. The market for central clearing of OTC derivatives is currently highly concentrated. For example, 97% of OTC interest rate derivatives are cleared in one UK CCP.

In order to be recognised by ESMA, a third country CCP must, among other things, be subject to an equivalent regulatory framework to that of the EU. On 19 December 2018, the European Commission adopted Commission Implementing Decision 2018/2031 determining that the regulatory framework applicable to UK-based Central Counterparties (“CCPs”) is equivalent to that applicable to EU based CCPs. The equivalence decision is valid for a 12 month period following a 'no-deal Brexit', which, according to the European Commission, should give EU27 companies enough time to have in place fully viable alternatives to UK CCPs. On 18 February 2019, ESMA announced that in the event of a 'no-deal Brexit', three UK established CCPs – LCH Limited, ICE Clear Europe Limited and LME Clear Limited will be recognised to provide their services in the EU.

The European Commission has also published two delegated regulations which are designed to facilitate novation, for a fixed period, of certain OTC derivative contracts with a UK-established counterparty, in order to replace that UK counterparty with a counterparty established in the EU. This means that such contracts can be transferred to an EU27 counterparty while maintaining their exempted status and thus not becoming subject to clearing and margining obligations under EMIR. See our related briefing here.

Memoranda of Understanding

On 1 February 2019, ESMA announced that it and European securities regulators had agreed MoUs with the FCA, as part of their preparation for a 'no-deal Brexit'. The MoUs are:

• an MoU between ESMA and the FCA concerning the exchange of information in relation to the supervision of credit rating agencies and trade repositories. According to ESMA, this MoU will allow ESMA to continue to discharge its mission and meet its mandate regarding investor protection, orderly markets and financial stability in the EU; and
• a multilateral MoU (“MMoU”) between EU/EEA securities regulators and the FCA covering supervisory cooperation, enforcement and information exchange between individual regulators and the FCA. The MMoU, will allow the various parties to share information relating to, amongst others, market surveillance, investment services and asset management activities. This will in turn permit certain activities, including fund manager outsourcing and delegation to continue to be carried out by UK based entities on behalf of EEA based counterparties.

Comment

As the prospect of a 'no-deal Brexit' looms large, the measures contained in the Withdrawal Bill will contribute to alleviating some of the difficulties which could otherwise arise at least in so far as finality of payment and securities settlement and insurance continuity are concerned.

There are however a host of other problems that remain outstanding. One of these relates to the share trading obligation set out in the Markets in Financial Trading Regulation 600/2014 (“MiFIR”). Under this obligation, EU investment firms are only allowed to trade shares, which are admitted to trading on a regulated market or traded on a trading venue, on regulated markets, MTFs, systematic internalisers or EU recognised equivalent third country trading venues, subject to certain exceptions. Consequently, in the event of a 'no-deal Brexit', EU investment firms will be unable to buy and sell on the London Stock Exchange shares of companies with dual listings in another EU member state, including those of a number of companies with shares listed on the Irish Stock Exchange, Euronext Dublin. According to ESMA, it is aware of this issue in relation to the trading obligation for shares and is currently looking into it.

In addition, there are other areas of UK-Irish financial services for which the Withdrawal Bill does not seek to provide any safe harbour, even on a temporary basis.  These include classic banking services such as cross border deposit taking by UK credit institutions from customers in Ireland; currently undertaken in reliance on EU passport rights.

It is still of course possible that we will avoid a 'no-deal Brexit' and the UK will agree to the Withdrawal Agreement, or some version of it. This will mean that there will be a transition period until at least the end of December 2020, during which the existing EU legislative framework will continue to apply to the UK, including the right to passport financial services to and from the EU27. The transition period may be extended until the end of 2021 or 2022.

Longer term, it appears that the provision of financial services between the EU27 and the UK will be based on equivalence, as set out in the Political Declaration which accompanies the Withdrawal Agreement.  This is much narrower than the access currently offered by passporting. Furthermore, there are different equivalence regimes for different financial services, meaning third countries’ laws have to meet different criteria for different services. Moreover, some financial services, including basic banking services such as lending and deposit-taking, are not covered by equivalence provisions. Trade for these services would revert to WTO terms or need to be negotiated separately in bilateral agreements.

In addition, looking to the future, there are already indications that Brexit may well result in a comprehensive review by the EU and its regulators of the relationship between the EU and third countries in the area of financial services as regards the cross border provision of services, equivalence, delegation and outsourcing.