In November 2020, the EU Services Sub-Committee of the House of Lords invited written contributions to its ongoing inquiry into financial services after Brexit. Read the responses submitted by Simon Thomas, Executive Chairman and Tim Reucroft, Chairman of the Advisory Board, Thomas Murray, given below. The opinions given are the authors' own, and not necessarily the view of Thomas Murray.
Thomas Murray Ltd is an independent non-regulated entity dedicated to post-trade risk and analytics. We have been in operation for over 25 years and count most of the major custodian banks as our clients as well as CSDs, CCPs, etc. www.thomasmurray.com
Question 1: Is the UK financial services sector well prepared for the end of the Brexit transition period? What are the main areas where arrangements are not yet in place? Could a lack of certainty prompt companies to move assets and personnel to the EU? How have these preparations shaped the UK financial services sector?
This horse has already bolted. Most banks with excess UK concentration have already restructured their group arrangements (balance sheets and infrastructure etc) to satisfy a hard Brexit. For example, EU subsidiaries of UK arms of USA banks have become the parent to UK entities. It is worth noting that EU regulators have been informally forcing US and UK banks to book EU business through EU entities for several years making the management of global books more difficult and less competitive as liquidity in the EU is too thin.
Question 2: How important is a UK-EU comprehensive trade agreement for the UK's financial services sector? Which specific areas should be a priority?
The UK financial services dominate EU financial services in most areas. The EU are determined to build their own financial services. A comprehensive trade agreement or no agreement should not matter to financial services. However, the EU have sought to conflate trade and financial negotiations. The EU threat to withdraw Equivalence is their weapon of choice, despite the UK being totally equivalent across all financial areas. It does not suit the EU (see question 4 below) that the UK is equivalent. Striking a limited agreement (concession) that central counterparties are equivalent means the EU has taken derivatives off the table and avoided massive EU systemic risk exposure associated with this sector. This has much reduced the UK’s negotiating position around other financial services sectors that require Equivalence to continue to operate as they do today. The conflation of trade and financial services should be resisted but the EU have introduced it and the UK needs to react. The agreement around central counterparties should be reopened and only agreed to if the EU agrees to, say, a five year equivalence notice period /run off across all financial sector activities and not the 30 day notice that remains a massive threat and highly destabilising to UK financial services.
UK financial market infrastructure is very important to the EU, and the UK should be using this extraordinary position to negotiate more effectively.
Question 3: What would be the implications of a 'no agreement' scenario for financial services firms? What more can be done to help the financial services sector prepare for a 'no agreement' scenario?
Preparations already made by banks that have long assumed a hard Brexit mean the UK financial services will be fine under this scenario. It is the EU that should (is) be concerned about the loss of access to UK financial market infrastructure. Notwithstanding this the EU will withdraw equivalence as soon as they can. This is patently a nonsense (refer to question 4 below) as their financial “market” is actually multiple local markets and as such largely fragmented. However, the EU is aggressively driving regulatory change across multiple financial market sectors to build its own financial market sector. The EU are using regulation to distort the existing dominance of Anglo Saxon financial services, and particularly the existing dominance of UK financial services in the EU.
This can be illustrated in the fund management sector where new capital requirements for investment firms are being proposed. This applies to UCITS and AIFMD products provided by MIFID licenced firms. It is being implemented via the Investment Firms Regulation and the Investment Firms Directive. The European Banking Authority has been given responsibility for developing the level II regulations. This suggests that the EU Commission sees it as banking regulations and not securities. A road map has been issued. Basically capital requirements for fund managers will be introduced. Any fund management group larger than €30 billion (consolidated AUM) will be required to become a credit institution and therefore regulated just like banks. Any fund manager larger than €5 billion (AUM) would also be caught. The impact on the UK’s asset/fund management sector cannot be underestimated. It is encouraging that the UK has delayed this until January 2022.
Question 4: What would be the consequences if the EU does not grant the UK positive equivalence determinations? In what areas are equivalence decisions particularly important?
The UK is super-equivalent. We set the standards that Europe has to date largely followed. Take the example of CCPs.
The detailed criteria of EU 2019-2099 states in para 2(c) page 21:
ESMA, after consulting the ESRB and in agreement with the central banks of issue referred to in point (f) of paragraph 3 in accordance with Article 24b(3) and commensurate with the degree of systemic importance of the CCP in accordance with paragraph 2a of this Article, may, on the basis of a fully reasoned assessment, conclude that a CCP or some of its clearing services are of such substantial systemic importance that that CCP should not be recognised to provide certain clearing services or activities.
There you have it – “a fully reasoned assessment”. Despite all the empirical criteria laid down, the Third Country CCP may still pass - but this cannot be allowed, so ESMA deem it to be too important (of such substantial systemic importance) – justifying a new rational criterion at the sole discretion of ESMA. British empiricism stymied by continental rationalism.
The EU has no intention of granting equivalence and is likely to leave the UK financial market under a constant threat of its withdrawal. It’s regulations are protectionist. It cannot win the contest on the basis of a level playing field. All the UK have to do is tilt the playing field in our favour. The government has started this strategy – see our response to question 7 below. Beyond an extended notice period (see response to question 2 above) equivalence determined by the EU is a nonsense. The UK needs to diverge. We should make the rules and develop our own equivalence standards. There will be short term disruption, duplication and dissent. The costs will be borne by the industry, both in the UK and EU. The long term reward will be an unassailable competitive advantage.
Equivalence must be made to go both ways. The UK might determine that EU counterparties cannot use UK CCPs because of the risk of contagion. Why should the Bank of England use UK taxpayers’ funds to bail out LCH Ltd if a German counterparty goes bust? A “fully reasoned assessment” must say no. Euroclear UK is an EU entity and as such should be brought under the control of the UK authorities. It really is of such systemic importance that it should be UK owned.
Question 7: The Government has now published the Financial Services Bill and Financial Services Future Regulatory Framework Review consultation paper. What are the strengths and weaknesses of these proposals?
We fully support an outcomes (empirical) approach to differentiate the UK from the EU’s rationalist approach. This better suits the purpose of regulation.
Adopting an outcomes approach presents a number of opportunities for the UK but these need to be captured in a business context. We need a financial sector blueprint for UK plc covering banking, capital markets, funds and insurance. Thomas Murray can only speak for the post-trade space within the capital markets, but here we need to identify the business opportunities across the asset classes (securities, fixed income, rates, credits, commodities, FX). There are some significant opportunities here which we could exploit. For brevity we will consider just two:
1. The funds space.
EU regulation has failed to tackle the enormous risk in the funds space, particularly in ETFs. Significant effort (and some progress) has been made in making CSDs fit for purpose but CSDR missed the opportunity to mandate the use of CSDs for funds. It’s been a headache for Germany and France who recognise, but can’t find a way around, the Luxembourg problem.
Just to declare our interests: Thomas Murray spent a great deal of time and money designing a Proof of Concept and Business Model for a pan-European FundsClear, but the EU banks were too preoccupied. The Thomas Murray model made funds a separate asset class with all the benefits that would bring – e.g. use of funds as collateral for additional liquidity, fund futures to avoid REITs lock ins, etc.
2. CCP end game
This addresses all the asset classes. With LCH Ltd we have a world leading CCP. With UK regulatory support it could become unassailable.
We’d like to see the Bank of England supply digital currency (CBDC) to UK CCPs so that they can move variation margin in real time 24x7 – every time the price moves, the variation margin moves. This means the Margin Period of Risk (MOPR) goes to zero and all arguments about initial margin disappear. Defaults would be dealt with in real time so that the default fund goes to zero. EU CCPs would still be expending all their efforts on regulatory reporting.
We would urge the government to include these opportunities for UK plc in their Future Regulatory Framework.
(End of Response)
To see the Committee's questions in full, visit https://committees.parliament.uk/work/752/financial-services-after-brexit/news/120485/committee-invites-fresh-evidence-to-its-inquiry-on-financial-services-after-brexit/
If you have any questions, please contact Simon Thomas or Tim Reucroft.