Brexit: the future of financial regulation and supervision Contents

Chapter 3: Incorporating the EU acquis in financial services

The EU (Withdrawal) Bill

64.The Government seeks to translate existing EU legislation into domestic law by means of delegated legislation, using powers set out in the European Union (Withdrawal) Bill. Stephen Barclay MP, the City Minister, summarised the Government’s approach: “We have been very clear that we are not looking to make policy changes. In essence, it is a cut and paste of the status quo. We are not seeking to deregulate.”114

65.While a ‘cut and paste’ approach may appear straightforward, the sheer scale of the process and the associated costs should not be underestimated. As TheCityUK commented: “The task of separating UK law from EU law has widely been recognised as the biggest legislative challenge the UK has ever faced, involving the translation of over 12,000 EU regulations into UK law and the adaptation of 7,900 statutory instruments which implement EU legislation.”115 This process poses particular challenges in the field of financial services. In the words of Stephen Jones of UK Finance: “It is an enormously complex piece of legislation that is required: essentially, the adoption of the acquis into English law. I believe there are 10,000 pages of EU originated financial services rules and, frankly, there is very little time.”116

66.The evidence from the financial services industry revealed broad support for the Government’s approach. Catherine McGuinness, of the City of London Corporation, said that “the key concern … is for clarity, certainty and stability, and just knowing that there are not going to be tweaks and changes—that we are going to be faced with where we are at the moment, and then we can move forward”.117 The Association for Financial Markets in Europe (AFME) also welcomed the Bill, and expressed support for “the objectives of clarity and continuity”.118

67.Despite the industry’s support for the Bill, AFME highlighted “a number of important challenges and issues”.119 Simon Lewis, Chief Executive of AFME, stated: “The sheer complexity of the EU (Withdrawal) Bill should not be underestimated, and I know that some of the regulators within the community are having to beef up their legal teams just to think about how they can understand the implications of what needs to be delivered.”120 The devil will lie in the detail.

Incorporating the Lamfalussy framework

68.Within the EU regulatory process in financial services, the ‘Lamfalussy process’ or ‘Lamfalussy architecture’ (named for Alexandre Lamfalussy, the Chair of the committee that created it) prevails. The process was first initiated in 2001, and amended in 2011 when the European Supervisory Authorities (ESAs) came into being.121 The Lamfalussy architecture, outlined in Box 3, was designed to allow for the swift amendment of what is often highly technical legislation.

Box 3: The Lamfalussy architecture: level 1, 2, 3, and 4 financial services regulation

The Lamfalussy architecture consists of four regulatory ‘levels’, all of which sit within the EU’s secondary law. The most significant is level 1, the ordinary legislative procedure, wherein the European Parliament and Council adopt laws (basic acts, either Directives or Regulations), which have been proposed by the Commission. Level 2 measures derive from provisions contained in basic acts that empower the Commission to adopt non-legislative delegated or implementing acts. These often set technical standards, on which the Commission consults the ESAs (in the case of Binding Technical Standards, the ESAs propose them for adoption by the Commission). Level 3 measures involve the ESAs issuing guidance on a comply-or-explain basis. Level 4 encompasses supervision enforcement by the ESAs and the Commission.122

Parliamentary scrutiny is built into the process: level 1 legislation is agreed by the co-legislators, the Council of Ministers and the European Parliament; level 2 technical standards are subject to a range of scrutiny processes according to whether they are delegated acts (under Article 290 TFEU) or implementing acts (under Article 291 TFEU). Under Article 290 the Council and European Parliament may block or revoke (by qualified majority and majority respectively) the Commission’s proposed acts; the act comes into force only if no such objection is expressed. Implementing acts are scrutinised via the examination procedure and the advisory procedure, both of which involve scrutiny by committees made up of representatives of the Member States’ finance ministers and a chair from the Commission. Under the examination procedure, the committee delivers a binding opinion by way of a qualified majority; under the advisory procedure the opinions are non-binding, and a simple majority vote is sufficient.

Source: Slaughter and May, Introduction to the legislative processes for European Union directives and regulations on financial services matters (April 2014): [accessed 12 January 2018]

69.Level 1 measures, as defined in the Lamfalussy framework, are a legally highly significant and far-reaching, but numerically small, component of EU law. The number of level 2 measures is, by contrast, very large,123 encompassing a body of law that may be less easily translated into the UK’s statute book. Moreover, there are a number of instruments below level 2, as the ESAs are empowered as a part of level 3 measures to produce non-binding guidance and Q&As that clarify the operation of level 1 texts. These Q&As can often have quite significant effects, leading the Financial Markets Law Committee to state, in a response to the Commission’s recent consultation on the ESAs, that the process is “characterised by a substantial element of practical and procedural uncertainty, which could be detrimental to participants in the markets supervised by the ESAs”.124 This uncertainty, inherent in the Lamfalussy framework, compounds the difficulty of translating the EU acquis into domestic law. As Professor Eilís Ferran said: “It is not at all clear what happens to the non-binding guidance that is given by the European Supervisory Authorities at the moment.”125

70.The City Minister, Stephen Barclay MP, explained the Government’s approach:

“I would break it down by saying that within the levels of legislation in Europe, levels 1 and 2 will clearly be for the scrutiny of Parliament, and levels 3 and 4—the technical standards—will be within the remit that the regulators already have under the guidance.”126

Challenging this neat division between levels, however, the Investment Association commented that “much of EU law, even at level 1, is at a level of detail that, if a domestic initiative, would be within the powers and responsibilities of the regulators”.127 The Building Societies Association was therefore concerned that the Government’s approach of translating level 1 law by means of domestic delegated legislation could encode an unwieldy structure: “Without considering how that acquis can be updated in future, the Bill will perpetuate one of the main defects of the current EU position, namely that too much detail is in legislation and is difficult to update.”128 Simon Gleeson also reflected on this point, commenting that many significant EU measures are contained in level 1 legislation:

“When we translate that into UK law, if we simply copy Europe … we will be moving into our primary legislation stuff that properly belongs in regulators’ rulebooks … If we take a bunch of regulatory material that, almost by its nature, should be reasonably dynamic, and hard-bake it into statutory instruments, we are creating a monstrous procedural problem for ourselves in how we regulate the market.”129

Unknowns and inoperables

71.While the Government’s approach of incorporating the acquis via the Bill may be correct, many details are still unclear. Certain elements of the EU framework are not immediately transposable, and are referred to as ‘inoperables’. The most obvious inoperable is the exercise of powers by the ESAs, which will need to be transferred to the PRA and FCA. As Stephen Jones told us, “amending the inoperables” means that “where jurisdiction cannot any more be held by European agencies, it needs to be transferred to an equivalent UK agency—we have to address that”.130 This is, however, perhaps the most straightforward part of the exercise. As Mr Jones went on to explain, “there are relatively few instances where there is not an immediate and obvious UK equivalent to replace a European authority that currently sits as an arbiter of the EU”.131

72.There are various other, more complex, inoperables. A key concern is what is often called ‘in-flight’ legislation, which is legislation that has been agreed but that has not fully entered into force before the point at which the UK leaves the EU. Professor Ferran elaborated this point: “We are going to convert EU law that is in force and applicable as at [the date of withdrawal]. Satisfying the law ‘in force and applicable’ requirement is potentially problematic if we have staggered starts to EU regulation, and we have not already completed the process of writing all the technical rules. That will give rise to legal uncertainty.”132 Andrew Bailey responded that “the clear rule of engagement up to March 2019 is that we are implementing EU legislation and EU rules”, and that “the same position holds for level 2 and level 3”, but that the ultimate status of legislation coming into force after that point “depends on agreement on a transition and whatever future agreement the UK Government reach with the EU”.133

73.A further issue concerns agreements with third countries. Richard Knox, of HM Treasury, said that “as the UK ceases to be an EU member state, the access privileges and rights with third countries by dint of being a member state fall away. We have systematically gone through … them and our intention is to provide continuity for industry to allow those access rights to continue.” He added: “There are a large number of agreements, I think 300 or so.”134 Simon Gleeson, however, questioned the status of these agreements during any transition period: “You do not just need an interim period with Europe; you also need an interim period with all the third countries that currently have equivalence and similar arrangements with Europe, so that they can put those in place with the UK before you get to the end.”135

74.Mr Gleeson also suggested that “the biggest thing” missing from the Bill was “the position of European businesses in the UK. Although transporting European law into the UK is easy, working out what we do domestically is a whole new issue.”136 The current scale of cross-border business is significant: Neena Gill MEP noted that 8,008 EU/EEA companies hold a total of 23,532 passports to do business in the UK.137 The Loan Market Association, which represents over 666 commercial and investment banks, institutional investors, law firms, service providers and rating agencies involved in the syndicated loan market, observed that in 2016, UK banks provided €46.4 billion in syndicated loans to borrowers in the EU-27; during the same period, EU banks funded €41.5 billion for UK borrowers.138

75.Sam Woods explained that a major issue for the PRA was “the inbounds. We have 160 branches here—about 75 banks and 85 insurance companies—from the EEA, and we need to think about how we can authorise those institutions.”139 Lowri Khan, of HM Treasury, said: “A certain amount could be done by allowing inbound firms to continue to service existing contracts. A range of different approaches could be taken. We are working through them to see which would best fit the circumstances and our objectives.”140

76.It is noteworthy that the Bank of England has recently consulted on proposals that would allow EU wholesale banks and insurers to be re-authorised as branches within the UK and so not be required to establish subsidiaries.141 The FCA also stated that it anticipates that “firms will be able to continue to benefit from passporting between the UK and EEA after the point of exit and during the implementation period”.142 The Chancellor of the Exchequer confirmed in a written statement that: “As requested by the Bank and the FCA, the Government will, if necessary, bring forward legislation … which will enable EEA firms and funds operating in the UK to obtain a ‘temporary permission’ to continue their activities in the UK for a limited period after withdrawal.”143 We are encouraged by the Bank’s initiative, and the Chancellor’s statement.

Conclusions and recommendations

77.A crucial element of the EU (Withdrawal) Bill process will lie in the resolution of ‘inoperables’: references to, for example, EU bodies that will no longer have jurisdiction after Brexit. Translating the acquis will also require dealing with the agreements the EU has with third countries. These cover areas such as equivalence rulings with non-EU members (for example the agreement with the US under EMIR, which allows EU clearing members to use US CCPs). The UK will need to decide how to incorporate these agreements. UK regulators have also begun to make statements regarding their proposed treatment of EU businesses within the UK. The clarity that these decisions will ultimately provide is very much to be welcomed. However, insofar as there is a risk to UK financial stability in granting access to third country firms, a new domestic permissions regime must be carefully managed.

Future parliamentary scrutiny

78.It is clear from the preceding paragraphs that Brexit will entail a substantial transfer of powers from EU institutions to domestic regulators. This has implications for the terrain of parliamentary scrutiny. That scrutiny is currently configured to reflect the UK’s membership of the EU: the House of Lords EU Financial Affairs Sub-Committee scrutinises legislation emerging from the EU in economic governance and financial services, as does the House of Commons European Scrutiny Committee. Withdrawal from the EU will necessarily change this model. In the context of financial services, once the end state has been reached, the complexity of the probable legislative process (involving both primary and secondary legislation and regulatory technical standards), coupled with the continued need to make policy in light of international standards and, in the event of a market access agreement being reached, EU law, will place considerable demands on the parliamentary scrutiny process.

79.Professor Niamh Moloney accordingly asked: “Where will the Financial Conduct Authority, the Bank of England and the Prudential Regulation Authority emerge at the end of this process as regards their regulatory powers to finesse and amend secondary legislation in a way that is nimble and gives the EU comfort?”144 The Financial Services Consumer Panel argued that “the way power, responsibility and accountability is distributed between these institutions will have a profound impact on all users of financial services. It is vital this impact is considered in the design of the post-exit framework.”145

80.Our witnesses certainly did not want the acquis to be transferred wholesale into primary legislation—as the Building Societies Association commented, it would be unworkable to require primary legislation every time regulations needed to be modified: “This cannot be a sensible outcome for banking regulation.”146 A similar objection may be made to the use of delegated legislation: as Stephen Jones told us, if every piece of regulation needs to go through the Withdrawal Bill process, “you are not going to be sleeping very much for the next 18 months”.147 This would therefore suggest that the majority of the current rulebook should be adopted by the UK’s regulators. A balance will therefore need to be struck between parliamentary scrutiny and flexibility.

81.This was identified as a challenge by several industry witnesses. PwC stated:

“Brexit has the potential to increase the powers and centralisation of the PRA and FCA significantly, as they are granted further direct and indirect supervisory and rule making powers post-Brexit … These developments further emphasise the need for accountability and scrutiny of the regulatory bodies by Parliament (through existing mechanisms) and openness and dialogue with industry and other stakeholders on regulatory decisions.”148

Clifford Chance agreed that incorporating rules into existing handbooks “raises the issue of the extent to which parliamentary scrutiny should be imposed over such rulemaking and, in particular, whether Parliament should be involved in subsequent amendments of such rules”.149 Dr Kay Swinburne MEP was clear that “If Parliament here has no oversight of the agencies’ rule-making and no ability to call them back in any way or to tell them that they are not in line with the original political intent, we are in a very difficult position, where you give a huge amount of authority and discretion to unelected, unaccountable entities”.150

82.The regulators recognised this challenge, which Andrew Bailey described as “a big issue for the role of Parliament”, adding that “it would make sense from the point of view of our accountability for there to be the power for Parliament to scrutinise things that we do in the future. I would not object; in fact, I would welcome it in some ways.” At the same time, he was “hesitant about making it the norm, simply because of the sheer volume of activity across the board, not just from us but in every other walk of public policy implementation”. Nevertheless, Mr Bailey stressed that “it is for you to decide what the role of Parliament is and not for us”.151 Julian Adams of Prudential concurred: “Clearly, it is for Parliament to decide how much is done by Parliament.”152

83.The transfer of powers to regulators also raises the issue of accountability to Government. Mr Adams told us that accountability would be due not only to Parliament, but also “we would want to introduce another intervention point, which we argue would be the Treasury”.153 PwC agreed that interaction between government, the industry and regulators would need to be institutionalised in future: “There should be effective collaboration between different Government departments, the industry and regulators in order to agree on priorities and actions.” They argued that “A joint body will need to be instituted to meet regularly.”154

84.A further issue is the extent to which Government and the regulators should consult with industry. Andrew Bailey commented: “We consult when we are implementing European legislation, although of course it is a very constrained form of consultation because we cannot change the underlying rules in that situation. We are under a responsibility to produce a cost-benefit analysis, which we do, for the proposals we make.”155 UK Finance noted: “There will be an important role for the regulators such as the PRA and FCA in both helping to define the Government’s aims and in translating the Government’s approach into clear guidelines for business. Close consultation with the banking and financial sector will be important to assist in the implementation of the task of transposition and reduce the risk of accidental errors.”156 The ABI also encouraged the Government “to consult extensively, and to draw on the experience of as many stakeholders as possible”, in particular before making delegated legislation.157

85.In considering how to carry out scrutiny in future, Parliament may wish to take account of the EU’s legislative scrutiny process. The Committee’s previous inquiry, The post-crisis EU financial regulatory framework: do the pieces fit?,158 heard a large amount of evidence from witnesses on the involvement of the European Parliament. Views on the substantive contribution made by MEPs were mixed: some witnesses (including those from industry) highlighted the sheer volume of work performed by MEPs during the crisis, amending some 30–40% of legislative texts, while others were of the view that some of these amendments were misguided.

86.In the present inquiry, Dr Kay Swinburne MEP praised the EU’s scrutiny processes, noting that it “set up a specific system where the Parliament and the Council have oversight of every rule that is made and the right to reject a rule if it is not in line with the political intent”. In particular, Dr Swinburne emphasised that the EU’s system had been instituted in response to concerns over the scrutiny process in place in the US, in which “the agencies are much more independent. Once they have the primary legislation handed to them, as a very large dossier, they effectively have little oversight of what goes on at the rule-making stage”. She argued that the EU had decided that this “was not a suitable system for modern-day financial services, because it gave too much interpretive value to the regulators themselves, with no scrutiny or accountability”.159

87.Dr Swinburne also noted the huge difference between the resources devoted to scrutiny in the European Parliament, and those currently available in the UK Parliament:

“The system in the UK needs to be reviewed. As a member of a committee in the European Parliament … I have resources that allow me to do impact assessments if we feel that the Commission’s impact assessments are not good enough. We have a policy unit that supports our work … We have external consultancies on our books that we can call upon to do external studies for us at any point, and we can call hearings and workshops on any topic that the committee decides to investigate. We have a very comprehensive set of tools at our disposal, with significant financial resources to make sure that, as non-experts, we have experts advising us at every stage.”160

88.Nonetheless, the current process of agreeing and scrutinising EU legislation is not without its critics, and the Investment and Life Assurance Group (ILAG) described it as “unwieldy and opaque: not all stages are open to public consultation”. They also highlighted the burden that engaging with the EU regulatory process placed upon industry: “Whilst the Level 1 legislation usually has a two-year implementation period, in practice most of this time is taken up by the EU bodies developing Level 2 material, leaving firms uncertain as to the detailed requirements until very close to the date by which they are required to comply.” They argued that lack of accountability and transparency “puts unnecessary strain on resources, and risks failure to implement on time”.161 The UK’s future legislative and scrutiny processes will need to be carefully designed to ensure the right balance is struck.

Conclusions and recommendations

89.The Government will need to adopt a nuanced approach towards the translation of EU regulation into domestic law. In future some rules will need to be enshrined in statute, which could be effected using powers contained in the European Union (Withdrawal) Bill. However, it may be more appropriate, where it is important that rules be flexible and dynamic, or where they concern more technical areas, for regulators to issue guidance and set standards. The Government should develop an appropriate architecture for the future domestic regulation of financial services.

90.Any future regulatory regime will probably result in a significant increase in the powers of domestic regulators to determine rules and provide non-statutory, but binding, guidance. It is vital that Brexit, in transferring powers to domestic regulators, should not result in an unintended deficit in democratic scrutiny and accountability.

91.The EU’s multi-layered approach to financial regulation is underpinned by detailed and resource-intensive scrutiny by the European Parliament. Assuming that domestic regulators will gain powers as a result of Brexit, the Westminster Parliament will need to increase commensurately the resources available to support a similar level of scrutiny. This is particularly the case with regard to the regulation of financial services, where powers transferred from the EU to UK regulators will require ongoing specialist scrutiny if the UK is to replicate the level of oversight that the European Parliament has to date provided.

92.We note that this issue concerns both Houses; we also note the forthcoming review of the Committee structure of the House of Lords, which is being conducted by the House of Lords Liaison Committee. In light of these factors, we do not seek to make specific recommendations on future parliamentary scrutiny. It is clear, however, that financial services will require increased scrutiny and resources in relation to domestic, EU and international level regulatory standards, and that the burden will necessarily fall upon Parliament. We look forward to the House of Lords Liaison Committee addressing this issue in the course of its review.

115 Written evidence from TheCityUK (FRS0041)

118 Written evidence from AFME (FRS0021)

119 Written evidence from AFME (FRS0021)

121 The three ESAs are the European Securities and Markets Authority (ESMA), the European Insurance and Occupational Pensions Authority (EIOPA), and the European Banking Authority (EBA) (which replaced a previous structure of Committees manned by national supervisors). Many of our previous reports cover the ESAs: for the most recent, see European Union Committee, The post-crisis EU financial regulatory framework: do the pieces fit? (5th Report, Session 2014–15, HL Paper 103).

122 See Financial Conduct Authority, A brief guide to the European Union and its legislative processes (June 2011): [accessed 19 January 2018]

123 European Commission Directorate-General for Financial Stability, ‘Financial Services and Capital Markets Union, Overview/Planning Level 2 legislative measures in the area of financial service’ (11 December 2017): [accessed 12 January 2018]

124 Financial Markets Law Committee, Issues of legal uncertainty arising in the context of the used of Q&A documents by the European Supervisory Authorities: response to the European Commission’s public consultation on the operations of the European Supervisory Authorities (May 2017): [accessed 12 January 2018]

127 Written evidence from the Investment Association (FRS0029)

128 Written evidence from the Building Societies Association (FRS0010)

137 Written evidence from Neena Gill MEP (FS0013)

138 Written evidence from the Loan Market Association (FRS0002)

141 Bank of England, Press Release: The Bank of England’s approach to the authorisation and supervision of international banks, insurers and central counterparties (20 December 2017): [accessed 12 January 2018]

142 Financial Conduct Authority, Press Release: FCA statement on EU withdrawal (20 December 2017): [accessed 12 January 2018]

143 HC Deb, 20 December 2017, col 57WS

145 Written evidence from the Financial Services Consumer Panel (FRS0024)

146 Written evidence from the Building Societies Association (FRS0010)

148 Written evidence from PwC (FRS0019)

149 Written evidence from Clifford Chance (FRS0039)

154 Written evidence from PwC (FRS0019)

156 Written evidence from UK Finance (FRS0044)

157 Written evidence from ABI (FRS0008)

158 European Union Committee, The post-crisis EU financial regulatory framework: do the pieces fit? (5th Report, Session 2014–15, HL 103) pp 30–32

161 Written evidence from ILAG (FRS0014)

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