Brexit: Financial Services Contracts Regime
What is the FSCR?
For some time now the UK Government has been implementing plans for a no deal Brexit scenario, where the UK leaves the EU without a ratified Withdrawal Agreement. These plans have essentially involved amending the UK statute book to onshore EU legislation so that it can continue to function immediately after exit day. Another important component of the UK Government’s no deal contingency planning is dealing with the significant number of EEA firms that currently passport their services into the UK. For these firms the UK Government is proposing two important regimes which will allow them to continue conducting business for a limited period of time:
- a temporary permission regime (TPR) which allows EEA firms to continue to operate in the UK after Brexit whilst they seek authorisation; and
- a financial services contracts regime (FSCR) that allows EEA firms to run down their UK contracts.
By introducing the TPR and the FSCR the UK Government has adopted a pragmatic approach to reducing the impact of a no deal Brexit on EEA firms. However, such regimes are UK centric; the European Commission has not replicated these regimes for UK financial institutions operating in the EU.
What is the statutory basis of the FSCR?
The statutory basis of the FSCR is The European Union (Withdrawal) Act 2018 (EUWA 2018). Under the EUWA 2018 HM Treasury has published, among other things, two draft statutory instruments relevant to the FSCR:
- The Financial Services Contracts (Transitional and Saving Provision) (EU Exit) Regulations. These Regulations make amendments to the Regulations that implement in the UK the TPR for investment firms and credit institutions, The EEA Passport Rights (Amendment, etc. and Transitional Provisions) (EU Exit) Regulations 2018; and
- The Financial Services Contracts (Transitional and Saving Provision) (EU Exit) (No.2) Regulations 2019. These Regulations make amendments to the Regulations that implement in the UK the TPR for payment institutions and e-money institutions, The Electronic Money, Payment Services and Payment Systems (Amendment and Transitional Provisions) (EU Exit) Regulations 2018.
What firms can enter into the FSCR?
The FSCR is designed for those EEA firms that passport into the UK immediately before exit day which: (i) do not make a notification to enter into the TPR; or (ii) make a notification to enter the TPR but exit that regime without full UK authorisation. The FSCR automatically applies to these firms.
A condition of entry into the FSCR is that a firm is regulated by its home Member State regulator and continues to be supervised by that regulator whilst in the regime. If home state authorisation is cancelled, a firm will cease to be in the FSCR.
What activities are permissible under the FSCR?
The activities permitted under the FSCR are limited to those required to service pre-existing contracts and to:
- reduce the financial risk of parties to pre-existing contracts and third parties affected by the performance of pre-existing contracts;
- transfer the property, rights or liabilities under a pre-existing contract; and
- comply with legal and regulatory requirements.
Importantly, the FSCR will not allow firms to undertake any new business in the UK post exit day.
Is the FSCR time limited?
Yes. Firms falling within the scope of the regime will be expected to run-off, close out, or transfer obligations arising from contracts that exceed the time limit of the regime (15 years for insurance contracts and 5 years for other contracts).
HM Treasury has the power to extend the length of the FSCR by statutory instrument if it considers it necessary to do so following the submission of a joint assessment by the UK regulatory authorities as to the effect of extending or not extending the regime.
What are the SRO and CRO mechanisms?
The FSCR establishes two mechanisms.
The first mechanism is supervised run-off (SRO). The types of firm that may enter into SRO include those:
- with a UK branch (operating under a freedom of establishment passport immediately before exit day) that does not enter the TPR;
- that enter the TPR but exit it without UK authorisation in respect of some or all of their regulated activities (operating under either a freedom of establishment or freedom of services passport immediately before exit day); and
- that hold top-up permissions before the UK’s exit from the EU and were operating under a freedom of establishment or freedom of services passport immediately before exit day and do not enter the TPR.
The second mechanism is contractual run-off (CRO). This covers firms without a UK branch (operating under a freedom of services passport immediately before exit day) that do not hold a top-up permission and do not enter the TPR.
Firms may find it useful to review chapter 2 of the FCA’s consultation paper on the FSCR (see below) as it discusses in further detail which types of firm are eligible for the SRO and CRO.
Firms can move from the SRO to the CRO and vice versa.
Are there PRA and FCA requirements?
Yes, at the time of writing this note both the PRA and FCA are consulting on proposed rules that will apply to firms in the FSCR.
The PRA has set out its proposals in Consultation Paper 32/18: UK withdrawal from the EU: further changes to – PRA Rulebook and Binding Technical Standards – Resolution Binding Technical Standards (PRA CP32/18). The deadline for comments on PRA CP32/18 is 21 January 2019.
The FCA has set out its proposals in Consultation Paper 19/2: Brexit and contract continuity (FCA CP19/2). The deadline for comments on FCA CP19/2 is 29 January 2019.
Tell us more about the PRA’s approach to SRO firms
EEA firms operating in the UK under a freedom of establishment or freedom of services passport that enter the SRO will become, and be treated as, third country firms.
Subject to certain modifications to its rules the PRA will expect SRO firms with a branch in the UK to comply with the same rules that apply to third country branches. For cross-border service providers in the SRO without a branch, the PRA proposes to apply a more limited set of rules. These will include rules that could apply, as currently written, to a PRA authorised third country firm without a UK branch.
Interestingly, the PRA is proposing a streamlined approach to the Senior Managers and Certification Regime (SM&CR) that focuses on the specific objective of an orderly run-off of the firm’s UK regulated activities. SRO firms will be required to have at least one individual approved to perform the Head of Overseas Branch function (SMF19). The PRA proposes to direct firms in the SRO to use a specific form for SMF approval applications. The regulator also proposes that SRO firms will have a grace period of 12 weeks from their date of entry into the regime in which to obtain deemed (or full) approval for an SMF19. A deemed approval will last up to 12 months. Within 12 months of receipt of a notice of deemed approval the relevant individual will need to undergo a full fit and proper assessment. The fit and proper assessment will focus on whether the relevant individual is fit and proper to deliver the objective of orderly run off of the firm’s UK activities within SRO. The usual prescribed responsibilities for third country branches will not, however, apply to SRO firms. Instead, the SMF19 will be subject to a standard, single responsibility to ‘oversee the orderly run-off of the firm’s UK –regulated activities’. The PRA also proposes that the Certification Regime will apply to the extent that it currently does pursuant to FCA rules (to firms currently operating in the UK as a branch via an establishment passport but not to any other firms).
Significantly the PRA also proposes that SRO firms provide it with a run-off plan which will describe the firm’s plans to run-off its business before the mechanism expires. Firms will be required to provide at least annual updates on progress and any unexpected divergence from it. This requirement will apply to banks operating under either a freedom of establishment or freedom of services passport.
Tell us more about the FCA’s approach to SRO firms
The FCA’s proposed approach to SRO firms is similar to that for TPR firms. In respect of their UK business, the FCA proposes that SRO firms comply with:
- all FCA rules which currently apply to them;
- all FCA rules which implement a requirement of an EU Directive which are currently reserved to the SRO firm’s home state and which the FCA does not currently apply to EEA firms (home state rules). Importantly, the FCA intends to accept ‘substituted compliance’ for these rules. If firms can demonstrate they continue to comply with the equivalent home state rules in respect of their UK business (including where this is on a voluntary basis if the relevant rules cease to cover UK business) they will be deemed to comply with the FCA’s rules; and
- certain additional FCA rules which the regulator believes are necessary to provide appropriate consumer protection or relate to funding requirements.
The FCA states in CP19/2 that it proposes to apply the rules to SRO firms by simply extending the definitions it uses for the TPR and TPR firms to include firms in the SRO. This means that the rules set out in Appendix 1 of Consultation Paper 18/29: TPR for inbound firms and funds and the rules relevant to TPR firms in Appendix 3 of Consultation Paper 18/36: Brexit: proposed changes to the Handbook and Binding Technical Standards – second consultation will also apply to SRO firms.
Tell us more about the approach to CRO firms
Whilst SRO firms will continue to be authorised persons for the purposes of UK law, CRO firms will have a limited exemption to the general prohibition in section 19 of the Financial Services and Markets Act 2000. However, the PRA and FCA may vary or cancel the exemption of a firm in certain circumstances, such as where they consider it necessary to advance their statutory objectives.
Notwithstanding the exemption, there are certain requirements applicable to CRO firms. For example in FCA CP19/2 the FCA mentions that whilst there is no notification requirement firms must notify it as soon as practicable after entry into the CRO that they are carrying on a regulated activity in the UK. In addition, as mentioned above, both SRO and CRO firms must maintain their home state authorisation. If their home state authorisation is varied or cancelled the relevant UK regulator must be notified.
The FCA also states in FCA CP19/2 that CRO firms will remain subject to any existing or future product intervention rules. In terms of future intervention the FCA is currently consulting on rules that:
- ban the sale, marketing and distribution of binary options to retail consumers; and
- restrict the sale, marketing and distribution of contracts for difference and similar products to retail customers.
CRO firms will not have cover under the Financial Services Compensation Scheme.
The FCA is proposing different wording for SRO firms to the wording which it proposed for TPR firms. This wording should be included in letters (and electronic equivalents) to retail clients explaining their authorisation status. This is to reflect the different regime and purpose of the regime. Firms which enter SRO on exiting the TPR will need to update their status disclosure to reflect this wording at that point. This will give consumers the opportunity to find out about the scope of a SRO firm’s permission, and that it cannot enter into new regulated business.
The FCA is proposing that SRO firms will pay periodic fees on the same basis as that proposed for TPR firms. The regulator is not proposing periodic fees for CRO firms, but instead a special project fee will be charged in instances where the regulator’s costs in carrying out its functions exceed a £5,000 threshold.