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This publication is available at https://www.gov.uk/government/publications/draft-financial-services-and-markets-act-2000-amendment-eu-exit-regulations-2019/the-financial-services-and-markets-act-2000-amendment-eu-exit-regulations-2019-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 explained in this policy note 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.
This policy note 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 and will be published in due course. 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 UK law do?
The Financial Services and Markets Act 2000 (FSMA) is an important part of the UK’s legislative framework for financial services regulation. FSMA and related secondary legislation define the ‘regulatory perimeter’, setting out the activities and entities that fall within the scope of UK financial services regulation. These activities are regulated and supervised by the two main financial services regulators in the UK: the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
FSMA and related secondary legislation also set out the requirements and procedures for financial services entities (for example, a firm) to be authorised to carry on regulated activities. Authorised entities are referred to as ‘authorised persons’ in FSMA. The legislation also provides the financial services regulators with the necessary functions and powers to grant authorisation to firms, to supervise their activities, and to enforce financial services requirements.
HM Treasury intends to make this statutory instrument under the EUWA to amend FSMA and related domestic legislation in order to ensure that the UK’s financial services framework continues to operate effectively in a scenario where the UK leaves the EU without an agreement. The SI is not intended to make substantive policy changes, but will ensure that the UK’s framework can function as a standalone regulatory regime. Some of these amendments are consequential to the approach taken in other financial services SIs that have been laid before Parliament as part of the government’s contingency preparations for a no deal scenario. The deficiency fixes explained here are consistent with the government’s general approach of treating the EU as any other third country. In particular, cross-references to EU legislation will be replaced with references to UK law.
3.2 What deficiencies arise from the UK’s withdrawal from the EU and how will they be fixed?
Most of the provisions in FSMA and related domestic legislation that will become deficient as a result of the UK’s withdrawal from the EU are explained below, along with the fixes that will be necessary to address them. While the majority of the amendments to FSMA that are required will be made by this SI, it will be necessary to make some other amendments to FSMA and related legislation in other SIs that HM Treasury is laying as part of its contingency preparations.
Regulated and prohibited activities
FSMA, and the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544) (RAO) made under FSMA, among other pieces of legislation, define the scope of financial services regulation in the UK. The legislation specifies the activities and entities that fall within the UK’s ‘regulatory perimeter’. These activities are then subject to the general prohibition in section 19 of FSMA, which provides that no entity may carry on a regulated activity in the UK, or purport to do so, unless they are authorised or exempt.
Many of the definitions for regulated activities and entities used in FSMA, the RAO and the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (SI 2005/1529) (FPO) are dependent on provisions in EU legislation, or use definitions based on an activity being carried out within the EU’s single market for financial services. Once outside of the EU, these definitions will need to be fixed so that they reflect the UK’s position as a standalone regulatory regime outside of the single market for financial services. Where necessary, the territorial scope of definitions will be changed from the European Economic Area (EEA) to the UK, and definitions of third-country activities or entities will cover the EEA as well as non-EEA countries.1 Many cross-references to EU legislation will be fixed by bringing an EU term or definition into UK law, or by referring to relevant UK legislation.
Consistent with the government’s overall approach to minimise disruption to firms and consumers, some of these amendments will be subject to transitional provisions. In a no deal scenario, the UK will fall out of the EEA financial services ‘passporting’ system. Passporting currently enables EEA financial services firms authorised by the regulatory authorities in their home EEA member state to provide their services to customers in any other EEA member state without having to obtain authorisation from the other member states’ regulatory authorities. The SI will also work in conjunction with the EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018 made under the EUWA, which provides for a ‘temporary permissions regime’ to allow EEA firms and funds operating in the UK via a passport to continue their activities for a limited period after exit day.
Permission to carry on regulated activities
Under section 19 of FSMA, a person is prohibited from carrying on a regulated activity in the UK, or purporting to do so, unless they are authorised or exempt. This is known as the ‘general prohibition’. Permission to carry out such regulated activities in the UK is, for the most part, granted under Part 4A of and Schedule 6 to FSMA. These provisions set out the procedures and requirements for obtaining Part 4A permission. Membership of the EU enables firms authorised in another EEA state to carry on regulated activities in the UK via a ‘passport’, without the need to apply for a separate permission from the UK regulators. Firms located outside the EEA (i.e. in ‘third countries’) need to apply to the UK regulators for permission to be authorised and carry out regulated activities in the UK. In some cases, certain rules which concern obtaining permission apply differently where a firm is connected to another person, such as a parent company, located in the EEA. From exit day, the special status afforded to companies incorporated in other EEA states for this purpose will end.
The passporting system relies upon a legal framework agreed between EEA member states. If the UK leaves the EU without a deal, there will be no agreed legal framework upon which the passporting system can continue. As a result, references in UK legislation to the EEA passporting regime will become deficient at the point of exit. To correct this, references to passporting are being revoked by the EEA Passport Rights SI, which has now been made law. This SI will make further consequential amendments to FSMA to revoke provisions that facilitate passporting.2
To mitigate cliff edge risks when the EEA passporting rights fall away, firms will be able to obtain temporary permission to continue their regulated activities under the EEA Passport Rights SI.
Performance of regulated activities
Part 5 of FSMA sets out a framework for the regulation of individuals working within the financial services sector. As part of this framework, individuals who will be carrying out certain key functions at authorised firms must obtain approval from the FCA or PRA, or they must be certified by the firm. Part 5 sets out the related responsibilities of firms and gives powers to the regulators to specify the functions where approval or certification is needed. There are currently two regimes in place: the Approved Persons Regime (APR) and Senior Managers & Certification Regime (SMCR) (which covers dual-regulated firms), as the new SMCR replaces the old APR. The SMCR has been in place for all banks, building societies, credit unions and PRA designated investment firms since 2016, and will be extended to the insurance sector in December 2018, and to the remaining financial sector firms regulated solely by the FCA in December 2019.
In Part 5 of FSMA, Sections 59(8) and 63E(7) exempt EEA firms from elements of the APR and SMCR where the responsibility for those elements falls to the EEA home state regulator. Once outside of the single market for financial services and the EU’s joint supervisory framework, this exemption will no longer be appropriate. In line with existing requirements for non-EEA firms operating in the UK, this exemption will be removed and EEA firms will be subject to the same framework as non-EEA firms.
Control of business transfers
FSMA provides for a court-sanctioned legal transfer of some, or all, of a business from one insurance or banking institution to another. The provisions for a business transfer scheme are set out in Part 7 of and Schedule 12 to FSMA, as well as in the Financial Services and Markets Act 2000 (Control of Business Transfers) (Requirements on Applicants) Regulations 2001 (SI 2001/3625). In addition, the Financial Services and Markets Act 2000 (Control of Business Done at Lloyd’s) Order 2001 (SI 2001/3626) includes provisions for an insurance transfer in relation to Lloyd’s of London. These business transfers, often referred to as ‘Part 7 transfers’, may include combining similar businesses from two or more institutions into a single institution, or transferring business between unrelated institutions.
Transfers of business from ring-fencing bodies, reclaim funds and banking businesses each currently require the regulators to obtain a certificate of consent from relevant EEA regulators where the transfer is to a body in an EEA state in order for the court to sanction a transfer. The requirement to obtain consent from home state regulators will fall away on exit.
However, the main provisions in Part 7 relate to insurance business transfers.
Part 7 insurance business transfers are restricted to firms operating in the EEA in accordance with the Solvency II Directive (Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance). This EU framework attaches several conditions to a Part 7 insurance business transfer, including cooperation between EU supervisors, so that a transfer can be approved.
Once the UK leaves the EU, this framework for insurance business transfers, based on the mutual recognition of home state procedures, will no longer operate effectively. The FSMA provisions facilitating transfers of insurance business from the EEA to the UK or from the UK to another EEA state will therefore be revoked. After exit, EEA branches authorised in the UK will be treated in the same way that third-country branches are treated now. Part 7 transfers will be possible from third-country branches authorised in the UK to other institutions within the UK, and from UK-authorised persons to UK-authorised branches of third-country firms. Accordingly, consequential amendments to the legislative provisions for a business transfer scheme will need to be made.3
In order to avoid disruption to firms that are already in the process of making a Part 7 insurance transfer between UK and EEA entities, onshoring legislation will be used to introduce a savings provision in relation to insurance business transfer schemes. This will allow up to two years from exit day for parties who have already initiated a transfer of insurance business under the pre-exit process to obtain a court order sanctioning the transfer. For the savings provision to be available, a regulatory transaction fee must have been paid to the PRA and an independent expert required for the transfer should have been appointed by exit day. It should be noted that the ability of the saving provision to facilitate completion of a Part 7 insurance transfer initiated before exit may be dependent on EEA states formally recognising business transfers involving UK firms or policies.
There are also provisions in Schedule 12 to FSMA which relate to transfers involving Switzerland. On exit from the EU, the UK will no longer be party to the EU-Swiss framework agreement on financial services. The government is working with Switzerland to replace this agreement on a bilateral basis. Existing provisions in Schedule 12 which relate to insurance business transfers involving Switzerland are therefore being amended and retained to facilitate this future agreement for Swiss firms and the Swiss supervisory authority.
Control over authorised persons
Part 12 of FSMA sets out requirements in respect of acquisitions or changes of control over certain types of firm, such as credit institutions, investment firms and insurance undertakings. Part 12 requires a person who decides to acquire a controlling interest in a firm to notify the appropriate regulator before making the acquisition. There are also requirements to notify if a person reduces or disposes of a controlling interest. The duties of the regulators in these circumstances are also set out in this part of FSMA. The requirements under Part 12 will not change, but amendments will be made so that the procedures to be followed reflect the UK’s position outside of the EU’s supervisory framework for financial services. In particular, binding obligations upon UK regulators to consult EU authorities will no longer be appropriate.
The definition of ‘relevant UK authorised person’ in Article 2 of the Financial Services and Markets Act 2000 (Controllers) (Exemption) Order 2009 (SI 2009/774) will be amended to refer to authorisation under the relevant domestic legislation. The control thresholds and bands for directive and non-directive firms will be maintained.
Provision of financial services by members of the professions
Part 20 of FSMA enables HM Treasury to designate professional bodies so that their members may be exempted from the general prohibition against carrying on a regulated activity without authorisation. Such bodies are referred to as ‘Designated Professional Bodies’ (DPBs). To designate a professional body, HM Treasury must be satisfied that the body has appropriate rules applicable to its members to effectively regulate the carrying on of a relevant regulated activity. The Financial Services and Markets Act 2000 (Designated Professional Bodies) Order 2001 (SI 2001/1226) sets out which professional bodies are exempt under Part 20. The Financial Services and Markets Act 2000 (Professions) (Non-Exempt Activities) Order 2001 (SI 2001/1227) specifies certain regulated activities which are not included in the exemption that operates under Part 20.
Consistent with the operation of the EU’s single market in financial services, Part 20 enables HM Treasury to designate a professional body that is established in an EEA state other than the UK. Once the UK has left the EU’s single market, exempting EEA professional bodies in this way will no longer be appropriate. This SI amends Part 20 so that HM Treasury’s power to designate a professional body is confined to UK bodies. Amendments are also made to the definitions of activities that are excluded from the Part 20 exemption so that they will refer to relevant UK law rather than referring to EU legislation.
Supervision and enforcement by the FCA and the PRA
FSMA includes provisions which set out the powers of the FCA and PRA to supervise financial services firms and to enforce domestic and relevant EU financial services regulatory requirements. The Financial Services and Markets Act 2000 (Qualifying EU Provisions) Order 2013 (SI 2013/419) (QEPO) made under Part 29 of FSMA is used to designate directly applicable EU regulations to ensure that the financial regulators’ enforcement powers can be used to enforce those regulations. EU measures designated under the QEPO are known as ‘qualifying EU provisions’. This SI will ensure that the domestic versions of those EU regulations (and in future, domestic legislation replacing them) can be enforced under FSMA. The SI will also fix relevant cross-references to EU legislation (principally Directives).
In FSMA and related secondary legislation, there are binding requirements on UK regulators to inform EU and member state authorities, including when regulators are considering or undertaking enforcement action against a UK regulated firm located in another member state and informing the European Supervisory Authorities about certain types of enforcement action. Once the UK is outside of the EU’s supervisory framework for financial services, it would be inappropriate for UK regulators to be unilaterally obliged to cooperate with EU authorities, without any guarantee of reciprocity. This SI removes the binding obligation, but UK regulators will still have the statutory ability to cooperate with EU authorities on a discretionary basis. Although cooperation will no longer be governed by a common legislative framework, the UK expects cooperation with EU authorities to continue.
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 are now in the process of consulting on these changes.
This SI will affect banks, building societies, investment firms and any other financial services institutions that are currently regulated in the UK. Amendments made by this SI will also affect the FCA and the PRA as the UK’s financial services regulators.
HM Treasury has engaged with industry bodies to ensure that firms are aware of changes to legislation being introduced by this SI that may affect them. This SI does not intend to make any substantive policy changes, other than to reflect the UK’s new position outside the EU. As such, many of the amendments to existing legislation made by this SI will not have any material impact on financial services firms.
This SI does not include all the 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 before exit.
5. Further information
If you have queries regarding this instrument, email FSlegislationEUWA@hmtreasury.gov.uk.
For example, the regulated activity of acting as trustee or depositary of a UCITS will be amended to refer to a UK UCITS. Another example includes how the concept of a ‘regulated mortgage contract’ will be limited to mortgages of land in the UK for contracts that are entered into on or after exit day. The status of contracts entered into pre-exit will not change. ↩
For example, HM Treasury proposes to retain the separate but related concepts of appointed representatives and tied agents. However, changes will be required to reflect the fact that passporting rights will cease after exit day. This will require changes both to sections 39 and 39A of FSMA, the latter of which will be retained for certain limited purposes. ↩
In particular, section 105 FSMA is being amended, while sections 114, 114A and Schedule 12, paragraph 6 of FSMA will be deleted. Article 3 of the Financial Services and Markets Act 2000 (Control of Business Transfers) (Requirements on Applicants) Regulations 2001 will also be amended. ↩