11 December 2020

Bank of England: The provision of financial services after the end of the transition period

Financial sector preparations for the end of the transition period with the EU are now in their final stages. Most risks to UK financial stability that could arise from disruption to the provision of cross-border financial services at the end of the transition period have been mitigated.

The UK’s transition period with the EU will end on 31 December 2020.

The UK left the EU with a Withdrawal Agreement on 31 January 2020, entering an 11-month transition period that will end on 31 December 2020. Negotiations on a free trade agreement (FTA) covering the broad arrangements for trading goods and services between the UK and EU are continuing. The ability to provide cross-border financial services between the UK and the EU will largely be determined by regulatory decisions made autonomously by the UK and EU, distinct from the broader FTA negotiations.

To facilitate continued access by UK households and businesses to financial services provided by EU financial institutions after the end of the transition period, the UK has temporary permissions and recognition regimes in place, alongside temporary powers allowing UK regulators to delay or phase-in changes to UK regulatory requirements. In addition, following its equivalence assessments of the EU, the Government has made a number of equivalence determinations in relation to the EU, with the intention of supporting well-regulated open markets.

Those equivalence decisions will, beyond the end of the temporary regimes and powers, allow favourable regulatory treatment for UK banks’ and insurers’ cross-border activity with the EU, and facilitate UK users’ continued access to EU central counterparties (CCPs) and central securities depositories (CSDs). The Government may make further equivalence determinations in the future.

The EU’s equivalence assessment of the UK is ongoing. The European Commission has stated that it will not assess the UK for equivalence in nine areas in the short or medium term, including MiFIR Article 47, which covers the direct provision of investment banking services across borders.^{footnote [9]} It has provided time-limited equivalence for the UK legal and supervisory framework for UK CCPs and CSDs.

Irrespective of the particular form of the UK’s future relationship with the EU, and consistent with its statutory responsibilities, the FPC will remain committed to the implementation of robust prudential standards in the UK. This will require maintaining a level of resilience that is at least as great as that currently planned, which itself exceeds that required by international baseline standards, as well as maintaining UK authorities’ ability to manage UK financial stability risks.

Most risks to UK financial stability that could arise from disruption to the provision of cross-border financial services at the end of the transition period have been mitigated.

Financial sector preparations for the end of the transition period are now in their final stages. Consistent with its financial stability objective, since 2016 the FPC has identified and monitored risks of disruption that could arise if no further arrangements were put in place for the provision of cross-border financial services when the UK’s trading arrangements with the EU change. The FPC reviewed its checklist of actions that would mitigate risks of disruption at the end of the transition period to important financial services used by households and businesses (Table 3.A). The FPC also reviewed other risks to the provision of cross-border financial services that could cause some, albeit less material, disruption if they are not mitigated (Table 3.B).

As set out above, temporary permission and recognition regimes and other preparations have been made by UK authorities to facilitate UK households’ and businesses’ access to existing and new services from EU financial institutions for a period after the end of the year. UK authorities have also acted to allow UK firms to continue trading all shares on EU trading venues after the end of the transition period.

UK financial institutions have continued to prepare for the continued provision of services to EU users.^{footnote [10]} All material subsidiaries of UK firms have been authorised in the EU and are fully operational and over two thirds of clients of major UK-based banks have now completed the necessary documentation to enter into derivatives trades with EU entities. Many clients are also actively trading from the new EU entities. UK firms also continue to novate existing trades where necessary to ensure clients can manage risks related to ‘lifecycle’ events. ^{footnote [11]} The EU has announced its intention to provide relief from margin and clearing requirements for certain existing trades that are novated from UK to EU counterparties before January 2022. If implemented, this would create further time for those trades to be novated without triggering additional requirements.

Reflecting the extensive preparations by UK authorities and the financial sector, the FPC continues to judge that most risks to UK financial stability that could arise from disruption to the provision of cross-border financial services at the end of the transition period have been mitigated.

Financial stability is not the same as market stability or the avoidance of any disruption to users of financial services.

Financial markets can be expected to react to the outcome of the negotiations on arrangements for trading goods and services between the UK and EU.

As reflected in the residual risks identified by the FPC in Table 3.A and Table 3.B, some disruption to financial services could arise. This could particularly affect EU-based clients and customers.

Some participants may not be fully ready to trade with EU counterparties or on EU or EU-recognised venues when EU participants’ ability to trade with UK entities or on UK venues becomes restricted. This could reinforce market volatility.

For example, on the basis of the approach that has been announced by the EU and in the absence of further authority action, EU firms in scope of the EU Derivatives Trading Obligation (DTO) would no longer be able to trade some classes of derivatives, such as certain interest rate swaps and credit default swaps, on UK trading venues, and UK firms in scope of the UK DTO would no longer be able to trade these derivatives on EU trading venues.

Based on transaction reporting data as of October 2020, it is estimated that around US$200 billion of interest rate swap trading that takes place daily in the UK is currently captured by the DTO. Absent a further change in policy, the portion of this covered by the EU DTO after the end of the transition period would be required to be traded on EU trading venues, or trading venues elsewhere recognised by the EU. To put this into context, the 2019 BIS triennial survey of derivative activity, which would include activity taking place on and off trading venues, suggested around US$1.2 trillion of interest rate swaps were traded in the UK daily.^{footnote [12]}

UK-based branches of EU firms would be subject to the UK DTO as well as the EU regime. As a result, these branches would only be able to trade those derivatives captured by the obligation on trading venues in other jurisdictions deemed equivalent by both the UK and the EU.

Firms are preparing to comply with the relevant obligations after the end of the transition period, including by executing some trades currently taking place on UK trading venues in the EU or other jurisdictions if necessary. This would result in fragmentation, and could give rise to disruption if some counterparties are not ready to trade immediately after the end of the transition period.

Other examples of disruption would affect households and businesses. Some UK banks have notified EU-based customers that they will not continue to provide certain retail banking services in some jurisdictions.

Processing payments, including Single Euro Payments Area (SEPA) payments, between the UK and EU will require additional information to be included after the end of the transition period, such as payers’ addresses. While banks will generally hold payers’ information for credit transfers originating from their customers, they are less likely to hold it for direct debits, where payments are initiated by creditors. Banks have been putting the necessary information in place. Larger UK firms are generally well advanced in providing the information, but there is less clarity about the progress of EU firms. To the extent that gaps remain at the end of the transition period, they are likely to result in some disruption to both EU and UK customers and businesses seeking to make and receive such payments.

Financial institutions should continue taking measures to minimise disruption, including by engaging with clients and customers.

Table 3.A: Checklist of actions to avoid disruption to end-users of financial services at the end of the transition period

This checklist reflects the risk of disruption to end-users including households and companies if no further arrangements are put in place for cross-border trade in financial services at the end of the transition period on 31 December 2020. The risk assessment takes account of progress made in mitigating any risks. It assesses risks of disruption to end-users of financial services in the UK and, because the impact could spill back, also to end-users in the EU.

Risks of disruption are categorised as low (green), medium (amber) or high (red). Arrows reflect developments since the FPC’s previously published checklist alongside the October 2020 Financial Policy Summary. Blue text is news since then.

The checklist is not a comprehensive assessment of risks to economic activity arising from the end of the transition period. It covers only the risks to activity that could stem from disruption to provision of cross-border financial services.

Bank of England

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