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This publication is available at https://www.gov.uk/government/publications/draft-capital-requirements-amendment-eu-exit-regulations-2018/capital-requirements-amendment-eu-exit-regulations-2018-explanatory-information
The European Union (Withdrawal) Act 2018 (EUWA) repeals the European Communities Act 1972 on the day the UK leaves the EU and converts into UK domestic law the existing body of directly applicable EU law. The purpose of the EUWA is to provide a functioning statute book on the day we leave the EU.
The EUWA also gives Ministers powers to make statutory instruments (SIs) to prevent, remedy or mitigate any failure of EU law to operate effectively, or any other deficiency in retained EU law. We refer to these contingency preparations for financial services legislation as ‘onshoring’.
HM Treasury is using these powers to ensure that the UK continues to have a functioning financial services regulatory regime in any scenario.
This SI is part of the wider work the government is undertaking to prepare for the UK’s withdrawal from the EU. It is not intended to make policy changes, other than to reflect the UK’s new position outside the EU, and to smooth the transition. The changes made in this SI would not take effect on 29 March 2019 if, as expected, we enter an implementation period.
The attached draft SI is intended to provide Parliament and stakeholders with further details on our approach to onshoring financial services legislation. The draft instrument is still in development. The drafting approach, and other technical aspects of the proposal, may change before the final instrument is laid before Parliament.
3. Policy background and purpose of the SI
3.1 What does the underlying EU regulation and UK law do?
Prudential regulation involves requiring financial institutions to hold sufficient capital and have adequate risk controls in place. The EU’s prudential policy regime for banks, building societies and investment firms consists of the Capital Requirements Regulation (CRR) (EU Regulation No. 575/2013), the Capital Requirements Directive IV (CRD IV), and a range of technical standards and non-binding guidelines.
The EU CRR/CRD IV was published in June 2013 and most of the rules contained within the package have applied across the EU since January 2014. CRD IV has been implemented into UK law, while CRR is currently a directly applicable EU regulation.
A key aim of CRR/CRD IV was to meet the EU’s commitment to implement the Basel accords, a set of international prudential standards predominantly developed in the aftermath of the financial crisis. Prudential standards help to protect depositors, consumers and other senior creditors of banks, building societies and investment firms. They further help to maintain confidence in financial systems and promote financial stability.
These standards include enhanced requirements for the quality and quantity of capital; a basis for new liquidity and leverage requirements; rules for counterparty risk; and macro-prudential standards such as capital buffers.
3.2 Deficiencies this SI remedies
This SI will make amendments to a number of aspects of CRR to ensure that it continues to operate effectively in the UK once the UK has left the EU.
The main pieces of sector-specific UK legislation that implement CRD IV (and previous CRD iterations) are the Regulated Covered Bonds Regulations 2008, the Capital Requirements Regulations 2013, the Capital Requirements (Country-by-Country Reporting) Regulations 2013, and the Capital Requirements (Capital Buffers and Macro-prudential Measures) Regulations 2014. This SI therefore also addresses these pieces of domestic legislation to ensure that they continue to function as intended post-exit.
Changes introduced by the SI include:
CRR currently requires groups to consolidate for capital purposes at member state level regardless of whether the ultimate parent is in the UK, EU27, or a third country. Therefore, all groups are already conducting capital consolidation under the UK parent, and this SI will not affect the basis on which capital requirements are applied.
However, while consolidated capital requirements are currently calculated on both a national and EU basis, CRR introduced consolidated liquidity requirements for EU banking groups which only apply on a cross-EU basis. Therefore, some groups with an EU parent entity and an EU consolidating supervisor that is not UK-based do not have a UK level of liquidity consolidation. As a third country, the UK will fall outside of this joint supervisory framework, meaning the UK will no longer be able to act as the EU consolidated group supervisor for a UK group with EU business, while the business of EU groups in the UK will similarly be subject to an additional layer of UK-led supervision.
To address this, this SI amends the geographical scope of all group consolidation provisions to restrict consolidation to the UK. This will not change the application of consolidated capital requirements, but would require an EU bank operating in the UK to be subject to a new layer of liquidity consolidation, overseen by the Prudential Regulation Authority (PRA).
The EU CRR specifies how much capital and liquidity firms must hold against different types of exposures, for example to CCPs or central banks, expressed as a percentage of the total exposure. EU assets, and those of third countries deemed equivalent by the Commission, are given preferential treatment under CRR – for example, exposures to EU sovereign debt are subject to a 0% risk weight, meaning no capital needs to be held against these exposures. In addition, there are certain preferential treatments for EU assets under the liquidity regime. In a no deal scenario and with no assessment of equivalence between the EU27 and UK, UK exposures would no longer be treated preferentially by the EU. Once the UK has left the EU, in the absence of an agreement and where no equivalence determination has been made, the EU27 would automatically fall into the category of a third country where EU27 exposures would no longer receive preferential capital treatment. Therefore, this SI will remove preferential treatment for EU27 exposures.
The EU CRR outlines a set of measures that national regulators can use in times of macroprudential or systemic risk – for example by providing the ability to adjust risk weights to certain exposures in the event of an asset bubble. CRR requires that regulators notify or seek approval from EU institutions of their intention to use some of these tools.
This SI will ensure that these tools remain available to UK regulators. The Financial Policy Committee (FPC) will also play a role in the framework, in line with the its role as a macroprudential authority.
Transfer of functions
Under the EU CRR, various functions are carried out by the European Supervisory Authorities – in particular, the European Banking Authority and European Securities and Markets Authority. In line with the Government’s cross-cutting approach on the transfer of functions, this SI will ensure that these functions are transferred to the appropriate UK bodies. For example, Article 124 of the EU CRR requires the European Banking Authority to publish the risk weights and criteria that competent authorities set for certain exposures. The responsibility to publish this information will be transferred to the PRA and FCA. A further example is the Article 135 requirement for the EBA to publish a list of External Credit Assessment Institutions – this function will also be transferred to the PRA and FCA.
Under CRR, a third-country’s regulatory or supervisory regime may be deemed by the European Commission to be equivalent to the approach set out in CRR. A third-country regime may be equivalent in relation to the approaches for: credit risk; exposures to central governments and central banks, regional governments or local authorities, and public sector entities; exposures in the form of units or shares in Collective Investment Undertakings (CIUs); and large financial sector entities. Equivalence decisions reduce duplication in regulatory or supervisory requirements between the EU and third countries and may also facilitate the exchange of services and products.
When the UK leaves the EU, the UK will no longer fall under the jurisdiction of the European Commission. To ensure that the CRR regime can continue to operate effectively in the UK, HM Treasury will take on the Commission’s function of making equivalence decisions for third country regimes, while the PRA will take on the role that the EBA currently has for providing technical assessments of third country regimes.
Where the Commission has already taken equivalence decisions for third countries, these will be incorporated into UK law by the EU (Withdrawal) Act and will continue to apply to the UK’s regulatory and supervisory relationship with those third-countries.
Information sharing and cooperation requirements between UK and EEA regulators
In CRR, there are binding obligations on UK authorities to cooperate and share information with EEA authorities. These obligate the PRA and FCA to cooperate and make joint decisions with EEA supervisors through the EU college of supervisors. They also require the PRA and FCA to share specified types of supervisory information with EEA supervisors and the EBA.
To reflect the UK’s new status when the UK leaves the EU, these obligations will be removed from UK legislation. This is appropriate given that the UK will no longer be a member of the European Union, and will ensure the UK is not obliged to share information or cooperate with the EU on a unilateral basis and with no guarantee of reciprocity. Instead, UK authorities will rely on the existing domestic framework provisions for cooperation and information sharing, which allow for this on a discretionary basis.
Where certain decisions under CRR are made on or before exit day by a body other than the PRA or FCA, the SI contains a provision whereby such decisions are ‘saved’ post-exit day. This means that, post-exit, the PRA and FCA will have the same powers in respect of such decisions after exit day as if they were the decisions taken by the PRA or FCA. This includes decisions taken via joint decision, for example in relation to internal models or on applications for various permissions.
Links to other dossiers
CRR contains definitions and provisions that refer to other EU dossiers. The draft SI has addressed deficiencies in those provisions as far as possible. However, as some of the statutory instruments that correspond to those dossiers will be laid at a later stage, we have not dealt with the relevant cross references at this stage. This includes cross references to the Financial Conglomerates Directive (Directive 2002/87/EC).
In addition, where aspects of CRR will be substantially amended by the Securitisation regulations (Regulations (EU) 2017/2402 and 2017/2401), these aspects will be amended at a later stage as part of the Securitisation onshoring. Similarly, references related to the EU’s European Market Infrastructure Regulation (Regulation (EU) 648/2012) and the EU Regulation on the Application of International Accounting Standards (Regulation (EC) 1606/2002) will be addressed through subsequent onshoring SIs.
Binding Technical Standards
Under the EU system of financial regulation, the Commission is responsible for developing legislation, with the exception of binding technical standards (BTS) which are developed and drafted by the EU Supervisory Authorities (ESAs). Across financial services regulation, the Treasury is transferring responsibility for all BTS to UK regulators. The basis on which this function is to be exercised is set out in the Financial Regulators’ Powers (Technical Standards) Statutory Instrument.
For CRR, all of the relevant BTS mandates will be brought into UK law with responsibility for meeting those mandates transferred to the PRA and FCA. The PRA and FCA will have responsibility for correcting deficiencies in CRR BTS so that they operate effectively from day one of exit, with the PRA and FCA then responsible for ensuring these BTS remain fit for purpose after exit.
3.3 Relevant rulebook and binding technical standard changes
The FCA and the PRA will be updating their Handbook/Rulebook and relevant binding technical standards to reflect the changes introduced through this SI, and to address any deficiencies due to the UK leaving the EU. Details of the FCA’s approach can be found here, and the PRA’s here. The FCA and the PRA have confirmed its intention to consult on these changes in the autumn.
This SI will affect those banks, building societies and investment firms already regulated in the UK under the EU CRR. As already noted, the intention of this SI is not to make policy changes, other than to reflect the UK’s new position outside the EU, and to smooth the transition to this position. HM Treasury have engaged with industry bodies to ensure awareness of these changes.
This SI does not include provisions that may be necessary to ensure Gibraltarian financial services firms’ continued access to UK markets in line with the UK government’s statement in March 2018, and other provisions dealing with Gibraltar more generally. Where necessary, provisions covering Gibraltar will be included in future SIs.
4. Next steps
HM Treasury plans to lay this instrument before Parliament in the autumn.
5. Further information
If you have queries regarding this instrument, email FSlegislationEUWA@hmtreasury.gov.uk.