Financial watchdogs risk breakdown without Brexit transition deal, UK FCA says

23 February 2017. By Matthew Holehouse and Lewis Crofts.

European financial regulators risk an "information gap" that would leave them blind to misconduct if Britain exits the EU under the "cliff-edge scenario" of no transitional agreement, the UK's Financial Conduct Authority has said.

Brexit poses "multiple risks" to financial services, the FCA said.

But these would be "particularly acute" if the UK exits after two years without having agreed transitional arrangements, which would cause a breakdown in co-operation between UK and EU regulators.

"The most critical risks relate to market integrity and consumer protection, but there are also competition risks and wider legal, operational and general market-stability risks to consider," FCA chief executive Andrew Bailey said in a letter to UK lawmakers.

Without a transitional period, Bailey said, the FCA might struggle to process authorizations for EU companies that want to keep doing business in the UK when their "passporting" rights lapse. Passporting allows a company regulated in one EU state to do business in another without any further authorization.

Companies would risk legal action for failure to deliver on contracts if they lose permissions with no backup plans in place, Bailey noted.

The UK government has said it will seek an "implementation period," to begin when the UK leaves in two years' time, in order to agree a new framework on financial regulation and allow companies to make adjustments. Such a move is controversial with some UK lawmakers, who fear talks might drag out indefinitely.

Bailey said it was perfectly normal for financial regulation to contain "bridging" provisions to allow companies to adjust and reduce risks. These are typically six months to eight years in length, but can be longer, such as 16 years in the case of the Solvency II insurance directive.

EU regulators are currently obliged to share firm-specific information, to reduce the risks around companies licensed in one state operating in another.

In the absence of a new arrangement allowing cooperation with European regulators, the FCA will "face operational risks in terms of the availability of important supervisory information on firms doing business in the UK," Bailey wrote.

"The information could, for example, relate to instances of cross-border market abuse — a real threat to our objectives — where the timely exchange of information is critical to resolve issues. As this information exchange is mutual, other EU regulators may also face risks around an information gap."

The transitional arrangement should also aim to offer "legal certainty to firms and consumers," Bailey said. "Market participants need to understand their rights and obligations and have appropriate time to prepare for any changes from the current framework."

Rush for authorization

He noted that 8,000 EU firms now rely on passporting authorization from a home state regulator to provide financial services in the UK, and said regulators risked being deluged with applications for authorization in the event of a Brexit "cliff edge."

It takes an average of 23 weeks for the FCA to grant a retail authorization, and 21 weeks for a wholesale authorization. "In the transition to a new set of arrangements, the necessary time period could be significantly longer," Bailey wrote.

For UK-based payment services needing new authorizations to operate in the EU, potential waiting times of 12-18 months have been cited, he said. Around half of the EU's payments operators are based in the UK.

For asset management, a complex interaction of three EU laws underpinned portfolio-management services for funds outside the UK, Bailey said. This could suffer under Brexit without transitional arrangements.

Finally, insurance products enabled by EU passporting rules could face "considerable uncertainty" because they rely on the EU authorization to process claims. Many of these will be on long-running contracts, such as life insurance.

"After the UK's withdrawal from the EU, it could become more difficult for providers to service contracts entered into before withdrawal in the absence of the EU passport," Bailey wrote.

Unknown unknowns

Bailey acknowledged that the regulator is still grappling with the unknown effects of a Brexit for the insurance sector without a transitional agreement. "We cannot rule out related risks at this stage, so my teams are continuing work to map and consider potential mitigations to these."

Bailey's concerns were set out in a letter to Andrew Tyrie, chairman of the UK Parliament's Treasury Committee, dated Jan. 13 and published today.

Bailey copied the letter to UK Chancellor Philip Hammond, Bank of England Governor Mark Carney, Brexit Secretary David Davis and civil-service chief Jeremy Heywood, citing its "substantial content…which is not contained in any other FCA publication."

	Eliot Gao