My Lords, as this instrument has been grouped, I will speak also to the Financial Markets and Insolvency Amendment and Transitional Provision (EU Exit) Regulations 2019.
As with the instruments we have just debated, these two instruments are also part of the same legislative programme to ensure that if the UK leaves the EU without a deal or an implementation period there continues to be a functioning legislative and regulatory regime for financial services in the UK.
Turning to the substance of the over the counter derivatives, central counterparties and trade repositories SI, many noble Lords will be familiar with the European market infrastructure regulation known as EMIR, which the EU implemented in 2012. It is Europe’s implementation of the G20 Pittsburgh commitment in 2009 to regulate over-the-counter derivative markets in the aftermath of the financial crisis, reduce risk and increase transparency in derivative markets. It should be noted that EMIR, and the financial markets and insolvency SI which we will come on to in a moment, concern activities that mainly take place on financial markets. EMIR imposes requirements on firms that enter into any form of derivative contract and establishes common organisational, conduct-of-business and prudential standards for trade repositories and central counterparties. Central counterparties, for example, stand between counterparties in financial contracts, becoming the buyer to every seller and the seller to
every buyer. They guarantee the terms of a trade, even if one party defaults on the agreement, thereby reducing counterparty risk.
This SI addresses deficiencies within EMIR and related UK legislation to ensure that after the UK has left the EU an effective legal supervisory and regulatory framework for over-the-counter derivatives, central counterparties and trade repositories remains. This instrument is the last of three key SIs that fix deficiencies in EMIR, and it follows two SIs which have already been debated in your Lordships’ House and which have subsequently been made: the central counterparties SI and the trade repositories SI.
Firstly, the SI continues key requirements of EMIR that include the clearing obligation, which requires firms to clear certain types of derivative contracts at a CCP, the reporting obligation, which requires firms and CCPs to report derivative trades to a registered or recognised trade repository, and margin requirements, which compel firms to put forward money to cover the costs associated with trades. In order to have a framework in place to facilitate these requirements the relevant functions are transferred from the European Commission to the Treasury, and from the European Securities and Markets Authority—ESMA—to the UK regulators, namely the Financial Conduct Authority or FCA, the Prudential Regulatory Authority, known as the PRA, and the Bank of England.
Secondly, the power of granting equivalence decisions for non-UK trade repositories is transferred from the European Commission to the Treasury and functions for recognising non-UK trade repositories are transferred from ESMA to the FCA. The SI also transfers powers from the Commission to the Treasury with regard to equivalence decisions on over-the-counter derivative requirements and whether non-UK markets are recognised for the purpose of trading exchange-traded derivatives.
Thirdly, a temporary intragroup exemption regime provides continuity by ensuring that exemptions from EMIR requirements for intragroup transactions will continue after exit day. The regime will last three years from exit day to allow time for consideration of an equivalence decision by the Treasury and for the FCA to determine a permanent exemption. This period can be extended by the Treasury if necessary. Under the MiFID II legislation, there is an exemption from clearing and margining for certain energy derivative contracts, and this exemption is maintained by this instrument. Finally, EU processes which will become redundant are removed and replaced with equivalent UK processes.
I turn now to the financial markets and insolvency SI. This instrument, broadly speaking, concerns insolvency-related protections that are provided to systems and central banks under the EU settlement finality directive, or SFD. Systems are financial market infrastructure, such as central counterparties, central security depositories and payment systems, which provide essential services and functions relied upon by the financial services sector.
Currently, if an EEA-based system is designated under the SFD and receives funds or securities from a system user—for example, a UK bank—those funds or securities cannot be clawed back in the event of the
UK bank being subject to insolvency proceedings. Importantly, this framework also benefits system users, who could receive services on less favourable terms, or not at all, if the EEA system were not protected from UK insolvency law. In certain cases, membership of a system is contingent on these protections. Designation is therefore important as it facilitates the smooth functioning of, and confidence in, financial markets.
In order to become a designated system, a system must be approved by its designating authority—the Bank of England, in the case of the UK. The Bank then informs ESMA, which places it on the EU register of designated systems. The SFD provides similar protections to central bank functions across the EEA. Collateral received by an EEA central bank in accordance with its functions, such as emergency lending, cannot be clawed back if the relevant counterparty to the central bank is subject to insolvency proceedings.
The relevant EU laws—the SFD and the financial collateral arrangements directive—are implemented in the UK via the Financial Markets and Insolvency (Settlement Finality) Regulations 1999, the Companies Act 1989, the Financial Collateral Arrangements (No. 2) Regulations 2003 and the Banking Act 2009. Should the UK leave the EU without a deal or an implementation period, there will be no framework for the UK to recognise systems designated in EU member states, which in turn may risk continuity of services from those designated systems for UK firms.
This SI therefore establishes two main measures to mitigate these risks and ensure that settlement finality protections continue to operate effectively following the UK’s withdrawal. First, this SI establishes a UK framework for designating any non-UK system, while maintaining existing designations for systems that were designated by the Bank of England before exit day. To do this, the Bank of England’s powers to designate, and charge fees to, UK systems will be expanded to non-EEA systems, such that they can be designated under UK law. Moreover, the Bank will be able to grant protections to non-UK central banks, including EEA central banks, which already receive protections under the SFD. This will help maintain the effect of the current framework, providing continuity to UK firms accessing systems and central banks, while assisting UK firms in accessing the global market.
Secondly, the SI establishes a temporary designation regime. This provides temporary designation for a period of three years to existing designated EEA systems that intend to be designated under the UK’s framework. The purpose of temporary designation is to allow time for designation applications to be processed by the Bank of England while ensuring continuity of access for UK firms to relevant EEA systems immediately after exit day. The SI also gives the Treasury the power to extend this regime should more time be required to consider these applications.
The Treasury has been working very closely with the regulators in the drafting of the instruments. It has also engaged the financial services industry on these SIs and will continue to do so going forward. The Treasury published these instruments in draft alongside Explanatory Notes to maximise transparency to Parliament, industry and the public. That took place
on 22 October and 31 October 2018 respectively for the Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2018 and the Financial Markets and Insolvency (Amendment and Transitional Provision) (EU Exit) Regulations 2019. Furthermore, the Treasury published the impact assessment that accompanies these SIs, providing further transparency regarding the reasons behind, and foreseen impacts, of these proposals.
The Government believe that the proposed legislation is necessary to ensure the smooth functioning of financial markets in the UK if the UK leaves the EU without a deal or an implementation period. I hope that noble Lords will join me in supporting the regulations. I beg to move.