Brexit and the EU Withdrawal Act: Update for Financial Services Firms

What Does the Act Do?

 The Act:

• will repeal the European Communities Act 1972, which will end the supremacy of EU law in the UK (section 1);
• will preserve UK domestic legislation derived from EU law and transpose directly applicable EU law into UK domestic law (sections 2 and 3);
• gives UK government ministers powers to make regulations to deal with “any failure of retained EU law to operate effectively” and “any other deficiency in retained EU law” (section 8); and
• requires that any withdrawal agreement with the EU must be approved by the UK’s House of Commons prior to ratification by the UK (section 13).

The Act is intended to ensure that the bulk of existing EU law applicable in the UK is retained as UK domestic law post-Brexit in order to ensure a smooth transition for the UK legal system with limited substantive changes taking effect on the date of Brexit. The powers bestowed on UK government ministers will allow the government to make changes to existing UK legislation without having to go through the full parliamentary scrutiny and approval processes that would normally apply to such changes. However, such powers expire two years after the UK leaves the EU.

Approach of the UK Government and Financial Regulators

 The UK’s finance ministry HM Treasury (the Treasury), the Bank of England, and the UK Financial Conduct Authority (the FCA) each issued a statement setting out its approach and its roles in relation to the Act. The statements are available at the following links:

• Treasury – https://www.gov.uk/government/publications/financial-services-legislation-under-the-eu-withdrawal-act
• Bank of England – https://www.bankofengland.co.uk/news/2018/june/boes-approach-to-financial-services-legislation-under-the-eu-withdrawal-act
• FCA – https://www.fca.org.uk/news/statements/fca-role-preparing-for-brexit

The statements provide guidance on the proposed implementation period for Brexit and changes that will be made to financial services regulation applicable in the UK.

On July 12, the UK government published a more general paper setting out its plans for Brexit, which is available here: https://www.gov.uk/government/publications/the-future-relationship-between-the-united-kingdom-and-the-european-union

What Will Happen During the Implementation Period?

In March 2018, the UK and the EU reached political consensus on the terms of an implementation period that will start on March 29, 2019 and will end on December 31, 2020. Such terms are intended to be included in the EU-UK withdrawal agreement, which is still being negotiated, and the EU has maintained that “nothing is agreed until everything is agreed.”

The UK government has confirmed its intention to introduce additional legislation – the Withdrawal Agreement and Implementation Bill – to give effect in domestic law to the major elements of the proposed withdrawal agreement, including the implementation period.

If an implementation period is formally agreed on the terms proposed, common EU rules will continue to apply in the UK during such period. The UK will continue to implement new EU law that comes into effect and will continue to be treated as part of the EU’s single market in financial services. This will mean that reciprocal access to the EU and UK markets will continue on current terms and that businesses, including financial services firms, will be able to trade on the same terms as now until December 31, 2020. This includes firms that operate under one of the EU regulatory passport regimes through a branch or on a cross-border basis. UK firms will need to comply with any new EU legislation that becomes applicable during the implementation period.

The Treasury has also confirmed statements on Brexit issued by the Bank of England and the FCA in March 2018, stating that “[i]nbound firms that are currently permitted to operate in the UK without UK authorisation or recognition may plan on the assumption that UK authorisation or recognition will not be needed before the end of the implementation period, following guidance from the UK’s financial services regulators.” In other words, firms passporting into the UK from a member state of the European Economic Area (EEA)¹ can assume that they may continue to do so during the implementation period.

The Treasury has also stated that it intends to legislate to provide the financial services regulators with powers to introduce transitional measures that they could use to phase in any “onshoring” changes, such as requiring EEA firms relying on passporting to apply for authorisation from the FCA or the Prudential Regulation Authority (PRA). The Treasury has stated that this means firms do not need to prepare now to implement such changes in the event no deal is reached with the EU. Instead, firms should continue to plan on the assumption that an implementation period will be in place from March 29, 2019, and therefore that they will be able to trade on their current terms until December 2020.

The FCA has said that EEA firms wishing to rely on such temporary permissions regime will need to notify the FCA before March 29, 2019 and that it plans to consult on the rules that will apply to firms under such a regime in due course.

If an EU-UK withdrawal agreement including terms for the proposed implementation period is not agreed and ratified by March 29, 2019, it is far from certain whether other EEA member states will take the same approach as the UK in granting temporary permissions to firms that would otherwise be subject to local licensing requirements. In this respect, firms passporting from the UK to other EEA member states would appear to face greater uncertainty than firms passporting from another EEA member state into the UK. Affected firms should therefore plan for the possibility of market access from the UK to the EEA becoming substantively limited on March 29, 2019.

What Changes Will Be Made to Regulation?

The UK’s Department for Exiting the European Union has said that around 800 pieces of secondary legislation will be needed to deal with Brexit. However, the Treasury has confirmed in respect of financial services regulation that such secondary legislation is not intended to make policy changes other than to reflect the UK’s new position outside the EU and to smooth the transition to this situation.

The Treasury has also said that as a general principle, the UK would need to default to treating EU member states, and presumably non-EU EEA member states, largely as it does other non-EU (or “third”) countries. However, the Treasury has stated that it would need to diverge from this approach in certain circumstances, including to provide for a smooth transition to a UK outside the EU. The Treasury has identified several principles that would justify taking a different approach:

• having a functioning legislative and regulatory regime in place, in particular, the regulators’ capability to fulfil their statutory objectives;
• enabling regulators and firms “to be ready” by minimizing disruption and avoiding material unintended consequences for the continuity of service provision to UK customers, investors and the market;
• protecting the existing rights of UK consumers; and
• ensuring financial stability.

The Treasury has stated that it plans to lay the relevant secondary legislation before the UK parliament from autumn 2018 into early 2019, and that it will prepare the relevant statutory instruments in groups, with some of the first to cover prudential regulation and capital markets. The Treasury plans to publish drafts of the first such group of statutory instruments and accompanying explanatory information over summer 2018 to give stakeholders an opportunity to “engage and familiarise themselves with the draft provisions.” This implies that legislation relating to other areas of financial services regulation, such as conduct of business rules, regulatory reporting and specific activities such as payments and consumer credit, may not be published until later in 2018 or in early 2019.

The Treasury also plans to delegate powers to the UK’s financial services regulators to address deficiencies arising as a result of Brexit in the regulators’ rulebooks and in the EU binding technical standards that will become part of UK domestic law. These will include, for example, various regulatory and implementing technical standards under the revised Markets in Financial Instruments Directive and accompanying Regulation, the European Market Infrastructure Regulation and the revised Payment Services Directive. The FCA has said that it plans to consult on such changes in autumn 2018, subject to the Treasury’s timetable for secondary legislation under the Act.

Next Steps for Firms

Firms providing regulated financial services in or from the UK should continue to monitor developments regarding changes to UK legislation and other regulatory rules, the proposed implementation period and the approach of the UK government and financial services regulators, as well as the negotiations between the UK and the EU on the withdrawal agreement.

Firms should look out for:

• draft secondary legislation affecting financial services regulation that applies to the firm’s business;
• FCA, PRA and Bank of England consultations and policy statements on their approach under the post-Brexit regime and changes to EU binding technical standards and the FCA and PRA rulebooks;
• updates from the UK government and regulators on the proposed temporary permissions regime for EEA firms; and
• any statements relating to Brexit from financial services regulators in EEA member states in which a UK firm carries on regulated activities through a local branch or on a cross-border basis.

UK firms relying on EU regulatory passports to access the EEA should plan for the possibility that there will not be an implementation period and that their passporting rights will be extinguished on March 29, 2019.

EEA firms relying on EU regulatory passports to access the UK should consider whether they would need to rely on the UK’s proposed temporary permissions regime in such case to continue to provide services in the UK. As stated above, the FCA has said that firms wishing to rely on the temporary permissions regime will need to notify the FCA before March 29, 2019.