Bank Recovery and Resolution and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018
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Lord Bates
That the Grand Committee do consider the Capital Requirements (Amendment) (EU Exit) Regulations 2018 and the Bank Recovery and Resolution and Miscellaneous Provisions (Amendment) (EU Exit) Regulations 2018.
The Minister of State, Department for International Development (Lord Bates) (Con)
My Lords, Her Majesty’s Treasury is in the process of laying statutory instruments under the European Union (Withdrawal) Act in order to deliver a functioning legislative and regulatory regime for financial services in the event of a no-deal scenario. The two SIs being debated in this group are part of this programme and will fix deficiencies in UK law relating to the UK’s prudential regime, which ensures that financial institutions hold sufficient capital and appropriately measure and manage their risks, and also relating to the UK’s bank resolution regime, which ensures that the UK authorities have the necessary tools to manage the failure of a bank, investment firm or building society in an orderly way. The approach taken in these SIs aligns with that of other SIs being laid and debated under the withdrawal Act by maintaining existing legislation at the point of exit to provide continuity but amending it where necessary to ensure that it works effectively in a no-deal scenario.
The first statutory instrument being considered today concerns the capital requirements framework, which aims to prevent the failure of financial institutions by setting prudential rules that apply to banks, investment firms and building societies. These rules are currently set through the EU capital requirements regulation and the EU capital requirements directive. The second statutory instrument relates to the bank recovery and resolution directive, which sets out the requirements that ensure that firms’ failures can be managed in an orderly way, avoiding the need for costly public bailouts. In a no-deal scenario, the UK would be outside the European Economic Area and outside the EU financial services framework. To ensure that the legislation continues to operate effectively in the UK once the UK has left the EU, these SIs will make amendments to retained EU law in relation to the capital requirements regulation and the bank recovery and resolution directive so that the legislation will continue to function effectively in a no-deal scenario.
I note that, in line with the general approach taken to the onshoring of EU legislation, both statutory instruments will transfer a number of functions currently within the remit of EU authorities, particularly the European Banking Authority and the European Securities and Markets Authority, to relevant UK bodies. These functions, such as the development of detailed technical rules on certain provisions of the regulations, will now be carried out by appropriate UK bodies: the Financial Conduct Authority, the Prudential Regulation Authority or the Bank of England. For example, the responsibility for binding technical standards under the bank resolution and recovery regime is being transferred to the Bank of England, given that it is the UK’s resolution authority. The PRA and FCA have extensive experience in setting firm-specific rules for international firms, and are therefore the most appropriate domestic institutions to take on these functions from the European supervisory authorities. The regulators are undertaking public consultations on the changes that they propose to make to binding technical standards.
These statutory instruments further confer regulation-making powers on the Treasury to replace delegated powers that were previously conferred on the European Commission, in line with the approach taken in other Treasury legislation.
The draft capital requirements regulations 2018 make changes primarily to the retained EU capital requirements regulation but also to certain domestic secondary legislation implementing the EU capital requirements directive. First, they introduce changes to the group consolidation regime. When the UK leaves the EU, we will also leave the EU supervisory regime. This means that we will need to limit the geographical scope of the capital and liquidity consolidation rules to the UK, rather than on an EU-wide basis as currently. This will introduce a new layer of liquidity consolidation in the UK, though it will not affect the application of consolidated capital requirements, which are currently calculated at the member state level.
Secondly, the draft regulations remove preferential capital treatment currently available for exposures to certain EU institutions and assets, including sovereign debt. The EU capital requirements regulation currently applies a zero-risk weighting to certain categories of EU assets such as sovereign debt. This means that firms do not have to hold capital for their exposure to such assets and are therefore incentivised to invest in them. In line with our general cross-government approach, it is our policy not to grant the EU unilateral preferential treatment in the absence of an assessment of equivalence after exit day. We will therefore end the preferential capital treatment for EU assets currently subject to the zero-risk weighting.
Finally, the draft regulations introduce changes meaning that UK regulators will no longer have to obtain approval from EU institutions before using macroprudential tools to address systemic risks, including in a financial crisis. This is appropriate given the UK would be a third country and will need the UK regulators to be able exercise macroprudential functions effectively in times of financial stress.
I turn now to the bank recovery and resolution statutory instrument, which amends the Banking Act 2009 and related domestic and retained EU legislation by making the following principal amendments. First, the draft regulations amend the scope of the UK’s third-country resolution recognition framework to include EEA-led resolutions. This ensures that, in a no-deal scenario, the same approach will be followed for both EEA and third countries in recognising third-country resolution actions.
Secondly, this statutory instrument removes deficient references requiring UK regulators to follow the specific operational and procedural mechanisms set out in the BRRD to co-operate with the EEA authorities. The removal of these references will not, however, prevent UK regulators from co-operating with their EEA counterparts after exit. UK regulators will remain able to share information with EEA authorities in the same way as they currently do with authorities in third countries such as the United States. Additionally, the UK will continue to participate in international crisis management groups which enhance co-operation between home and host authorities of systemically important banks.
Finally, the draft regulations address deficient cross-references to the BRRD in UK legislation and ensure that delegated regulations retained by the European Union (Withdrawal) Act continue to be in a workable form following exit.
To summarise, the Government believe that these statutory instruments are needed to ensure that the regulatory regime applying to banks, building societies and investment firms works effectively if the UK leaves the EU without a deal or an implementation period. I commend the regulations to the Committee.
The Deputy Chairman of Committees (Baroness Fookes) (Con)
My Lords, before the debate begins, it may be helpful if I explain that the rather quaint little hats sitting on the ends of some of the microphones are an indication that they are not working.
Lord Bates
I thank noble Lords for bringing their considerable expertise to bear on the important regulations before us. I will address some of the points raised.
First, the noble Baroness, Lady Drake, asked whether there is sufficient time for the regulators to put the consultation in place. I am confident that regulators are making adequate preparations and effectively allocating resources ahead of March 2019. They have been actively participating in a wide range of groups developing these technical and regulatory rules. They have also chaired a number of committees and task forces, and have considerable experience in implementing EU legislation. This means that the responsibilities of EU bodies can be reassigned effectively and efficiently, providing firms, funds and their customers with confidence. Since October, regulators have begun consulting, and I am confident that they will complete their consultations ahead of exit day. The noble Baroness also asked whether the regulators have adequate resourcing for a no-deal scenario. I repeat my confidence that the regulators are making adequate preparations and have the resources and expertise to ensure that this happens.
The noble Baroness, Lady Drake, also asked whether the capital requirements regulation statutory instrument will decrease the level of accountability for the Prudential Regulation Authority or the Financial Conduct Authority. Although certain functions, such as the mandate to develop binding technical standards, are being transferred to the regulators from EU authorities, such functions are currently carried out not by the Commission or the UK Government but by agencies with specific expertise in setting and calibrating firm-specific macroprudential rules. The Treasury will work closely with regulators in the development of binding technical standards; those standards will also be subject to consultation, ensuring that key stakeholders’ views are taken into account. Regulators will not be able to make significant policy changes.
The noble Baroness, Lady Bowles, asked whether there is a substantial difference in being in only the crisis management groups. Nothing in the SI will change the UK’s ability to co-operate with third countries on planning for executing the resolution of cross-border banks. The majority of the work takes place in international crisis management groups designed to facilitate international co-operation through bodies such as the G20. Of course, we are a key part of the financial stability group’s work on key priorities. There is an existing robust framework in UK law for resolution co-operation with third countries, such as the United States.
The noble Baroness, Lady Bowles, spoke a great deal about the loss of zero-risk weighting on EU debt calculation. It could seem as if that were a new policy. When we leave the EU, the EU will treat us as a third country, without any special arrangements to treat the UK differently. The UK Government have said that we will also treat the EU as a third country; we are therefore being consistent with other SIs that have been passed through your Lordships’ House. Since sovereign debt already attracts a very low risk weight, the change in capital requirements should not be significant. None the less, we have discussed the risks associated with the loss of zero-risk weighting on EU sovereign debt for the industry, and we understand that the issue will affect only a small number of firms. The exact impact cannot be estimated because firms will change their capital holdings and restructure.
We are also developing broad transitional powers for the regulators that will allow them to phase in new requirements gradually. The regulators are already consulting on a proposal to delay all changes to risk weights. This would eliminate any cliff-edge risks and give firms additional time to prepare for these changes.
The noble Baroness, Lady Bowles, asked about the reference to a predecessor body in the statutory instrument. This was inserted to ensure that we have a consistent approach across every file being onshored. The wording is drawn from existing UK statutes, such as the Payment Services Regulations 2012.
The noble Lord, Lord Tunnicliffe, asked whether the SIs make policy changes. As I said in response to the noble Baroness, Lady Drake, they are not intended to make policy changes other than to reflect the UK’s new position outside the European Union if we leave in March 2019 in a no-deal scenario.
The noble Lord also asked whether UK firms would be disadvantaged by the changes in risk weights. I made detailed reference to that in my previous answer to the noble Baroness, Lady Bowles, but since sovereign debt already attracts a very low risk weight, the change in capital requirements should not be significant. As I mentioned, regulators are consulting on a proposal to delay all changes to risk weights, which would eliminate a potential cliff edge.
The noble Lord then drew the Committee’s attention to page 41 of the BRR SI and asked whether the relevant section existed beforehand and, if so, why it was not cross-referenced. The insertion of Schedule A1, on page 41 of the SI, addresses deficiencies stemming from the UK’s departure from the EU and does not bring about any policy changes. In particular, it corrects a reference in the Bank Recovery and Resolution Order 2014 to the requirements of the directive with regard to resolution plans. This will not be appropriate after exit day as the directive will not have the force of law in the UK. To ensure that such information can still be referenced, we are bringing this content into UK law. The schedule uses text from the relevant sections of the directive but with some minor additional fixes, as is allowed under the EU withdrawal Act, to take account of the UK’s exit from the EU. For example, references to “central banks” will be replaced by references to the UK’s central bank, the Bank of England.
I will of course review the official record of our debate today to see whether there are any questions which I have not answered. I thank noble Lords again for their contributions.