FCA consultation

On October 10, 2018, the FCA published its first consultation paper setting out proposed changes to its Handbook and to binding technical standards (BTS) as a result of Brexit. At over 780 pages long Consultation Paper 18/28 – Brexit: proposed changes to the Handbook and BTS – first consultation (CP18/28) is the FCA’s first publicly available policy paper on Brexit.

What does CP18/28 cover?

CP18/28 is part of the UK’s contingency planning for a hard “no deal” Brexit. Another important component of this contingency planning is the draft statutory instruments (draft SIs) that HM Treasury has been publishing under the powers given to it by the European Union (Withdrawal) Act 2018 (the EUWA). Essentially the draft SIs “onshore” in the UK directly applicable EU financial services legislation, remedying deficiencies in domestic UK law should the UK leave the EU without a deal.

CP18/28 sets out amendments to the FCA Handbook (hereafter Handbook) and BTS which relate to the draft SIs that HM Treasury has so far published (a list of draft SIs is set out in Annex 2 of CP18/28). In addition, CP18/28 deals with the FCA’s proposed approach to the related EU nonlegislative material otherwise known as Level 3 material (i.e. guidelines, recommendations and Q&As produced by the European Supervisory Authorities (ESAs).

Is CP18/28 the whole story?

No. CP18/28 only deals with the draft SIs that have so far been published by HM Treasury. More draft SIs are expected. The whole of EU financial services law has to be dealt with. In all it is rumoured that 60 or so draft SIs will be produced.

The FCA states that a second consultation paper will be published later this Autumn covering the BTS and parts of the Handbook that are affected by the draft SIs that are published later. Also, the FCA warns that material in CP18/28 may be further revised in light of other changes being made to the Handbook. Such Handbook changes include those relating to the extension of the senior managers’ and certification regime to non-bank financial services firms.

Do the new rules come into force on Brexit day?

Maybe, it depends if the UK and EU can finalise the withdrawal agreement.

The consultation period for CP18/28 is fairly short (deadline by December 7, 2018) in order to give the FCA sufficient time to reflect on industry comment before publishing the new rules ahead of Brexit. If a no deal Brexit occurs, then the new rules come into effect at 11pm on March 29, 2019 when the UK leaves the EU.

However, if the UK and the EU finalise the withdrawal agreement, the new rules that were proposed in CP18/28 will not come into effect until sometime after December 31, 2020 when the implementation period expires. In addition, the new rules may be subject to further change. The FCA states in CP18/28 that “the changes we make to the Handbook and to BTS after the implementation period will depend on the outcome of the negotiations on the future relationship between the UK and the EU.”

Should all financial services firms take notice of CP18/28?

Yes, most definitely.

To help firms the FCA has set out in chapter 4 of CP18/28 (para 4.4) a useful table that gives an overview of the sourcebooks and chapters it has reviewed for the consultation and the potential interested stakeholders by sourcebook.

Generally speaking, what is the FCA proposing to change?

The FCA states in CP18/28 that most of the proposed changes are consequential in nature and follow the amendments HM Treasury is making in the draft SIs. The regulator adds that its approach has not been to revisit previous policy decisions or make refinements unconnected to Brexit.

That does not sound too onerous?

Like always the devil will be in the detail and practitioners will need to undertake a line by line review of the amended Handbook text set out in Appendix 1 of CP18/28.

Can you tell us more on the FCA’s approach to reviewing the Handbook and BTS?

Chapter 2 of CP18/28 explains the legal basis for the amendments and the FCA’s general approach to the changes. As mentioned above, the FCA has said that it’s only proposing changes to the Handbook and BTS that deal with deficiencies in its Handbook that arise from Brexit, broader policy changes are not introduced. A “deficiency” is explicitly defined in the EUWA thereby limiting, at least in theory, what changes the FCA can propose.

In paras 2.11 to 2.14 of CP18/28 the FCA discusses the underlying assumptions for its amendments applying the test set out in the Financial Regulators’ Powers (Technical Standards etc) (Amendment etc) (EU Exit) Regulations 2018. The baseline approach is that the FCA will be treating the EU and its Member States in the same way as it treats non-EU or third countries after Brexit day. However, there will be some divergence from this baseline approach where the regulator either judges it is needed to ensure a sound, functional regulatory regime after Brexit day or where it wishes to avoid significant disruption to firms, investors and/or consumers.

What about implementation challenges?

Obviously there will be many implementation challenges for firms.

The FCA discusses implementation challenges in paras 2.24 to 2.29 of CP18/28. In particular, the regulator states that it expects to use the powers that HM Treasury will confer on it to phase in changes to firms’ regulatory requirements. The FCA states that it will use these powers in a “proportionate manner bearing in mind [its] statutory objectives.” It also adds that firms “will not be expected to make individual applications to benefit from the transitional powers that HM Treasury is giving the regulators”.

The FCA is keen to get feedback on the challenges associated with implementing the changes that have been proposed in CP18/28. In particular, it would welcome feedback on any systems that may need to be developed or amendments, including the expected time needed to build these changes. Feedback on compliance challenges should provide evidence of the reasons why full compliance would be at risk.

What are “cross-cutting issues”?

Chapter 3 of CP18/28 deals exclusively with cross-cutting issues and these are issues that affect several chapters or sourcebooks in the Handbook. The FCA will consult further on cross-cutting issues in its next consultation paper.

Generally, the approach taken by the FCA is to reflect the changes that are being made by the draft SIs. This includes proposing amendments so that

• The Handbook (including glossary terms) refers to the new or revised UK legislation (or specific provisions of that legislation), rather than the EU equivalents.
• Passages of EU law, or UK law now being amended, that have been replicated in the Handbook are updated to reflect the new provisions.
• Where relevant, references are kept to EU law to explain how the Handbook or BTS implemented EU law in the past (rather than implements them).

A further proposed amendment deals with the references in the Handbook to the Treaty on the Functioning of the European Union (the Treaty). As the UK will no longer be a party to the Treaty on Brexit day the FCA is proposing to remove references to it in the Handbook, this includes where such a reference is part of a specific term – for example “Treaty firm”. However, the FCA states that there are some exceptions to this and from the examples provided in chapter 3 (COLL references to EU Capital Requirements Regulation (CRR) are retained as are UK CRR (there is a new glossary definition for EU CRR)) these exceptions may not be material.

What about the Handbook provisions dealing with passporting?

The Handbook provisions dealing with passporting are another cross-cutting issue considered in chapter 3 of CP18/28. The course of action the FCA is proposing (see para 3.18) is that these provisions will be removed from the Handbook. This includes deleting references to the roles and responsibilities of “home” and “host” state regulators that relate to passported activities. It also means amending or deleting some glossary terms such as consent notice, passported activity or passport right. However, the proposed changes are distinct from the FCA proposals for a temporary permissions regime.

EU institutions another cross-cutting issue?

Yes. The FCA proposes to remove or replace the references in the Handbook to the EU institutions with the relevant UK institution.

Information sharing another cross-cutting issue?

Yes. However, the FCA confirms that it will continue to share information with the ESAs despite the EU legislative obligations to do so falling away on Brexit day.

Where can I find information on the changes that affect my sector?

Chapter 4 of CP18/28 deals with the FCA’s proposed amendments to the Handbook on a sector by sector basis. As mentioned earlier a table in para 4.4 gives an overview of the impacted sourcebooks. It’s also worth noting that the FCA has reviewed the following Handbook guides: Energy Market Participants Guide (EMPS), Oil Markets Participants Guide (OMPS) and Service Companies Guide (SERV).

Can you tell us more about some of the proposed changes to the FCA Handbook?

Yes, in summary

• Paras 4.9 to 4.14 deal with the Prudential Standards sourcebooks. These include changes to prudential rules for solo-regulated firms prudentially regulated by the FCA and to conduct rules with prudential aspects for insurers and friendly societies. Paras 4.15 to 4.19 deal with stocklending transactions where the counterparty is authorised in an EEA state. Exposure to stocklending transactions with EEA-authorised counterparties will be permitted on the same basis as the current rules.
• Paras 4.20 to 4.40 deal with proposed changes to the Conduct of Business sourcebook (COBS). These proposals include changes to conduct rules that apply to insurers and friendly societies and the territorial application of the sourcebook. In relation to territorial application the FCA’s baseline approach is to treat EEA Member States the same as any other third country and the provisions in COBS are being amended accordingly. At present, UK conduct rules generally only apply to an EEA firm when it carries on business from a branch in the UK. Incoming EEA firms providing services on a cross-border passported basis are generally subject to Home state conduct rules. After Brexit day, if an EEA firm were to obtain authorisation from the FCA or the PRA, then COBS would apply to it in the same way as any other UK-authorised third country firm. Also, in relation to client categorisation EEA local public authorities or municipalities will be treated under COBS 3 in the same way as local authority clients based in third countries. When re-categorising EEA local public authorities, firms will need to follow the same quantitative test that is applied in relation to MiFID or equivalent third-country business generally under COBS 3.5.3R(2). In relation to the appropriateness test in COBS 10, the guidance in COBS 10.5.5G which deals with the FCA’s views on when a valuation system will be regarded as being “independent of the issuer” is being amended so that the reference to a depositary in “another EEA state” is replaced with in “the UK”.
• Paras 4.41 to 5.50 deals with changes affecting the fund management sector, principally, amendments to the Investment Funds sourcebook (FUND) and the Collective Investment Schemes sourcebook (COLL). The proposals include those relating to the establishment of a UK UCITS regime (the applicable draft SI is the Collective Investment Schemes (Amendment etc) (EU Exit) Regulations 2018) and the creation of an equivalent UK alternative investment fund manager (AIFM) regime for existing alternative investment funds (AIFs) managed by UK AIFMs and for AIFMs that may wish to launch new funds (the applicable draft SI is the Alternative Investment Fund Managers (Amendment) (EU Exit) Regulations 2018). The FCA’s proposals do not cover the Collective Investment Scheme Information Guide on the basis that the regulator feels that it needs a broader set of updates, beyond those related to Brexit.
• Paras 4.51 to 4.55 provides a brief overview of MiFID II-related Handbook changes. The FCA is proposing to include in certain parts of the Handbook (notably in SYSC and COBS) text copied out from Commission delegated regulations. In terms of deficiencies relating to the transparency regime, transaction reporting and the ancillary exemption these are being dealt with through the draft SI (the Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018) and the UK versions of the BTS.

The FCA’s approach to BTS is discussed in chapter 5 of CP18/28. It’s important to note that the consultation does not cover BTS for all EU financial services legislation, rather those pieces of EU legislation that HM Treasury has already published a draft SI for. Consequently this means that the proposals cover BTS in respect of: credit rating agencies, fund management, EMIR (only BTS related to registration and application of trade repositories), MiFID II/MiFIR, short selling and capital requirements. The FCA’s second consultation later this Autumn will deal with BTS in other pieces of EU financial services legislation.

BTS – is it the responsibility of the FCA or the PRA or both?

Responsibility for BTS is set out in the Financial Regulators’ Powers (Technical Standards) (Amendment etc.) (EU Exit) Regulations 2018. This draft SI sets out which BTS each of the FCA, the PRA and the Payment Systems Regulator is responsible for. In some cases both the FCA and the PRA are responsible for a particular BTS.

The FCA explains in CP18/28 that in respect of where responsibility for a BTS is shared, one of the UK regulators will take the lead in making the amendments. This will be based on which authority’s remit and objectives are most relevant.

What changes is the FCA proposing to BTS?

In essence the changes the FCA is proposing are designed to make the BTS fit for purpose after Brexit day.

It’s also worth noting that

• The FCA has not identified any deficiencies in Commission Delegated Regulation (EU) No 2014/694, which defines when AIFs should be considered open-ended or closed-ended, except for a cross reference to an Article in AIFMD that needs to be replaced by its implementing measure in the UK.
• Commission Implementing Regulation (EU) No 2016/1212, which prescribes the process for reporting sanctions to the European Securities and Markets Authority under Article 99e of the UCITS Directive, will be removed as the reporting requirements will cease on Brexit.
• The proposed amendments to the two BTS associated with registration and application of trade repositories (Commission Implementing Regulation (EU) No 1248/2012 and Commission Delegated Regulation (EU) No 150/2013) are consequential and derive from the relevant draft SI (the Trade Repositories (Amendment and Transitional Provision) (EU Exit) Regulations 2018).
• The FCA’s proposals do not cover all 44 BTS associated with MiFID II particularly those relating to pre-and post-trade transparency. The FCA considers that the proposed amendments to those BTS that have been reviewed are non-material in nature and minor except for Regulatory Technical Standards (RTS) 22 and 23. In RTS 23 firms will still be required to report reference data based on Central European Time rather than British Summer Time. In RTS 22 the FCA maintains the application of reporting requirements to the same categorises of UK firms. Whilst noting that the amendments to RTS 22 and 23 are technical in nature the FCA draws firms’ attention to their effects (see para 5.30 of CP18/28) which includes that UK firms will no longer be able to meet the conditions for transmission if they transmit orders to an EEA firm. A number of RTS, implementing technical standards and implementing and delegated regulations are proposed to be removed (a list can be found in para 5.33 of CP18/28) on the basis that the obligations set out within them cease to apply once the UK leaves the EU.
• While the FCA is conducting its own consultation on the capital requirements associated BTS it is responsible for, FCA authorised firms should have regard to the PRA consultation that will be published shortly.

What is happening to non-binding guidelines, recommendations and Q&As produced by the ESAs?

The FCA’s supervisory expectations in respect of guidelines and recommendations will remain the same. In particular, the regulator will expect firms and market participants to continue to apply them to the extent they remain relevant, as they did before Brexit day.

In terms of other non-binding material the FCA states that it will continue to have regard to it where it is relevant, taking into account Brexit and ongoing domestic legislation. Firms, market participants and stakeholders should also continue to do so.

Paragraphs 12 to 16 of Appendix 3 of CP18/28 set out certain exceptions to the approach set out above. For instance, where the FCA has informed the relevant ESA that it would not comply with part of or all of a pre-Brexit day guideline it will continue with this approach. One example given by the FCA concerns the European Banking Authority’s (EBA) guidelines on sound remuneration policies. This is where the FCA notified the EBA that it would comply with all aspects of these guidelines, except for the requirement that the limit on awarding variable remuneration to 100per cent of fixed remuneration, or 200per cent with shareholder approval (the bonus cap) must be applied in any case to all firms subject to the CRD IV.

In terms of materials that the ESA produce post Brexit day, the FCA states that it will consider them and set out its expectations as to how they should be treated where its appropriate to do so.

Any changes to the guidance on remuneration?

It’s worth noting that the FCA is proposing to change the text in chapters 19A and 19D of SYSC which allows firms to apply a notional discount rate to the total variable remuneration awarded to material risk takers to calculate the bonus cap. The Handbook currently requires firms wishing to apply the discount rate to apply the methodology set out in the EBA guidelines on applicable notional discount rate for variable remuneration. Compliance with these guidelines is mandatory and the formula for calculation relies on inflation and interest rates produced by Eurostat. The figures produced by Eurostat may not be produced for the UK following Brexit and to deal with this the FCA proposes to remove from its rules the requirement to discount variable remuneration in the way specified in the guidelines and replace this with a Handbook note reference.

AOB?

The FCA is not currently consulting on how it will change its forms in a no deal Brexit scenario. This will be covered in a future consultation.