The UK Government's 'no deal' notices and the future of financial services

As announced earlier this summer, the UK Government has now begun to publish the first of what is expected to be a series of over 80Brexit 'no deal' technical notes. The 25 documents released by the UK Government on 23 August _ and the further 28 released on 13 September _ contain information about some of the potential impacts of a 'no deal' scenario for citizens and businesses in the UK, and identify steps that could be taken to mitigate that impact.

Earlier this year, 'in view of the considerable uncertainties', the EU had published its own'preparedness notices'. While the UK Government iscommitted to reach a negotiated deal with the EU, it too recognises the need to prepare for a 'no deal' scenario. AsDominic Raab, the Secretary of State for Exiting the EU put it: 'We have a duty, as a responsible government, to plan for every eventuality.'

The UK's 'no deal' notices cover a wide range of issues. Some of the notices are specific to particular industries or sectors, while others will be relevant more generally. This update covers the UK Government's approach in relation tobanking, insurance and other financial services.

Temporary Permissions and Recognition Regimes

As discussed in our recentlegal update, the UK Government has proposed a 3-year 'temporary permissions regime' intended to minimise disruption and maintain stability in the financial services sector in the event of a 'no deal' scenario. This regime will enable EEA firms currently operating in the UK via a passport to continue to provide their services in the UK (within the same scope as their existing passport) for a period of up to 3 years after the 29 March 2019 exit date while applying for full authorisation from UK regulators. Firms will be able to apply for admission to the regime prior to the exit date, or alternatively provide notification of their intention to enter the regime within its 3-year duration.

A 'temporary recognition regime' will also be established for central counterparties (CCPs), thereby enabling non-UK CCPs to continue providing clearing services to UK firms _ again, for a period of up to 3 years from the exit date _ pending application for UK authorisation. Draft legislation has been prepared in respect of both the permissions and recognition regimes.

The UK Government has confirmed that similar regimes will be provided for, among others, EEA electronic money and payment institutions, registered account information service providers, EEA funds that are marketed into the UK, credit rating agencies and central securities depositories; however, further details of these corresponding regimes are yet to emerge. The government has also revealed its intention to equip regulators such as the FCA and theBank of England with a 'general transitional tool', using the powers contained in theEuropean Union (Withdrawal) Act 2018. This will provide a mechanism whereby regulatory reforms can be phased in post-exit, thereby providing firms with time to adjust to the new UK regimes that will be implemented. Further details in respect of this are awaited.

Individual and business customers

The recent financial services 'no deal' technical note also outlines the Government's proposals to minimise the impact of a 'no deal' on individuals and business customers.

By virtue of the temporary permissions regime outlined above, EEA firms will be permitted to continue providing financial services to UK-based customers for the 3-year period following the exit date pending full authorisation. Similarly, consultation with UK regulators will take place this autumn to ensure continued protection of UK-based customers under the UK's Financial Services Compensation Scheme in respect of products deriving from UK-authorised firms, including some products with EEA firms.

The Government has also committed to continue to treat prospectuses that have been validated prior to the exit date as valid for the 12 months following the date of their approval _ this will include prospectuses approved by competent authorities in other EU Member States.

Whilst the Government's proposals seek to address a range of issues arising from a 'no deal' scenario the proposals are, ultimately, unilateral. UK firms operating in the EEA, and EEA-based customers using the services of UK-based firms, are reliant on reciprocal measures being implemented by the EU if they are to maintain access to, and continue to provide financial services within, the EEA. In particular, without further action on the part of the EU, UK firms will be unable to provide financial services to EEA-based customers (including UK citizens living in the EEA) as they do presently. Some UK-based firms are establishing EU-based, authorised subsidiaries in order to allow continued operation in the EEA post-exit.

Similarly, access to centralised infrastructure (such as central payments infrastructure (TARGET2 and the Single Euro Payments Area (SEPA)) will be unavailable to UK firms, which will likely lead to increased cost and slower processing in respect of Euro-based transactions for customers.

Financial services firms and funds

The UK Government has reiterated that financial services firms should plan on the basis that a deal will be reached with the EU and that an implementation period will operate from the date of the UK's withdrawal from the EU until the end of December 2020.

Nonetheless, the technical notice highlights that the ability of UK firms to meet their contractual obligations under cross-border contracts may be impacted in the event of a 'no deal' scenario and that coordinated action with the EU is required to address this. As the proposed UK regimes will apply only to inbound EEA firms and funds, there is no guarantee that EEA countries will implement similar regimes should a wider exit agreement not be reached by the exit date.

The UK Government is hopeful that reciprocal arrangements will be implemented; in particular, the technical notice reiterates the willingness of UK regulatory authorities to agree and enter into cooperation arrangements with their EU counterparts to enable delegation of portfolio management services to firms based in the UK. Current EU legislation allows for this, and would enable the UK to take advantage of the approach currently utilised in respect of firms in non-EEA countries.

Financial Market Infrastructure

While the temporary recognition regime will allow non-UK CCPs to continue to provide services in the UK following the exit date, UK CCPs will be unable to provide clearing services to EEA customers unless they are granted equivalence under the EU Commission's equivalence regime and are recognised per relevant EMIR requirements. Otherwise, without further EU action, UK CCPs would require to move their business to the EU (i.e. establish at least one legal entity in one or more Member States and obtain authorisation) in order to continue providing services. Similarly, without EU cooperation, the ability of customers to settle EU securities in the UK would also be limited and EU settlement finality protection would cease to apply to UK Financial Market Infrastructures.

Ramifications may also be felt in the form of a reduction in market liquidity in both the UK and the EU, as certain EEA firms may be unable to remain as members of UK trading venues; membership would only be allowed if permitted under the national law applicable to each respective firm, as UK venues would no longer qualify as EU trading venues.

EEA firms will also be unable to access UK Credit Rating Agencies (CRAs) and Trade Repositories (TRs) after exit unless action is taken by the EU. The government intends to provide the FCA with powers to authorise and regulate both UK and non-UK CRAs and TRs post-exit, as well as implement a temporary regime to minimise impact on UK customers of EU CRAs and TRs; more details of this regime are anticipated this month. However, without action by the EU, EEA firms will be unable to access UK CRAs and TRs post-exit, and the ratings of UK CRAs will not be able to be used for regulatory purposes in the EU.

Going forward

The technical notice clearly restates the UK Government's preference for a 'smooth' Brexit, and a desire to have withdrawal arrangements in place with the EU by the 29 March exit date. Nonetheless, it provides welcome guidance as to the probable framework that would be implemented in the event of a 'no deal' scenario. Indeed, whilst the note states that EEA states and firms will largely be treated in the same manner as third countries and third country firms in such circumstances, it is clear that the UK Government is keen to limit disruption within the financial services sector by implementing regimes that will allow for continued recognition of, and openness to, EEA firms. Although there is no certainty that the measures outlined within the notice will be implemented, it does provide visibility on the UK Government's proposed course of action in such an event, and allows businesses to enact contingencies accordingly.

Both the FCA and the PRA are due to engage in formal consultation in respect of the new recognition and permissions regimes this autumn, so further updates should be anticipated once the consultation completes. A policy statement and rules for the regimes are expected in early 2019.

We will be reporting further, so keep an eye on ourBrexit Hub.