Amid ongoing discussions on the U.K.’s future relationship with the European Union, the Bank of England announced plans to consult on an updated approach to authorising and supervising international banks and insurers.
Additionally, the Bank of England said it is issuing guidance on its approach to international central counterparties. It has also published letters to relevant firms setting out its approach to the authorisation of those firms, “so that this process can proceed in an orderly manner,” the Bank of England stated.
The Bank of England stated that the foundation of its approach is the presumption that “a high degree of supervisory cooperation” will continue between the United Kingdom and the EU. On this basis, EEA banks and insurers may (if they are not conducting material retail business) apply for authorisation to operate as a branch in the United Kingdom. The Bank of England said it expects no implications of the proposed policy for the current operations of banks and insurers United Kingdom.
Two of the most important components of the U.K. financial system are international banking and insurance: 160 branches of international banks sit in the United Kingdom, of which 77 are from the EEA, with assets totaling £4 trillion—substantially larger than the U.K. GDP. There are also 110 branches of international insurers in the United Kingdom, of which 80 are from the EEA. Other countries rely on the services these institutions provide.
Large and complex global financial services firms bring significant benefits, but also significant risks. The Bank of England said it manages these risks through:
Strong regulatory standards: These have been materially reinforced since the financial crisis due to the actions of the United Kingdom and its key G20 partners. Banks are now much more resilient, with capital requirements for the largest global banks ten times higher.
Deep supervisory cooperation: The United Kingdom has actively worked since the crisis to build strong bilateral and multilateral cooperation mechanisms both through participation in supervisory colleges and crisis management groups, and via the development of agreed approaches to supervisory oversight and enforcement. Although some of this cooperation has been supported through underlying legal structures within the EU, the majority has been developed through direct interactions with regulators including in third countries.
Transparent and effective resolution regimes: These are essential for ensuring that institutions can maintain critical functions even when they fail. For example, large banks are now required to hold significant quantities of debt that can be written down or converted to equity to recapitalise them in resolution. Firms must also work with authorities to develop resolution plans and are subject to regular resolvability assessments to ensure continuity of critical functions without exposing taxpayers to loss.
“We expect the U.K. financial system to stay very large and it may, over time, become more complex, reducing the visibility to supervisors of overseas firms operating in the United Kingdom,” the Bank of England stated. “This could place greater demands on supervision and could pose challenges for effective resolution, which in turn requires deep supervisory cooperation.”
To meet these challenges, the Bank of England on 20 December 2017, announced a proposed updated approach to authorising and supervising branches of international banks and insurers. The proposed policy will be out for public comment until the end of February 2018, at which time the Bank of England said it intends to finalise the policy shortly thereafter.
“In expectation of the future legal framework following the negotiations between the United Kingdom and the EU, firms currently branching into the United Kingdom. under ‘passporting’ will need to be authorised to operate in the United Kingdom,” the Bank of England stated.
The Prudential Regulatory Authority (PRA), therefore, expects to undertake the authorisation of relevant firms based on this proposed updated approach and has published letters to relevant firms to inform them of this.
The updated policy will particularly consider, first, what international firms do in the United Kingdom and, second, where they are from. In terms of what firms do, the PRA must consider how “systemic” their activities are in the United Kingdom.
“Specifically, the types and amounts of business undertaken will determine the intensity of the PRA’s approach to supervision,” the Bank of England stated. “If the branch is important for the resilience and stability of the U.K. financial system as a whole, the PRA will place greater emphasis on the degree of influence and visibility that it has over the firm.” For example, in making its assessment of whether a branch is systemic, the PRA will consider numerous factors, including size (whether the firm’s U.K. footprint is larger than £15 billion in total assets), and inter-connectedness with the U.K. financial system.
The PRA said it already expects third-country banks with material U.K. retail deposits to operate through subsidiaries. It has proposed to extend this broad approach to insurers, based on the scale of their liabilities protected by the U.K. Financial Services Compensation Scheme.
Regarding where global financial firms are from, the PRA’s approach is based on an assessment of the degree of equivalence of the home state regulatory regime in meeting international standards, and, importantly, the level of cooperation with the home state supervisor. Where sufficient supervisory cooperation and assurance on resolution exists, a firm may apply to operate as a branch.
The PRA does not expect the new approach to affect the current operations of any of the non-EEA international banks and insurers currently operating in the United Kingdom as branches. “This is because we already have an appropriate level of third country supervisory cooperation with their home state supervisors in light of the systemic importance of the relevant firms,” the Bank of England stated.
New approach to central counterparties
The Bank of England also announced guidance on its approach to non-U.K. central counterparties (CCPs), which provide services in the United Kingdom so that they can continue doing so following the U.K.’s withdrawal.
“CCPs lie at the heart of the global and U.K. financial system and provide the infrastructure that allows the financial system to function in an orderly manner,” The Bank of England stated. “Well-functioning CCPs are crucial to the resilience of the UK financial system.
Thus, the Bank of England said it has written to non-U.K. CCPs outlining the circumstances in which, if they wish to operate in the United Kingdom, they would need to be recognised to do so by the U.K. authorities, as well the approach to recognition that the Bank of England expects to take. The Bank of England said it “anticipates that, at the point of exit, the U.K. authorities will apply the recognition regime currently in force in the EU. Our presumption is that, subject to this process, non-UK CCPs operating here at present will be able to do so after the U.K.’s withdrawal from the EU.”
The Bank of England said it intends to proceed on the presumption that a high degree of supervisory cooperation with the EU continues following Brexit: “EEA firms may, therefore, plan on the assumption that the requirements for equivalence, supervisory cooperation and adequate assurance over resolution will be met, and, provided they are not conducting material retail business in the United Kingdom, they may apply for authorisation as a branch.”
If the PRA cannot gain sufficient assurance over the degree of cooperation with the home state supervisor and its oversight of the firm, it may impose specific regulatory requirements at the branch level. If this proves to be ineffective, the PRA would likely authorise the firm only as a subsidiary.
The approach to authorisation and supervision of international firms will be out for consultation until February 2018, and the PRA will be open for applications from the beginning of 2018.
Given the prudential risk associated with complex banking activities undertaken in the United Kingdom, the Bank of England said it is “open to receiving authorisation applications from firms that would fall within the PRA regulatory perimeter and engaging with CCPs on the recognition process from the beginning of the year to ensure an orderly process and readiness.”
HM Treasury response
In response to the Bank of England’s announcement, the government announced its intention, only if necessary, to legislate for a temporary permissions regime for its firms and a temporary regime for CCPs. HM Treasury said it will, if necessary, bring forward legislation that will enable EEA firms and funds operating in the UK to obtain a “temporary permission” to continue their activities in the United Kingdom for a limited period after withdrawal; and alongside the temporary permissions regime, the government will legislate, if necessary, to ensure that contractual obligations, such as insurance contracts, which are not covered by the regime, can continue to be met.
“We will also bring forward secondary legislation to ensure that U.K. authorities are able to carry out functions currently undertaken by EU authorities,” HM Treasury stated. Thus, it has proposed to give the Bank of England functions and powers in relation to non-U.K. CCPs and non-U.K. central securities depositories (CSDs).
HM Treasury added that, if necessary, it will also “provide for a temporary regime to enable the bank to permit these firms to continue to operate in the United Kingdom for a limited period after exit. We will also provide the FCA with functions and powers in relation to the United Kingdom and non-U.K. credit rating Agencies and Trade Repositories and any powers necessary to manage the transition post-exit. HM Treasury will work with the Bank and FCA as they determine how they will use these powers, consistent with their statutory objectives.”
Financial Conduct Authority response
In a statement concerning EU withdrawal, the Financial Conduct Authority said it will monitor the negotiations and provide further information to firms as appropriate. “For firms and funds that are solely regulated in the United Kingdom by the FCA, they would need to notify the FCA before exit day of their desire to benefit from the regime—but this notification for temporary permission will not require the submission of an application for authorization,” the FCA said, adding that it will set out further details of its approach in the New Year.
“To support this and to provide consistent and effective supervision, the FCA will continue to cooperate closely with the home state regulators of EEA firms and the European Supervisory Authorities,” the FCA added.
FCA noted that U.K.-based firms servicing clients in the EEA should continue to prepare for a range of scenarios and should discuss these arrangements and the implications of an implementation period with the relevant EU regulator. “The FCA will keep these expectations under review as negotiations on an implementation period progress and communicate to firms accordingly,” it stated.
In response to the HM Treasury announcement, the FCA said it “will work closely with the government and with U.K. credit rating agencies and trade repositories with the aim of ensuring a smooth transition to the new U.K. regime.
Concluded the FCA: “The United Kingdom remains a member state of the EU and, therefore, all rights and obligations derived from EU law continue to apply. Firms must abide by their obligations and continue with implementation plans for legislation that is still to come into effect.”