FCA issues second Brexit consultation

On November 23, 2018, the FCA published its second Brexit consultation, Consultation Paper 18/36: Brexit: Proposed changes to the Handbook and Binding Technical Standards – second consultation (CP18/36). In CP18/36 the FCA sets out its proposals for amending the Handbook and onshoring BTS related to those statutory instruments that HM Treasury published after its first Brexit consultation paper published in October. A list of the HM Treasury statutory instruments and BTS covered by the consultation can be found in Annexes 3 and 4 of CP18/36.

The FCA repeats a point made in its first Brexit consultation paper that it is keen to get feedback on whether compliance with its proposals from exit day onwards will be a challenge for firms. The FCA has previously explained that HM Treasury has confirmed that it will bring forward legislation to allow the UK regulators to phase in changes to firm’s regulatory requirements in a no-deal scenario.

In chapter 1 of CP18/36 the FCA states that it wants to introduce general continuity provisions for all parts of the Handbook and BTS not covered by a specific transitional arrangement. The proposed approach provides that references in the Handbook and BTS are generally to be read in a way that preserves the continuity of regulatory requirements which straddle exit day in some way. The FCA gives the example that where a firm breaches a requirement pre-exit and only discovers this post-exit, it would be required to notify the regulator of this pre-exit breach of the substantially similar pre-exit regulatory requirement. Further information on the general continuity provisions can be found in Appendix 3 of CP18/36.

Cross-cutting issues were discussed in the FCA’s first Brexit consultation paper and these are essentially issues that affect multiple parts of the Handbook and BTS. In CP18/36 the FCA discusses cross cutting issues relating to two EU Directives (the Distance Marketing Directive and the E-Commerce Directive) and references to EU institutions.

In terms of the Distance Marketing Directive (DMD) the FCA reports that it has not identified any reason to depart from its baseline approach of treating EEA States the same as any other third country. That means that after exit day, the DMD-related Handbook provisions will generally no longer apply to UK firms’ distance marketing activity with respect to consumers in EEA States.

In relation to the E-Commerce Directive (ECD), the FCA reports that it intends to make amendments to the Handbook to reflect the UK Government’s intention to revoke legislation, or parts thereof, relating to the cross-border provision of financial services via the exemption from host State regulation in the ECD. However, e-commerce rules will apply to EEA based firms which enter the temporary permissions regime (TPR).

The FCA proposes that in most instances, references to EU institutions will be replaced with a UK institution.

Most of the changes the FCA proposes to make to the Handbook are cross-cutting in nature or consequential upon the approach taken in the HM Treasury statutory instruments. The FCA has set out an overview of these types of changes in a table which can be found below paragraph 3.5 of CP18/36.

Yes. The FCA discusses the Senior Managers’ and Certification Regime (SM&CR) in paras 3.7 to 3.13 and 4.6 to 4.20 of CP18/36. Importantly, the FCA sets out two useful tables in paragraph 3.13 of CP18/36 which illustrates the differences in the senior management functions applicable to dual regulated (PRA and FCA) branches and solo regulated (FCA only) branches both in the TPR and fully authorised. As mentioned in its first Brexit consultation, the Approved Persons Regime (APR) will continue to apply to solo regulated firms until the SM&CR for solo regulated firms takes effect on December 9, 2019.

In terms of EEA services firms, the FCA states that the SM&CR and the APR will not apply to them whilst in the TPR. However, the APR and the SM&CR will apply to such firms once they have been fully authorised and leave the TPR.

Yes, the FCA briefly discusses contractual recognition of bail-in stating that on exit day, all contracts for relevant liabilities governed by the law of an EEA Member State will become subject to the provisions on third country contractual recognition of bail-in. The regulator adds that this means that firms will need to include a new term in the relevant contracts for liabilities such that the creditor agrees to the fact that the liability may be written down or converted by the Bank of England. This would apply to any new contracts and to any existing contracts that are materially amended after exit day.

The FCA’s proposals seem to follow the PRA’s proposals for contractual recognition of bail-in (see chapter 4 of PRA Consultation Paper 26/18 – UK withdrawal from the EU: changes to PRA Rulebook and onshored BTS).

The FCA proposes to maintain the status quo.

At present the Conduct of Business sourcebook (COBS) 10A.4.1R provides that an appropriateness assessment is not required if certain conditions are met. One such condition is that the service relates to certain types of non-complex financial instruments. The list of non-complex financial instruments in COBS 10A.4.1R(2) includes shares and bonds or other forms of securitised debt admitted to trading on: (i) a regulated market; (ii) an equivalent third country market; or (iii) a multilateral trading facility. To maintain the status quo, the FCA is proposing to keep the current scope and consider shares and bonds admitted to trading on UK and EEA regulated markets as essentially non-complex.

Yes. The FCA proposes that the Handbook definition of “UCITS” post exit day will incorporate both UK and EEA UCITS schemes. As such the FCA intends to regard UK and EEA UCITS as essentially non-complex. This means that the FCA will be treating EEA UCITS differently to any other third country fund. However, the policy reason behind this is that the volume of EEA UCITS impacted would be considerable if it were to change the scope to UK UCITS only.

Currently, manufacturers of UCITS funds are exempt from the product information obligations under the PRIIPs Regulation. This is on the basis that these manufacturers are obliged to prepare a key information document under the UCITS Directive. A similar exemption applies to manufacturers of non-UCITS retail schemes (NURS) offered to retail investors where they are subject to similar rules as those that apply in relation to UCITS funds. HM Treasury is maintaining this exemption for UK and EEA UCITS as well as NURs in its onshoring legislation. The FCA is reflecting this it is proposed changes to COBS 13 and 14.

Section 3.5 of CP18/36 discusses proposals concerning regulatory processes, specifically dealing with the tied agent regime and primary markets (listing rules and disclosure guidance and transparency rules). In relation to the listing rules, the FCA proposes to amend the free float rules which are a continuing obligation on issuers requiring them to maintain the level of shares in public hands within the EEA at 25 per cent or above (or a lower level if agreed). The FCA proposes to remove the reference to EEA holders meaning that holders from any jurisdiction can be counted towards the free float. The FCA’s rationale for this change is that in practice liquidity is largely independent of the geographical location of the holders of securities and that it regularly grants waivers from the free float requirement to allow the calculation to include “rest of the world” investors.

The UK Government has previously said that the UK will be excluded from participating in the EU Emissions Trading System in a no-deal scenario. The FCA expects that the main consequences for UK financial services firms will be

• The regulated activity of bidding in emission auctions will cease as of exit day and firms’ permissions will no longer comprise this activity.
• There will be no UK emission auction platform under the Recognition Auction Platform Regulations 2011.

However, the FCA adds that UK firms will still be able to trade in the secondary EU emission allowances market.

Chapter 4 of CP18/36 covers changes related to the TPR, specifically the SM&CR and APR (see above), the Financial Services Compensation Scheme (FSCS), Financial Ombudsman Service and the disclosure of authorisation status.

In relation to the FSCS, the FCA reminds firms that it proposed in its first Brexit consultation paper that firms in the TPR will have to comply with the Principles for Businesses. In CP18/36 the FCA proposes the following guidance in relation to Principle 7 (firms to pay due regard to the information needs of their clients, and communicate information to them in a way which is clear, fair and not misleading)

• We expect incoming EEA-based firms in the TPR to consider and communicate to their customers any material changes in home state investor compensation scheme coverage, as a result of UK withdrawal from the European Union. We would also expect such a firm to provide, on a customer’s request, information concerning the firm’s inclusion in any compensation schemes, including the firm’s home state scheme.

In terms of disclosure of authorisation status the FCA sets out in paragraphs 4.33 and 4.44 the wording it intends to use for sol-regulated TPR firms and dual regulated TPR firms.

Chapter 5 of CP18/36 covers many of the BTS that were not addressed in the FCA’s first Brexit consultation paper, but not all of them. However, the BTS that are covered relate to a number of important pieces of EU financial services legislation including MiFID II, MiFIR, PRIIPs Regulation, Market Abuse Regulation, EMIR and the Benchmarks Regulation.

Most of the changes that the FCA is proposing to make to the BTS are designed to fix gaps that are cross-cutting in nature and follow the framework that HM Treasury has created through its statutory instruments.

In terms of MiFID II BTS, the FCA makes a number of points including

• The Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018 (MiFID II Exit Instrument) grant a set of temporary powers that provide the FCA with some flexibility as to how the MiFID II transparency regime is operated during a transitional period of up to four years from exit day, with a view to maintaining existing outcomes as far as possible. The FCA states that it will issue a statement of policy on how the temporary powers will be used.
• The MiFID II transparency regime has several BTS associated with it. The key changes that the FCA proposes to make to these BTS are intended to give effect to the onshoring principles in the MiFID II Exit Instrument. This includes inserting the concept of the “relevant area” (consisting of the UK and other countries or regions the FCA specifies) into specific calculations and continuing to publish transparency information under Commission Delegated Regulations 2017/587, 2017/583 and 2017/588.

For the PRIIPs Regulation BTS the FCA proposes to amend Regulatory Technical Standard (RTS) 2017/653 so that EEA entities are not treated as third-country entities under certain RTS provisions related to risk indicators. One of the reasons for this proposal is to ensure that the FCA maintains operable equivalence with the methodologies in the RTS and avoid risk ratings set out in key information documents for certain PRIIPs increasing on exit day.

In relation to EMIR, the FCA is consulting on proposed changes to BTSs concerning the data publication and data access requirements for trade repositories, general “level 2” requirements concerning clearing, access by central counterparties to trading venue market data and risk mitigation techniques and the content, format and frequency of reports to be made to a trade repository. The relevant BTSs are Commission Delegated Regulations 149/2013, 148/2013, 1247/2012 and 151/2013.

Specific points that the FCA make include

• In onshoring Commission Delegated Regulation 151/2013, it is proposed that the technical arrangements necessary for trade repositories to provide access to trade data be amended, in accordance with Article 81 of EMIR. The FCA states that this is a consequence of it replacing the European Securities and Markets Authority’s (ESMA) TRACE system with its own Derivatives Data Store system.
• In onshoring Commission Delegated Regulation 1247/2012, removing the sentences referring to Article 9(3) of EMIR in relation to reporting to ESMA until a trade repository is registered for a particular derivatives class. Also, references to “ESMA” will be replaced with references to the ‘FCA’ in connection with the endorsement of the code referred to in Article 4(9) and the unique trade identifier referred to in Article 4a(1).

The FCA states that, similar to the PRA, it will not be undertaking a line by line review of all of its forms. Instead it will produce a guide which will set out the approach it expects users of Handbook forms to take.

The deadline for comments on CP18/36 is December 21, 2018 (three weeks after the deadline for responding to the first FCA Brexit consultation paper). The FCA states that it intends to provide feedback and publish final rules in “early 2019”.