My Lords, this statutory instrument will fix deficiencies in the Financial Services and Markets Act 2000 and subordinate legislation made under FiSMA, which is an important part of the UK’s regulatory framework for financial services. This instrument has already been debated and approved by the House of Commons.
A key function of this legislation is to define the regulatory perimeter which sets out the activities and financial institutions that are in scope of UK financial services regulation. In a no-deal scenario, the UK would be outside the EU’s supervisory and regulatory framework, resulting in deficiencies in the existing legislation. Specifically, many provisions in this legislation set out the scope of regulated activities based on firms being authorised and operating across the single market, or by referring to definitions in EU law, which will no longer be workable after exit. In particular, the UK is currently part of the EEA’s financial services passporting arrangements, which allow EEA firms to freely provide products and services throughout the EEA. Once outside the EU, the UK will no longer be part of these arrangements.
As your Lordships will be aware, the EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018, which Parliament has approved, begin the process of removing legislative provisions which facilitate passporting in the UK, as well as providing for a temporary permissions regime allowing EEA firms to continue their activities for a limited period after exit day, giving them time to become UK-authorised. Although the statutory instrument being debated today does not alter the underlying policy of the UK’s legislative framework for financial services, many of the proposed changes in this SI are necessary to complete the task of removing passporting-related provisions, and to define the UK’s regulatory perimeter as a regime operating outside the EU.
Many of the definitions for regulated activities in FiSMA, and in the 2001 regulated activities order made under it, include the EEA in their scope and rely on definitions in EU law to operate. To reflect the UK’s new position outside the EU, the SI will amend the territorial scope of these definitions where needed so that they only apply to the UK after exit. Some of the changes proposed in this SI are also needed so that UK regulators can continue to carry out their existing statutory functions. As mentioned already, this SI will complete the process of removing passporting-related provisions. This will mean that some firms and fund managers will face new requirements as a result of these necessary changes. The SI therefore creates some transitional arrangements to mitigate disruption to those EEA firms and their consumers. For example, some of the transitional provisions relate to certain financial instruments, financial documents, or contracts which have been issued or entered into pre-exit, ensuring that they continue to operate effectively after exit for an appropriate period.
By exercising this temporary power, regulators will not be able to alter the end-state regime that has been approved by Parliament. I also make it clear that this is strictly a no-deal power. Therefore, if the withdrawal agreement is ratified, as we all hope, this transitional power will be immediately withdrawn and the delegation of power to the regulators will be revoked. When preparing to exercise the power, the SI obliges the regulators to consult each other and the Treasury before making directions under the power. For transparency, the regulators must generally publish any directions made under the power, explain their rationale for using the power, and state that they are acting in accordance with their existing statutory objectives as set by Parliament.
The SI also obliges the regulators to provide an annual report to Parliament every 12 months explaining how they have exercised the power. In response to a request from your Lordships, specifically the noble Lords, Lord Tunnicliffe and Lord Sharkey, and the noble Baroness, Lady Kramer, the regulators would be happy to provide Parliament with six-monthly updates on how the power is being used. Although it is highly unlikely, in the event that a regulator makes a direction under the power which is not published because it relates to commercially or market-sensitive information, the regulator and the Treasury will find appropriate ways to keep Parliament informed.
The regulators have been consulting with industry on how they intend to use the temporary transitional power in a no-deal scenario. On 28 February, the Financial Conduct Authority and the Bank of England published statements on their proposed use of the power following this consultation, stating that they intend to use the power broadly, delaying most changed requirements for firms for 15 months from exit day. The regulators will keep this approach under review and will be prepared to use the transitional power further, within the two-year period permitted, should circumstances require it.
An example of the proposed use of the power relates to changed requirements on the treatment of EU 27 exposures. Under changes that will be introduced by the capital requirements and Solvency II EU exit SIs, which have already been debated and approved by Parliament, including this House, firms will have to treat EU assets as third-country exposures from exit day. In some instances, this will mean that firms will need to hold more capital for these exposures than they do now. Implementing these changes for exit day would be costly and time-consuming for firms. Therefore, the regulators have proposed to allow firms more time to adapt to this change by deferring this requirement using the temporary transitional power.
A further example is the use of credit ratings for regulatory purposes. After exit, UK-supervised firms wishing to rely on credit ratings must have those ratings issued or endorsed by a UK-registered rating agency. Under the transitional power, firms will be able to continue using EEA-issued or endorsed ratings for a year after exit, giving those firms time to make alternative arrangements.
The changed application of group supervision requirements is also an example of the transitional power being used to give firms time to adapt. Once the UK is outside the EU’s joint supervisory framework, some EEA groups with business in the UK will be subject to additional supervision from the PRA. For 15 months from exit, those groups can continue to comply with their current group supervision arrangements, and move to new group supervision requirements in an orderly way.
The Economic Secretary to the Treasury has committed to keeping Parliament informed of any directions that the regulators make under this power, ensuring that directions will be brought to the attention of the Treasury Select Committee and opposition parties, as well as laying all directions in the Libraries of both Houses. He wants to ensure that the power is used as transparently as possible and will be happy to meet Members from both Houses at any point to discuss its use.
The Government are particularly grateful to members of the Treasury Select Committee who took the time to scrutinise the temporary transitional power in a recent hearing on 29 January. I am pleased to say that the committee acknowledged the need for a temporary power, with the chairman concluding that,
“although this is unprecedented, these powers are needed in order to make sure our financial services sector works, whatever might happen”.
The Financial Policy Committee, the body tasked by Parliament with safeguarding the UK’s financial stability, has said that this SI is one of 16 under the EU withdrawal Act that the committee has identified as being,
“particularly important to mitigate risks of disruption to users of financial services”,
if the UK leaves the EU without a deal.
The Treasury has been working very closely with the regulators in drafting this SI. It has also engaged with industry through the cross-sectoral working group, including representatives of the financial services sector. The group is chaired by TheCityUK and has representation from a number of trade associations and law firms. Industry has expressed support for the provisions in the SI and welcomed the proposed transitional arrangements as “prudent and pragmatic”.
Before concluding, I draw the attention of the House to a minor error which has been discovered in the Explanatory Memorandum. Unfortunately, mistakes do happen from time to time, and I would like to ensure that an explanation of the error is put on the record. This SI removes the exemption from the requirement for a financial prospectus to be approved by the FCA if it has been approved in another EEA state. This amendment is correctly explained in paragraph 2.55 of the Explanatory Memorandum but the paragraph also says that the SI makes transitional provision for prospectuses approved by an EEA regulator before exit day. While there will be such a transitional provision, it is made not in this SI but in the Official Listing of Securities, Prospectus and Transparency (Amendment etc.) (EU Exit) Regulations 2019, which were debated in this House on 19 February and in the other place on 18 February. I apologise for this mistake but I hope that the House will agree that it is a minor error which does not alter the substance of the explanation provided in the Explanatory Memorandum. The Economic Secretary will be relaying the Explanatory Memorandum to ensure that this mistake is corrected.
In summary, the Government believe that the proposed legislation is necessary to ensure that there is a functioning legislative framework for financial services regulation in the UK after exit. I hope that noble Lords will join me in supporting these regulations.
My Lords, I congratulate my noble friend on moving this statutory instrument, which I welcome. I have a few questions about it.
What has changed since this instrument was considered in the House of Commons is that the Government have published Implications for Business and Trade of a No Deal Exit on 29 March 2019. Paragraphs 41 and 42 flag up a particular case study and the implications for financial services. I shall not rehearse all the arguments, but it concludes that, in,
“the absence of action by EU authorities to mitigate risks in some areas of financial services, there could be some disruption in a no deal scenario”.
When this instrument was considered in Committee in the other place, a number of issues were raised, and I hope that more details may be put to the House this evening.
Page 21 of the impact assessment very helpfully sets out that the importance of the financial services sector to the UK is approximately £4.5 trillion, and it itemises various aspects of how that is broken down:
“Approximately £4.5tn … is currently invested in the UK’s capital markets (both primary and secondary) through pensions funds, insurance policies and individual private savings”.
That is a not inconsiderable sum; it brings many jobs, primarily to London, but also to other financial centres such as Leeds and Edinburgh.
A number of comments were made about the size of the statutory instrument considered in Grand Committee yesterday, where all the regulations were lumped together. The Government cannot win, because putting them all together leads to criticism. However, there has been justified criticism about this mix-and-match, rather piecemeal approach. My noble friend referred to a number of regulations that have already been considered and have a crossover effect on this statutory instrument and others that will follow. If it is confusing for your Lordships’ House, imagine how much more confusing it is for those who have to abide by this rather scatter-gun approach.
My Lords, I begin with a thank you. My noble friend Lord Sharkey and I—I know that the noble Lord, Lord Tunnicliffe, will speak for himself, as he always does so well—very much appreciated the opportunity to meet the Minister, the Economic Secretary and key staff to talk in detail about this statutory instrument. I completely concur with the comments of the Treasury Select Committee that these are sweeping powers which, under normal circumstances, I do not think anybody, in any part of this House, would dream of granting to a regulator. However, under the circumstances we would face in a no-deal scenario, it seems vital that the regulator has the ability to mitigate a crisis cliff edge for key parts of the financial services industry.
I note that in the guidance published by the Bank of England and the FCA last Friday, they will be attempting to limit the transitional period, as the Minister said, to 15 months, so that firms will manage within that 15-month period to go from where we are now, essentially—let us call it scenario A—to life outside the EU in a no-deal scenario, which we will call scenario B. It would give them some 15 months, typically, but with the capacity to extend that to two years if necessary. Also, the Bank of England has made exceptions for the bail-in rules, the stay in resolution rules and the FSCS rules, all of which relate closely to financial stability. We appreciate that it would be very hard to provide any transitional time for those rules and their consequences, but does the Minister have any comment to make around the significance of deciding on those three exemptions? Can he confirm that, if we were to have no deal and find ourselves in that reality and the regulators decided that the situation was better managed by finding some flexibility around these three rules, the regulator has given away the capacity to do so? Or does it retain an opportunity to change its mind and provide some mechanism for adjustment? One would hope that that was not necessary. Across the credit rating agency assessments, we will get only a 12-month extension, though I think all of us recognise that that is probably not problematic for any of the players.
My Lords, I feel the need to start with my standard speech about how much I object to being here processing statutory instruments for a no-deal situation. I entirely agree with the noble Baroness, Lady Kramer, in her dislike of such a situation and the chaos that will prevail. Having said that, I am forced to say nice things about the Government and, indeed, about the Lib Dem Front Bench in this whole affair. The Treasury SIs we have passed so far have, to a large extent, despite some of the speeches, been fairly non-controversial. What I have been looking for all the way through are attempts by the Treasury or the Government to smuggle through policy changes, which they promised not to do in the original legislation, and I must say that, broadly speaking, I think the Treasury has not sought to smuggle through any of significance. However, the result of that is that our debates have been rather dry.
This SI was quite shocking on initial reading. Part 7 has such sweeping powers, with no formal parliamentary involvement, that I thought—and we spoke to our colleagues on the Liberal Democrat Front Bench about this—that we really had to take it very seriously. I once again repeat my thanks to the Liberal Democrats for coming along on this and to the Government for the positive way in which they have reacted. For the record, I will briefly run over our concerns and note that they have been largely covered in the speech made by the Minister. We were first concerned about the limitations in the power in Part 7; there is a time limit of two years, and it is important to emphasise that that limitation is not just for making directions—rather, directions must cease within two years of exit day. That is fairly clear from reading the document.
It is more difficult to grasp the scope. One of the useful things we discussed at our meeting with John Glen, the Economic Secretary to the Treasury, was scope. Scope is difficult to get into words, and we thank the Minister for the detailed examples in his speech, which will, we hope, be useful for practitioners in understanding it. In particular, we had some concerns over whether it might be used in crisis circumstances, and received a very strong assurance that separate legislation would be used in such circumstances.
I thank my noble friend Lady McIntosh, the noble Baroness, Lady Kramer, and the noble Lord, Lord Tunnicliffe, for their contributions and engagement through this whole process. I am particularly grateful to my noble friend Lady McIntosh for participating in the debate and for opening it up with some perspectives on this. She said it was unclear what the post-exit requirements for derivatives were. We have made several onshoring SIs relevant to trading and issuing of derivatives already. I think we are currently up to SI number 40. Within that batch of 40, there were some specifically on that. I will certainly write to my noble friend to explain exactly how this regime will operate post exit.
She also asked about the direction of the transitional power. The power is available to regulators for two years from exit. It is then for the regulators to propose appropriate delay or phasing in of requirements within the two-year period. She also asked about the impact assessment—I applaud her for her scrutiny in getting to that level of detail in the specific tables. Let me populate some of the information from them. As outlined in the impact assessment, while the overall familiarisation costs were estimated at £110 million, the cost per firm was estimated at £1,900. The number of firms affected was based on the fact that FiSMA applies to all firms regulated by the PRA and FCA, which amounts to approximately 58,000 firms. It is also estimated that there will be an additional 1,200 firms entering into the temporary permissions regime, which then brings the total to 59,200. While FiSMA applies to all firms regulated by the PRA and FCA, many of the effects of this SI result from the loss of passporting rights at exit. I note that the remarks she made were drawn from considerable experience of how hard-fought those rights were. Of course, that is a consequence of decisions taken ultimately by the British people. This means that changes made by the SI will, in terms of the number of firms affected, predominantly affect those 1,200 firms entering the temporary permissions regime.
Moving to the remarks made by the noble Baroness, Lady Kramer, I again thank her for her input on this. She asked whether we could map all the onshoring changes. She made that request at the meeting with the Economic Secretary to the Treasury. Although we recognised that there were some challenges in doing just that, we felt that it was a very reasonable request when we met last week. I can confirm that we are working on this and will be in touch, I hope with a positive mapping exercise to share with her.
I am very happy to do that. I should also say that all these changes are being made because of the quite brilliant Economic Secretary to the Treasury, John Glen. He is an outstanding Economic Secretary, and takes his duties very seriously. As a more senior person, I find it encouraging to see young Ministers who are so diligent in the way they engage with Parliament and the department. He is an example to others in how he does it. The noble Lord, Lord Tunnicliffe, found a polite way of saying that he found it refreshing to be talking to the butcher, not the block. I absolutely get the point, and he could not be engaging with a better metaphorical butcher in this regard.
The noble Baroness, Lady Kramer, asked me to comment on the significance of the Bank of England exemptions regarding the FSCS rules. The regulators have judged that bringing in these requirements immediately is important for the financial stability. The Treasury was consulted and agrees with this. We do not anticipate that this will change.
On the point made by the noble Lord, Lord Tunnicliffe, on the use of unpublished directions, on which again, we had a substantial and useful discussion, it should be stressed that the Treasury and the regulators would want to avoid unpublished directions as the power is to be used broadly across a large range of firms. Unpublished directions would not be effective—as I read that out I thought that the noble Lord was ahead of us in that he was not asking for the unpublished directions but was rather seeking an engagement on matters after the fact. I certainly know that the Economic Secretary is taking that seriously.
I thank noble Lords again for their engagement on this, particularly my noble friend Lady McIntosh. I also thank the Opposition and Lib Dem Benches for the constructive way in which they have engaged with the Government on this, as a result producing a better outcome for regulation.
Motion agreed.
I will use the rest of my opening remarks to focus on the temporary transitional power in Part 7 of this SI—a very significant part of the no-deal preparations—to which some of your Lordships are paying particularly close attention. This power is a significant delegation of responsibility to the UK regulators so it is quite right that noble Lords have been scrutinising this power in detail. The Economic Secretary and I are very grateful for the constructive meeting which we had with the noble Lords, Lord Tunnicliffe and Lord Sharkey, and the noble Baroness, Lady Kramer, last week to discuss the temporary transitional power. My opening speech will be longer than normal as a result of that meeting, at which they invited me to put on record some remarks to make the nature of those transitional arrangements clear.
Despite the specific transitional arrangements which we are putting in place through a number of SIs, firms will still be faced with a large volume of regulatory changes to which they will need to adapt in a no-deal scenario. This could cause significant disruption to the financial services sector, and consumers, immediately after exit. To prepare for this scenario, this SI creates a temporary transitional power, which allows the UK regulators to defer or modify changed requirements for firms. While I acknowledge that this is a broad power to delegate to UK regulators, in a no-deal scenario the regulators will need flexibility to ensure that firms can reach compliance with onshoring regulatory changes in an orderly way and to respond to unforeseen pressures on firms. Given their supervisory responsibility for firms, the regulators, using their supervisory judgement, are best placed to decide how to phase in onshoring regulatory changes.
This is not intended to be a crisis intervention power to deal with failing firms or financial instability. UK regulators already have a comprehensive range of crisis intervention tools available. Rather, the power is intended to give the regulators flexibility to smooth the regulatory adaptation challenge for firms, to prevent instability and disruption from arising in the first place. While the power is broad in terms of the regulatory requirements it can apply to, the purpose for which it can be used is very specific. It can be used only to prevent or mitigate disruption that may reasonably be expected to arise for firms as a result of legislative changes made under the EU withdrawal Act. Also, the regulators can use the power only to delay or modify financial services requirements which they are responsible for supervising. Onshoring changes on accounting standards, for instance, are not the responsibility of financial services regulators and would be out of scope of this power.
Given that firms have been preparing on the basis that there will be a withdrawal agreement, this temporary power is designed to replace the adjustment time that firms would have if the implementation period in the proposed withdrawal agreement were ratified. For this reason, the temporary transitional power is available for two years from exit day. The power, and any directions made under it, would therefore automatically expire at the end of this two-year period, after which firms would have to comply with all new requirements set by Parliament in legislation. If, for any reason, the Treasury subsequently took the view that more time was needed for firms to adapt, we would need to return to Parliament with new legislation. This SI does not provide for any extension of the transitional power.
The specific questions I would like to put to my noble friend relate to costings. There is a rather interesting table—Table 3 in the impact assessment—which may be in language that I do not understand. It gives a “Summary of anticipated costs by SI” but it is blank; it just has crosses against it. I am not very good with figures, but “X” is not a figure. This was raised by my right honourable friend Nicky Morgan, who chairs the Treasury Select Committee which has spent an inordinate amount of time, quite rightly, scrutinising this in the other place. If your Lordships’ House does not have those figures, how on earth are firms operating in financial services expected to know?
I understand that a figure of £1,900 has been given as a costing for each firm, but I do not know whether that is purely for familiarisation or if it also goes to the cost of complying with the regulation for business. Should we simply multiply that figure by the number of companies operating in the sector? It would be very helpful to understand exactly what the costs will be.
My second question is on the SI’s regulatory reach, particularly the rather formidable array of regulatory authorities that companies will come under, quite rightly, for continuity purposes. That includes the Prudential Regulation Authority, the Financial Conduct Authority, the Bank of England, as my noble friend mentioned, and the Treasury. I have a concern about the duration of the powers. My noble friend very kindly explained that, in one scenario, it will be two years from exit day in the event of no deal. I hope that this statutory instrument and the others we will consider will not be needed, because I fervently hope that we will have a deal and an orderly exit. In other circumstances, the deadline is 12 months, and I am mindful of the fact that my noble friend referred to the loss of passporting rights. We cannot imagine what the cost of that loss will be until we have left the European Union; it took us years to establish passporting rights, and now we are giving them back. I understand that there is a temporary arrangement giving London-based clearing houses licences to carry on doing business with EU-based customers, but that is only valid for 12 months. Already we have identified two different dates with which all the firms operating in the City will have to comply.
My last question relates to the concern that has been expressed by the City of London about the ongoing lack of clarity, shall I say, regarding contract continuity, cross-border data references and uncleared derivatives. It may well be that my noble friend does not have the answer this evening—it may not form part of this statutory instrument covering all the regulations before us this evening in this one instrument—but it is causing concern in the City of London, and I would be very grateful if he could assuage those fears.
In our discussion, as the Minister indicated, we asked for more frequent reporting than just 12 months from now. It seemed a bit like closing the stable door after the horse has bolted to wait for that period. We very much appreciate that the Treasury and the regulators have agreed that they can update us every six months: that is exceedingly helpful. We also appreciate the description that the Minister gave when he had to make a correction, which we perfectly accept is a very minor correction. The noble Baroness, Lady McIntosh, picked up the fact that the complexity here is extraordinary. It is very hard to predict, very hard to track and very hard to play through the scenarios and understand exactly how each needs to be handled, certainly in advance. So I think we might find ourselves trying to take advantage of the offer from the regulators of specific discussions if a particular issue arises. I am grateful again that the Minister has had a conversation with the regulators that led them to say that that will be open to us: it is exceedingly welcome.
This underscores the point of the noble Baroness, Lady McIntosh, about the extent to which, given all this complexity, there might be some way to provide some mapping of exactly what is happening where—what is moving and what is changing. That is a big ask at the moment, I understand, but if there could be some thought around that, it would be very useful, not just to this House and the other place but to the industry, which I am sure must be struggling with all this, although it very much appreciates the detailed engagement it has had with the Treasury, with Ministers and with the regulators. If we move to a practice of mapping under such circumstances, that might be a healthier environment to get to. It was one of our asks of the Minister that he felt he could not commit to at this point.
Our second ask was for some specific examples. My noble friend Lord Sharkey is unable to be here. He was particularly concerned to work through some specific examples in his head, so he may come back to ask for something more detailed. I particularly appreciated that the Minister gave an example of an issue that, as he knows, has exercised me: how do we manage the fact that our major financial institutions have significant exposure to EU and EEA assets and will incur higher capital ratios because they will no longer have preferred status if we leave on a no-deal basis? I was very glad that he gave us that particular example.
We very much hope that we do not have to use this, and it would be exceedingly helpful to know that we are not going to have no deal, because despite all the preparation that I understand is being done with real concentration and thought, it does not deal with the fact that there is going to be an almighty problem. I can see firms—all of them, though they are competitors—in different stages, different states with different micro-problems, all of which regulators are trying to manage so that there is no knock-on effect on financial stability or to the economy. It is going to be an extraordinarily difficult situation to manage, and anything we can do to make sure it does not happen will be extremely useful. If I can encourage anyone in this House to take no deal off the table, let me use this opportunity to do so.
I come finally to the lack of any parliamentary involvement in the process. This was clearly also the concern of the Treasury Select Committee; being a big, powerful committee, using its own mechanisms, it can rapidly draw Ministers to account. It did that with the Economic Secretary to the Treasury, and got assurances from him, as I understand it, that whenever the power was used to create a direction it would be advised. Clearly, it was then able to summon a Minister to hold the Government to account on its use. We did not have such a parallel situation, so we asked, and then got this assurance in the speech, that whenever such a notification went to the Treasury Select Committee, a copy would come to representatives on both our Front Bench and the Liberal Democrats’. The second part of that, in a sense, was an assurance that we would get access. I do not mean to suggest the Minister is not an important person, but at the end of the day his interest is in DfID. He simply speaks for the Treasury here. It was good that the Economic Secretary to the Treasury said that he would make himself available to answer any of our questions about how the power had been used. That was very reassuring.
Embedded deep in the SI and the Explanatory Memorandum is the fact that certain directions may have to be secret. We were concerned that when any organisation has the option of making something secret it tends to do so. We would like to know when and for what reasons that is used. That was also acknowledged in the speech. Clearly this has to be post facto—obviously it has to be when it is no longer embarrassing—but it is important that the use of this power is fully understood.
Lastly, we felt that 12-monthly reports on a power that was going to last for only two years would be insufficient. Assuming it is for the previous 12 months, the report takes a couple of months to write and so on, and then you are half way through the second year. The acceptance of six-monthly reports is extremely welcome. I repeat my thanks to the Government for co-operating in the way they did; it has allowed us to create a mechanism for an involvement of this House in the use of this power and, with those conditions attached, we accept the logic that says it is necessary.