Speech by Andrew Bailey, Chief Executive of the FCA, delivered at Bloomberg - London
Speaker: Andrew Bailey, Chief Executive
Event: Bloomberg, London
Delivered: 16 September 2019
Note: this is the speech as drafted and may differ from the delivered version
- There is no doubt that financial sector preparations for no deal Brexit have advanced over the course of this year. However we are not complacent.
- There are number of issues that in one form or another require further action, either in the UK or the EU.
- We will take a pragmatic approach to issues as they arise. We will use forbearance generously but appropriately, to maintain market integrity and protect consumers and market uses.
Thank you for providing the opportunity to give an update on Brexit planning and preparation at the FCA and in financial services more broadly. As usual, I have to emphasise at the start that the FCA takes no position on the substance of Brexit itself. We continue to prepare for a full range of possible outcomes and scenarios, which is what we must do as a public body.
At the heart of the FCA’s approach is our strong commitment to open global financial markets. There is no reason to believe that Brexit should restrict access to financial markets. The UK’s financial markets are – as the IMF has described them – a global public good, and we want to keep it that way.
Our preparation work therefore requires close involvement with our counterparts around the world, and particularly in the European Union. As part of that, we continue to be an active member of ESMA and we work closely with regulatory authorities in the EU27. As I said in April, wherever we end up, our markets will remain closely linked and we will continue to co-operate closely with our EU counterparts after exit in order to meet our objectives.
There are clear principles and objectives governing the operation of our financial markets which embody the broad public interest. One of the most important principles for wholesale financial markets is best execution for clients – for users to get the best terms available wherever the users or markets may be located. And, of course, using that principle we can further our objective of competition in the interests of consumers as users of markets. Consistent with that, best execution does not mean closing access to markets.
But a principle like best execution does depend on the overall integrity of markets, which is one of the FCA’s three statutory objectives along with consumer protection and competition in the interests of consumers. Integrity in financial markets requires definition – on its own it could become rather trite. There are 4 important and complementary component parts to the objective of integrity: that markets are orderly, resilient, transparent and clean in terms of not being used for a purpose connected with financial crime and not being affected by behaviour that amounts to market abuse. These principles transcend any particular set of rules, and they shape the outcomes that we all want to see. My view is that UK financial markets meet high standards in this area – and the FCA’s work helps with that. They should therefore be open to all counterparties who act consistently with the objective of integrity. We intend to preserve open markets and not limit access.
Progress on preparations for Brexit
At the FCA, we continue to plan for all potential outcomes, and that of course includes the possibility of no deal exit. I say that deliberately, not because I take a view on the substance of the matter, but because in terms of contingency planning it would be foolish not to do so.
Firms in the UK have stepped up their preparations, the authorities in the UK have made good progress, and in the EU authorities have mitigated risks of material disruption to cleared derivative markets
As the Bank of England has recently set out, preparations for a No Deal No Transition Scenario have advanced. It is worth noting that the largest part of the overall Brexit preparation work is for this scenario, because it would involve the largest change in short order. As a consequence of the progress made, the Bank has judged that its assessment of the impact of this scenario has become less severe. This reflects progress across much of the economy. Consistent with that conclusion, there is no doubt that financial sector preparations have advanced over the course of this year.
Firms in the UK have stepped up their preparations, the authorities in the UK have made good progress, and in the EU authorities have mitigated risks of material disruption to cleared derivative markets by announcing temporary recognition and conditional equivalence decisions for the UK’s CCPs and the regulatory framework for them – though I should make clear that with the elapsing of time, there will need soon to be agreement to renew this arrangement.
Most EU states with material uncleared derivatives activity have implemented measures which seek to address cross border contract continuity – though some uncertainty remains about the scope of current or proposed legislation in some jurisdictions. On this point, I think there would be real benefit with our EU counterparts to making clear that in practical terms we will aim to mitigate any disruption to markets, and thus do what we need to do to preserve integrity. I can assure you that this is what the FCA will do.
The upshot of this progress and improvements in preparedness is that the Bank of England has concluded that the appropriate assumptions to underpin a worst case scenario would now be less severe than those of a year ago. But a worst case scenario remains just that, even though we have worked to mitigate most of the potential disruption, we cannot provide the assurance that there will be none.
And, just to re-emphasise, the worst case is what we must prepare for – it is what could happen, a scenario not a forecast but real nonetheless. This is particularly apposite for financial services, because in the global financial crisis pretty much the worst did happen – yes, it could have been even worse, but it was a bad outcome, no doubt about that. So, we have had the experience, and I think the memory of the crisis has conditioned the rigour of preparations in financial services. And, to be very clear, we are not complacent, because to be so would be inconsistent with our objectives and responsibilities and with our experience.
Let me now turn to describing the main developments.
Legislation and the Temporary Transitional Power
We have been working closely with the Treasury and the Bank of England to make sure that EU financial services legislation is effectively on-shored by exit date. To date, over 50 statutory instruments have been made to achieve this. This is most of what needs to be done on this front – only a small number of SIs remain outstanding. Alongside this legislative activity, at the FCA we have made, and continue to make, corresponding amendments to our Handbook and to Binding Technical Standards made in the EU. This has, I admit, led to some hefty consultation documents – monsters even by our standards. All I can say is, needs must.
The Temporary Transitional Power gives the FCA the ability to delay or phase changes to regulatory requirements made under the EU (Withdrawal) Act 2018. In the event of a UK exit from the EU without a transitional period, we intend to provide a transitional relief period up to the end of next year.
This means that firms and other regulated entities do not generally need to prepare now to meet the changes to their UK regulatory obligations resulting from onshoring. That said, we will not exercise the TTP in some areas where to do so would be inconsistent with out statutory objectives, for example in relation to key reporting obligations.
Memoranda of Understanding
We have concluded new cooperation agreements with the EU markets, insurance and banking authorities which will take effect in a no deal outcome. These MoUs provide a framework for the sharing of confidential information, which will assist us in carrying out our functions; allow UK or EU based firms to delegate or outsource certain activities to firms based in the other jurisdiction; and support future market access and equivalence decisions. We have also agreed changes to 43 non-EU MoUs that we need to amend and expect to have all necessary MoUs signed by exit day.
We have an extensive programme of work to be ready within the FCA. That work is on track with the range of possible scenarios. We will be taking on several functions in respect of the UK which are currently performed by ESMA at the level of the EU, notably regulation of Credit Rating Agencies and Trade Repositories. We will also be taking on from ESMA responsibilities in respect of MIFID2.
The 7 issues are the Share Trading Obligation, the Derivatives Trading Obligation, clearing, uncleared derivatives, data exchange, progress on contract repapering and retail financial services preparation.
There are several major changes which will impact our public-facing systems and on which we are engaging with firms in advance: switchover for the Market Data Processor (MDP); updating the Financial Services Register to take account of the Temporary Permissions Regime (TPR); and changes to the Handbook website to accommodate onshoring changes and new materials. The switching on of the UK Credit Rating Agency and Trade Repository regimes will also impact firms. UK TRs that are in a position to provide us with reports straight away will be able to do so. We continue to engage with industry on the immediate operational and timing concerns of reporting counterparties under MiFID and EMIR. In line with statements already published, we expect firms and other regulated entities to take reasonable steps to comply with the changes to their reporting obligations by exit day. But where they have done so, we intend to act proportionality.
Communications are obviously another important part of our work. If you have looked at the FCA website – and I hope you use it regularly – you will see that we have employed it actively for Brexit-related communications. We have launched new material designed to ensure that firms have the right information to allow them to plan for exit. There is a particular focus on material for small firms. Although, we see larger firms more regularly, please also use the website as a source of I hope useful information.
We have also set up a Brexit information line for firms and are using social media to direct people to our website – though I must be clear that Arnie is not returning.
Issues that remain
I want to focus on a number of issues that in one form or another require further action, either in the UK or the EU. The 7 issues are the Share Trading Obligation, the Derivatives Trading Obligation, clearing, uncleared derivatives, data exchange, progress on contract repapering and retail financial services preparation.
The Share Trading Obligation (STO)
The STO is a rule in EU law that requires EU MIFID firms to trade certain shares only on EU venues, systematic internalises or equivalent third country trading venues. The UK has onshored the share trading obligation under the EU Withdrawal Act. The obligation applies to all shares traded on venues in the UK or EU, except where trading is non-systematic, ad hoc, irregular and infrequent. It is for the FCA and ESMA to regulate the scope of respective STOs. ESMA has stated that its trading obligation applies to the shares of all companies headquartered in the EU that are traded on a trading venue in the EU.
Before adding another layer of complication, let me summarise all of that – but there is no test afterwards. If an EU stock is frequently traded on an EU market, EU MIFID counterparties must trade on that market or an equivalent one, not elsewhere. That’s the simple version. The UK STO will – other things being equal – do the same thing for stocks trading frequently here – subject to defining the meaning of terms like frequent trading.
Now, unfortunately, I will add the extra layer of complication. Absent other action – I will come back to that – the 2 STOs will overlap in respect of EU shares traded here. Think of it like a Venn diagram of overlapping circles.
The effect of the overlap is that the shares in the middle overlapping zone – which to be clear do not include UK shares because of ESMA’s definition – would be caught by both STOs. It is therefore easy to conclude that for those shares, market liquidity would be damaged to no good end.
Let me quickly run through a number of fairly obvious questions. First, how did the overlap happen? That’s a product of closely onshoring EU law into the UK for Day 1. There are very good reasons for doing this – it was the only feasible and realistic way to undertake such a massive exercise. So, the better approach is to deal with the consequences, and fortunately we have some tools to do this.
Second, surely the answer to this is an equivalence agreement between the UK and the EU? Absolutely, and the onshored UK framework will be the most equivalent in the world to the EU’s. The UK authorities would do this, and take the issue away. The EU have said to date they will not do that.
Third, what do we learn of relevance here from the recent Swiss experience with trading equivalence? It’s a very salutary reminder that equivalence can be lost, but beyond that some of the commentary somewhat mispresents the read-across, because in the Swiss case the issue is trading of Swiss shares (which has migrated to Switzerland) whereas in the UK we are talking about the trading of non-UK shares.
Fourth, what are we going to do about it, and when? First of all, a similar implementation of the UK STO would cover a large number of EU shares traded in the UK. We could however use our transitional powers to mitigate disruption caused by the overlap. The extent to which we choose to use these powers to minimise the overlap is a genuine choice, but we cannot fully mitigate the damage done by the STOs. For example, due to the EU’s STO, EU investors will not be able to access liquidity on EU shares listed in London. You do not need to guess that our preference would be to emphasise open markets, free trade, and the principle of best execution being achieved by markets not by regulators, where we can. We would like to think that the EU would follow the same approach but we need to find a way through this together that does not create barriers and distortions on either side. We stand ready to enter into dialogue with our European counterparts before we finalise our approach.
We need to decide this soon. So, if you have views that we haven’t yet heard, please talk to us and our European counterparts quickly. We need to balance a range of interests across the market and the views we have heard to date do not provide a decisive answer.
The Derivatives Trading Obligation (DTO)
The EU’s Derivatives Trading Obligations (DTO) requires EU firms to trade some classes of OTC derivatives on EU or equivalent third country Trading Venues. The DTO comes from a G20 agreement that both we and the EU are committed to and which, outside the EU, through our work to onshore the EU acquis the UK will have implemented identically. This means that unless the UK and EU find each other’s regulatory regimes as equivalent, EU firms will not be able to meet the EU’s DTO by using UK trading venues to trade in-scope derivatives, and vice versa.
In the absence of equivalence, we will work with EU regulators to try and avoid firms being caught by both the EU and UK DTOs.
Currently all OTC derivatives subject to the EU DTO have their main pool of liquidity on a UK venue. Without action, EU firms may lose access to UK liquidity pools and liquidity would be fragmented, harming both markets.
Like with the STO, the best answer must be an equivalence agreement between the UK and the EU, not least because on day one our rules would be identical – and even more so because it is a G20 commitment which G20 nations have committed to defer to each other on.
In the absence of equivalence, we will work with EU regulators to try and avoid firms being caught by both the EU and UK DTOs. We believe the right outcome would be for regulators to ensure that where there is a conflict of law, we are clear which rule firms should follow. But this would only work if EU regulators were able to do the same. It would be a suboptimal outcome if the only place firms can execute in a way that complies with their regulatory obligations is outside Europe.
Clearing is a very big subject, but unlike the STO I am not going to start from first principles because it is pretty well-trodden ground.
We welcome steps already taken by UK and EU authorities to mitigate the risks around continued access to UK and EU clearing services. The UK government has legislated to allow UK businesses to use EU-based clearing houses for 3 years from the date of Brexit. Likewise, the steps taken by EU authorities to allow for temporary recognition of UK CCPs have also removed the immediate risk that UK CCPs would not be able to continue clearing for EU firms in a no deal scenario. However, temporary recognition for UK CCPs would expire in March 2020. Without greater clarity on the regulatory status of UK CCPs after this date, the contracts that EU members clear with UK CCPs will need to be closed out or transferred by then. This process would need to begin by the end of this year, and would impose significant costs on EU firms as well as potentially straining market capacity. Further action may therefore be necessary to prevent this. Ultimately, the best solution is for the EU to grant permanent recognition to UK CCPs.
The UK, through the Temporary Permissions Regime and Financial Services Contracts Regime, has taken appropriate measures to allow firms to service existing uncleared derivatives between UK and EU counterparties. But the EU has not taken reciprocal action. This means it is up to individual Member States to prevent disruption to contract continuity. Many EU states have implemented measures which seek to address these risks - but uncertainty remains about the scope of current or proposed legislation, in some jurisdictions. And in some cases additional action needs to be taken by regulators before firms can avail themselves of the regimes. I hope that EU regulators, with us, can commit to providing certainty and support firms by minimising disruption.
The UK Government has legislated to allow the free flow of personal data from the UK to the EU in a no-deal scenario, but without action by EU authorities EU rules would limit the flow of personal data from the EU to the UK. This could restrict EU households and businesses accessing financial services from, and continuing contracts with, UK financial service providers. Given the large range and critical nature of activities, the variety of financial services sectors potentially affected and the scale and importance of cross-border flows of financial services between the UK and EU, we believe there are risks if there is disruption to cross-border flows of personal data from exit day.
As regulators, we also share a lot of data with our European counterparts. Since the introduction of MiFID II in January 2018, we are now passing on around 70% of transaction reports to counterparts across the EU. Data sharing provides both the UK and EU countries with a vital foundation to tackle cross-border market abuse, including insider dealing and cross-market manipulation. We believe it is important for our respective public interest objectives that under all scenarios ways are found to continue this flow of information.
Progress on contract repapering
It is fair to say that progress on repapering has been gradual. I’m not particularly surprised by this as it is unlikely to be top of many people’s list of favourite things to do.
The majority of UK firms have confirmed that they plan to maintain existing products and services to their customers resident in the EU.
But, the absence of repapering may have an impact on business in the EU post exit. Several EU Member States have legislated to allow UK firms to continue temporarily to provide certain services in their jurisdiction following a no-deal Brexit. But these access provisions are not EU-wide, and they vary in respect of which activities they cover and what their durations are. There is therefore uncertainly around how some of these provisions will be applied. That uncertainty will not exist in the UK because of the temporary transitional arrangements. Moreover, I can assure you that the FCA will be pragmatic in its approach to adherence by firms with provisions overseas, because we prioritise pragmatism and protection of consumers and market users wherever they are. And I would also urge firms which have outstanding contracts with counterparties or customers in the EU to ensure they have done what they need to avail themselves of these regimes, and speak to the relevant Member State regulator if needs be.
Retail Financial Services
Let me start by emphasising the FCA’s commitment to prioritising consumer protection in financial services, and to be clear that applies to all consumers wherever they are located. As an example, UK insurers should pay claims on existing policies wherever the policyholder happens to be located. To be clear, I have never met an insurer who disagrees with this statement, and I doubt that policyholders would either. For our part, we are clear that our consumer protection objective applies equally in respect of consumers wherever they are resident.
The majority of UK firms have confirmed that they plan to maintain existing products and services to their customers resident in the EU.
Firms positions have generally been informed by the relevant transitional regimes offered by member states as well as their understanding of the legal and regulatory position, and a good dose of common sense. But, there remains a risk that lack of legal certainty in some jurisdictions will create adverse outcomes for consumers.
Our approach to these issues has been a mix of engagement with other authorities and seeking to ensure firms are prepared. We have been clear that we expect firms to do what they can to act consistently with local legal and regulatory requirements and expectations whilst being driven by the right consumer outcomes.
I hope I have emphasised enough that at the FCA we do not take a view on the substance of Brexit, but we do believe that however and whenever it happens it should not compromise protection for all consumers wherever they are domiciled, there is no reason to sacrifice open financial markets and many reasons to preserve them, and in particular wholesale markets counterparties should be able to choose where they trade according to principles such as best execution.
Much progress has been made on preparations in financial services, and this is recognised in the adjustments the Bank of England has made to its scenarios, including its worst case one. Inevitably, we cannot relax, progress is welcome but there are issues still to be resolved and uncertainly to be dealt with.
At the FCA, we will take a pragmatic approach to issues as they arise. We will use forbearance generously but appropriately, to maintain market integrity and protect consumers and market uses. This is what we did around the introduction of MIFID2. It amuses me that it led some commentators to call for my resignation for not implementing the letter of the regulation immediately come what may. So be it, I’m still here. Our priority is to do the right thing according to our public interest objectives.
To that end, we will work with firms to make sure their contingency plans are executed effectively. We will continue to engage closely with our EU counterparts and I hope we can commit to take the necessary joint activity to deal with issues that arise. In our view, the UK and the EU should be able to find each other equivalent on day one by virtue of having the same legislation and well established supervisory approaches. We co-ordinate closely with the Treasury and the Bank of England. As I said earlier, our experience of the financial crisis has imprinted this sort of work firmly in our DNA. And, we will maintain an active programme of communications, for firms and for the public.
So, in short, and to end, we have made considerable progress, but we do not underestimate the task ahead.