Association for Financial Markets In Europe (AFME) – Written Evidence (FRS0021)

Introduction

1. The Association for Financial Markets in Europe (AFME) welcomes the opportunity to respond to the House of Lords European Union Committee Financial Affairs’ inquiry into financial regulation and supervision following Brexit (the “Inquiry”).
2. AFME represents a broad array of European and global participants in the wholesale financial markets. Its members comprise pan-EU and global banks as well as key regional banks, brokers, law firms, investors and other financial market participants. We advocate stable, competitive, sustainable European financial markets that support economic growth and benefit society.
3. AFME is the European member of the Global Financial Markets Association (GFMA) a global alliance with the Securities Industry and Financial Markets Association (SIFMA) in the US, and the Asia Securities Industry and Financial Markets Association (ASIFMA) in Asia.
4. AFME is committed to fostering deep and integrated European capital markets which serve the needs of companies, investors and savers across Europe. AFME’s approach to Brexit is pan-European, fact-based and location neutral. Our focus is on the need to maintain efficient capital markets and ensure financial stability.
5. It is critical that policymakers and legislators are well-informed of the potential impact their decisions could have on the financial services sector and its clients. We therefore welcome the Inquiry and the opportunity to respond to this Call for Evidence as well as have Simon Lewis, CEO of AFME, provide oral evidence on 18th October.

Summary

6. The UK has played an important role in the development of regulatory standards and regulation both at the international and EU level. This extensive post-crisis reform programme has significantly strengthened the resilience of the banking sector and improved investor protection. The existing regulatory framework in place is broadly fit-for-purpose and has achieved the objectives that were set out. We have however called on policymakers to continue reviewing and fine-tuning specific elements of the regulatory reform programme to avoid unintended consequences on banks and the economy.
7. In light of this, we have welcomed the European Commission’s Call for Evidence on the Regulatory Framework for Financial Services and their announced follow-up actions. We believe that if the UK leaves the EU before certain announcements from the Call for Evidence follow-up action plan have been implemented, the UK should nevertheless implement these reforms domestically.
8. We welcome the Government’s efforts to provide continuity with regard to the domestication of EU-derived law before the UK leaves the EU through the European Union (Withdrawal) Bill (Withdrawal Bill). We support the objectives of clarity and continuity, but there are a number of important challenges and issues that need to be considered as part of the Withdrawal Bill process. We believe it is crucial that as part of the process, sufficient opportunity is provided for industry input.
9. We have consistently made the case for transitional arrangements following the Article 50 negotiation period and in light of this, we welcome Prime Minister’s Theresa May’s proposal, as set out in her recent speech in Florence, for an implementation period after the UK leaves the EU. We have argued that during the transitional period, existing market arrangements would need to be maintained to provide certainty and stability to businesses and market participants.
10. We have also highlighted the need to provide clarity in respect of the continuity of existing contracts following the UK’s withdrawal from the EU. We believe that, either as part of an agreement on transitional arrangements or in a separate arrangement, cross-border contracts which are executed prior to Brexit, but which continue after the point of Brexit, should be grandfathered.
11. For the transitional arrangements to have maximum effect, it is important that the EU and UK agree on them as soon as possible. If an agreement on transitional arrangements is reached late in the Article 50 negotiation process, its beneficial effects will have significantly diminished. It is also necessary for the arrangements to be of a legally binding nature in order to be effective.
12. With regard to innovation in financial markets, it is important that regulation should neither stifle innovation nor prevent sound and safe competition. We believe that activities should be regulated, not the technology that delivers it.
13. On the future of the ESAs, in response to the Commission’s review of the ESAs we have argued that it would be appropriate for the Commission to further reflect on the functioning of the ESAs at the time when the details of the future EU-UK relationship are known. The proposals for the review of the ESAs, published on 20th September, may have an impact on the way the future EU-UK relationship will work.
14. The impact on euroclearing in the UK after Brexit will depend on the definition of “substantial systemic importance” in relation to a CCP.  If designated as such, a CCP may no longer be classed as a recognised CCP and would therefore be required to set up in the European Union to continue servicing EU clients. 
15. AFME is concerned that the withdraw of recognition to non-EU CCPs of substantial systemic significance action could have unintended consequences to financial stability as well as adverse effects on operational and systemic risk in the EU, impacting not just banks but also imposing a cost impact to real economy investors.

Call for Evidence questions

Current regulatory regimes

Q1What is your overall assessment of the EU’s financial services regime, in light of its current application to the UK? To what extent is it effective, and for whom?

16. Following the G20 agreement in Pittsburgh in 2009, the European Union introduced a very significant regulatory reform programme intended to address the shortcomings exposed in the financial crisis. The majority of this regulatory reform programme reflected the European implementation of the globally agreed response to the crisis led by the G20, the Financial Stability Board, Basel Committee and IOSCO. The UK has played an important role in the development of these standards and regulations both at the international and EU level.
17. Key elements of the programme included strengthening the capital and supervisory framework, introducing a new framework for bank recovery and resolution and promoting market integrity and transparency, all with the intention to support investment, growth and jobs. This reform programme, which consisted of more than 40 significant pieces of legislation, has substantially strengthened the resilience of the banking sector and improved investor protection. It is also significantly reshaping how financial markets operate. Banks are now much less likely to fail; and were they to do so, authorities have the tools to ensure that they can fail with any losses being borne by bank investors rather than taxpayers.
18. AFME has been supportive of the regulatory reform programme and has engaged constructively with policymakers throughout the process. We would argue that the existing regulatory framework in place, including those measures which will take effect shortly (e.g. MiFID II/MiFIR), is broadly fit-for-purpose and has achieved the objectives that were set out.
19. Besides improving the financial stability of individual institutions, and thereby the system as a whole, the European Commission has also taken important steps in addressing the lack of diversification in the European financial system. In Europe, the financial crisis highlighted both the heavy reliance on bank financing and the interdependence between the financial health of banks and sovereigns as sources of systemic weakness. With the launch of the Capital Markets Union (CMU) initiative, the Commission seeks to create deeper and more integrated capital markets. Besides diversifying funding sources for companies, this also provides new investment opportunities for savers and investors. AFME has been a strong supporter of the CMU initiative.
20. Making greater use of capital market financing reduces the overall reliance on bank lending. Developing a single market for capital in the EU makes the financial system more resilient. Building a broader and deeper EU capital market would provide central banks with new policy options and also increase the impact of existing monetary policy measures focused on the capital markets.
21. There is however room for improvement in certain areas. We have called on policymakers to continue reviewing and fine-tuning specific elements of the regulatory reform programme to avoid unintended consequences on banks and the economy. We therefore welcomed the Commission’s Call for Evidence on the Regulatory Framework for Financial Services[1]. In our response, we emphasised the importance of ensuring that regulation does not negatively impact market liquidity and that market makers are able to perform their role in secondary markets. Market liquidity is crucial both from a financial stability point of view and as a core requirement for the successful development of capital markets.
22. The development of the single market for financial services, supported by the regulatory framework that currently exists, has provided an important foundation for increased integration and harmonisation of EU capital markets. It has enabled UK-based firms to provide cross-border services to clients throughout the EU without the need for additional local authorisations. We are supportive of this deep level of integration that has been achieved. 
23. The UK has benefited from the development of the single market and increased global and European consistency of regulation. This is important to foster cross-border capital markets and reduce regional fragmentation. 

Q2. Are current EU proposals on banking and financial services in your view positive for financial stability? How do you expect the EU’s regulatory framework to evolve in the coming years?

24. We believe that the regulatory reform programme as implemented in recent years has significantly improved the financial stability of the system. The banking system is better capitalised and individual institutions are less likely to fail. Regulators have been given the tools to resolve institutions that are failing and these have already been used[2] demonstrating the important progress that has been achieved in recent years in stabilising the European banking system.
25. As mentioned in response to question 1, in 2015-16 the Commission conducted a Call for Evidence on the Regulatory Framework for Financial Services. Following on from this, the Commission announced a number of targeted actions to improve the regulatory framework. These included adjustments to the BRRD and Solvency II. The Commission also announced further targeted reviews of specific regulations and market segments, including a review of liquidity in the repo market. We believe it is the right approach to regularly review the regulatory framework in a holistic manner and implement targeted changes where needed.
26. We also welcome continued implementation of global standards in Europe, for example the FSB standard on Total Loss-absorbing Capacity (TLAC) and the revisions to the capital framework under the Capital Requirements Regulation and Capital Requirements Directive. Our detailed views on these proposals are available on our website[3].
27. We also welcome the fact that the Commission has taken note of the comments made with regard to measures which were not yet agreed at the moment the Call for Evidence took place. Examples of this are reflected in its proposals for the CRD/R review and include the changes to the leverage ratio being adjusted to reflect the diversity in the EU financial sector, some fine-tuning of aspects of the NSFR (for instance in relation to the treatment of repos/reverse repos) as well as the extension of the SME supporting factor under CRR2. We have also seen the introduction of an observation period for the FRTB during which a scaling factor will apply to compensate for the current calibration of this new standard while international developments are ongoing. We believe that if the UK leaves the EU before certain announcements from the Call for Evidence follow-up action plan have been implemented, the UK should nevertheless implement these reforms domestically in order to stay in line with the European regulatory standards.
28. As part of the Commission’s CMU Mid Term Review Communication[4] the Commission also announced that they will conduct an assessment of whether targeted amendments to relevant EU legislation can deliver a more proportionate regulatory environment supporting SME listing on public markets. They also announced assessing the impact of MiFID II Level 2 rules on listed SME equity research. We would be supportive of appropriate regulatory calibrations being made in these areas. If these calibrations are implemented after the date the UK has left the EU, we believe that the UK should make use of the analysis conducted and equally consider implementing these calibrations in the domestic regulatory framework.
29. AFME strongly supports the CMU initiative. We believe that the measures that have been proposed in the CMU Action Plan and the CMU Mid-Term Review together lead to deeper capital markets and contribute to financial stability. We expect that the EU’s regulatory framework will continue to develop over the coming years, focusing on promoting a single market for capital in the EU. There might be further regulatory developments with respect to market infrastructures over the coming years as well (CCPs in particular). We provide our views on regulatory development with regard to CCPs in response to questions 14 and 15 below.

Q3. What are the key differences between financial regulation as agreed at the international, EU and UK levels, and where are the gaps? How important is it to maintain a level playing field for regulation?

30. A number of key principles and frameworks, for example in the area of bank regulation and derivatives markets, have been agreed at global level and provide international regulatory coherence. These principles and frameworks are being implemented in the EU, UK and other jurisdictions. We are supportive of a strong framework for global regulatory coordination.
31. In the aftermath of the financial crisis, as agreed by the G20, jurisdictions adopted a range of measures designed to strengthen the financial system so as to avoid future crises. However, although generally designed to achieve the same objectives, the new rules that were introduced were often adopted in an uncoordinated way, both in respect of implementation timing and content. The implementation process in different jurisdictions has led to some differences being introduced and not all regulations are perfectly aligned.  Insufficient weight was being given to the practical challenges for international financial services firms which would need to comply with the measures being introduced in all the jurisdictions in which they provide services.
32. Conflicting regulatory policies and divergent implementation of global standards create barriers to capital flows and reduce market efficiency. This in the end increases the cost of doing business impacting market participants and their clients. It is however challenging to assess key differences between financial regulatory frameworks in different jurisdictions as each regulatory area needs to be considered within its specific context.
33. Capital markets are international and global in nature. We therefore believe that it is important to maintain broad regulatory principles and a level playing field, where possible and desirable, to avoid the risk of damaging regulatory divergence. Initiatives such as the EU-US Financial Regulatory Forum and the IOSCO Task Force on Cross-Border Regulation help in promoting better regulatory coordination. Regardless of the ultimate relationship between the EU and the UK going forward, we regard it as very important to develop mechanisms for ensuring consistency with global standards, regulatory coordination and cooperation following the UK’s departure from the EU.

Q4. Are there any particular legal or practical challenges related to incorporating the existing body of EU financial services legislation into the UK’s domestic law, for example the PRA rulebook?

34. There are significant potential implications of Brexit for UK financial services law. Our members are seeking as much certainty and clarity as possible in this process to enable them to plan and adapt to any changes. We support the UK government’s objectives of providing for the continuity of EU-derived law and maintaining as close to the status quo as possible at the point of Brexit. This is vital for banks, businesses and other market participants to have clarity on the future regulatory framework at the point of the UK’s exit from the European Union.
35. The Withdrawal Bill is important in achieving this objective. However, while we strongly support the objective of maintaining continuity and incorporating the acquis of EU-derived law into UK domestic law, we recognise that achieving this in practice involves a very significant exercise in terms of its scale and complexity. This is particularly important in the area of financial services due to the very significant amount of EU-derived law in this area.
36. We therefore recognise the significant scope of this exercise and the importance of ‘getting it right’. We believe it is crucial that as part of the process, sufficient opportunity is provided for industry input and consultation in order to avoid any unintended consequences as the EU acquis is brought across into UK domestic law.
37. There are a number of important challenges and issues that need to be considered as part of the domestication process. First, the scope of the Withdrawal Bill itself gives rise to challenges and uncertainty. As proposed, the scope of the bill includes EU-derived law which is in effect at the time of the UK’s exit. This arises from the requirement that legislation is “operative immediately before exit day” under clause 3 of the bill. Accordingly, this does not extend to legislation which is in force but not in effect at that date. For example, a provision of a regulation which is in force, but does not take effect until a specified time after the date of the UK’s exit would, it appears, not fall within the scope of the bill. Similarly, legislation which is not yet in force at the date of exit would not fall within the scope of the bill. This creates uncertainty and is likely to require the UK to introduce further legislation or take further steps to maintain consistency with European law. Some significant pieces of financial services legislation could fall within this potential lacuna, for example:

      the revisions to the capital and resolution framework under the Capital Requirements Regulation, Capital Requirements Directive and Bank Recovery & Resolution Directive, which are currently under negotiation and might not be in force at the date of the UK’s exit. This legislation implements a number of important changes to the prudential and resolution frameworks;

      the proposed regulation on recovery and resolution of Central Counterparties;

      the proposed revisions to the European Market Infrastructure Regulation, as proposed in May 2017.

38. The government should clarify its proposed approach to legislation which is not in effect at the date of exit to provide clarity and enable firms to plan for implementation. This is also important to avoid divergence between UK and EU law which could otherwise occur quite quickly following exit. This also needs to be considered in the context of any transitional period as discussed below.
39. Secondly, it will be important to avoid any unnecessary changes or further goldplating as part of the exercise. Given the complex process banks are having to go through as part of the Brexit process, maintaining a consistent regulatory framework is important so that resources can be focused on making sure that clients can continue to be served in the way needed. Unnecessary changes or goldplating regulation would complicate the process for banks and their clients, which already going through a very significant transition. We are supportive of the IRSG’s guiding principles as set out in their recent publication on the domestication of EU legislation[5], one of which is that policy changes need to be dealt with separately from domestication.
40. Third, important decisions will need to be made on what happens to the decisions taken and powers currently exercised by the European institutions and the ESAs. For example, ESMA is responsible for the supervision of credit rating agencies. Clarity needs to be provided on who will assume these powers in the UK.
41. In addition to their other roles, the ESAs issue non-binding guidelines, recommendations and Q&As. These instruments provide important clarifications on implementation matters which frequently have significant implications for market participants. Guidance and Q&As are considered to be tools to address issues of a more technical nature or a way to clarify certain issues arising from Level 1 or Level 2 legislation. Q&As are theoretically non-binding guidance but the interpretations and clarifications provided by the ESAs in Q&As have a significant impact across the marketplace with supervised entities being encouraged to follow the guidance in the same way as they follow the actual rules. It will therefore be important to clarify whether ESA guidance and Q&As are considered to be part of the EU body of legislation that will be incorporated into UK domestic law. We would argue that they should be in order to achieve the government’s objective of maintaining continuity, but they currently fall outside the scope of the Withdrawal Bill.
42. Fourth, clarity needs to be provided on the status of decisions of the Court of Justice of the EU (CJEU) and how UK courts are expected to interpret legislation in the future. For example, should future decisions of the CJEU interpreting existing EU law formally be of persuasive relevance in the future interpretation of that legislation by the UK courts? What happens with respect to the EU principles that have been applied in the past, such as the proportionality principle? Clarity needs to be provided on whether EU-derived law should be interpreted by UK courts in accordance with EU legal principles, looking at the purpose of the provision, or UK principles, generally following a common law approach.
43. Fifth, we believe that the role of regulators in amending existing legislation should be clarified. We recognise the important role that the UK Parliament plays in the process of the Withdrawal Bill and the domestication of EU legislation. However, for amending technical standards we believe that the FCA or PRA are likely to be better placed to do this given their deep technical expertise and the importance of maintaining the status quo from a regulatory perspective. We would welcome further consideration on this issue.
44. Finally, important policy choices will need to be made in particular in respect of how the UK should treat reciprocal rights under EU-derived legislation. Clarity should be provided as soon as possible to enable affected firms to plan and make any necessary adaptations. 

Transition, equivalence and alignment

Q5. What would be the key priorities for a transitional arrangement, and how much continuity would you expect to see under such an arrangement?

45. The Brexit negotiations are taking place under significant time pressure with the UK’s membership of the EU due to end on 29 March 2019. Faced with no clarity on the future relationship between the EU and the UK, market participants are having to take important decisions amid considerable uncertainty. In light of this, we have consistently made the case for transitional arrangements following the Article 50 negotiation period. We therefore very much welcome the proposal from Prime Minister Theresa May, as set out in her recent speech in Florance, for an implementation period after the UK leaves the EU during which current arrangements would continue.
46. We have explained the importance of transitional arrangements in more detail in a recent publication[6]. It is expected that the UK will leave the EU without having agreed on a new relationship that can be entered into on day one. This means that clients and firms are faced with cliff edge risks that need to be avoided to preserve economic certainty and financial stability.
47. Banks are putting arrangements in place to minimise the disruption to their businesses and clients. However, not all cliff edge risks can be avoided through firms’ planning. A number of arrangements will need to be adjusted to future regulatory conditions which will be apparent when a new EU-UK relationship is established, including in financial services.
48. There are a number of key priorities for a transitional arrangement. First, we believe that during the transitional period, existing market arrangements would need to be maintained to provide certainty and stability to businesses and market participants as they prepare to adjust their operations to the final permanent relationship. This means that existing legislation, regulation, permissions and authorisations should continue to be effective during the transitional period. This would create a maximum level of continuity to business and market participants and avoids them having to adjust twice (i.e. first to the transitional arrangements and subsequently to the future, long-term arrangements that the EU and UK might agree on) and provide a “standstill” while the future arrangements are finalised. We also believe that a further adaptation period should be provided to enable time to adapt to the final arrangements between the UK and the EU once they are agreed.
49. Second, either as part of an agreement on transitional arrangements or in a separate arrangement, we believe that cross-border contracts which are executed prior to Brexit, but which continue after the point of Brexit, should be grandfathered. Absent grandfathering, there is uncertainty regarding the ability of banks to continue to perform regulated activities under existing cross-border contracts between the EU and UK following Brexit. There is a very significant stock of existing contracts, many of which span a number of years and are important to support the financing and risk management activities of businesses. Clarity on the ability of businesses to rely on existing contracts is therefore essential. Existing contracts should therefore be allowed to continue and run to maturity, subject to certain limitations or conditions. We have recently published a paper on the issue of grandfathering of cross-border financial services contracts, in conjunction with UK Finance[7].
50. Third, during a transition period it is important that regulators, central banks and national governments provide as much clarity and certainty as possible and continue to support financial market stability. This may require particular attention during the uncertain period around Brexit, and in particular during the transition, and may involve more regular market communications and targeted support in case of market need (e.g. access to liquidity schemes).

Q6. In practical terms, how and when could a transitional arrangement be agreed and put in place? How long would such a transition need to last?

51. For the transitional arrangements to have maximum effect, it is important that the EU and UK agree on them as soon as possible. If an agreement on transitional arrangements is reached late in the Article 50 negotiation process, its beneficial effects will have significantly diminished. An early agreement on a transitional phase would allow for much better preparation to minimise risks and disruptions that could impact the economy. Absent an early agreement on transitional arrangements, business will be forced to make sub-optimal decisions and may further delay investment. We have argued that clarity on transitional arrangements should be provided as soon as possible by the end of 2017.
52. For an agreement on transitional arrangements to be effective, it should be of a legally binding nature. A simple statement of commitment to a transitional period would be helpful but is unlikely to be sufficient for business to be able to rely on and to adjust their Brexit implementation work. The EU27 and UK Government should commit to a period of transition in a legally and regulatory underpinned binding agreement. We believe that this should be worked out as soon as possible and should be prioritised at the start of phase 2 of the negotiations.
53. In terms of the length of the transitional arrangements, we believe that they should comprise both the period during which the EU and UK will be negotiating and ratifying the new relationship (the ‘bridging period’) as well as a period of phased adjustment to the new trade relationship (the ‘adaptation period’). It is therefore important for it to be a sufficient length. The exact time needed will however depend on both the time needed to negotiate the new trade relationship as well as the difference between the current EU membership arrangement and the arrangements under such new trade relationship. The smaller the difference between the two, the shorter a transitional period is likely to be needed.

Q7. What are the benefits and drawbacks of seeking equivalence? What conditions are likely to be attached by the EU to any equivalence decisions?

54. Third country regimes could provide a means of mitigating some of the impact of the exit of the UK from the EU on continued cross-border business by UK and EU27 firms, because - at least at the outset following the UK's exit - the UK could ensure that its regulatory regime is equivalent to the regime in the EU27 by maintaining its existing regulatory regime implementing EU laws. Conversely, the UK could offer reciprocal access to EU27 firms. This would promote continued post-Brexit cross border activity for the services where a third country equivalence regime is available offering more choice to end clients.
55. At the same time, it needs to be recognised that the equivalence framework is not a substitute for the benefits that the current Single Market arrangements provide. The equivalence regimes do not cover all services and activities. For example, they do not cover firms' rights to access market infrastructure, lending, deposit-taking, foreign exchange or other banking services falling outside the scope of MiFID II/MiFIR, payment services or retail investment services (including private wealth business). In general, the equivalence regimes provide only limited rights of access in relation to retail clients. Therefore, these equivalence regimes cannot replicate the existing arrangements.
56. Also, as highlighted in our publication with Clifford Chance last year[8], many of these equivalence regimes are yet untested and there is a risk that political constraints may make it more difficult for the EU27 to extend these benefits of equivalence to the UK. It is unclear to some extent what ‘equivalence’ exactly means in practice. Equivalence assessments are supposed to be outcomes-based, and some divergence between two regulatory regimes is permitted, but it is not clear when such divergences will result in a regime being considered to be non-equivalent.
57. In addition, these regimes are largely conditioned on equivalence and effective reciprocity and, therefore, the UK may lose the benefits of these regimes unless it is prepared to maintain its existing regulatory regime implementing EU laws and adapting its laws to reflect new EU laws as they develop over time - even though it would no longer have a direct means of influencing the development of those laws. In that sense the requirement to be equivalent is ongoing.
58. Also, EU legislators would be able at any time unilaterally to amend or withdraw these regimes. Therefore, in the longer term, these regimes may not provide a stable mechanism protecting market access if the UK and the EU take increasingly divergent approaches to regulation.
59. Finally, a significant element of concern exists around the timing of when equivalence determinations for the UK would be made. EU authorities need to make a formal determination of equivalence but under the existing regimes the EU can only conduct such assessment on third countries. This could lead to the situation whereby the UK would need to leave the EU first before being assessed by the EU for equivalence status. This risks creating a gap between the date of the UK’s exit from the EU and the date on which the equivalence regime takes effect. During this period, firms in the UK would not be able to continue to provide the services they would be permitted to provide if the UK was considered to be equivalent immediately following Brexit.

Q8. What alternatives may exist for maintaining alignment between the UK’s and EU’s regimes? What options could be considered for resolving disputes or arbitrating on such matters? What would be the barriers to a more bespoke arrangement?

60. We have decided not to answer this question as the alternatives for maintaining alignment between the UK’s and EU’s regime will depend to a large extent on the outcomes of political decisions concerning the UK’s withdrawal from the EU.

The future environment

Q9. What effect will the loss of the UK have on the development of the EU financial services framework and its capital markets?

61. The UK currently constitutes that the EU’s main centre for wholesale financial markets by a considerable margin. The effect of the UK’s withdrawal is difficult to discern at this stage as this will depend on the future relationship between the EU and the UK and arrangements in the financial services sector and other political developments. We are therefore not able to comment on the future development of the EU’s capital markets in detail.
62. We have stated before that EU and UK capital markets have achieved a significant level of integration which has been mutually beneficial. It will become important post-Brexit for the EU27 to continue building up its capital market infrastructure that is able to finance its economy, as long as new EU27-specific infrastructure does not decrease efficiency or increase costs for pan-European market participants. Alongside this future EU27 capital market, the UK will remain a close and major international financial centre, and it will be in the interests of both the UK and the EU27 to cooperate in fostering growth and cooperation in their respective markets.
63. Besides developments in the structure of Europe’s capital markets itself, it can be expected that the UK’s departure will also impact the regulatory framework for financial services. In the first place, the UK will no longer participate in the Council discussions on financial services regulation where they have been an important voice and able to contribute their technical expertise to the development of financial services regulation. Similarly, the UK will no longer have a European Commissioner or have MEPs participating in the European Parliament.
64. Second, the UK’s departure from the EU will demand a consideration of the future resourcing arrangements of the ESAs, including personnel and budgetary needs. The PRA is an important contributor to the EBA’s work and the FCA to ESMA’s work both in terms of personnel support and capacity provided as well as technical expertise. The gap that this creates will need to be filled to preserve the quality of the regulatory framework.

Q10. Where is there scope for the UK to amend its regulatory regime? What precedents exist under current equivalence decisions for divergence to occur?

65. AFME takes a pan-European approach to Brexit. We believe that the UK should remain in compliance with global regulatory standards and minimise divergence from EU regulation. In light of this approach, we have decided not to comment on the scope for the UK to amend its regulatory regime.

Q11. What challenges will expected innovations in financial markets, for instance in the FinTech sector, present in respect of regulation and supervision post-Brexit? How can these challenges be overcome? Can the UK maintain a competitive advantage while adapting to a new regime? If so, how?

66. AFME supports the growing use of FinTech within the wholesale markets, noting that FinTech can deliver a more competitive and innovative financial sector providing opportunities for more efficient customer servicing at lower costs.  AFME members support a collaborative approach to working with FinTech within the wider eco-system and we note that the success of this collaboration is ultimately dependent on certain factors, which determine the incentive to innovate (e.g. risk appetite, the amount of investment capital available, scalability, skills, competition and regulatory approach).
67. As we have recently argued in response to the Commission’s consultation on FinTech[9], we believe that activities should be regulated, not the technology that delivers it. Certain activities warrant careful attention by regulators, regardless of who is engaging in them, as the risks associated with these activities have far reaching impacts to consumers and the broader financial system. Regulation should neither stifle innovation nor prevent sound and safe competition. This is an approach that we would also advocate UK authorities to follow in a post-Brexit environment.
68. As the FinTech ecosystem evolves, regulators should monitor for emerging risks and act when warranted, while ensuring there are no constraints on collaboration within the ecosystem. Engagement beyond this may have unintended consequences. We have argued that any regulatory framework should take into account banks’ existing authorities to develop, test and launch innovative products and services. Any new regulatory framework should be flexible, graduated and principles-based, and oversight should be tied to scale and the risks presented.

Q12. Will leaving the EU affect the way that the UK represents itself in international fora? How can the UK continue to maintain influence when dealing with organisations such as the FSB and IOSCO in setting international standards?

69. In response to the first part of this question it is important to note that the UK is already directly represented in the main international fora. For example, the FCA represents the UK in IOSCO and the Bank of England / PRA represents the UK in the Basel Committee and Financial Stability Board. This will continue to be the case after the UK’s departure from the EU. The UK will however lose its indirect representation through the European Commission and ESMA in IOSCO where they are associate members and the Commission and EBA’s status as observers in the Basel Committee.
70. The UK would also lose its representation in bilateral dialogues that the EU has, such as the EU-US Financial Regulatory Forum.

Supervision

Q13. The Commission is currently conducting a review of the European Supervisory Agencies. What, in your view, are the key areas where reform should be pursued and what might be the impact of such reform on UK supervision?

71. In response to the Commission’s review of the ESAs we have argued that it would be appropriate for the Commission to further reflect on the functioning of the ESAs at the time when the details of the future EU-UK relationship are known. Any arrangements for supervisory and regulatory cooperation between the EU and the UK, which should involve the ESAs, can then be decided upon.
72. In our response to the Commission’s consultation on the review of the ESAs we identified the following eight key priorities for the ESAs:

      supervisory convergence contributes to the reduction of fragmentation of the Single Market and to realising the EU’s potential for growth and competitiveness. Supervisory convergence should therefore remain a key priority for the ESAs as it enables firms to operate cross-border more easily. Supervisory convergence can be enhanced by discouraging goldplating by the National Competent Authorities (NCAs), conducting and publicising more peer reviews and getting involved earlier in case of cross-border conflicts. The ESAs have a key role to play in ensuring a level playing field across the EU;

      improve the involvement of stakeholders by creating more opportunities for contributions from market participants in the Level 2 and Level 3 processes, improving the transparency of how the ESAs deal with input from stakeholders and strengthening the role of the stakeholder groups. The ESAs should follow better regulation principles when engaging with stakeholders and in particular the transparency of the Questions and Answers (Q&A) process should be improved;

      work with realistic implementation deadlines ensuring that sufficient time is given between the finalisation of Level 2 texts and their implementation. It should be considered whether dynamic implementation dates can be used that would be subject to the timing of finalising Level 2 measures and their implementation;

      reform the governance of the ESAs enabling them to pursue a more common European approach by giving the Chairs and Executive Directors voting rights and introducing independent members on the Boards of Supervisors. The Management Boards should be transformed into Executive Boards focusing more on policy content and should be given more decision-making powers;

      increase ESMA’s powers in certain areas of cross-border activity for example by introducing joint supervision of critical benchmarks and Markets in Financial Instruments Directive (MiFID) regulated data providers and beginning to build the capacity and expertise to participate in the supervision of Central Counterparties (CCPs) and Central Securities Depositories (CSDs) while leaving the supervisory responsibilities for these institutions with the NCAs for now. ESMA should also be provided with “Emergency Relief” type of powers to temporarily suspend the application of regulatory requirements in certain circumstances and within a reasonable timeframe;

      give the ESAs a more prominent role in the equivalence assessment process following an outcome-based approach supporting open capital markets. In particular, they could strengthen their valuable role in providing more resource and technical advice in the context of equivalence assessments and ongoing monitoring of equivalence. The ESAs should be tasked more consistently with timely and effectively monitoring the regulatory, supervisory and market developments in third countries while leaving the ultimate decision on the third country equivalence status with the European Commission;

      increase the resources of the ESAs appropriately given the current workload and the proposed additional tasks. We would expect the ESAs to optimise their efficiency in a way to minimise the need for additional funding;

      accept a funding system which would be partly funded by the industry but subject to certain conditions and further detailed consultation with the industry. For example, in cases where activities currently performed by NCAs are transferred to the ESAs, then so should relevant funding arrangements to avoid double charging.

73. Given the fact that the future relationship between the UK and the EU is unknown at this stage and it is unclear which reforms of the ESAs will be agreed upon by the EU, it is difficult to comment on the impact of such reform on the UK supervision. In the context of regulatory cooperation post-Brexit, we have argued that some changes to the governance set-up of the ESAs should be made with regard to their relationship with third country NCAs, which would also cover the UK.
74. At the moment, NCAs from the EEA countries are allowed to attend meetings of the Boards of Supervisors in an observer capacity for Level 2 and Level 3 discussions. Given the enhanced role we are suggesting for the ESAs in the equivalence assessment framework, we would support a reinforced information exchange and an enhanced cooperation framework with other third country NCAs as well. Further consultation on the exact design of this would be needed.
75. Furthermore, we would support the creation of an Advisory Board comprising delegates of third country NCAs with a limited number of members giving advice to the Management Boards and the Supervisory Boards of the ESAs. Its advice would not be binding.
76. On 20th September, the Commission published its legislative proposals amending the mandate of the ESAs. These proposals might have an impact on the way the future EU-UK relationship could work. We are currently reviewing the proposals and would be pleased to share our views in due course.

Q14. How could an enhanced role for ESMA and the ECB in respect of euro-denominated clearing work? What are the options for the UK to retain euro clearing in the light of the European Commission’s recent proposals?

77. On 13th June 2017, the Commission published a proposal to amend EMIR to strengthen supervision of central counterparties (CCPs). Under this proposal, ESMA would become a joint regulator together with the regulator of the CCP’s home country. The Central Bank of Issuance (e.g. ECB for the Euro) would also gain powers of objection in areas such as an extension of activities and services. Third country CCPs would be required to subject themselves to ESMA’s proposed powers in conjunction with the regulator in the home country. Currently regulators sit in EMIR colleges and the home regulator is responsible for regulating the CCP. This regime will change under the new proposal as ESMA is given more power and the various home regulators will need to adapt to the new arrangement.
78. The impact on euroclearing in the UK after Brexit will depend on the definition of “substantial systemic importance” in relation to a CCP.  If designated as such, a CCP may no longer be classed as a recognised CCP and would therefore be required to set up in the European Union to continue servicing EU clients.  The crucial part of the proposal states that, if compliance with certain conditions “does not sufficiently ensure the financial stability of the Union or one of its members states”, then it should not be recognised. “Substantial systemic importance” is not defined or clarified in the text of the proposal. If the CCP is not deemed to endanger the financial stability of the EU, then it will be bound by the more intrusive third-country powers of ESMA although these may be acceptable for the CCP to continue as an equivalent, third country CCP.
79. Separately, but also important to note is that, if there are no transitional arrangements, all UK CCPs will lose the “qualifying” status as the UK withdraws from the EU. Each CCP must then apply for recognition based on an assessment by the Commission and ESMA or otherwise be treated as a third country CCP. As a result, EU27 banks maintaining positions in any non-qualifying CCPs could be in breach of regulations and suffer punitive capital increases.

Q15. How would supervisory cooperation (as envisaged for CCPs) work in practice? Are there any precedents? What are the potential risks?

80. AFME supports the Commission’s objectives of achieving enhanced supervision of CCPs, and of mitigating potential systemic risks in the context of highly integrated global and European financial markets. We consider that the most desirable outcome is a situation in which EU and third country CCPs can continue to service integrated global markets, and in which risks associated with such an outcome are managed appropriately and proportionately.
81. We support the main elements of the Commission’s proposals to enhance the supervision of CCPs in the EU and in relevant third countries to foster financial stability and strong competition among CCPs within and beyond the boundaries of the EU. We call for maximum consistency between the reforms at the supervisory level and recovery and resolution levels of CCPs in the EU and globally. Furthermore, given the global character of the derivatives and clearing market, AFME supports alignment with the global standards developed at FSB/CPMI/IOSCO on CCP resilience, recovery planning and resolvability. In terms of how the proposal would work in practice, it can be noted that:

      the new supervisory powers envisaged by the European Commission proposal will see ESMA become a co-supervisor of the third country CCP;

      a third country CCP would need to formally agree to provide ESMA, directly if necessary, with all relevant information and to allow on-site inspections. Additionally, a legal opinion should be sought confirming that such arrangements are valid in their home jurisdiction;

      the Central Banks of Issue (ECB in case of Euro) will be given powers to impose additional requirements to carry out their monetary policy tasks on third country CCPs seeking recognition.

82. We are not aware of an exact precedent (twin supervisor, direct request for information). The CFTC and EU chose the substituted compliance framework for dual-registered central counterparties (CCPs). This method allowed US based CCPs to seek recognition in the EU based on common internal rules and procedures. The CFTC proposed a determination of comparability with respect to EU requirements, which permitted EU CCPs to provide services to US clearing members and clients whilst complying with certain corresponding EU requirements. Given the global nature of derivatives markets, a common approach to their regulation and supervision is deemed as critical to supporting cross border activity and maintaining financial stability. 
83. AFME is concerned that the withdraw of recognition to non-EU CCPs of substantial systemic significance action could have unintended consequences to financial stability as well as adverse effects on operational and systemic risk in the EU, impacting not just banks but also imposing a cost impact to real economy investors. We consider that regulatory requirements leading to fragmented, inefficient and expensive markets for real economy corporates and investors should be avoided.

29 September 2017