(a), (c) and (d): Not cleared from scrutiny; further information requested; drawn to the attention of the Treasury Committee; (b) Cleared from scrutiny.
(a) Proposed Directive concerning bank resolution and recovery; (b) Proposed Directive about the ranking of unsecured debt instruments in insolvency hierarchy; (c) Proposed Directive concerning aspects of capital requirements; (d) Proposed Regulation concerning aspects of capital requirements
Article 114 TFEU, ordinary legislative procedure, QMV
(a) (38300), 14777/16 + ADDs 1–2, COM(16) 852; (b) (38301), 14778/16 + ADDs 1–2, COM(16) 853; (c) (38303), 14776/16 + ADDs 1–2 COM(16) 854; (d) (38304), 14775/16 + ADDs 1–3, COM(16) 850
19.1The European Commission in November 2016 tabled a package of legislative proposals to further reduce risk in the EU’s financial system (referred to as the Risk Reduction Measures or RRM). The proposals aim to bring the EU’s existing legislation in line with new international standards on prudential requirements (ensuring banks have sufficient capital to withstand a run on deposits or illiquidity in the markets) and recapitalisation of banks at risk of collapse. Two elements of the package, on the creditor hierarchy in bank insolvencies and the adoption of a new accounting standard on expected credit losses, were fast-tracked by the Council to expedite their entry into force (see “Background” for more information).
19.2The Economic Secretary to the Treasury (Stephen Barclay) wrote to the European Scrutiny Committee on 30 June 2017 about progress made in the negotiations on the RRM package. He informs the Committee that the ECOFIN Council, with the UK’s support, had adopted general approaches on the two fast-tracked proposals despite the fact that the previous Committee had not lifted its scrutiny reserve. He apologises for this override of scrutiny, which he said only occurred because the Committee had not yet been reformed at the time of the Council meeting. Formal adoption of the fast-tracked legislation is expected to follow by the end of 2017 to allow for their entry into force in early 2018.
19.3With respect to the remaining proposals of the package, the Minister described the areas where discussions within the Council are on-going (see “Background” for more information). These include restrictions on staff remuneration, the total loss-absorption capacity of failing banks, the net stable funding ratio and firm-specific Pillar 2 requirements. He also notes that there is no consensus yet within the Council on the proposal to require some large third-country banks with independently-authorised subsidiaries in the EU to establish an additional, fully-capitalised Intermediate Holding Company within the Single Market.
19.4In August the Minister indicated that the Estonian Presidency is aiming for the adoption of a Council General Approach on the remaining proposals by the end of 2017, and that trilogues with the European Parliament were expected to commence in 2018. He concluded that formal adoption of the package of legislation “is unlikely until at least early 2019”. The bulk of the RRM package is therefore not expected to enter into force before the end of the UK’s two-year notification period to withdraw from the EU under Article 50 TEU. However, the Prime Minister in September called for a post-Brexit “implementation period” during which UK and EU access to one another’s markets for both services and goods “should continue on current terms” using the framework of “existing structure of EU rules and regulations”. It is unclear if the Government accepts such an arrangement would in all likelihood necessitate continued adherence to EU law for its duration, or how the Prime Minister’s proposal could be compatible with the claims by Cabinet Ministers that the UK will leave the Single Market in March 2019.
19.5We are grateful to the Minister for his comprehensive overview of the deliberations within the Council on the entire RRM package. We accept his explanation for the override of scrutiny in the adoption of the two general approaches on the fast-tracked proposals at the June ECOFIN Council. The Estonian Presidency has indicated it will aim to adopt a general approach on the proposals which were not fast-tracked at the ECOFIN Council in December 2017. We ask the Minister to write to us in good time with the relevant trilogue agreements or Presidency proposals in due course.
19.6Meanwhile, the repercussions of Brexit for the UK banking industry remain unclear. While the Chancellor has insisted that the UK will leave the Single Market in March 2019, the Prime Minister has asked for an interim arrangement immediately following the end of the Article 50 period, during which the market access between the UK and the EU would continue on “current terms”, to “minimise disruption and avoid cliff edges” in the provision of financial services. How this would constitute anything other than continued membership of the Single Market, with the attendant legal obligations but without UK representation in the EU institutions, is unclear.
19.7In the absence of an interim arrangement, however, an abrupt departure from the Single Market in March 2019 would have significant implications for UK banks who operate elsewhere in the EU from their British base. As “third country” financial institutions, they will not benefit from the “passporting” arrangements created by the Capital Requirements Directive and other sectoral legislation. EU law does not currently allow for significant cross-border access to the European market for financial services by firms not based in the EU or EFTA-EEA countries. Once we are outside the Single Market, UK banks would have to cease or limit the provision of a number of services covered by the Capital Requirements Directive to EU-based customers, including deposit-taking, commercial lending, and payment services. To continue all of their activities in the EU-27 as they do at present, UK banks would have to establish independently-capitalised subsidiaries within the EU.
19.8It is also clear that the interim period as suggested by the Prime Minister would only delay the imposition of the restrictions EU law foresees for “third country” banks on UK-based institutions. While the Chancellor has called for a continued free flow of financial services between the UK and the EU based on “a new process for establishing regulatory requirements for cross-border business”, the Government has provided no detail about the scope or terms of such an arrangement. Nor do we have any indication that any form of joint regulatory oversight of such a key sector would be acceptable to the EU-27.
19.9In order to clarify how the disruptive “cliff edge” in the provision of financial services and an end to Single Market membership can be achieved simultaneously, we will be writing to the Minister separately about the Chancellor’s proposals for the overarching institutional EU-UK framework for financial services during both immediate post-Brexit period, and in the long-term.
19.10There is also a specific Brexit-related impact of the RRM proposals on British banks. Once the UK becomes a “third country” vis-à-vis the EU (whether in March 2019 or following a further transitional period), the proposed new requirements for non-EU banks will apply to UK-based institutions. We therefore ask the Minister to provide us with his impact assessment of the proposals on intermediate holding companies for third-country banks with EU-based subsidiaries following Brexit. We would also be grateful to know what consultations the Minister has had with the financial services industry about the UK’s exit from the EU’s banking regulatory framework, and what opportunities our withdrawal presents to increase the competitiveness of that industry post-Brexit.
19.11In anticipation of further information from the Minister about these outstanding issues, we retain the RRM proposals under scrutiny with the exemption of the IFRS 9 and creditor hierarchy proposals, which we now clear from scrutiny. We also draw these developments to the attention of the Treasury Committee.
(a) Proposed Directive amending Directive 2014/59/EU on loss-absorbing and recapitalisation capacity of credit institutions and investment firms and amending Directive 98/26/EC, Directive 2002/47/EC, Directive 2012/30/EU, Directive 2011/35/EU, Directive 2005/56/EC, Directive 2004/25/EC and Directive 2007/36/EC: (38300), + ADDs 1–2, COM(16) 852; (b) Proposed Directive on amending Directive 2014/59/EU of the European Parliament and of the Council as regards the ranking of unsecured debt instruments in insolvency hierarchy: (38301), + ADDs 1–2, COM(16) 853; (c) Proposed Directive amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures: (38303), + ADDs 1–2 COM(16) 854; (d) Proposed Regulation amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements and amending Regulation (EU) No 648/2012: (38304), + ADDs 1–3, COM(16) 850.
19.12In November 2016, the Commission proposed a package of three Directives and a Regulation with complex and technical provisions concerning bank resolution and recovery, the ranking of unsecured debt instruments in the insolvency hierarchy of bank creditors, and prudential requirements. Their purpose is to reduce the overall risk in the EU’s financial system by making banks and other financial institutions more prudentially sound and more resistant to externals shocks, based primarily on standards recently-agreed by the Basel Committee on Banking Supervision (BCBS) and the Financial Stability Board (FSB).
19.13These interrelated proposals, collectively referred to as the “Risk Reduction Measures” (RRM), would affect many important aspects of EU financial regulation. The main objectives of the RRM package are to:
19.14The then-Economic Secretary to the Treasury (Simon Kirby) submitted an Explanatory Memorandum on all four proposals in December 2016. This shows that the Government was generally supportive of the Commission’s proposals, but also underlines the need to ensure that EU legislation was consistent with agreed international standards, was flexible and proportionate, and had appropriate technical detail set in the primary legislation.
19.15The Minister also notes that the Commission had proposed to lift some of the EU’s rules on remuneration for bankers, relating to deferral of bonuses and pay-out in instruments, for companies with less than €5 billion (£4.5 billion) in assets or for staff in any firm with relatively low bonus payments. Individual Member States would retain the flexibility to impose the full restrictions if they so choose.
19.16In February 2017 the Government gave our predecessors a first update on Council working group consideration of the proposals. The most significant development had been a decision by the Council to accelerate two specific elements: the Creditor Hierarchy Directive on statutory subordination (part of the EU’s efforts to comply with the new total loss-absorbing capacity standards) and the provisions of the amendment to the Capital Requirements Regulation dealing with the International Financial Reporting Standards (IFRS) 9 accounting rules.
19.17The Creditor Hierarchy Directive (document b) was fast-tracked by the Council to ensure an EU-wide harmonised approach to statutory subordination of bank creditors’ claims in the event of insolvency. Rapid harmonisation in this field was considered desirable after a number of Member States began revising their national insolvency hierarchy rules in disparate ways to meet the new Total Loss-absorbing Capacity (TLAC) standard of the Financial Stability Board, which is due to be implemented globally by January 2019. Member States were of the opinion that early agreement on a new EU-wide approach to statutory subordinated liabilities would give financial institutions a sound legal basis to issue buffers of eligible debt, and provide legal certainty to investors.
19.18The second expedited proposal was the proposed transitional phase-in for the IFRS 9 accounting rules under the amendments to Capital Requirements Regulation or CRR (document d). IFRS 9 was published by the International Accounting Standards Board (IASB) in 2014, to improve the reporting on banks’ expected credit losses on financial assets for financial periods starting on or after 1 January 2018. The new model is likely to lead to higher loss predictions and, as a result, a reduction in the capital held by financial institutions to meet regulatory requirements.
19.19The proposal amending the CRR included a transitional period to allow institutions to phase-in the potential detrimental effect of IFRS 9 on their capital ratios for a period of time. The Council agreed to bring the start of the phase-in forward to 1 January 2018. Given the timetable for the adoption of the Regulation as a whole, this required its separation from the remainder of the proposal.
19.20The Minister’s letter of February 2017 also sets out the possible timetable for implementation of the RRM package, then estimated “no earlier than late 2018 [or] early 2019”, with the exception of the IFRS 9 proposal. The Minister reiterates the Government’s intention that the UK would continue to be strongly supportive of international rule-setting for financial services, post-Brexit.
19.21The previous Committee noted this account of where matters stood on negotiation of these proposals and looked forward to further reports in due course. Meanwhile it retained the documents under scrutiny.
19.22The previous Committee received a letter from the then-Economic Secretary to the Treasury (Simon Kirby) on 24 April 2017, too late to be considered before the prorogation of Parliament. In it, the Minister gives an account of the negotiations on the RRM package as the Maltese Presidency was entering its final phase. We received a further letter from the Mr. Kirby’s successor as Economic Secretary (Stephen Barclay) on 30 June, following formal consideration of the proposals by EU Finance Ministers at the June ECOFIN Council.
19.23At its meeting on 16 June 2017, the ECOFIN Council adopted general approaches on both statutory subordination of bank creditors and the IFRS9 standard. The Council also asked the Presidency to start trilogue negotiations with the European Parliament as soon as the latter had adopted its position on both proposals. In his letter, the Minister notes that the Government supported both proposals (in the process overriding scrutiny), as it was “national interest to vote in favour”.
19.24The Minister reiterates, with respect to Creditor Hierarchy Directive, that the ECOFIN general approach would create a harmonised approach to statutory subordination by requiring Member States to create a class of “non-preferred senior debt”. The Minister adds that the text of the proposal would not prevent the UK from pursuing structural subordination, which was its preferred approach in most cases. If other Member States chose to use statutory subordination, they would have to follow the harmonised approach laid down in the new Directive.
19.25On the proposed transitional phase-in for the IFRS 9 accounting rules, the Minister emphasises that the Government had continued to support a fast-tracked transition to the new standard as an “important regulatory tool to prevent pro-cyclical macroeconomic instability”. He added that the Council’s general approach would phase-in IFRS 9 gradually, in recognition of the fact that the new model could “potentially see … bank capital fall substantially in the event of any worsening economic situation”. The Minister concludes:
“The legislation balances competing Member State views around the need to afford banks flexibility, and those, largely from smaller Member States, who were concerned with introducing complexity. We proposed a compromise in the form of a ‘Modified Static Approach’, which is responsive to any changes in provisions over the lifetime of the transition. […] Our proposal has been adopted and we believe it will allow banks to adequately mitigate the impacts and remain appropriate capitalised.”
19.26The two fast-tracked proposals must still be agreed between the Council and the European Parliament under the ordinary legislative procedure. The Parliament’s Economic & Monetary Affairs (ECON) Committee adopted its position on the IFRS9 proposal on 11 July and on the Insolvency Hierarchy Directive on 10 October. On the latter file, agreement was reached after a single trilogue meeting on 25 October. Trilogues on the IFRS9 proposal are expected to conclude before the end of 2017, and both proposals are scheduled for entry into force in early 2018.
19.27In addition to the adoption of general approaches on the two fast-tracked elements of the RRM package, the ECOFIN Council of 16 June also considered the progress made towards adoption of the remaining three proposals. In his letter, the Minister provided an update on these the outcome of these discussions:
19.28We are grateful to the Minister for his comprehensive overview of the deliberations within the Council on the entire RRM package. We have accepted the Minister’s explanation for the override of scrutiny in the adoption of the general approaches at the June ECOFIN Council.
19.29It is clear from the state of play that formal adoption of these proposals, with the exception of the two fast-tracked files, is unlikely to take place before early to mid-2018. The Estonian Presidency has indicated it hopes to adopt general approaches on the three remaining proposals of the RRM package at the ECOFIN Council meeting on 5 December 2017.
19.30While the EU’s financial regulatory framework—and the market access restrictions it imposes on firms from non-EU countries—raises significant questions for the ability of UK-based banks to conduct business within the Single Market post-Brexit, the RRM proposals, for the most part, do not have any immediate Brexit implications as they largely implement international standards by which the UK is bound independently.
19.31However, the Commission has proposed to require some large third-country banks with independently-authorised subsidiaries in the EU to establish an additional, fully-capitalised Intermediate Holding Company within the Single Market. Post-Brexit, this could impact on UK-based banks with subsidiaries elsewhere in the Single Market. In February 2017, the then-Economic Secretary explains that the UK had taken the line that the proposal was tabled “without proper scrutiny, and may be protectionist in a way that could impose costs on firms that are not appropriately justified by any resolution or financial stability benefits”.
19.32In response to a request from the previous Committee for “the Government’s assessment of the consequences for the UK” of the RRM package in the context of Brexit, the previous Economic Secretary responded that he would not “speculate on UK rulemaking at some unspecified point in the future”, and referred to the Government’s intention to put all pre-Brexit EU financial services legislation on a domestic statutory footing through the Repeal Bill. He adds that the other focus of the Government’s work was the “negotiations on the final EU/UK relationship”.
19.33We do not consider that this reply adequately covers the implications the possible implications of Brexit for the UK financial services industry. We have written to the Economic Secretary separately to ask for further clarification of the Government’s proposals on the post-Brexit framework for trade in financial services between the UK and the EU, including services covered by the Capital Requirements Directive and other pieces of sectoral EU legislation. With respect to the RRM package, we have also asked him to provide us with the Government’s assessment of the potential consequences of the IHC proposal for UK-based banks with subsidiaries elsewhere in the EU, once those institutions become “third-country firms” post-Brexit.
19.34As regards the application of the RRM proposals in the UK, we note that their likely date of applicability will fall after March 2019. The European Union (Withdrawal) Bill does not foresee the implementation of EU legislation which is adopted prior to Brexit, but which is not yet applicable when the UK ceases to be a Member State. However, the Prime Minister is seeking an “implementation period” after March 2019 during which the UK would retain its current level of market access to the EU, which we presume would be contingent on its continued implementation of EU law (including European legislation which becomes effective during this interim period).
19.35We have asked for urgent clarification from the Economic Secretary about the proposed terms of the “implementation period”, and whether the Government is preparing for the possibility that EU law which enters into force after the two-year Article 50 period might still be binding on the UK. Until we have clarity on this point, it is impossible to come to an informed assessment of the likely impact of the RRM proposals—or any other pending EU legislation—in the UK.
215 from Stephen Barclay to the Chair of the European Scrutiny Committee (30 June 2017).
216 Estonian Presidency, ““ (27 October 2017).
217 from Stephen Barclay to Lord Boswell (7 August 2017).
218 by Prime Minister Theresa May (Florence, 22 September 2017).
219 The Daily Telegraph, ““ (13 August 2017).
220 from Stephen Barclay to Lord Boswell (24 August 2017).
222 The four proposals are a ; a ; a ; and a .
223 The package presented by the Commission contained a fifth proposal, concerning the Single Resolution Mechanism (SRM), which was cleared by the previous Committee in January 2017 as the SRM does not apply to the UK. See our for more details.
224 See our predecessors’ Report of 11 January 2017 for more details: Twenty-fifth Report HC 71–xxiii (2016–17), (11 January 2017).
225 HM Treasury submitted a single Explanatory Memorandum on the amendments to the Bank Recovery and Resolution Directive, the Capital Requirements Directive and the Capital Requirements Regulation on 20 December 2016. HM Treasury’s Explanatory Memorandum on the insolvency hierarchy proposal (dated 14 December 2016) can be found here.
226 The Capital Requirements Directive requires firms to hold discretionary pension benefits of employees who leave before retirement for a five-year period in the form of shares or other financial instruments, rather than cash.
227 The so-called “bonus cap”, which limits bankers’ bonuses to 200 per cent of their fixed salary, is not affected by this new exemption.
228 from Simon Kirby to Sir William Cash (14 February 2017).
229 Under statutory subordination, the law of the country where a company is registered provides that debt held by an external investor is subordinated to other types of liabilities on the company’s balance sheet.
230 The Financial Stability Board is an internal organisation that makes recommendations for the safety and soundness of the global financial system, established by the G20 in 2009. Bank of England Governor Mark Carney is its current Chair.
231 The TLAC standard is part of the resolution framework for failing systemically important banks (restructuring them to preserve their stability and critical functions). One bank resolution tool is “bail-in”, which sees debt claims or other liabilities converted written off, internally recapitalising the institution and passing the costs on to shareholders and other creditors rather than the taxpayer. The liabilities that can be converted in this way are ranked in a hierarchy, where some forms of liabilities would be converted first (e.g. outstanding shares) while others are converted last or not at all (such as outstanding tax liabilities). A liability which is converted before another in this hierarchy is called “subordinated”. The TLAC standard requires the largest banks to hold a sufficient minimum amount of subordinated liabilities to ensure smooth and fast absorption of losses and recapitalisation in the event of resolution.
232 A particular concern was that a bank’s outstanding shares can be treated less favourably (from the shareholders’ perspective) under a resolution scenario than if the bank were to become insolvent, because they are easier to bail-in than certain other liabilities (such as derivatives or short-term inter-bank loans), even if the shares are not subordinated in the insolvency hierarchy to these other liabilities (and so shareholders would have an equal claim in the event of insolvency). To address this discrepancy and prevent legal claims by shareholders for compensation if their shares are ‘bailed-in’, the TLAC standard therefore requires any liabilities counted towards the TLAC requirement to be subordinated. In effect this makes the position of shareholders equal under both the resolution and the insolvency scenario.
233 See .
234 The European Parliament on 18 May 2017 to split the IFRS9 provisions from the rest of the proposal to amend the Capital Requirements Regulation. As a result, the original legislative procedure (reference number 2016/0360/COD) has been split, with 2016/0360A constituting the bulk of the original proposal and the IFRS9 standard now contained in procedure 2016/0360B.
235 from Simon Kirby to Sir William Cash (24 April 2017).
236 from Stephen Barclay to the Chair of the European Scrutiny Committee (30 June 2017).
237 ECOFIN Council, (16 June 2017).
241 Under structural subordination, group structures are used to ensure that debt issued to external investors is subordinate in the event of insolvency. An investor lends money to a holding company, which in turn lends it to one of its operating subsidiaries. If insolvency occurs, the investor cannot access the assets of these subsidiaries until all the creditors of the subsidiaries have been paid.
242 The Regulation on IFSR 9 also contains provisions on large exposure limits in Member States who issue public debt denominated in a currency other than their own. This applies primarily to smaller EU countries who are not part of the Eurozone but issue debt in euros.
243 For more information on the content and objectives of these proposals, please refer to our predecessors’ .
244 submitted by HM Treasury (20 December 2016).
245 Letter from Simon Kirby to Sir William Cash of 14 February 2017
20 November 2017