Brexit: the future of financial regulation and supervision Contents

Chapter 4: Possibilities for a transition period

The Committee’s letter to the Chancellor of the Exchequer on the need for a transition

93.From an early stage of the inquiry, witnesses emphasised how vital a transition period, before current relationships change, would prove—for both financial services providers, and for the businesses relying on them, across the whole of the EU. Catherine McGuinness, Policy Chairman of the City of London Corporation, told us that the most critical requirement was “knowing now—and I mean now, as soon as possible, such that there will be further time to work this through”.162

94.On 8 November 2017 we therefore wrote to the Chancellor of the Exchequer (see Appendix 4) to highlight the pressing need for the UK Government to seek an agreement on a ‘standstill’ transition period in the negotiations.163 The urgency of this issue was reflected in our decision to issue the letter at the mid-point of the inquiry, rather than waiting for this report. The letter echoed the Chancellor’s own words in describing such a period as a ‘wasting asset’: if it were to be agreed too late, it would have little impact on the financial services sector’s contingency planning. The letter also outlined concerns regarding contractual continuity and the potential legal form of such a transition agreement.

95.The Chancellor replied on 2 December 2017. He stated that the Government “agreed with the Committee on the importance of minimising any risks of disruption as the UK withdraws from the EU, and maintaining the ability of the financial services industry to continue the orderly service of cross-border clients”.164 He pointed to the comments of the Financial Policy Committee on cross-border contractual continuity contained in its November Financial Stability Report, particularly with regard to risks associated with over-the-counter (OTC) derivatives and insurance contracts.165 The Chancellor made clear that the Government was considering all risks associated with contractual continuity, and that “an integral part of delivering our withdrawal will be the negotiation of a time-limited implementation period, to provide certainty and avoid a cliff-edge for business and individuals during the adjustment from the current structures of membership to the new relationship”.166

The need for a transition and implementation period

96.Both industry and regulators made a convincing case for the financial stability benefits of a transition period. However, the term ‘transition period’ disguises a number of different possible meanings. Stephen Jones, Chief Executive of UK Finance, told us: “One person’s transition is someone else’s standstill is someone else’s implementation, and one of the biggest problems in this debate is language.”167 Andrew Bailey stated that transition was “separate” from “an implementation agreement. The reason why it is understandable that they get conflated is that they may well overlap in time, but they are conceptually slightly different.”168 Miles Celic, Chief Executive of TheCityUK, defined two distinct phases: “First, there is a bridging period between the end of the Article 50 process and the start of the new relationship, should that be required … and then an adaptation period.”169 The European Union Committee’s report, Brexit: deal or no deal, published in December 2017, endorsed this analysis, concluding that there were “two aspects of transition: a ‘standstill period’ … and an implementation or adaptation period”.170

97.The Government’s position was set out in Prime Minister Theresa May’s speech in Florence on 22 September 2017, in which she described a period of ‘implementation’, to be agreed under Article 50. This would take place “after the UK leaves the EU”, and would provide that “access to one another’s markets should continue on current terms”, ensuring that businesses “only have to plan for one set of changes in the relationship between the UK and the EU”. This period, the Prime Minister said, should be “strictly time-limited”, its length determined “by how long it will take to prepare and implement the new processes and new systems that will underpin that future partnership”. This, she believed, would entail a period of approximately two years.171

98.Stephen Jones summarised the Government’s ask as “an implementation period that would take effect in March 2019, there having been reached a detailed agreement in trade and services before then”.172 Such an implementation period would indeed be welcome, as it would give industry time to adapt to the new rules in an orderly fashion, but implementation, as Catherine McGuiness told us, only makes sense if parties know what the future arrangement will look like.173 Miles Celic commented that “the nature of FTAs is that you go through and agree them, then move to an adaptation period where it is effectively bedded in”.174

99.John McFarlane explained the view of Barclays: “Transitioning is most valuable if it is to somewhere worthwhile at the end. Transitioning to nowhere does not have the same value.”175 This concern clearly resonated across the industry, as Charlotte Crosswell of Innovate Finance told us: “There would be huge value in a transition period, because FinTech firms would know what they were trying to move towards.”176 Sir Jon Cunliffe told us that the destination of transition was also critical for the regulators, arguing that it was crucial from a financial stability perspective that “firms have the ability to make a transition to wherever they need to go, in good time and in an orderly way”; he quoted the Chancellor’s perspective that “you do not want firms to make changes twice … so they need to have some idea of the end point they are moving to”.177

100.Witnesses were, however, dubious that a final agreement, which adequately covered services, could be struck prior to March 2019. As John McFarlane said: “I do not think that is very likely, so we will have to work in this uncertain period not knowing where we will end up.”178 Miles Celic noted that the time available to reach such a “full, comprehensive free-trade agreement”was in fact less than 12 months, because “clearly this will need to go to individual parliaments and so forth for ratification on the European side”.179 He described the Government’s approach as “ambitious”, and commented that the Comprehensive Economic and Trade Agreement (CETA) between Canada and the EU took seven years to agree. Precedent, as the European Union Committee noted in its report on Brexit: deal or no deal, suggests that a ‘standstill’ period will probably be needed, “to buy time to finalise an agreement on the future relationship”.180

101.It is unclear how the Commission’s position aligns with a two-stage transition period. The Commission’s negotiating guidelines of 29 April 2017 specify that “to the extent necessary and legally possible, the negotiations may seek to determine transitional arrangements … to provide for bridges towards the foreseeable framework for the future relationship in the light of the progress made”.181 The Commission has since added that a transition period should continue the current acquis in its current form, and last until the end of 2020 to dovetail with the period of the current multiannual financial framework.182 The accompanying Commission proposals make clear that during the transition period “the competences of the Union institutions (in particular the full jurisdiction of the Court of Justice of the European Union)” should be honoured.183 This sounds like a standstill, not an implementation or adaptation period, and there is no guarantee that the fixed time period will align with the agreement of a future relationship.

Conclusions and recommendations

102.Transition should in the first instance provide a standstill extension of the current conditions of market access: this appears to be envisaged by both the Commission and the Government. To be useful, however, any period of transition needs to form part of a three-stage process. First, a standstill period, allowing time for the two sides to agree the terms of their future relationship; then, once that relationship (the ultimate destination) is known, a period of adaptation; and, finally, the seamless commencement of trade under the terms of the new relationship. Absent all these elements of transition, financial services firms will be forced to activate their worst-case scenario contingency plans, with stark implications for the continued provision of services and for financial stability.

Making and averting contingency plans in financial services

103.The financial services industry has already made contingency plans for the ‘worst-case’ scenario that no agreement will be in place on the date of Brexit, 29 March 2019. As Sally Dewar of JP Morgan said: “When we think about Brexit, we do not assume any negotiated position. For us, it is a hard Brexit position.”184 EU agencies have published guidance to business outlining that the UK will become a third country (we note that no guidance was issued to the financial services industry).185 For the industry’s contingency plans not to be activated, a transition period must be announced imminently to address these concerns, or it will be too late. Simon Gleeson, Partner at Clifford Chance, put it bluntly: “If business thinks that it is heading for no deal and no transition, it will be under enormous pressure to move to Europe, and will do so. If at the end of the process we discover that we had a transition after all, that transition will be completely useless.”186

104.Contingency planning for a ‘no deal’ scenario is being supported by the PRA, which has, as Sam Woods explained, “asked firms to show us what they would do in order to preserve the safety and soundness of their business in the event that, at the end of March 2019, there is no successor to passporting as it currently exists between the UK and the EU-27, and there is no transition period”.187 Sally Dewar explained that the PRA asked firms to consider “three scenarios: worst case, best case and a middle case. The PRA focus was on the worst-case scenario and the contingency around that.”188 John McFarlane, Chairman of Barclays, painted a similar picture.189 On the basis of these contingency plans, Sam Woods told us that he expected “around 2% of UK bank and insurance jobs,” to move to the EU on day one, with more to follow after that depending on the form of the agreement that is reached between the UK and EU.190

105.A significant part of firms’ relocation plans concerns the need to set up and authorise businesses within the EU-27, in the event that there is a diminution or cessation of access by UK firms to the EU’s markets. This requires firms to secure licensing approvals, which in turn necessitates a long lead-in time. Barclays told us: “Significant execution actions in respect of Barclays’ relocation plan, which it will be very difficult and costly to reverse, will begin towards the end of Q4 2017 in order to dovetail with necessary licensing approvals.”191 The London Metal exchange agreed that it would take
18–24 months to acquire the necessary licences in order to continue servicing clients in EU countries;192 PwC also suggested that “getting a banking licence can take up to 18 months”.193 In addition to obtaining licences for new business, moves may involve setting up subsidiaries from scratch: Lloyd’s, the insurance market, is already establishing a subsidiary insurance company within the EU in order to continue to write EU business.194

106.Thus businesses are having to move to stand still. Sally Dewar stated that their goal was “to ensure uninterrupted service to our clients. When we think about hard Brexit, the focus is on how we make sure that we continue to serve those clients in the same way as today from 1 April 2019.”195 Sir Jon Cunliffe agreed: “Firms are doing what you would expect them to do. They are saying, ‘Until I know what happens, I will assume no European authorisations other than WTO, and no transition’, and that is necessary for the management of stability risk as a whole.”196 We heard evidence that the industry is well prepared, but cannot afford to wait until the final shape of an agreement is visible before taking irrevocable decisions. Sally Dewar emphasised that JP Morgan had “a very well-established transition plan to make sure that we are ready in time, but we are already in execution mode”.197

Timing and form of an agreement

107.The Minister, Stephen Barclay MP, stated that “we are all acutely aware that timing is a critical factor in transition for firms’ contingency plans. Early agreement on transition is clearly desirable.”198 Mr Gleeson said in October that the deadline would be Christmas 2017;199 Jonathan Herbst and Mark Hoban both told us “the sooner the better”.200 Sam Woods commented: “If we get to around the new year and there has not been a clear political announcement from both sides on a transition, for purely operational reasons we will need to get going on all that work.”201 Andrew Bailey agreed that “it is necessary to have a transition period to allow us time to deal with those risks. That is the thing that needs to be sorted out PDQ.”202 On the other hand, the Secretary of State, the Rt Hon David Davis MP, stated on 2 January 2018 that agreement on a transition “by March [2018] is doable”.203

108.Stephen Jones was emphatic that UK Finance’s members’ plans would be enacted shortly: “The latest date by which most of our mutual members tell us that they can avoid exercising their contingency plans is the end of this year [2017], or possibly Q1 of next year.”204 UK Finance’s members would take promises to deliver a future agreement by March 2019 “with a certain pinch of salt”, adding that if businesses had to wait until March 2019 for “confirmation that there is that ‘implementation period’ and for confirmation as to what that implementation period is actually implementing”,205 they would invoke their contingency plans.

109.The legal form of a transition period is an open question. The CBI stressed that the UK Government and EU-27 should “commit to binding transitional arrangements as soon as possible to manage uncertainty for businesses and bolster confidence”.206 But the meaning of ‘binding’ is by no means clear. Clifford Chance interpreted an ‘agreement’ as no more than “a common announcement by the EU and the UK of an understanding on this issue. This is because a transitional agreement becomes of limited value if its announcement is delayed, and it will not be possible to implement a formal agreement in the time available.”207 However, Miles Celic of TheCityUK was emphatic that a political declaration would “not be ample—nor, for many companies, sufficient”, and called instead for “a legally binding agreement between the UK and the EU-27 that there will be a transitional period”.208 He suggested this could be achieved through a number of means, including lodging a Memorandum of Understanding with the UN.

110.Mark Hoban summarised the issue thus: “An agreement in principle from the EU-27 that there will be a transition period would be very helpful. There is a continuum from a planned statement in a communiqué to something that is legally watertight and, frankly, for the industry, the closer we are to legally watertight, the better.”209 Andrew Bailey concurred: “We need something that is legally binding, in the sense that it can be applied.”210 He suggested that this could be written into European Council conclusions. Sir Jon Cunliffe was more cautious: “I do not see any way that the European Council could make a legally binding commitment until it either has a treaty between the UK as a non-EU member and the EU, or some other legal means.”211 He felt that a political statement would be more feasible: “If firms know that this issue is going to be addressed, how it is going to be addressed, and there is a legal vehicle to take it forward, then my view is that it would give them much of the certainty they need.”212

111.The European Union Committee’s recent report, Brexit: deal or no deal, focused on the logic of the EU’s legal framework: “Article 50 provides only for a withdrawal agreement—any final agreement on the future UK-EU relationship will require a separate legal base (most likely to be Article 218 TFEU), and the European Council guidelines confirm that such an agreement can only be concluded once the UK is no longer a Member State. Prior to 29 March 2019, the most that can be achieved is a political agreement on that future relationship.”213

Contractual continuity

112.Many of our witnesses pointed to contractual continuity as a concern allied with the need for a transition period. The issue is of particular concern to insurers. In the words of Lloyd’s, “Without a transitional arrangement, 29 March 2019 will see Lloyd’s underwriters immediately losing their authorisation to carry on business in EEA countries on a services or an establishment basis.”214 PwC cautioned that without an agreement, insurers would “risk breaching regulatory requirements, as well as potentially committing a criminal offence for carrying on regulated business without required authorisations”.215 Zurich, the Swiss-based insurance group, argued for “a permanent solution to ensure service continuation until their termination”,216 while Simon Lewis, Chief Executive of AFME, told us that “contracts should be grandfathered [treated for their duration under existing terms] to provide certainty to all parties”.217

113.However, the need for contractual continuity in insurance, while it may coincide in large part with any transitional arrangements, also has much longer-term implications. The Financial Services Consumer Panel noted that “hundreds of thousands of existing insurance contracts have terms covering decades”.218 Lloyd’s also argued that “this is not an issue that can be resolved purely through a transitional arrangement, which may only be in place for a short period. It needs to be considered as a separate issue.”219 Zurich agreed that transitional measures were “unlikely to resolve the problem of servicing contracts written under passporting”.220 We therefore anticipate that issues of contractual continuity will be dealt with on a permanent basis, either as part of a separate treaty, or through the Article 50 withdrawal agreement.221

114.In sectors other than insurance, issues of contractual continuity (including the servicing of derivatives contracts and cross-border loans) are likely to be shorter term, with more scope to be resolved within the terms of transition. Simon Puleston Jones, Head of Europe at the Futures Industry Association (FIA), told us that as far as the issues for derivatives contracts are concerned, “We tend to talk about grandfathering not in a contractual sense but in a regulatory sense … From a regulatory perspective, the grandfathering would end at the end of the transition period. The extent to which grandfathering is needed beyond that for contractual reasons is something that still requires further analysis at this stage.”222

115.Sam Woods identified three options for resolving the problem of contractual continuity. His preferred solution would be to include contractual continuity “in the withdrawal agreement, or a separations issue agreement of some kind—a bilateral agreement to fix these things in a symmetrical way on both sides”. There was precedent for this approach in the introduction of the euro, which superseded contracts written in the legacy currencies: “That would be by far the best fix; that would give certainty, and would effectively deal with the issue.”223 Andrew Bailey concurred: “You could deal with it in the Article 50 agreement itself. In many ways, that would be the simplest thing to do.”224

116.Mr Woods identified two less effective options. One was for “the UK and the EU-27 … either in a loose agreement or entirely separately but informally coordinated, [to] take unilateral actions to deal with that problem”. This, he suggested, would be “messy”. The least desirable outcome, which he said was “very unlikely to be satisfactorily effective” was “self-solving by firms”, where they move contracts: “They can set up a thing called a societas Europaea and move that across a border.”225 The Investment and Life Assurance Group (ILAG) further explained that contractual consolidation was, in the normal order of things, “delivered through a Transfer of Engagements under Part VII of the Financial Services and Markets Act 2000”. They continued: “This process works well, albeit with the commitment of time and money, and requires the UK regulators to notify any relevant EU regulator where there is expected to be an affected policyholder in that territory. There is a period of three-months for the relevant EU regulator to raise objections to the proposed transfer; no response is regarded as consent.”226

117.An alternative, according to Mr Woods, was for firms to get their clients to agree to re-issue existing contracts through new bodies (known as re-papering), but he did not believe “that all these contracts with all customers can be re-papered in the timeframe that we are talking about”.227 Andrew Bailey agreed: “The problem with leaving firms to sort it out is that it is extremely disruptive and there is not enough time to do it. It means novation of contracts, for instance. It involves court processes, and there just is not enough time to deal with the volume.”228 The record of the FPC’s meetings on 22 and 27 November 2017, published 5 December, subsequently revealed that “the Bank had written to the High Court to alert them to the potential for increased applications”.229

118.There is, finally, an outstanding issue concerning the status of contracts entered into during any transition period. Professor Eilís Ferran told us that, while it seemed straightforward to “preserve legal rights that have already been acquired, and not disrupt them”, allowing certainty for new contracts entered into during a transition period “gets you into a much more open-ended and rather difficult area”.230 Jonathan Herbst identified two distinct issues: the first was, “Can you lawfully continue to provide business cross-border?” The second was, “Are pre-existing contracts still binding and valid? It does not automatically follow from a lack of the first that the second is the case.”231 This would also need to be written into any agreement on withdrawal and transition in order to resolve uncertainty.

Conclusions and recommendations

119.We welcome the announcement by the European Council that the first priority for negotiations in 2018 will be agreement on transition. Such an agreement needs to be announced soon for it to prevent the enactment of the financial services industry’s contingency plans, with the disruption and uncertainty that would cause for counterparties in both the UK and the EU-27.

120.We note the views of those in the financial services sector who seek a legally binding transition agreement in Q1 2018. Whether or not this is feasible, any such agreement will need to be at least politically binding if it is to provide reassurance to firms that there will be no cliff-edge in 2019. Due to the central position of the UK’s financial services sector within the EU’s financial services industry, and the number of EU-27 clients that rely on accessing this market, it is in the interests of both the UK and the EU that such an agreement is in place, in order to prevent large-scale risks to financial stability.

121.It will be essential, either alongside or as part of a transition agreement, to provide clarity on issues of contractual continuity. Insurance contracts will need to be ‘grandfathered’—treated according to current terms—for their duration. It may be possible for other contractual issues, such as the servicing of derivatives contracts, to be provided for within the time-limited confines of a transition period, but such a period cannot be expected to solve all issues. It is imperative therefore that continuity of contracts is treated and resolved comprehensively.

163 Letter to the Rt Hon Philip Hammond MP, Chancellor of the Exchequer, from Baroness Falkner of Margravine Chairman, EU Financial Affairs Sub-Committee on ‘financial regulation and supervision following Brexit’ (8 November 2017): [accessed 18 December 2017]

164 Letter to Baroness Falkner of Margravine Chairman, EU Financial Affairs Sub-Committee from the Rt Hon Philip Hammond MP, Chancellor of the Exchequer on ‘financial regulation and supervision following Brexit’ 2 December 2017: [accessed 12 January 2018]

165 Bank of England, Financial Stability Report (November 2017): [accessed 19 January 2018]

166 Letter to Baroness Falkner of Margravine Chairman, EU Financial Affairs Sub-Committee from the Rt Hon Philip Hammond MP, Chancellor of the Exchequer, on ‘financial regulation and supervision following Brexit’ (2 December 2017): [accessed 12 January 2018]

169 Oral evidence taken before the European Union Committee, 24 October 2017 (Session 2017–19), QQ 22 and 28 and written evidence from TheCityUK (DND0015) para 26

170 European Union Committee, Brexit: deal or no deal (7th Report, Session 2017–19, HL Paper 46) para  129

171 Rt Hon Theresa May MP, speech on ‘a new era of cooperation and partnership between the UK and the EU’ (22 September 2017): [accessed 12 January 2018]

174 Oral evidence taken before the European Union Committee, 24 October 2017 (Session 2017–19), 28

179 Oral evidence taken before the European Union Committee, 24 October 2017 (Session 2017–19), 22

180 European Union Committee, Brexit: deal or no deal (7th Report, Session 2017–19, HL Paper 46) para  129

181 European Council, ‘Guidelines following the United Kingdom’s notification under Article 50 TEU’ 29 April 2017: [accessed 18 January 2018]

182 Alex Barker, Jim Brunsden and Henry Mance, ‘”Brexit transition must end in December 2020”, says Barnier’, Financial Times (20 December 2017): [accessed 18 January 2018]. See also European Union Committee, Brexit and the EU Budget (15th Report, Session 2016–17, HL Paper 125).

183 Annex to the recommendation for a Council Decision supplementing the Council Decision of 22 May 2017 authorising the opening of negotiations with the United Kingdom of Great Britain and Northern Ireland for an agreement setting out the arrangements for its withdrawal from the European Union, COM(2017) 830 final

185 Jim Pickard and Alex Barker, ‘David Davis attacks EU’s “damaging” no-deal Brexit planning’, Financial Times (8 January 2018): [accessed 18 January 2018]

191 Written evidence from Barclays (FRS0040)

192 Written evidence from the London Metal Exchange (FRS0048)

193 Written evidence from PwC (FRS0019)

194 Written evidence from Lloyd’s and the Lloyd’s Market Association (FRS0028)

200 Q 18 (Jonathan Herbst), Q 27 (Mark Hoban)

203 David Davis, ‘How we will deliver the best Brexit in 2018’, The Daily Telegraph (1 January 2018): [accessed 16 January 2018]

206 Written evidence from the CBI (FRS0025)

207 Written evidence from Clifford Chance (FRS0039)

208 Oral evidence taken before the European Union Committee, 24 October 2017 (Session 2017–19), 31

213 European Union Committee, Brexit: deal or no deal (7th Report, Session 2017–19, HL Paper 46) para 111

214 Written evidence from Lloyd’s and the Lloyd’s Market Association (FRS0028)

215 Written evidence from PwC (FRS0019)

216 Written evidence from Zurich Insurance (FRS0042)

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

219 Written evidence from Lloyd’s and the Lloyd’s Market Association (FRS0028)

220 Written evidence from Zurich Insurance (FRS0042)

221 European Union Committee, Brexit: deal or no deal (7th Report, Session 2017–19, HL Paper 46) para  87

226 Written evidence from ILAG (FRS0014)

229 Bank of England, Record of the Financial Policy Committee Meetings held on 22 and 27 November 2017 (5 December 2017): [accessed 16 January 2018]

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