Bank of England to allow most E.U. firms to operate through branches | Wolters Kluwer
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  • Bank of England to allow most E.U. firms to operate through branches

    By Michael Imeson

    Published March 21, 2018

    Most E.U. banks and insurance companies will be able to operate in the U.K. through branches rather than more heavily regulated and expensive subsidiaries post-Brexit, according to Bank of England proposals being consulted on, writes Michael Imeson.

    Come Brexit day, E.U. banks and insurance companies will no longer be able to use their U.K. branches to passport their services into the U.K. but must apply to the Bank of England’s Prudential Regulatory Authority (PRA) for authorisation, just as non-E.U. firms must do today.

    But E.U. firms should have nothing to fear, judging by the Bank’s announcement in December 2017 about how it intends to authorise and supervise these firms. Banks, for example, will in most cases be allowed to operate in the U.K. as branches along the same lines as now, although branches conducting “significant retail” or “systemic wholesale” business in the U.K. may have additional requirements imposed on them. Only in relatively few cases will they be required to run their business through more complex and costly subsidiaries.

    Similarly, insurers will be able to operate as branches except where the scale of their activities reaches a certain threshold, in which case they must go down the subsidiaries route.

    The Bank set out its proposals in a public consultation document and wrote to the chief executive officers of all E.U. firms affected. The consultation closed on February 27, 2018. The new regime will start in the next few weeks. Firms will then be able to apply for authorisation as a branch or subsidiary, with their authorisation coming into effect after the U.K. withdraws from the E.U.

     “In the absence of continued passporting rights post-Brexit, firms currently exercising those rights to establish a branch or provide services into the U.K. will need to seek PRA authorisation to carry on PRA-regulated activities in the U.K.,” said Sam Woods, Deputy Governor of the Bank of England and CEO of the PRA in the December 2017 announcement.

    Banking associations are relieved the PRA’s stance will allow most E.U. banks and insurers to operate through branches instead of subsidiaries. Branches are mainly overseen by their home regulator and can repatriate capital overnight; subsidiaries are directly overseen by the PRA and must keep capital and liquidity in the U.K.

    There was a fear the Bank of England would impose a wider obligation for firms to use subsidiaries. A requirement to subsidiarise was “a clear red line for E.U. bank branches”, according to a survey by the Association of Foreign Banks (AFB) and law firm Norton Rose Fulbright, published just before the PRA announced its plans.

     “A significant majority of E.U. branch respondents said that enforced subsidiarisation would cause them to reconsider their presence in the U.K., with the two most likely outcomes being reallocation of regulated activity into the E.U., or closure of London branches and withdrawal from the U.K. altogether,” claimed the survey.

    The need for openness and close supervision

    The Bank said it wants to keep the U.K. financial sector open to the E.U., and vice versa, and stressed the benefits the sector brings to both sides. The new approach applies not just to E.U. member states, but to all European Economic Areas (EEA) countries – the E.U. plus Norway, Liechtenstein and Norway. There are 160 branches of international banks in the U.K., 77 of which are from the EEA operating under the passporting arrangements; and there are 110 branches of international insurers in the U.K., 80 of which are from the EEA.

    Despite the clear advantages of having so many large and complex foreign financial institutions, there are two main drawbacks. First, they are “inherently risky”. If they do not properly manage themselves, or the authorities do not keep them under close supervision, “these risks could spill over and damage the real economy”, said the Bank. Second, as the U.K. leaves the E.U., its financial system may become more complex, reducing the Bank’s “visibility” of overseas banks and insurers.

    Consequently, it is important that E.U. banks and insurers are properly authorised and supervised by the PRA. Whether they are authorised as branches or subsidiaries, or authorised at all, will depend on what they do and where they are from.

    What they do: if a firm’s activities are not of significant importance, such as a retail bank holding “material U.K. retail deposits”, it will probably be able to operate as a branch, but if its activities are significant it must comply with additional branch requirements or be a subsidiary. The Bank proposes to extend this approach to insurers, based on “the scale of their liabilities protected by the U.K. Financial Services Compensation Scheme”.

    Where they are from: if the regulatory regime in the firm’s country of origin meets international standards, and the level of cooperation that country’s regulator has with the PRA is high, it can apply to operate as a branch; but if standards and cooperation are low, additional branch regulations may be applied and a subsidiary may be needed.

    The bank consultation paper includes a draft supervisory statement (SS) which will replace the current SS10/14 “Supervising international banks: the Prudential Regulation Authority’s approach to branch supervision”.

    The insurance paper also includes a draft supervisory statement, “International insurers: the PRA’s approach to branch authorisation and supervision”, which will supplement the current Supervisory Statement (SS) 44/15 “Solvency II: third-country insurance and pure reinsurance branches”.

    The new approaches will not affect non-E.U. banks and insurers currently operating in the U.K. as branches or subsidiaries. “This is because we already have an appropriate level of third-country supervisory cooperation with their home state supervisors in light of the systemic importance of the relevant firms,” said the Bank.

    CCPs – a similar approach

    The Bank of England has also published guidance on what its supervisory approach will be to E.U. central counterparties (CCPs) providing services in the U.K., “so that they can continue doing so after the U.K.’s withdrawal”. CCPs are financial market intermediaries that put themselves between trading counterparties to ensure transactions are cleared and payments settled.

     “The Bank of England is therefore writing to non-U.K. CCPs outlining the circumstances in which, if they wish to operate in the U.K., they would need to be recognised to do so by the U.K. authorities, and the approach to recognition we expect to take,” it said. “The Bank of England anticipates that, at the point of exit, the U.K. authorities will apply the recognition regime currently in force in the E.U. Our presumption is that, subject to this process, non-U.K. CCPs operating here at present will be able to do so after the U.K.’s withdrawal from the E.U.”

    Industry response

    Stephen Jones, Chief Executive of U.K. Finance, said the Bank’s decision sends a clear signal that the U.K. is taking a “thoughtful and measured approach” to the practical challenges of Brexit. “International banks, often active in the U.K. through branches of EEA banks, are an important part of the U.K.’s financial services system and make a significant contribution to our economy,” he said.

     “The PRA’s consultation suggests a pragmatic approach will be taken for any reauthorisation process, indicating that alternative mechanisms to branch subsidiarisation may be available for systemically important branches. This attempts to provide greater clarity which is what we have been calling for since the referendum result.”

    Simon Lewis, Chief Executive of the Association of Financial Markets in Europe (AFME), welcomed the Bank of England’s proposals on branch authorisation. “This provides welcome clarity for firms, enabling them to proceed with their Brexit planning and avoiding additional fragmentation of capital within Europe,” he said.

    Miles Celic, Chief Executive Officer of TheCityUK, was similarly upbeat. “The Bank of England’s proposed approach to E.U. banks, insurers and CCPs is a positive move. It is an act of economic common sense. Encouraging E.U. headquartered financial institutions to stay in the U.K. post-Brexit will also ultimately support continued U.K. competitiveness, help preserve financial stability, and defend London and the U.K.’s position as an open global financial centre.”

    As for the insurance sector, Hugh Savill, Director of Regulation at the Association of British Insurers, described it as a “pragmatic approach”. “By taking unilateral action to pursue openness, important clarity has been provided for insurers,” he said. By “unilateral action” he meant the U.K. is making it clear it will keep its financial sector open to E.U. firms without having received a similar commitment from the E.U.

    A note of caution

    It is important to stress that the Bank of England’s approach to bank and insurance branch authorisation is based on the presumption that the high level of supervisory cooperation with the E.U. will continue following Brexit.

     “In the event of a non-cooperative relationship, however, there could be implications for how we oversee some EEA firms in the U.K.”, it cautioned. If the PRA cannot gain enough co-operation with a firm’s home state regulator about its oversight of that firm, “it may impose specific regulatory requirements” on the branches. Furthermore, “if this proves to be ineffective, the PRA would likely authorise the firm only as a subsidiary”.

    Take note, E.U. bankers, insurers and regulators: you have been warned.

    About the author: Michael Imeson Chartered MCSI is Contributing Editor of The Banker magazine; Senior Content Editor at Financial Times Live where his role is to organise and/or chair events on financial services; and the owner of editorial services agency Financial & Business Publication. Michael is also a regular contributor to Wolters Kluwer’s Compliance Resource Network.

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