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Brexit update


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In the May 2017 edition of the Delta Report, we provided a case review of the landmark Article 50 ruling handed down by the UK Supreme Court and described the UK government's current strategy on implementing Britain's exit from the European Union ("EU") as outlined in a recently published White Paper3. The White Paper set out the key elements of how to legislate for withdrawal including a 'Great Repeal Bill'(now known as the 'Repeal Bill'), which would end the supremacy of EU law (known as the 'acquis communautaire') in the UK by repealing the European Communities Act 1972 and lift all existing EU laws directly onto the UK statute book where Parliament could then look to amend and/or repeal them as appropriate.

On 8 June 2017, the UK held a snap general election which was widely expected to provide a large parliamentary majority in the House of Commons for incumbent Prime Minister Theresa May's Conservative and Unionist Party. Instead, the general election resulted in the government losing its majority in the House of Commons making the task of passing the 'Repeal Bill' and an additional, vast amount of primary and secondary legislation to legislate for withdrawal even more daunting.

Nevertheless, it would appear, as of the time of publication, that the government has been able to establish a working majority in the House of Commons with the support of the Democratic Unionist Party of Northern Ireland and Mrs May's government has stated that it will keep to the EU's timetable for talks. Negotiations around the exit arrangements duly commenced on 19 June 2017 followed by the 'Queen's Speech' on 21 June 2017 setting the legislative agenda for a special 2017 – 2019 (i.e. 2 year instead of 1 year) Parliament. In the speech it was stated that the government would press ahead with the 'Repeal Bill' which would be complemented by legislation to ensure that the UK "[establishes] new national policies on immigration, international sanctions, nuclear safeguards, agriculture, and fisheries".

As to the approach to the negotiations, the EU's negotiating guidelines4 (as approved by the 27 other Member States of the EU) stipulate that the UK and the EU must first make "sufficient progress" in respect of agreeing the amount of the UK's existing and contingent liabilities to the EU before talks can commence on the future trading and political relationship between them5. While the UK had insisted that these two processes were carried out in parallel (given the longstop date by which exit will automatically occur (unless otherwise agreed) is 2 years from the date of service of the Article 50 notice6), it would seem that the UK has acceded to this position and agreed to follow the EU's mandated approach7.

Despite the general election result for the government, their position appears to have been left unchanged in respect of the form that Brexit will take. In her Lancaster House speech in January 20178, Mrs May stated that the government's position would be for the UK to leave the European Single Market9 as well as the EU 'Customs Union' and negotiate in their place a bespoke free trade arrangement. No further detail on what this would encompass has yet been released.


The way forward – UK Financial services and the derivatives market

In summary, the position for the UK's future trade relationship with the EU, the likelihood, shape or duration of any transitional arrangements and the impact on UK financial institutions and their ability to 'passport'10 across Europe remain wholly unclear at this stage.

Since the Lancaster House speech, media comment and discussions with clients have indicated a significant step-up in planning for a post-Brexit environment where financial institutions based in the UK will no longer be able to rely on passporting arrangements. In particular, increasing focus has been given to a scenario where the UK exits the EU with no transitional arrangements in place and with no future trading relationship agreed (a so-called 'cliff-edge Brexit'). Clearly, such a scenario would have a significantly detrimental impact on the ability of London based financial institutions to provide financial services and sell financial products within the EU. Consideration has been given to the possibility of relying on 'equivalence'11 arrangements but this has been given short shrift as the current regime only covers certain financial products12 and decisions made by the EU that a regime is 'equivalent ' can be revoked on 30 days' notice. Instead, and as noted in the media, a number of our clients are instead looking at the EU's requirements for trading out of an EU based branch or subsidiary. This in turn requires consideration of issues such as whether (i) the EU based entity would need to be separately capitalised and 'hived off' from the UK entity, (ii) key ancillary functions such as risk and compliance would also need to be handled within that entity, and (iii) personnel will need to be physically relocated to the jurisdiction where that entity is based.

Separately, much consideration has also been given to the future of the UK's well established euro derivatives clearing business. In 2015, the ECJ ruled in favour of the UK government13 against the 'location policy' of the European Central Bank (the "ECB"). This policy (while not actually implemented at the time) could have forced clearing house operators to be based in the Eurozone when handling significant euro-denominated business but was viewed by the ECJ as being outside the legal mandate scope of the ECB.

The European Commission is now proposing to amend14 the European Market Infrastructure Regulation15 ("EMIR") in order to implement a two tier system16 for clearing houses. Pursuant to the EMIR Review, 'Tier 1' (i.e. smaller) clearing houses would continue to operate within the parameters of the existing framework, which allows equivalence decisions to be taken where the clearing house is located outside of the EU.

However, for 'Tier 2' (i.e. 'systemically important') clearing houses, it is proposed that stricter requirements will be applied. The European Commission states that "a limited number of these systemically important clearing houses may be of such systemic importance, that the requirements are deemed insufficient to mitigate the potential risks (so called 'substantially systemically important'). In such instances, a decision may be taken allowing a CCP to provide services in the [EU] if it is authorised under EMIR and establishes itself in the EU ". In short, such legislation could be utilised to mandate the relocation of large clearing houses based in third countries (which the UK will become upon exit) to within the EU if the proposal should pass into law.

On 23 June 2017, the ECB also released a statement recommending17 that Article 22 of the Statute of the European System of Central Banks and of the European Central Bank be amended to provide it with clear legal competence in the central clearing sector and thereby giving the bank greater oversight of systemically important clearing houses outside the EU if they handle significant amounts of euro-denominated transactions (e.g. as contemplated by the EMIR Review).

Deliberations by the EU institutions aside, this issue will likely be the subject of further discussion in the Brexit negotiations. We will be monitoring this matter closely and assessing the likely impact on our derivatives clients and the market generally in future issues of the Delta Report once it becomes clearer what action (if any) will be taken.


Derivatives Newsletter
July 2017

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3 White Paper, 'Legislating for the United Kingdom's withdrawal from the European Union'
5 A range of figures have been quoted in media globally and by various representatives of the EU institutions. However, it would appear that the opening position for the negotiations is that the UK will be liable for a gross amount of approximately EUR 100 billion
6 Article 50, Treaty on European Union
10 Subject to its fulfilment of conditions under the relevant single market directive, a firm authorised in a European Economic Area (EEA) state is entitled to carry on permitted activities in any other EEA state by either exercising the right of establishment (of a branch and/or agents) or providing cross-border services. This is referred to in the UK Financial Services and Markets Act 2000 (as amended) as an 'EEA right' and the exercise of this right is known as 'passporting'
11 Equivalence is the concept that the regulatory regime of a third country (as it relates to a particular sector) is of an 'equivalent' standard to that applicable under EU law. For the purposes of financial services, such an assessment will typically be made by the European Commission, based on advice given by one of the European Supervisory Authorities
12 The concept of 'equivalence' in the context of access to markets is currently only available as an option in two sets of legislation: namely MiFID II and the AIFMD. This means that, unless there are significant changes to EU financial services legislation, equivalence in the context of access to markets will not be relevant to large proportion of the UK's financial services sector
14 Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 1095/2010 establishing a European Supervisory Authority (European Securities and Markets Authority) and amending Regulation (EU) No 648/2012 as regards the procedures and authorities involved for the authorisation of CCPs and requirements for the recognition of third-country CCPs (the "EMIR Review"). For further detail, please see the article on these legislative proposals in this edition of the Delta Report
15 Regulation (EU) No 648/2012


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