## 1gbrea2022008 ## Source details **Canonical URL:** [1gbrea2022008](https://www.imf.org/-/media/files/publications/cr/2022/english/1gbrea2022008.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1gbrea2022008.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1gbrea2022008.pdf.json) --- ### Executive summary: post-Brexit outcome, risks, and near-term recommendations - Smooth post-Brexit transition with "no material disruption" nor crystalized financial stability risks. - Drivers of smooth outcome: extensive preparations by U.K. authorities, EU authorities in some cases, and firms; U.K. authorities engaged proactively with industry, monitored risks, and provided legal certainty in a timely manner. - Key longer-term determinants: - (i) future EU and U.K. regulatory developments and supervisory expectations (including the ECB); - (ii) how internationally active firms optimize footprints across the EU and the United Kingdom and globally; - (iii) whether the United Kingdom can offset business lost to the EU with new business from other jurisdictions. - Legal/institutional notes: - TCA concluded December 24, 2020; broadly in line with WTO rules on financial services liberalization. - High-level MoU for structured regulatory cooperation agreed at technical level but not signed as of end-January 2022. - Equivalence is important but limited: activity-based, unilateral, can be conditional/time-limited, and may involve political aspects. - Observed and possible market fragmentation: - Trading of EU shares (except sterling-denominated) moved to EU venues. - Some OTC derivatives trading shifted to the EU and United States. - Fragmentation could increase costs and inefficiencies and prompt further optimization or migration of businesses to other third-country centers. - Near-term recommendation (excerpt): - Immediate (Within one year): Maintain the UK’s commitment to mutual co-operation with the EU post Brexit — Responsible agencies: HMT, BOE/PRA and FCA. - Near Term (1-3 years) / Medium Term (3+ years): Continue to stand ready to engage with the EU regarding the regulatory status of UK CCPs; monitor legal uncertainties and review the UK equivalence framework — Responsible agencies: BOE, BOE/PRA, FCA, HMT. ### Context, onshoring and regulatory adjustments - Loss of single market passport rights under EU directives (examples cited: CRD, Solvency II, MiFID, UCITS, AIFMD, IMD, MCD, EMD, PSD). - United Kingdom onshored directly applicable EU law via the European Union (Withdrawal) Act 2018 (as amended). - HMT used onshoring powers (Section 8) and brought forward almost 70 Statutory Instruments to prevent, remedy or mitigate failures or deficiencies in retained EU law; U.K. financial regulators corrected Binding Technical Standards and their own rules. - Analysis reflects regulatory frameworks and information available as per end-January 2022. - U.K. financial sector: financial and related professional services contribute to around 10% of the United Kingdom’s economic output; the U.K. hosts three G-SIBs and two systemically important CCPs. ### Cross-border cooperation, supervisory and crisis-management implications - Post-Brexit cooperation resembles third-country arrangements rather than intra-EU arrangements. - U.K. has an extensive network of MoUs for information sharing and cross-border cooperation on supervision and resolution; crisis-management effectiveness remains untested in stress. - Authorities should monitor areas where third-country cooperation may not replicate intra-EU access to information and take mitigating actions (example: leverage data for investment funds). - From a global financial stability perspective, U.K. authorities should stand ready to engage with the EU on the regulatory status of U.K. CCPs and continue monitoring developments. ### Market fragmentation, CCPs, and clearing risks - Temporary equivalence/recognition decisions for U.K. CCPs serving EU clearing members expire in June 2022; non-renewal risks include off-boarding EU members and disorderly close-out of positions. - ESMA reviewed “substantial systemic importance” of two U.K. CCPs and did not recommend de-recognition while proposing mitigating measures for the EU. - Fragmentation can raise costs to clear derivatives via loss of multi-currency netting benefits, higher margin requirements, and concentrated local markets — potentially creating pressure to relax the clearing mandate. ### Impact on Rest of the World (RoW) - U.K. onshoring and temporary regimes implemented to avoid adverse effects for RoW jurisdictions. - So far limited evidence of major relocations of transactions or firms to RoW, except for some IRS trading and some CDS clearing moving to the United States. - U.K. expanded cross-border cooperation with RoW jurisdictions; further fragmentation could prompt additional relocation. ### Key factual snapshots and relocation evidence - Preliminary relocation reports (Box 1 findings): - New Financial survey (April 2021): relocation by more than 440 U.K. based firms; banks transferring more than £900bn (€1.05 trillion); insurance firms and asset managers £100bn (€118n) in assets and funds; estimated staff moves around 7400 or local hires; headcount moves represent a maximum of 10% into the EU in most significant cases. - Ernst and Young survey: number of financial firms announcing moves increased from 92 to 97 (out of total 222 firms) between January 2020 and December 2021; estimated staff relocations revised to 7400; since the referendum 24 firms announced transfer of assets totaling £1.3 trillion (flat in 2021). - Destination patterns: Dublin and Luxembourg for investment funds and asset managers; Frankfurt and Paris for banks; Amsterdam for market infrastructure and trading firms — no single dominant EU financial center emerged. ### Equivalence regimes: scope, numbers and limitations - U.K. has onshored the EU approach to equivalence and "onshored around 270 EU equivalence decisions." - U.K. has issued "28 equivalence determinations for EU jurisdictions." - EU granted the U.K. "two time-limited equivalence decisions, one for CCPs and one for CSDs (the latter has now expired)," plus four exemptions covering central bank, monetary and public debt management activities. - Equivalence is activity-based, not a substitute for passporting; time-limited and withdrawable unilaterally; may not replicate passporting certainty. ### Regulatory reallocation and Future Regulatory Framework Review - Responsibilities previously exercised at the EU level are now split between HMT and U.K. financial regulators. - The United Kingdom launched a Financial Services Future Regulatory Framework Review to redesign the regulatory framework and review selected legislation (for example, the wholesale markets regulatory framework). - Strengths retained: consistent and effective business laws, accounting/auditing/legal professions, effective judiciary, efficient payment, clearing and settlement systems. - Limitations: loss of some EU-level arrangements (e.g., EU-level settlement finality protections for CCPs); U.K. firms may need to assess/manage risks separately for each EU27 jurisdiction. ### Data protection, adequacy and cross-border data flows - TCA contained a four-month window (extendable by two months) during which the United Kingdom would not be treated as a third country for the purpose of the EU GDPR; EC concluded U.K. rules essentially equivalent, yielding an Adequacy Decision applying for four years from its entry into force. - U.K. authorities announced a review of U.K. data protection rules with intent not to dilute them; stakeholders caution changes could negatively affect the EC’s Adequacy Decision. - Other transfer mechanisms (e.g., standard contractual clauses) remain available. ### Investment funds and asset management — market size, measures, and frictions - Market size and structure: - U.K. asset managers manage around £3.7 trillion of investment fund assets as of end-2020. - 63 percent of this figure sits with funds domiciled overseas (mainly Ireland and Luxembourg) — an 11percentage point increase since 2015. - Total managed assets within the wider industry estimated around £11.0 trillion in 2020. - UK firms manage 20% net assets of the EU’s AIFs; in hedge funds, 76% of net hedge-fund assets originated from the United Kingdom. - U.K. regulatory measures: - Temporary Marketing Permissions Regime ensures continuity of marketing of more than 8000 retail funds (including MMFs) in the United Kingdom until the end of 2025. - Overseas Funds Regime (OFR) to allow overseas retail funds to be marketed where HMT has made a jurisdictional equivalence decision. - MMFs, delegation arrangements, and the Multilateral Memorandum of Understanding (FCA and NCAs) facilitate delegation of portfolio management/risk management. - Market frictions: - Operational frictions for EU UCITS investing in U.K. markets, and potential DTO/DTO misalignments; reporting overlaps under EMIR and SFTR can lead to overlapping reporting requirements. - Observed market shifts: decline in EUR IRS trading share on U.K. venues (July 2020–June 2021); more trading moved to US SEFs than EU venues across EUR, GBP and USD; US SEFs saw increased EUR CDS trading. ### CCPs and clearing — dominance, regulatory uncertainty and ESMA recommendations - Over 90 percent of euro-denominated interest rate and overnight index swaps clear at LCH — share stable over last six quarters as of Q3 2021. - ESMA concluded Swapclear and certain ICE services are of substantial systemic importance to the EU but did not recommend de-recognition because costs would outweigh benefits; ESMA proposed mitigating measures: - (i) regulatory/supervisory measures to incentivize EU participants to reduce exposures to UK CCPs; - (ii) revision of EU comparable compliance framework for ongoing EMIR assessment; - (iii) expansion of ESMA’s supervisory and crisis management toolbox; - (iv) enhanced cooperation with UK authorities on CCP recovery and resolution. - EC indicated plan to extend its equivalence decision for a further three years (until June 2025) but no formal decision made as of end-January 2022. ### Cross-border supervision, resolution and crisis-management arrangements - U.K. regulators (BOE, PRA, FCA) agreed over 30 MoUs with EU institutions and NCAs; PRA has Split of Responsibility agreements with EU authorities for firms with U.K. branches. - Supervisory colleges and Crisis Management Groups (CMGs) continue to involve EU/EU27 authorities; BOE and PRA chair colleges for U.K. G-SIBs and CCPs. - Legal gateways (FSMA sections and HMT Regulations) provide for exchange of non-public information with overseas authorities subject to confidentiality safeguards. - Recognition of foreign resolution actions no longer automatic; BOE may recognize an overseas jurisdiction’s resolution action absent specified refusal grounds and subject to HMT approval. - SRB considers liabilities issued under English law by EU banks eligible for MREL until June 2025 if issued on or before November 15, 2018; PRA clarified contractual recognition clause requirements and delayed obligations under certain conditions. ### Open Banking (OB) — rationale, uptake and risks - Open Banking launched in 2018 to improve customer choice and competition; OBIE funded by CMA9 at an average of £33 million annually over first 3 years. - Adoption: "Open banking now has around 4 million users. Perhaps as many as half the United Kingdom’s SMEs now use tools employing open banking functionality." - Near-term financial stability assessment: - Liquidity risks via deposit switching judged modest given gradual uptake and current switching data. - Business-model risk: pure payments income is small (less than 0.8 percentage points of bank return on equity), limiting near-term risks. - Operational and cyber risks: increased entry points for data-sharing raise operational/cyber vulnerabilities; mitigants include FCA licensing and operational/security requirements (REP018, major incident reporting, RTS on Strong Customer Authentication). - Look-ahead: - Governance changes to OBIE under consultation; potential expansion toward open finance. - Bigtech entry scenario: illustrative shock of a 10 percent drop in market share in lending and deposit taking highlights potential material impacts if platform-scale entrants rapidly enter financial services. - Policy recommendations: - Continued monitoring of technological transformation, coordination between competition and stability-focused regulators, and study of policy tools (designation, interoperability, data portability) to address platform risks. ### LIBOR transition to SONIA — progress, tools and remaining issues - Status (as of the chapter): transition from Sterling LIBOR to SONIA "is well advanced" and, as noted in the unit, since then further events occurred and the transition from Sterling LIBOR to SONIA is now complete. - Key facts: - Half of all LIBOR based interest rate derivatives outstanding in U.K. domiciled firms mature beyond the end of 2021. - In the United Kingdom, "around 85 percent of LIBOR based contracts were derivatives in September 2020." - Strategy and tools: - Bank of England convened RFRWG (2015); SONIA recommended April 2017. - Industry milestones and supervisory "Dear CEO" letters used to push endgame. - ISDA IBOR Fallbacks Protocol sets fallbacks to relevant RFR plus fixed spread (spread set March 2021). - U.K. Financial Services Act 2021 amended Benchmarks Regulation giving FCA powers (Articles 21A, 23A–23D) to prohibit new use, designate benchmarks as unrepresentative, and facilitate orderly cessation including synthetic LIBOR backstops. - Critical Benchmarks (References and Administrators’ Liability) Act (December 2021) clarifies interpretation of synthetic LIBOR in contracts. - Remaining priorities: - Active conversion of legacy contracts, especially non-sterling (USD) instruments. - International coordination to support USD transition to SOFR and avoid fragile credit-sensitive replacement rates. - Continued monitoring and possible stronger preemptive tools for future benchmark transition risks. ### Crypto assets, stablecoins, CBDC and digital money risks - Crypto market capitalization grew by factor 10 since 2018; stablecoins and DeFi growing fast. - As of November 2021: - Chain analysis (2021) ranks the U.K. first in Europe and 12th globally in value received; 5th in DeFi transaction volumes. - FCA surveys estimate about 2.3 million adults hold crypto assets. - Risks and policy stance: - Financial stability risks not yet systemic but require close monitoring; many crypto assets fall outside regulatory perimeter. - HMT consultation principle: "same activity, same risks, same regulatory outcomes." - HM Treasury proposed thresholds for systemically important stablecoins; systemic stablecoins should meet standards equivalent to commercial bank money on stability of value, legal claim robustness and redeemability. - CBDC exploration: - BOE/HMT Taskforce announced April 19, 2021; consultation planned in 2022 to inform decision on whether to enter a 'development' phase. - Earliest possible U.K. CBDC launch: second half of the decade if development proceeds. - BOE proposed a "platform" model with public infrastructure and private Payment Interface Providers. ### Climate-related disclosures and integrated SDR/Green Taxonomy - U.K. roadmap to mandatory-aligned TCFD disclosure is underway; Government published Roadmap to Sustainable Investing (October 2021) and aims for integrated economy-wide disclosure through Sustainability Disclosure Requirements (SDR) and U.K. Green Taxonomy. - Coverage and targets: - Initial requirement: most "economically significant" U.K.-registered and U.K.-listed companies to incorporate Green Taxonomy and ISSB disclosures in annual reports within one to two years of Royal Assent. - Coverage milestones: 57 percent of assets owned by banks subject to FCA rule in 2021; coverage to reach 94 percent of banking assets in 2022. - Observed progress and data gaps: - Large banks have improved TCFD-aligned governance and disclosures, but disclosures remain incomplete across TCFD pillars; data gaps and methodological issues persist (e.g., financed emissions, scenario analysis). - Policy recommendations: - Move to mandatory disclosures, enhance standardization and comparability, specify reporting requirements and transition-plan content, and build on international standards (ISSB). - Priority: High; Timeline: MT (within 1 to 3 years). ### Cross-cutting supervisory and policy observations - Existing cross-border arrangements and MoUs provide a good basis for cooperation with the EU on resolution and crisis management but will be tested in distress. - Legal/statutory powers exist for BOE and HMT to recognize foreign resolution actions where broadly comparable to U.K. stabilization options; further guidance and possible internal rules on branch resolution could be useful. - Around 60% of MREL-eligible debt issued by UK banks is governed by U.S. law; issuance under other non-UK and non-US law contracts make up less than 5 percent. - Monitoring areas flagged for continued attention include: residual cooperation gaps with EU (data sharing, college participation), status of U.K. CCPs in EU (temporary equivalence expiries and possible EC extensions), market fragmentation impacts on netting/clearing efficiencies, LIBOR legacy conversion (notably USD), and the evolution of digital money and stablecoins. *IMF Technical Note, “IMPLICATIONS OF BREXIT ON CROSS-BORDER FINANCIAL SERVICES” (chapter authored by Ender Emre and Hans Weenink); reflects frameworks and information as per end-January 2022.* ### 1. Preliminary Reports on Relocation to the EU ________________________________________________________ 16 ### 1. Preliminary Reports on Relocation to the EU ### Executive summary: Post-Brexit outcome and risks - There has been a very smooth post-Brexit transition, with no material disruption nor any crystalized financial stability risks. - The smooth outcome reflected extensive preparations by U.K. authorities, EU authorities in some cases, and firms; U.K. authorities engaged proactively with industry, monitored risks, and provided legal certainty in a timely manner. - After a smooth transition, further changes to the U.K. financial system because of Brexit are possible. Key determinants of longer-term impact include: - (i) future EU and U.K. regulatory developments and the supervisory expectations of EU supervisory authorities including the ECB; - (ii) how internationally active firms optimize their footprint across the EU and the United Kingdom as well as globally; and - (iii) whether the United Kingdom can offset business lost to the EU with new business from other jurisdictions. - The TCA concluded on December 24, 2020, is broadly in line with WTO rules on financial services liberalization; a high-level MoU for structured regulatory cooperation has been agreed at technical level but not signed yet. - Equivalence is an important tool but has limitations: it covers only specific elements of financial services, is granted and revoked unilaterally, can be conditional, and may involve political aspects. - Some market fragmentation has already occurred and remains possible: - Trading of EU shares (except denominated in sterling) on U.K. venues moved to EU venues. - Some OTC derivatives trading shifted from the United Kingdom to the EU and United States. - Fragmentation could increase costs, inefficiencies, further optimization, and possibly migration of businesses to other third-country financial centers. - Brexit has fundamentally changed formal cross-border cooperation between the United Kingdom and EU in supervision and resolution; cooperation now resembles that with other third countries rather than intra-EU arrangements. - The long-term status of U.K. CCPs in the EU remains open; temporary equivalence and recognition decisions expire in June 2022 and non-renewal could force off-boarding of EU members and risk disorderly close-out of positions. The EC has signaled it would avoid cliff-edge risks through an extension but no formal decision had been made as of the document’s information date. - Impact on rest of the world (RoW) financial firms has so far been modest; limited evidence of major relocation except for some IRS trading and some CDS clearing moving to the United States. - Going forward, the United Kingdom should continue to balance openness and financial stability in its market access regime; HMT published Guidance Document on the U.K.’s approach to equivalence and review of the Overseas Framework (including the Overseas Person Exclusion) is welcome. ### Context and institutional setting; legal/regulatory adjustments - Brexit removed single market passport rights under certain EU financial services directives (examples cited: CRD, Solvency II, MiFID, UCITS, AIFMD, IMD, MCD, EMD, PSD). - To ensure a functioning legal framework post-Brexit, the United Kingdom transformed directly applicable EU law at the end of the transition period into retained EU law via the European Union (Withdrawal) Act 2018 (as amended by the European Union (Withdrawal Agreement) Act 2020). - HMT used onshoring powers (Section 8) and brought forward almost 70 Statutory Instruments to prevent, remedy or mitigate failures or deficiencies in retained EU law; U.K. financial regulators corrected deficiencies in Binding Technical Standards and their own rules based on HMT sub-delegation. - The analysis reflects regulatory frameworks and information available as per end-January 2022. - The U.K. financial sector is a central global node: financial and related professional services contribute to around 10% of the United Kingdom’s economic output and the U.K. hosts three G-SIBs and two systemically important CCPs. ### Cross-border cooperation, supervisory and crisis-management implications - Instead of intra-EU arrangements, the U.K. and EU will now cooperate as third countries; the U.K. has an extensive network of MoUs for information sharing and cross-border cooperation on supervision and resolution, though the effectiveness of crisis-management arrangements has not been tested in stress. - Authorities should monitor areas where third-country cooperation may not replicate the same extent and ease of access to information under intra-EU cooperation and take mitigating actions where available (example: leverage data for investment funds). - From a global financial stability perspective, U.K. authorities should stand ready to engage with the EU regarding the regulatory status of U.K. CCPs and continue monitoring developments. ### Market fragmentation, CCPs, and clearing risks - Market fragmentation observed and possible future fragmentation can affect market access and increase costs. - The temporary equivalence/recognition decisions for U.K. CCPs serving EU clearing members expire in June 2022; non-renewal risks include off-boarding EU members and disorderly close-out of positions. - ESMA reviewed “substantial systemic importance” of two U.K. CCPs and did not recommend de-recognition while proposing mitigating measures for the EU. - Fragmentation could raise costs to clear derivatives via loss of multi-currency netting benefits, higher margin requirements, and concentrated local markets, potentially creating pressure to relax the clearing mandate. ### Impact on the Rest of the World (RoW) - U.K. actions included onshoring EU equivalence decisions and temporary regimes to avoid adverse effects for RoW jurisdictions. - Brexit expanded the U.K. authorities’ cross-border cooperation arrangements with RoW jurisdictions. - Limited evidence so far of major relocations of transactions or firms to RoW, except for some IRS trading and some CDS clearing moving to the United States; further fragmentation could prompt additional relocation. ### Key recommendations (excerpted from Table 1) - Immediate (Within one year): - Maintain the UK’s commitment to mutual co-operation with the EU post Brexit, including promoting a regulatory dialogue that can support financial stability and mitigate market fragmentation risks. — Responsible agencies: HMT, BOE/PRA and FCA. - Near Term (1-3 years), Medium Term (3+ years): - The UK authorities should continue to stand ready to engage with the EU regarding the regulatory status of UK CCPs. — Responsible agency: BOE. - Continue monitoring and identifying any legal uncertainties that may arise for UK financial firms post-Brexit and stand ready to provide legal and regulatory certainty as needed and where feasible. — Responsible agencies: BOE/PRA, FCA and HMT. - Review the UK equivalence framework inherited from the EU at an opportune moment and continue to enhance transparency for overseas jurisdictions through cooperative dialogues. — Responsible agencies: HMT, BOE/PRA and FCA. - Continue monitoring any potential residual gaps to cross-border cooperation with the EU on supervision and resolution, and take mitigating actions, where available. — Responsible agencies: BOE/PRA and FCA. *Document scope and timing* - This Technical Note (TN) assesses the situation a year on from the end of the transition period and covers regulatory frameworks and information as per end-January 2022. - The TN focuses on financial firms (notably banks undertaking investment services and investment firms), financial markets and FMIs (notably CCPs, CSDs and Trade Repositories), primarily in the United Kingdom while noting relevant EU and RoW aspects. *Italic source attribution: IMF Technical Note, “IMPLICATIONS OF BREXIT ON CROSS-BORDER FINANCIAL SERVICES” (chapter authored by Ender Emre and Hans Weenink); reflects frameworks and information as per end-January 2022.* ### 14. Responsibilities carried out previously at the EU level are now split between the HMT ### 14. Responsibilities carried out previously at the EU level are now split between the HMT and U.K. financial regulators ### Regulatory reallocation and framework review - Responsibilities previously exercised at the EU level are now split between HMT and U.K. financial regulators. - The United Kingdom has launched a Financial Services Future Regulatory Framework Review, which will result in proposals for redesigning the regulatory framework within which the U.K. financial services regulators will operate. - The U.K. authorities are reviewing their overall regulatory framework through the Future Regulatory Framework Review, and selected financial services legislation, such as for example the wholesale markets regulatory framework. ### Strengths and limitations of the broader U.K. legal and regulatory infrastructure - The broader U.K. legal and regulatory infrastructure remains strong and covers: - consistent and effective business laws and dispute resolution mechanisms, - the accounting, auditing and legal professions, - an effective and reliable judiciary, - efficient payment, clearing and settlement systems. - Limitation: U.K. firms can no longer benefit from some EU-level arrangements when providing cross-border services into the EU (e.g., U.K. CCPs previously benefited from EU-level settlement finality protections; treatment as third country CCPs may differ across EU27 post-Brexit). - EU-level instruments previously gave effect to agreements that: - attribute jurisdiction to a EU27’s court if one party is EU-domiciled, - provide for the mutual recognition and enforcement of judgments across the EU. - Post-Brexit mitigations: - U.K. authorities have taken actions to mitigate the impact of the loss of EU arrangements. - Industry associations have developed contractual solutions. - Practical implication: in certain cases, U.K. firms will need to assess and manage their risks separately for each EU27 as they navigate the post-Brexit environment. ### Data protection, adequacy, and cross-border data flows - Prior to the end of the transition period, the United Kingdom legislated to allow the transfer of data from the United Kingdom to the EU on a transitional basis for 4 years. - The TCA contained a four-month window (which could be extended by a further two months) during which the United Kingdom would not be treated as a third country for the purpose of the EU General Data Protection Regulation (GDPR). - The EC used this “bridging mechanism” to assess the U.K. Data Protection Act and U.K. GDPR to be essentially equivalent to the EU GDPR, allowing it to conclude that the United Kingdom ensures an adequate level of protection within the meaning of the EU GDPR. - This Adequacy Decision applies for four years from its entry into force. - U.K. authorities have announced a review of the U.K. data protection rules and clarified their intention not to dilute the rules; stakeholders caution any changes could negatively impact the EC’s Adequacy Decision and potentially impair some firms’ ability to provide cross-border services that involve transfer of personal data. - Other mechanisms (e.g., use of standard contractual clauses) remain available for transferring personal data. - A House of Lords Committee recommended the United Kingdom pursue a close dialogue with the EU to ensure implications for EU data adequacy are factored into any changes to the United Kingdom’s domestic data protection regime. ### Legal uncertainties, exit risk measures, and recommended monitoring - U.K. measures to address exit risks (including the onshoring process and transitional regimes) provided certainty to markets. - Legal uncertainties have arisen as U.K. firms navigate a complex EU and EU27 framework as third country firms; further uncertainties may arise from the relatively complex U.K. legal framework post-Brexit. - Recommendation: The U.K. authorities should continue their proactive monitoring of legal uncertainties that may arise going forward. - The U.K. authorities should continue their existing dialogue with EU counterparties including through existing international fora and cross-border supervision/resolution arrangements. ### The Trade and Cooperation Agreement (TCA) and institutional cooperation - The TCA is a preferential free trade agreement with similar financial sector liberalization to the EU’s other trade agreements; it is structured on a WTO basis and its primary focus is on trade in goods. - The TCA contains minimal provisions on financial services, excludes financial services from a small number of provisions relevant for general services, and commits both parties to maintain their markets open for operators from the other party seeking to supply services through establishments. - The TCA preserves parties’ right to adopt or maintain measures for prudential reasons (‘prudential carve-out'), including to preserve financial stability and the integrity of financial markets. - The TCA Annexes list extensive financial services reservations for the United Kingdom, EU and EU27. - The TCA includes a “best endeavors” commitment by both parties to implement international standards; its liberalization of the financial sector is less ambitious than in a single market or mutual recognition regime. - The MoU between HMT and the EC establishing structured regulatory cooperation is yet to be finalized: - A Joint Declaration accompanying the TCA mentions a MoU to establish durable and stable regulatory cooperation. - The MoU would allow for structured bilateral exchanges of views and analysis on regulatory initiatives, transparency and appropriate dialogue regarding equivalence decisions, and enhanced cooperation and coordination including in international bodies as appropriate. - The MoU was agreed at a technical level (in March 2021) but has still not been signed due to formal steps that still need to be taken by EU authorities. - Finalization of the U.K./EU institutional framework is not under the sole control of the U.K. authorities. ### Immediate impact of Brexit: loss of passporting and transitional measures - Consequence: EU and U.K. financial firms no longer have single market passport rights to access each other’s markets. - Passporting allowed firms authorized in one Member State to provide financial services across the EEA, subject to requirements within each sectoral framework. - The transition to the post-Brexit era was extensively prepared for by the United Kingdom and by targeted decisions by the EU and EU27. - HMT introduced a range of temporary permissions and transitional regimes to facilitate the transition for firms and their customers. Selected post-Brexit transitional measures (Transition Regime — Relevance — Timeline): - Temporary Permission Regime (TPR) — EU firms providing services into the United Kingdom unless covered by other temporary regimes — End-2023 - Temporary Recognition Regime — EU and third country CCPs — [no timeline entry in source beyond label] - Temporary Designation Regime — EU payment and settlement systems — [no timeline entry in source beyond label] - Temporary Marketing Permissions Regime — EU investment funds — End-2025 - Temporary Transitional Powers (TTP) — Delays or modifies firms’ obligations where they have changed because of onshoring changes to EU financial services legislation — End-March 2022, except for the share and derivative trading obligation - Financial Services Contracts Regime (FSCR) — For the orderly run down of EU firms that have not entered the TPR and those that exit the TPR without U.K. authorization — Current - Note: A separate transitional recognition regime for CSDs has no specified point at which it ends. There also exists a separate 'temporary registration and conversion regime' in relation to trade repositories. ### Market outcomes, relocation, and costs - U.K. firms engaged in contingency planning: adapted legal and operational structures, served EU clients from within the EU, and moved some assets and staff to the EU. - The degree of restructuring differed across firms, depending on business model and whether they had existing EU establishments. - The size of relocation was smaller than anticipated after the 2016 referendum. - Preliminary relocation reports (Box 1 findings): - New Financial survey (April 2021): - relocation by more than 440 U.K. based firms, - banks transferring more than £900bn (€1.05 trillion), - insurance firms and asset managers £100bn (€118n) in assets and funds, - estimated staff moves from the U.K. to the EU around 7400 or local hires; in headcount terms, even the most significant relocations represent a maximum of 10% move into the EU. - Ernst and Young survey: - between January 2020 and December 2021, number of financial firms announcing moves increased from 92 to 97 out of a total of 222 firms, - estimated staff relocations from the U.K. to the EU revised to 7400, - since the referendum a total of 24 firms announced transfer of assets totaling £1.3 trillion from the U.K. to the EU; this figure remained flat in 2021. - Destination patterns: Dublin and Luxembourg major for investment funds and asset managers; Frankfurt and Paris for many banks; Amsterdam for market infrastructure providers and trading firms. No single dominant EU financial center emerged. - Market impact: - Market parties report so far Brexit has not had disruptive effects on capital markets. - Some trading in EU shares and bonds migrated to the EU, and certain derivatives to the EU and United States. - The transition was very smooth without any material impact on financial stability despite coinciding with the pandemic. - Remaining challenges: - Firms’ adaptation introduced inefficiencies in capital, operating, and business models, increasing costs. - The longer-term impact depends on the interplay between the United Kingdom’s regulatory sovereignty and the degree of the EU’s openness. - Market fragmentation risks cannot be excluded while U.K. and EU regulatory frameworks continue to evolve; fragmentation could affect market access or increase costs, inefficiencies, further optimization, and possible further migration of financial services businesses to other third-country financial centers. - Costs of market fragmentation can particularly impact financial firms with comparatively lower profit margins. ### Equivalence regimes and cross-border regulatory deference - The United Kingdom has onshored the EU approach to equivalence; equivalence is one of the regulatory instruments the United Kingdom can use to support openness of the U.K. financial sector. - Equivalence, as a form of regulatory deference, facilitates market access and minimizes regulatory burden while supporting financial stability, market integrity and consumer protection. It involves a positive assessment of another country’s framework, enabling reliance on that country’s rules and supervisor. - Equivalence requires trust in the other country’s rules and supervisory actions. - The United Kingdom and EU equivalence regimes are activity-based, not general supervisory/regulatory regimes applicable to an entire overseas jurisdiction. - In U.K. and EU banking and financial sector legislation, the concept of equivalence is currently used in 13 legal acts, while 21 legal instruments have no provision on equivalence. - Example: there is no equivalence regime for deposit taking and lending, and cross-border payments. - Some equivalence provisions provide for market access (targeted to specific defined activities), whereas others provide regulatory relief to facilitate cross-border business (e.g., capital or reporting requirements). _Italic: Source — IMF staff summary of content unit "14. Responsibilities carried out previously at the EU level are now split between the HMT" from the provided PDF content._ ### 28. HMT’s Guidance on the principles of U.K. equivalence determinations is welcome. It ### 28. HMT’s Guidance on the principles of U.K. equivalence determinations is welcome. ### HMT Guidance: nature and objectives - HMT notes that U.K. equivalence determinations "are evidence and outcome based." - Determinations are unilateral but taken "in a transparent and cooperative manner including engagement with stakeholders." - Determinations can be time limited, and "withdrawn autonomously as a last resort measure, absent an agreement on appropriate solutions, and with possible measures to mitigate the disruptive effects of withdrawal." - The process aims to provide stability (also with respect to the review and, as necessary, withdrawal of determinations). - The Guidance Document resembles, but is somewhat different than, the EU approach that presents equivalence "primarily as a risk management exercise." ### Recommendations to enhance transparency and consistency - Continue to build on the Guidance Document by further enhancing transparency and consistency through cooperative dialogue with overseas jurisdictions, including the US, Singapore, Japan, and other priority jurisdictions. - Dialogue could, as appropriate, clarify: - how the balance between market access and financial stability will be determined in the relevant equivalence discussed (i.e., what considerations and indicators will be taken into account); - how the equivalent outcomes of supervisory approaches will be decided; - how resolution considerations will be integrated into equivalence assessments where applicable; and - how the engagement with stakeholders highlighted in the Guidance Document will be given substance. - The framework inherited from the EU should be reviewed "at an opportune moment to ensure it is fit for the United Kingdom." ### Current state of equivalence decisions (facts and figures) - The United Kingdom has issued "28 equivalence determinations for EU jurisdictions (and onshored around 270 EU equivalence decisions)." - The EU has granted the U.K. "two time-limited equivalence decisions, one for CCPs and one for CSDs (the latter of which has now expired), in addition to four exemptions covering central bank, monetary and public debt management activities." - The EC has indicated that "there is no expectation of further equivalence decisions" (with an exception discussed later regarding CCPs). ### Conceptual limits and operational implications of equivalence - Equivalence may not constitute a stable enough basis for markets "that have been—and remain—deeply connected at so many levels." - Various specific equivalence measures "cannot fully replicate the EU passporting regime." - Determinations can take time; U.K. firms have restructured and "incurred costs" to adjust to the end of passporting. - Where granted as a time-limited decision, equivalence "only provides temporary solutions, whereas markets seek longer term certainty." - Equivalence determinations can be withdrawn unilaterally; while issuance and withdrawal "should be evidence-based decisions," they "may have political aspects," as ultimate decisions belong to HMT in the United Kingdom and the EC in the EU. - Equivalence decisions must be compatible with policy priorities including (but not limited to) "the rule of law, international sanctions, human rights, and efforts to combat money laundering." ### Overview of cross-border regulation approaches (summarized from Box 2) - International practice developed several approaches to preserve financial stability while minimizing market fragmentation. Approaches vary in regulatory control over inbound and outbound services and can be applied by activity: - National treatment: apply domestic regime while allowing exemptions or substituted compliance for foreign persons, entities and products. - Regulatory deference: assess a foreign regime as equivalent or comparable (terms include "equivalence", "substituted compliance", and "recognition"); can be mutual or unilateral. - Passporting: single authorization/registration permitting services within a passporting area under a single home authority. - International agreements: mutual commitments to reduce overlaps and enhance reliance (example: EU-Switzerland Non-Life Insurance Agreement). - The G-20 recommended deference where appropriate, stating jurisdictions "should be able to defer to one another when it is justified by the quality of their respective regulatory and enforcement regimes, based on similar outcomes, in a non-discriminatory way and paying due regard to home country regulatory regimes." ### Market access and impacts on financial firms - Post-Brexit market access is more complex compared to passporting; EU third country regimes "do not, even in aggregate, offer comprehensive access to the single market, i.e., across the full range of financial services business lines." - U.K. impact so far: - U.K. transitional arrangements and historically open market access limited the impact on EU firms' access to the United Kingdom. - The U.K.’s overseas framework (including the overseas person exclusion, OPE) is a major contributor to the U.K.’s success as an international hub. - Elements of the U.K. overseas framework: - Exclusions where an overseas firm is deemed not to carry on a regulated activity in the United Kingdom (OPE). - Exemptions (e.g., recognized overseas investment exchanges) where activity is regulated but exempt from authorization. - Jurisdictional arrangements where cross-border access is available based on close cooperation/deference to the home regulator (i.e., equivalence and substituted compliance). - Access by U.K. firms to the EU/EU27: - In the absence of single market passports, U.K. banks mostly opted for a commercial presence in the EU to serve EU clients; many core retail activities cannot be provided cross-border into the EU/EU27. - Routes offering some cross-border access are limited or not uniform, and U.K. firms' use has been limited: - (i) Transitional regimes: some EU27 allowed U.K. firms to continue wholesale investment services for legacy contracts or temporarily for new contracts prior to authorization. - (ii) National exemptions: typically limited to wholesale activities; access requirements vary from notification to an equivalence determination by an EU27. - (iii) Reverse solicitation: allows provision of services based on the exclusive initiative of the client; EU27 policies vary significantly and present operational and legal risks. - Relocation and restructuring: - U.K. firms’ legal and operational relocation to the EU was informed by business model, tax, and regulatory considerations. - Subsidiaries benefit from passporting within the EU and can serve as depositary banks for UCITS and AIFs; branches offer limited access to a member state and may offer favorable prudential regimes. - Relocation and restructuring resulted in additional capital and operational costs across entities in the region, but the PRA notes "the impact on a consolidated level was moderate." - Supervisory developments influencing future activity: - The ECB expects that an "empty shell" will not be acceptable; banks must manage material risks locally. - ESMA has issued recommendations concerning substance for incoming U.K. investment firms. - U.K. banks agreed with the ECB and NCAs on timelines to reach target operating models for EU-nexus products and transactions. - The EU’s new intermediate parent undertaking (IPU) requirements for third country firms starting from "end-2023" could lead to costs associated with capital requirements at the level of new EU entities, but are not expected to cause disruption. - The EU is considering more harmonization of the regulatory framework for third country branches; if adopted, this could lead groups to reassess their use of branches in the EU. *Source: IMF staff summary of chapter content.* ### 2. Investment Funds and Asset Management ### 2. Investment Funds and Asset Management ### Market size and structure - U.K. asset managers manage around £3.7 trillion of investment fund assets as of end-2020. - 63 percent of this figure sits with funds domiciled overseas, mainly in Ireland and Luxembourg, indicating an 11percentage point increase since 2015 as U.K. asset managers transferred EU clients to overseas funds as part of their Brexit preparations. - The total size of managed assets within the wider industry is estimated to be around £11.0 trillion in 2020 according to the Investment Association’s Annual Survey for 2021. - UK firms manage 20% net assets of the EU’s AIFs, and in the specific category of hedge funds, 76% of net hedge-fund assets originated from the United Kingdom. ### U.K. regulatory measures to preserve fund marketing and delegation - A temporary marketing permissions regime ensures the continuity of marketing of more than 8000 retail funds, including MMFs, in the United Kingdom until the end of 2025. - EU alternative investment funds aimed at professional investors could benefit from the temporary marketing permissions regime before registering under the National Private Placement Regime. - The United Kingdom will introduce an Overseas Funds Regime (OFR) allowing overseas retail investment funds, including sub-funds and MMFs, to be marketed to retail and professional clients where HMT has made a jurisdictional equivalence decision. - The OFR expands the scope of the U.K. equivalence framework to include a mechanism for assessing overseas jurisdictions for inbound marketing of funds to retail clients, which is not the case in the EU. - Some operational frictions remain: EU-based UCITS face difficulties complying with national rules when investing in transferable securities dealt on U.K. markets, investing in U.K. UCITS, or depositing money with U.K. banks. - U.K. asset managers acting on behalf of EU funds subject to the EU derivatives trading obligation (DTO) may have had difficulties when trading in-scope derivatives with U.K. firms subject to the U.K. DTO, although the FCA clarified that transactions concluded by an EEA UCITS fund or an EEA AIF are currently outside the scope of the U.K. DTO. - The 2019 Multilateral Memorandum of Understanding between the FCA and National Competent Authorities facilitates delegation of portfolio management or risk management to U.K.-based managers. - The EC’s proposal of November 25, 2021, on amendments to the AIFMD and UCITS Directives allows delegation to continue and proposes additional requirements in terms of supervision and administration. ### Impact on markets: fragmentation, trading obligations, and reporting - Market fragmentation risks remain post-Brexit and can reduce efficiency and increase costs, potentially impairing market liquidity in periods of stress. - Passporting and integrated services disruptions: - Pre-transition, CRD and MiFID passports enabled U.K. firms to provide corporate lending, derivatives risk management, portfolio management, investment advice, and facilitate securities issuance across EU27. - Post-transition, deposit taking and certain investment services require authorization in EU27 member states unless equivalence, reverse solicitation, or national exemptions apply. - Share Trading Obligation (STO) effects: - Absent an EU equivalence determination for U.K. venues, the EU STO does not permit EU trading firms post-Brexit to trade in EU shares on U.K. venues (unless shares are denominated in sterling). - The FCA transitional relief allows U.K. participants to continue trading all shares on EU venues with relevant permissions. - The U.K. government has said it will seek to legislate to remove the U.K. STO. - The EC has proposed legal amendments to streamline the STO to apply only to shares with a primary listing in the EU and not to EU shares traded on a third country venue with a local currency denomination. - These differences led to a shift of trading in EU shares from U.K. venues to EU venues, mostly to Amsterdam, after the end of the transition period. - Derivatives Trading Obligation (DTO) effects: - Both U.K. and EU laws require certain counterparties to trade some classes of derivatives on local venues or equivalent third country venues. - Without mutual equivalence, the EU DTO and U.K. DTO would prevent firms using venues in the other’s jurisdiction and create conflicting obligations for some firms (e.g., branches of EU firms operating in the United Kingdom). - The FCA granted a time-limited and targeted relief allowing U.K. firms to trade in-scope derivatives on EU trading venues to which they have access, subject to conditions (including that the client has no access to an equivalent non-EU country venue). - The United Kingdom is considering the introduction of standing powers allowing the suspension or modification of the DTO if needed. - The EC proposed amendments to enable the suspension of the DTO in cross border relationships when conflicting trading obligations prevent an EU counterparty entering a derivatives contract with a non-EU counterparty. - Observed market shifts: - Market intelligence demonstrates in-scope derivatives trading moved from U.K. trading venues to EU and US trading venues, which hold equivalence decisions from both parties. - Reports indicate the market share of all EUR IRS trading on U.K. venues (MTF/OTF) declined from July 2020 to June 2021, while the share of EU and US venues increased. - Overall, across EUR, GBP and USD, more trading moved to US SEFs than EU venues. US SEFs also saw an increase in EUR CDSs trading. - The FCA has not observed, and market sources have not indicated, any significant deterioration in U.K. market participants’ ability to source liquidity in the United Kingdom or overseas. - Reporting and overlapping requirements: - EMIR and SFTR require reporting of derivatives and securities financing transactions to a trade repository (TR) or a recognized third country TR, based on equivalence. - Post-Brexit, U.K. counterparties are required to report to a FCA-registered or recognized TR and EU counterparties to an ESMA registered or recognized TR; this can lead to overlapping reporting requirements for some firms. - The United Kingdom has introduced a temporary registration regime for EU trade repositories. - Broad alignment of reporting requirements has limited the impact so far, but markets are cautious about potential future divergence. - Other misalignments: - EMIR exempts, subject to equivalence, certain intragroup OTC derivatives transactions with a third country from clearing and margin obligations. The United Kingdom has issued a unilateral equivalence decision, and the EU has provided a temporary exemption (until June 2022 for the present). - Absent permanent solutions, the cost of risk management by cross-border groups may increase. - Without equivalence, ETD derivatives concluded on U.K. venues would qualify as OTC derivatives under EU EMIR after Brexit, which might cause small financial firms and non-financial EU firms to exceed clearing thresholds and incur additional costs. ### Impact on CCPs and clearing - Third country CCPs’ access to local clearing members and trading venues is subject to a recognition decision, based on equivalence, under both the United Kingdom and EU EMIR. - Equivalence applies to the relevant jurisdiction; recognition is granted to individual CCPs and covers all their services, including derivatives where applicable. - Central clearing is mandatory for certain classes of OTC derivative contracts. - U.K. measures pre-Brexit: - In November 2020, HMT granted CCP equivalence to the EU. - The temporary recognition regime enables EU CCPs to continue providing services until December 31, 2023, to U.K. clearing members, while these CCPs apply for recognition. - A temporary designation regime ensures overseas FMIs (including CCPs) and any system previously covered by the EU’s SFD continue to benefit from the United Kingdom’s settlement finality protection, subject to their application for permanent designation. - ESMA and EU actions: - ESMA recognized three U.K. CCPs, conditional on an EC determination that the U.K. regulatory framework for CCPs is equivalent to the EU framework. - Two of these CCPs are classified as systemically important Tier 2 CCPs and therefore subject to dual supervision by the BOE and ESMA. - In its equivalence decision, the EC stated it was temporary because of the high concentration of the clearing of euro-denominated OTC interest rate derivatives in a single Tier 2 U.K. CCP. - The EC considers this concentration to entail financial stability risks and has a “clear expectation” that EU clearing members should reduce their euro-denominated OTC derivative exposures to Tier 2 U.K. CCPs. - The EC requested ESMA review whether the systemic importance of certain U.K. CCPs is such that a CCP (or some of its services) should not be recognized in the EU, or its recognition withdrawn, which could prevent a U.K. CCP serving EU clearing members on a cross-border basis depending on the coverage of services or products. _1gbrea2022008 - 2. Investment Funds and Asset Management_ ### 51. U.K. CCPs maintain their dominant position in euro-denominated interest rate and ### 1gbrea2022008 - 51. U.K. CCPs maintain their dominant position in euro-denominated interest rate and ### Dominance of U.K. CCPs in euro-denominated derivatives and clearing shifts - Over 90 percent of euro-denominated interest rate and overnight index swaps clear at LCH — a share that has remained stable over the last six quarters, as of Q3 2021. - In February 2019, a concerted effort between repo dealers and the two LCH CCPs in London and Paris led to the relocation of the near-totality of euro-denominated repo clearing from the United Kingdom to France. Although driven by client request, rather than Brexit, this move brought euro-denominated repo clearing under direct supervision of EU authorities. ### Uncertainty of U.K. CCPs’ regulatory status in the EU and ESMA assessment - U.K. CCPs currently benefit from a temporary equivalence decision, which allows EU clearing members to clear derivatives contracts with U.K. CCPs. - The EC has recently indicated that it plans to extend its equivalence decision for a further three years (until June 2025) but has not yet made a formal decision. - ESMA concluded that Swapclear (for clearing Euro and Polish zloty-denominated IRS); ICE CDS and ICE short-term rates (for Euro-denominated products) are of substantial systemic importance to the EU or Member States, but it did not recommend to de-recognize these services as the costs of doing so would outweigh the benefits. - ESMA suggested the adoption of mitigating measures, which in their view, would address the financial stability risks for the EU: - (i) measures of regulatory and/or supervisory nature that would incentivize EU clearing participants and EU clients to reduce their exposures towards UK CCPs and to rebalance these towards EU CCPs; - (ii) a revision of the EU framework for comparable compliance with a view to providing ESMA the appropriate tools to fully assess ongoing compliance with EMIR; - (iii) expansion of ESMA’s supervisory and crisis management toolbox; - (iv) enhancement of cooperation with UK authorities on CCP recovery and resolution. - Market participants welcomed the EC’s extension plan, but details of this temporary extension and of the extent of any future mitigating measures are unknown at the time of writing of this TN. ### Financial stability implications of fragmentation - Fragmentation of liquidity pools could reduce the efficiencies central clearing provides through the netting of positions and thereby raises the cost of clearing. - Increased costs to clear OTC derivatives in case of market fragmentation — due to loss of multi-currency netting benefits, higher margin requirements, and concentrations in fragmented local markets — may create pressures globally to relax the clearing mandate, a key post-GFC reform important for financial stability. - The U.K. authorities note that the legal permission of U.K. CCPs to offer services in the EU is ultimately a decision for the EU authorities. From a global financial stability perspective, the U.K. authorities will continue to monitor and stand ready to engage with the EU regarding the regulatory status of U.K. CCPs. ### Impact on cross-border cooperation on supervision and resolution — frameworks and practice - Brexit changed cross-border cooperation arrangements on resolution and supervision between the United Kingdom and the EU/EU27: cooperation now occurs outside the EU’s legal structure and the UK is withdrawn from the European System of Financial Supervision. - The U.K. authorities remain committed to strong cooperation with overseas jurisdictions, including the EU, reflected in statutory requirements and published approaches to supervision. - An extensive network of MoUs and institution-specific arrangements underpins U.K.-EU/EU27 cooperation: - The BOE, PRA and FCA have agreed over 30 MoUs with EU institutions and agencies (ECB, SRB, and ESAs), and NCAs. - The PRA has agreed Split of Responsibility (SoR) agreements with all EU authorities responsible for supervising firms with a branch in the United Kingdom. - As home authorities, the PRA and BOE respectively chair supervisory colleges and CMGs for U.K. G-SIBs and CCPs, involving EU/EU27 authorities, and participate in supervisory colleges and CMGs set up for four EU-GSIBs and EU CCPs. - Existing international fora further facilitate cooperation, including BCBS, FSB, IAIS, and IOSCO. - Supervisory colleges and CMGs for 14 G-SIBs from the RoW (namely, from the United States, Japan, and Switzerland) enable host-to-host cooperation between the U.K. and EU. A Trilateral Principal Level Exercise regularly engages authorities responsible for GSIB resolution from the EU, United Kingdom, and United States. ### Cross-border supervision: legal basis and operational notes - FSMA requires U.K. regulators to cooperate with other bodies, including in overseas jurisdictions (Section 354A, 354B, and Section 23A of Schedule 17 of FSMA). - HMT Regulations provide legal gateways to exchange non-public information with overseas authorities, subject to confidentiality safeguards. - The U.K. FSAP TN on Banking Supervision and Regulation assessed U.K. authorities’ cross-border cooperation with EU counterparties as generally effective; supervisory cooperation during the COVID-19 pandemic was effective. - The BOE and ESMA have concluded an MoU on cooperation for the recognition and supervision of U.K. CCPs: - It is a statement of intent to consult, cooperate and exchange information with respect to the three U.K. CCPs. - The MoU details cooperation and contains provisions on resolving disagreements and allows either party to deny cooperation in limited and clearly specified cases (national interest or where cooperation would run counter to legal/regulatory requirements or statutory objectives). - Monitoring potential residual cooperation gaps is advisable. Example gaps: - NCAs are required to share certain data on alternative investment funds’ activities with each other as well as ESMA and the ESRB, while the United Kingdom and EU are not required to share this information after Brexit. - The FCA considers it has mechanisms to mitigate this gap (regular engagement and MoUs), but access to relevant data might not be as timely and comprehensive as before. - PRA and BOE now have observer status in some colleges; they are monitoring how this affects involvement in tasks and information exchange, subject to college members’ agreement. ### Cross-border resolution: frameworks, recognition, and operational considerations - Both the United Kingdom and EU have developed resolution frameworks since the GFC; the EU recently adopted its CCP Recovery and Resolution Regulation, and HMT published a Consultation Paper (Expanded Resolution Regime: Central Counterparties) in February 2021 on improvements to its CCP resolution regime. - Both U.K. and EU regimes include statutory frameworks allowing recognition of foreign resolution actions and promote contractual mechanisms for recognition of bail-in and temporary stay of early termination rights governed by third country laws. - Progress in resolution planning and investments to improve resolvability by both U.K. and EU authorities supports cooperative approaches. - The automatic recognition of EU resolution actions in the United Kingdom (and vice versa) has ended, but the BOE’s mandate for cross-border cooperation with the EU remains strong: - The law requires the BOE to consider the impact of stabilization powers on the financial stability of overseas jurisdictions where a group operates. - Insofar as a resolution action would be broadly comparable to the outcomes and objectives of a stabilisation option under the U.K. regime, the BOE will recognize an overseas jurisdiction’s resolution action, subject to HMT approval, absent specified refusal grounds like those in the BRRD and in line with the FSB Key Attributes. - The BOE can give effect to foreign resolution measures through supporting actions, including supervisory approvals, and the use of its resolution powers or inaction. - The BOE’s use of its recognition powers will be key to give effect to EU actions in specific areas, including: - recognition of the bail-in of EU banks’ legacy liabilities subject to English law without a contractual recognition clause; - giving effect to measures for operational continuity under contracts subject to English law, including maintaining access to U.K. FMIs, or the provision of critical services; - early termination of financial contracts not already covered by the ISDA Protocol (or similar). - Further guidance could be useful on the scope of overseas jurisdictions’ resolution actions subject to the BOE’s recognition powers: - U.K. courts confirmed that the Cross-Border Insolvency Regulations 2006 (CBIR 2006) can apply to recognize or assist EU bank insolvency proceedings (In the Matter of Greensill Bank AG, [2021] EWHC 966 (Ch)). - The BOE does not have a statutory role in CBIR applications but could be given a right to be heard in case of a risk to its resolution objectives and actions. - A foreign action could potentially qualify both as a foreign insolvency proceeding under the CBIR and be comparable to a U.K. stabilization option, creating potential legal uncertainty over which proceeding will apply, though this uncertainty has not materialized in practice to date. - Treatment of liabilities and MREL eligibility: - The SRB considers liabilities issued under English law by EU banks to be eligible for MREL until June 2025 if they were issued on or before November 15, 2018. - The PRA clarified that the contractual recognition clause requirement for MREL and (temporary stays) does not generally apply to liabilities governed by EU27 law and created before the end of the transition period (unless materially amended afterwards). The PRA also delayed the obligation to include a contractual recognition of a bail-in term in new or materially amended phase two liabilities governed by EU law until the end of the TTP period. - The BOE (with HMT approval) can independently resolve the U.K. branch of an overseas jurisdiction’s bank if no co-operative solution exists to protect the United Kingdom’s public interest; developing further internal guidance on branch resolution may be useful given several systemic EU branches will continue wholesale activities in the United Kingdom. - There remains a residual possibility of misaligned incentives between the EU and United Kingdom in cross-border resolution due to potential for divergent actions; CMGs present a forum to discuss such issues. The SPE strategy with adequate loss absorbency is designed to avoid imposing losses on depositors, but residual ranking issues may create incentives for unilateral action. *IMF staff compilation from the provided U.K. FSAP technical note excerpt.* ### 70. Overall, the existing cross-border arrangements constitute a good basis for ### 1gbrea2022008 - 70. Overall, the existing cross-border arrangements constitute a good basis for ### Cross-border resolution and crisis management: assessment and challenges - Existing cross-border arrangements constitute a good basis for cooperation with the EU on resolution and crisis management, but their true value will be tested during times of distress. - These arrangements can help cooperation during: - resolution planning (e.g., for the clear allocation of internal TLAC/MREL within a cross-border group as well as relevant triggers), - resolution implementation, - managing a crisis (e.g., communication arrangements between home and host authorities). - Memoranda of Understanding (MoUs) work well during normal times, but challenges can arise during crisis times. - During a crisis: - communication lines between resolution authorities remain open, but ultimate decisions will likely involve political factors, informed by, inter alia, the distribution of losses to local creditors and fiscal risks. - mutual trust is key for cooperative cross-border resolutions. - Some supervisory crisis management tools are new and untested in a cross-border context. Example: - The United Kingdom and EU EMIR Regulations allow the supervisor to suspend the clearing obligation for a specific class of OTC derivatives or a specific type of counterparty in well-defined situations (notably serious threats to financial stability or the orderly functioning of financial markets). - Uncertainty exists about how this power could be used in cross-border situations (e.g., if problems affect mostly clearing members in one jurisdiction and not in others, or only certain instruments denominated in a particular currency). - Effective implementation of such measures would require a high degree of trust and cooperation, and involvement of relevant authorities globally (i.e., not only between the United Kingdom and EU). ### Key statistics on legal jurisdiction and instruments - Around 60% of MREL-eligible debt issued by UK banks is governed by U.S. law; issuance under other non-UK and non-US law contracts make up less than 5 percent. - Reference: prudential grandfathering and contractual recognition clauses under Article 494b CRR (SRB communication on eligibility of U.K. law instruments without bail-in clauses after Brexit, March 22, 2021) is noted in context. ### Impact on Rest of the World (RoW) - The impact of Brexit on RoW financial firms has so far been modest and there has not been a discernable risk to financial stability. - This outcome reflected U.K. authorities’ pro-active measures: - onshoring EU law, - existing EU equivalence determinations vis-à-vis RoW jurisdictions, - temporary regimes (e.g., the Temporary Recognition Regime). - An overview shows RoW jurisdictions benefit from more EU equivalence decisions than the United Kingdom. - As an EU member, the United Kingdom had benefited from deference decisions for the EU made by third countries; in many cases such countries have extended their deference arrangements to the United Kingdom after its departure from the EU. - Post-Brexit actions by the United Kingdom: - pursuing its own deference decisions with overseas jurisdictions, notably the United States and Switzerland, - actively pursuing free trade agreements with RoW jurisdictions and recently agreed a new FTA with Australia. - Brexit has not changed the formal status of the British Overseas Territories in terms of access to the EU and U.K. markets. - So far limited evidence of major relocation of financial transactions or firms to RoW jurisdictions (except for some IRS trading and CDS clearing moving to the US). Additional relocation cannot be excluded if further market fragmentation occurs. ### Expansion of U.K. cooperation with RoW jurisdictions - Brexit resulted in updating or establishing new agreements for reasons including: - EU law ceases to apply in the United Kingdom (see the MoU between the SEC and the FCA), - U.K. authorities’ new responsibilities assumed from EU authorities (such as supervision of credit rating agencies), - recognizing/registering overseas firms under onshored EU law (e.g., overseas CCPs, CSDs, and trade repositories). - Where existing agreements are not sufficient, it is important to establish new agreements in a timely manner with RoW jurisdictions. - For recognition processes for overseas CCPs and CSDs, the BOE will need to agree new cooperation agreements with all applicant jurisdictions. - Recommendation cross-reference: U.K. FSAP TN on Bank Supervision and Regulation recommends putting in place arrangements with other home state supervisors as well. ### Open Banking: rationale and design - Information sharing is essential for banks to assess borrowers’ risks; credit bureaus historically intermediate such data. - Open banking grants consumers the right to control who gets access to their financial data and provides an operational setting to exercise that right. - Open banking can stimulate competition and innovation by enabling access to data across incumbents and new competitors. - Approaches vary across jurisdictions: - public mandates for reciprocal data sharing, - public encouragement by regulators, - private sector led initiatives with public neutrality. - Common technical enabler: standards or common approaches for APIs that allow data to be transferred securely in standardized formats. - Two key innovations relative to traditional credit bureaus: - direct data exchange between financial institutions (allowing use of granular data for proprietary analysis and customized products), - control over data access moved from financial institutions and credit bureaus to individual customers (user-initiated data transfers and user control over what is shared). ### Open Banking in the United Kingdom: implementation and uptake - The United Kingdom launched the Open Banking (OB) initiative in 2018 to improve customer choice and increase competition. - CMA action followed the Retail Banking Market Investigation noting customers did not switch between banks, certain costs were high, and overall quality of service could be improved. - CMA aimed to place competitive pressure on larger banks (which have accounted for over 80% of the current account market for many years) by requiring them to create and fund an open banking entity. - Parallel payment services regulation requires all payment account providers to provide access to customers’ accounts to regulated third parties with the customer’s explicit consent. - OB allows consumers and SMEs to share bank account information securely with regulated third parties (service providers) to perform regulated activities (account information services) and, for some providers, to initiate payments (payment initiation service providers). - The Open Banking Implementation Entity (OBIE): - mandated by the CMA, - funded by the nine largest current account providing banks in the United Kingdom (CMA9) at an average of £33 million annually over the first 3 years, - tasked to build a common set of API standards and support technical implementation. - Licensing of OB service providers is undertaken by the FCA; there has been rapid growth of fintechs operating in the eco-system—however no large technology companies currently are part of the OB system in the United Kingdom. - Take-up: - “Open banking now has around 4 million users. Perhaps as many as half the United Kingdom’s SMEs now use tools employing open banking functionality and this level of adoption is likely to be reinforced as HMRC begins using open banking for tax payments.” ### Comparative design features (high-level synthesis from table) - Jurisdictions differ in launch dates, national digital ID presence, perimeter of participants, interoperable payment initiation, mandate, data classes, and features. - United Kingdom (2018): No national digital ID; banks and payment service providers including regulated fintechs; interoperable payment initiation yes, mandate; data classes: Payment account data - Account balances; Transactions; Asymmetric obligation where banks and other account providers required to share; the non CMA9 account providers may voluntarily be part of the open banking entity. - Other jurisdictions in comparison include Australia (2020), China, European Union (2019), India (UPI 2016), New Zealand (2017). ### Potential risks, operational issues, and enhancements - Operational issues: - non-negligible rate of API call fails, affecting trust especially for smaller OBs and customer retention. - downtime for payments apps induces high rate of customers trying an app once and not again. - Potential enhancements: - developing multiple infrastructure layers (digital ID linked to payments linked to privacy consent management—a synergistic stack), - exploring mechanisms to operationalize consent for user data sharing (for example by data fiduciaries in finance and, eventually, in other sectors), - consideration of potential expansion of the perimeter of data and financial activities that must be shared (FCA considering in context of responses to the 2019 call for feedback on open finance; see FCA FS21/7: Open finance – feedback statement). *Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1gbrea2022008.pdf* ### 83. The near-term financial stability risks arising from the OB initiative appear to be ### 1gbrea2022008 - 83. The near-term financial stability risks arising from the OB initiative appear to be ### Liquidity risks - Principal channel identified: liquidity via deposit switching (consumers across banks and from traditional banks to new banks, including potentially OB service providers that obtain deposit taking licenses to become new banks). - Current assessment: near-term liquidity risks are modest in the current configuration of the system. - Evidence: gradual uptake of the OB system and data on current account switching since inception do not point to OB generating substantial current account switching (though there has been some switching of deposits to neo-banks) in the last years. - Implication: large and rapid deposit switching could generate liquidity risks for incumbent banks, but this is not judged imminent given observed uptake. ### Business-model risks - Principal channel identified: competition from OB service providers in current account payment services (e.g., money management or payments initiation) that could undermine bank income, capital generation, and hence stability. - Current magnitude: the share of bank income derived from pure payments services is small (less than 0.8 percentage points of bank return on equity), which mitigates near-term risks. - Potential future risk: if OB service providers leverage data to provide additional financial services (lending and asset management), they could eventually have a more significant impact on incumbent banks’ income. - Regulatory constraint: certain activities by OB service providers would require various permissions from regulators. - Timing/adjustment: assuming entry by OB service providers over the next 3-5 years into provision of such services is gradual, banks would have time to adjust business models containing stability risks. ### Operational and cyber risks - Principal channel identified: operational risks from increased opening access to user data increasing risk of data loss and fraud. - Mechanism: a greater number of providers entering the market, with customer data shared more widely, may create more avenues for operational and cyber threats and more points of importance within the system's infrastructure. - Mitigants: FCA licensing of OB service providers and requirements, in coordination with the OBIE, on appropriate standards and safeguards for the API infrastructure underpinning OB. - Regulatory detail: Open Banking firms and payment account providers must comply with conduct and security and operational requirements described in the Regulatory Technical Standards on Strong Customer Authentication; the FCA monitors firms’ operational and security risk via intelligence including an operational and security risk report (REP018) submitted at least annually and major incident reports in accordance with EBA reporting guidelines. - Conduct limitation: Under the Payment Services Regulations 2017 (PSRs), OB service providers are not permitted to use, access, or store any account information for any purpose except for the provision of the account information service, or payment initiation service, explicitly requested by the customer. The PSRs do not specify the types of OB enabled services that firms may offer. ### Look ahead: development of the OB framework and governance - Current dynamics: some existing banks are developing their own OB platforms and seeking to use open data to compete on margins with other large banks, which could increase competition among established banks. - Governance changes: changes to the governance framework of the OBIE in light of recent feedback have already been announced. U.K. Finance has proposed arrangements for the OBIE following completion of the Open Banking roadmap; CMA consultation noted requirements that future arrangements be (i) independently-led and accountable, (ii) adequately resourced to perform the functions required, (iii) dedicated to serving the interests of consumers and SMEs, and (iv) sustainable and adaptable to future needs of the ecosystem. - Possible evolution: one element under consideration is an upgrade of the OBIE with a new entity less focused on compliance with the CMA order by the largest banks and more on expanding the ambit of data sharing and API development to a larger set of potential financial services deliverers. The consultation on the future of the OB entity is still ongoing; the FSAP does not review this issue nor the features of this new “entity.” ### Bigtech entry — scenario analysis and implications - Current status: Bigtechs are offering payments services in the United Kingdom but are not currently active in the OB ecosystem. - Scenario illustrative shock: a 10 percent drop in market share in lending and deposit taking for U.K. banks (noted as very large by historical standards) is used to illustrate potential impact of large scale market structure changes that could result from bigtech entry. - Potential impacts: such a shock could see an erosion in net income margins and capital over a short-term horizon based on historical relationships between net margins and market share, pointing to the potential relevance of the discussed channels. - Offsetting possibilities: banks could themselves benefit from new opportunities from OB offsetting pressure on their margins; technological adaptation could create benefits for incumbents as well as challengers. - Scale risk: given the scale and network externalities of platform-based technology companies, massive and rapid entry could take place with bigtechs by contrast with the existing fintech ecosystem, increasing speed and magnitude of impacts. ### Policy attention: monitoring, coordination, and learning - Monitoring: - Need for continued close monitoring of technological transformation and its pressure on margins and funding which could lead to structural change in the banking system (acquisitions, mergers, orderly exits). - Continued monitoring is called for given the potential for scale and speed of technological change (including permissioned bigtech entry). - Coordination: - Regulators have a range of options to address issues from potential entry and/or increased competition while protecting stability and consumers. - Dialogue between regulators on competition and financial stability has been ongoing, including in the establishment of OB. - The FCA is required to consider consumer protection, work with the Bank of England on financial stability risks and promote competition. - The United Kingdom created the Digital Regulation Cooperation Forum (DRCF) in 2020 (CMA, ICO, Ofcom). - Gap noted: the CMA’s mandate for introducing competition remedies does not formally require regard to other objectives (e.g., financial stability); the report recommends considering formal mechanisms to ensure views from regulators focused on stability are taken into account in deliberations on competition policy interventions in the financial services sector. - Learning: - Experience from OB could lead to shifts to open finance or a fully open data economy, broadening the role of data across financial and other services. - An innovative review of the policy framework for managing competition in digital markets is underway in the United Kingdom considering the Furman review, including potential new tools (designation as SMS, interoperability requirements, data portability) that could address competition concerns raised by digital platforms. - Recommendation: study potential impact of such policy tools on financial stability risks arising from platform delivery of financial services. ### Challenges as OB matures - Level playing field: entrants differ in data endowments—banks may have decades of granular customer data while new fintechs/bigtechs may have alternative large datasets. - AI risks: design of OB frameworks must be mindful of risks from wider use of AI based on customer data harvested via OB for decisions on granting financial services. - Cross-sector expansion: U.K. authorities plan to expand open rights to other structured data classes (energy and telecommunications sectors), and OB could be a steppingstone toward broader open data frameworks. - Global policy challenge: developing global policy frameworks for the management of data across sectors and borders remains an important challenge. ### Transition from LIBOR to SONIA (summary points included in the unit) - Status (reflecting information up to December 2021): the transition from Sterling LIBOR to SONIA is well advanced in the United Kingdom; since then further significant transition events have occurred and the transition from Sterling LIBOR to SONIA is now complete. - Continued attention required: - Conversion of existing legacy LIBOR-based instruments: processes and backstops are in place but not all instruments have been converted; U.K. authorities have regulatory and legal tools to encourage active transition; backstops exist for contracts that cannot practicably be renegotiated while discouraging long-term reliance on backstops. - Progress with non-sterling instruments: transition responsibility rests with domestic authorities; transition progress in U.S. dollar markets is somewhat less advanced; U.K. authorities should continue to assist foreign regulators (particularly U.S.) to prepare markets for transition from end 2021. - Term SONIA: availability of a forward-looking Term SONIA rate can provide a temporary backstop to sterling instruments traded in the United Kingdom by foreign customers in emerging and developing markets. - Future vigilance: - Authorities and markets should remain focused on risks of the next “LIBOR”; emerging Credit-Sensitive-Rates in US dollar markets may replicate weaknesses of LIBOR and may not be robust. - Recommendation: consider a suitable domestic group of regulators and market participants to maintain a watching brief on financial benchmarks and explore updating regulatory tools to allow pre-emptive action if new non-robust financial benchmarks emerge. *Italic: International Monetary Fund — source content as provided in the PDF chapter excerpt.* ### 93. LIBOR is a critical financial benchmark that links participants in interest rate markets ### LIBOR is a critical financial benchmark that links participants in interest rate markets ### Criticality and systemic importance - LIBOR is "a critical financial benchmark" that links participants in interest rate markets globally. - Few benchmark interest rates play a more significant role than LIBOR in the pricing of funding, liquidity, and risk globally. - LIBOR is either the predominant or one of the leading short-term interest rate benchmarks used in the five largest used currencies globally. - The 2019 BIS Triennial Survey finds that derivatives trading in the LIBOR-5 currencies covers "more than 85 percent of global turnover in Over the Counter (OTC) interest rate derivatives" and "almost 80 percent of trading in OTC FX instruments." - Turnover and outstanding volumes of derivatives contracts far outweigh that of other instruments and the bulk of interest rate derivatives are linked to LIBOR. - In the United Kingdom, "around 85 percent of LIBOR based contracts were derivatives in September 2020." - LIBOR transition raises potential financial stability risks from a disorderly transition that disrupts credit intermediation. ### United Kingdom’s role and exposures - The United Kingdom is a key global financial center and hosts many LIBOR-based instruments beyond sterling. - LIBOR-based instruments in the United Kingdom outside of sterling exceed those denominated in sterling. - U.K. financial market users globally rely heavily on U.K. markets to access funding and manage risks in all the LIBOR currencies. - Significant exposures of U.K. domiciled firms to non-sterling LIBOR currencies—specifically to U.S. dollar LIBOR—mean that a disorderly transition in non-sterling LIBOR currencies could have a material impact on U.K. markets. - This is particularly concerning for users in Emerging and Developing jurisdictions who are customers of U.K. regulated financial firms and may have fewer alternative financing or risk management options. ### Maturity profile and transition urgency - Many LIBOR-based instruments mature beyond the dates when regulators indicated LIBOR will have ceased: "December 2021 for most currencies, June 2023 for some important USD fixings." - "Half of all LIBOR based interest rate derivatives outstanding in U.K. domiciled firms mature beyond the end of 2021." - A greater proportion of other instruments mature beyond 2021. - These features imply the need for an active transition to transfer existing exposures from LIBOR to a more robust benchmark prior to maturity. ### Retail usage - LIBOR is not heavily used in retail lending in the United Kingdom; historically, the Bank of England base rate has been the most used benchmark for retail instruments. - This reduces complexity for less sophisticated retail parties as the primary transition participants are more sophisticated institutions. ### Managing the transition from LIBOR to SONIA — strategy overview - The U.K. authorities adopted a structured, progressive approach to manage transition, aiming to minimize the risk of financial system disruption from a sudden cessation of LIBOR. - The approach sequence: - Stabilize the status quo to prevent disorderly cessation risks. - Create a robust alternative benchmark (SONIA) and develop liquid markets to support funding and hedging without LIBOR. - Manage legacy LIBOR exposures via active transformation to RFR-based instruments, development and implementation of fallbacks, and tools for remaining legacy instruments. ### Stabilization measures - Initial focus (from 2017) was to reduce disruption risk if LIBOR panel banks ceased contributing quotations due to lack of robust underlying unsecured interbank wholesale term lending markets. - Authorities secured panel bank support to continue providing LIBOR inputs "until end 2021 (later extended to June 2023 for some USD fixings)." ### Adoption of SONIA as sterling RFR - The Bank of England convened the Working Group on Sterling Risk-Free Reference Rates (RFRWG) in 2015; the RFRWG recommended a reformed SONIA rate as the new sterling markets benchmark in April 2017. - The United Kingdom leveraged an existing reformed benchmark (SONIA) rather than creating a new benchmark. - RFRWG guidance and market development efforts addressed conventions, operational capacity, and infrastructure needed to use overnight SONIA across loans, bonds, derivatives, futures, and Floating Rate Notes. - Development and communication of best practices for referencing SONIA across bonds, loans, and derivatives occurred from the second half of 2018; operational capacity was developed over 2019. ### Term SONIA and use cases - Sterling term benchmark rates were developed for a minority of cases where compounded overnight SONIA in arrears was less feasible. - Over 2018–2019 work advanced on a forward-looking term benchmark; in early 2020 RFRWG identified a small set of instruments suitable for Term SONIA. - The FICC Markets Standards Board (FMSB) produced a market standard emphasizing limited use cases for Term SONIA, including "Trade and Working Capital products, Export finance, Emerging markets lending and Islamic finance-based facilities." - Two providers of sterling Term SONIA emerged (ICE Benchmark Administration and Refinitiv); the RFRWG published a summary of key characteristics but left market participants to choose. - The RFRWG and U.K. authorities emphasized limited use of Term RFRs to concentrate bulk of new business on overnight SONIA compounded in arrears to preserve systemic risk advantages and liquidity. ### Milestones and market conventions to drive endgame - Industry recommended milestones in 2021 pushed for the end of new LIBOR-based lending and derivatives, supported by the PRA and FCA in a March 2021 letter to senior managers and CEOs. - Sequential "SONIA first" initiatives coordinated by the FCA and Bank of England changed quotation conventions for LIBOR-based derivatives by encouraging dealers to quote prices calculated based on SONIA rather than LIBOR, fostering price discovery and hedging in SONIA markets. - Continued LIBOR trading in derivatives was permitted for risk management of existing positions and to support active conversion of legacy exposures. ### Supervisory engagement and industry implementation - U.K. authorities used multi-layered supervisory engagement to encourage and facilitate transition. - "Dear CEO" letters were sent by the PRA and FCA in September 2018, February 2020 and March 2021 advising firms to prepare transition plans and encourage customers to move to RFR-based instruments. - Regulators required firms to identify and nominate a Senior Manager responsible for LIBOR transition to ensure clear oversight and accountability. - The Financial Policy Committee (FPC) in 2019 noted the importance of active transition and pointed to supervisory tools to encourage it. - Bilateral supervisory engagement reviewed firm transition plans, provided comments, and collected regular information on transition progress, with heavier engagement for larger and more complex firms. ### Fallbacks, contracts, and legislative tools - As alternative markets developed, efforts increased to convert legacy instruments from LIBOR to new benchmark instruments where possible. - Appropriate fallback arrangements were developed for many legacy instruments to allow continuity if LIBOR ceased. - The ISDA IBOR Fallbacks Protocol and Supplement settled on ISDA-governed instruments resetting on the relevant currency RFR plus a fixed spread (the spread was set in March 2021). - Fallbacks have also been used in recently issued contracts expected to transition at LIBOR cessation. - The U.K.’s existing Benchmarks Regulation provided limited ability to manage legacy contracts; the U.K. authorities developed new legislation—the U.K. Financial Services Act 2021—with provisions that gave the FCA enhanced powers by amending the Benchmarks Regulation to manage an orderly wind down of LIBOR. - Key provisions included: - Prohibition on new use of a critical benchmark that is known to be ceasing (Article 21A) - Designation of a critical benchmark as permanently unrepresentative (Article 23A) - Prohibition on the use of an Article 23A designated benchmark (Article 23B) - Possible exemption from the use prohibition for some or all legacy use of an Article 23A designated benchmark (Article 23C) - Orderly cessation of an Article 23A designated benchmark including a change in methodology (Article 23D) - These powers allowed the FCA to facilitate wind down, stop new use of LIBOR, and permit limited ongoing legacy use of an Article 23A designated benchmark (which could be subject to changes in methodology, e.g., a synthetic LIBOR). - The U.K. Government passed the Critical Benchmarks (References and Administrators’ Liability) Act in December 2021 to clarify how references to synthetic LIBOR should be interpreted in contracts and arrangements. - Industry was generally supportive of the United Kingdom’s approach. *Source: UNITED KINGDOM INTERNATIONAL MONETARY FUND* ### 107. LIBOR transition has been a joint industry/regulator partnership. The transition effort ### LIBOR transition has been a joint industry/regulator partnership. The transition effort ### RFRWG composition, objectives, and milestones - The transition effort has been primarily implemented through the RFRWG from January 2018 when the RFRWG was reconstituted and expanded to include a much wider/diverse range of stakeholders including additional banks and dealers, investment managers, non-financial corporates, infrastructure providers, trade associations and professional services firms. - The broader constitution of the RFRWG was important in it realizing its objective to catalyze a broad-based transition to SONIA based markets by end 2021. - Key stages and objectives set out by the RFRWG and supported by regulators: - Enable transition - Stabilize LIBOR - Agreement with panel banks to remain as submitters until end-2021. Further announcements made in March 2021 - Establish Risk Free Rate - SONIA recommended as the preferred alternative RFR to GBP LIBOR by the RFRWG - Proactive transition of new and legacy business - Develop new markets - Build SONIA Liquidity - Convert legacy stock - Active conversion (e.g. through consent solicitations) - End-game - Adopt fallbacks - Develop contractual fallbacks (e.g. ISDAIBOR fallbacks protocol) - Develop safety net - Legislation or other measures to address legacy contracts that cannot be transitioned by end-2021 ### Channels of implementation and engagement - The transition strategy has been implemented through engagement through three channels: - through market participants, - through official sector regulatory groups, and - international Risk-Free Rates working groups in the other LIBOR jurisdictions. - Market engagement has been two-pronged: - Initiatives targeted at regulated firms via supervisors (including consistent messaging and “Dear CEO” letters linking to Senior Manager’s responsibilities under the United Kingdom’s Senior Managers and Certification Regime). - Market-wide initiatives aimed at end users (RFRWG technical subgroups, outreach to industry associations, high-level speeches by U.K. authorities). - International engagement: the U.K. authorities co-chaired and led at the FSB’s Official Sector Steering Group (OSSG) until end-2021 and maintained bilateral regulator relationships and engagement with other RFR working groups. ### United Kingdom leadership and milestone-setting - The United Kingdom set early, time-bound milestones to inject accountability and guide market action; the RFRWG agreed metrics of success in 2018 and laid out clear milestones in 2020 and 2021. - The PRA and FCA explicitly supported RFRWG milestones, aligning supervisory expectations with industry recommendations. ### Market readiness for transition to SONIA - SONIA robustness and behavior - The Bank of England took responsibility for calculation and production of SONIA in 2016 and reformed the rate in April 2018. - Traded volumes have been significant and increased in the post Covid-19 period; SONIA has consistently traded close to and moved with Bank Rate. - During the COVID-19 shock in March 2020 SONIA showed resiliency relative to LIBOR: the value of transactions underpinning SONIA rose as market activity shifted to overnight maturities while transactions underpinning LIBOR fell; SONIA only briefly spiked relative to Bank Rate while the spread of LIBOR relative to equivalent Overnight Indexed Swap rates benchmarked to SONIA remained elevated for several weeks after onset of volatility in March 2020. - Futures and derivatives markets - Futures markets gradually adopted SONIA supported by the “SONIA-first” initiative in 2021. - The initiative encouraged market participants to shift the default traded instruments to SONIA in exchange traded derivatives from June 17, 2021. - OTC short term interest rate derivatives transitioned to SONIA (including nonlinear instruments) supported by the “SONIA-first” quotation convention in sterling non-linear derivatives from May 11, 2021. - Sterling swaps liquidity - Over half of traded volumes in shorter term sterling swaps have been in swaps tied to SONIA for some years. - Turnover in longer dated swaps increased from the second half of 2020. - The sterling swaps “SONIA-first” initiative in Q4 2020 assisted the shift to SONIA based swaps trading. - Bond market - New issuance of sterling floating rate notes tied to LIBOR largely ceased by the first half of 2020 and now all sterling issuance occurs based on SONIA indicating a full transition. - ISDA fallbacks and contract coverage - ISDA 2020 IBOR fallbacks protocol (available October 2020) facilitates smoother transition for derivatives governed by ISDA Master Agreements in the event of LIBOR cessation or becoming unrepresentative. - Take-up in the United Kingdom has been strong: - Over 85 percent of uncleared sterling LIBOR-referencing swaps now have effective fallbacks through dual-side adherence and over 99 percent have one-sided adherence. - Clearing house conversion mechanisms mean that 97 percent of sterling derivatives are covered by fallbacks. - Adherence has included interdealer brokers/banks and a wide range of buy side end users; the Bank of England has adhered to the protocol in its own operations. ### Remaining issues and policy recommendations - Managing legacy LIBOR contracts - Active conversion of legacy LIBOR based instruments to RFRs is important across all LIBOR jurisdictions because many legacy instruments mature beyond the end of LIBOR. - The U.K. authorities should continue multi-level active supervisory engagement with U.K. firms to encourage continued transition both in the lead-up to and after end-2021. - The United Kingdom’s regulatory framework and the availability of synthetic LIBOR provide a temporary backstop that will give market participants time to continue transition or allow contracts to run off. - The U.K. authorities clarified how references to LIBOR should be treated in legacy contracts that could reference LIBOR after the FCA imposes a synthetic methodology, balancing contract functionality and consumer protection. - Supporting migration beyond sterling (especially USD) - Sterling markets are largely ready, but more work is needed in other actively traded currencies—especially USD. - USD instruments are heavily used in the United Kingdom by U.K. and global users; the U.K. authorities should support foreign authorities (particularly in the US) and National Working Groups to ensure new business in all currencies traded in the United Kingdom can migrate to RFRs from end 2021. - The U.K. authorities’ role is largely advocacy supporting U.S. actions to end most new use of U.S. dollar LIBOR by end-2021 and to transition to SOFR; the U.K. supported the US-led ‘RFR First’ and CFTC ‘SOFR First’ initiatives. - U.K. authorities have reiterated that alternative credit sensitive benchmarks replicate LIBOR’s weaknesses and are unsuitable for widespread use. - Regulatory tools and backstops - The FCA can decide to compel the LIBOR administrator to continue publishing certain LIBOR currency-tenor pairs under a synthetic methodology for one year at a time, up to a maximum duration of 10 years, provided necessary inputs are available and there is a risk to consumers or market integrity from a disorderly wind down. - Example design features cited: Requirement under Section 23 D of the UK Financial Services Act for a synthetic LIBOR will be made in conjunction with the FCA’s decision to compel IBA to continue publishing LIBOR; this compulsion can last for 12-month at a time and needs to be reviewed at the end of the compulsion period; the FCA could compel IBA up to 10 years maximum. - For Japanese Yen synthetic LIBOR, the FCA indicated it will be available for one year only from end 2021. - The U.K. authorities have used powers to stop U.K. based firms from writing new LIBOR based business in support of foreign authorities’ timelines (example: on 16 November 2021 the FCA published a notice confirming the prohibition on new LIBOR use of the five continuing U.S. dollar LIBOR settings from the start of 2022, under Article 21A of the Benchmarks Regulation, and the exceptions under which new use is allowed). - Monitoring and governance of benchmarks - Continued active monitoring and regulation of systemically important financial benchmarks is important to prevent new LIBOR-like problems. - The U.K. can play a role via participation and leadership on the FSB-OSSG and IOSCO. - Domestically, a market/regulator oversight group with a refocused remit could manage future benchmark representativeness and transition risks (for example a revamped ToR for the RFRWG or the SONIA oversight or Money Market Committees). - International coordination will remain central in the cross-jurisdictional and decentralized post-LIBOR world; an ideal oversight group would combine market participants and regulators as in the RFRWG. *Source: IMF staff analysis from chapter on United Kingdom LIBOR transition efforts.* ### 120. The U.K. regulatory framework might benefit from stronger preemptive tools for ### The U.K. regulatory framework might benefit from stronger preemptive tools for managing future transition risks. ### U.K. regulatory framework and benchmark transition - The United Kingdom’s regulatory framework provides the FCA with one of the most flexible toolkits for managing financial benchmarks globally. - The existing framework, while catering well for the transition from LIBOR as it is specified as a critical benchmark that is known to be ceasing, includes fewer tools for the authorities to use earlier in the development of markets to preemptively manage the risks of emerging benchmarks. - The U.K. authorities could explore options for updating the regulatory framework in this regard, alongside other possible policy interventions, over the medium term to ensure that the tools are in place for managing future transition risks. - Indicators of transition progress in sterling markets (text references only): SONIA benchmark robustness and resilience; short-term futures trading shift to SONIA has taken longer; longer-term interest rate hedging instruments for SONIA are well established; sterling bond market has fully transitioned; broad adoption of ISDA fallbacks in the United Kingdom; liquidity metrics in SONIA hedging markets suggest robust and improving levels of liquidity. ### Evolving global landscape for crypto assets and digital money - Crypto assets total market capitalization has grown by a factor 10 since 2018 and is now comparable to some established asset classes such as US high-yield bonds. - More recent innovations such as stablecoins and decentralized finance (DeFi) have been growing fast and have potential to grow their use cases and gain adoption. - Financial stability risks are not yet systemic but should be closely monitored given the global implications and the inadequate existing operational and regulatory frameworks in most jurisdictions. - Many Central Banks are also considering issuing Central Bank Digital Currencies (CBDCs), with policy objectives and design choices varying with their context. - Crypto assets encompass a wide array of new private digital assets: - Original crypto assets (like Bitcoin and Ethereum) are denominated in their own unit of account and are unbacked, have no intrinsic value and are highly volatile and risky investments. - A large proportion of crypto assets are not regulated and could expose consumers and the financial system to risks. - Decentralized Finance (DeFi) products can expose users to risks as their products are more complex and less transparent, with technological and governance risks potentially arising. - Stablecoins aim to maintain stable value—usually relative to a fiat currency—and currently are mostly used as a medium of exchange on cryptocurrency networks but have the potential to become means of payment. - Some existing stablecoin arrangements may not be able to guarantee redemption at face value into commercial bank or central bank money on demand in every state of the world. - Depending on perceived safety, backstops, and adoption, stablecoins could create consumer, market integrity, and financial stability risks just as traditional payment systems can. - The possible entry of new players with large digital user bases may accelerate adoption and create systemic risks quickly. ### Trends, challenges, and U.K. policy approach - As of November 2021, the size of the United Kingdom’s crypto asset market (including stablecoins) is still relatively small but growing. - Monitoring crypto asset service providers is complicated by the global and largely unregulated nature of the market and by limited, fragmented, and in some cases unreliable data. - Available evidence on U.K. adoption: - Chain analysis (2021) ranks the U.K. first in Europe and 12th globally in terms of value received per country, and 5th in terms of DeFi transaction volumes. - The Financial Conduct Authority (FCA) yearly user surveys since 2019: latest survey results estimate that about 2.3 million adults hold crypto assets and show that main retail case is speculative investment, with more seeing these assets as part of an investment portfolio and planning to invest more. - U.K. authorities’ actions: - The FCA clarified that most crypto assets fall outside its regulatory perimeter, issued consumer warnings, banned derivative trading for retail users, and became the anti-money laundering and counter-terrorist financing supervisor of U.K. businesses carrying out specific crypto asset activities. - In October 2020, a consultation on bringing more crypto assets within FCA financial promotions regime was published. - In January 2021, HM Treasury (HMT) issued a consultation on the broader regulatory approach to crypto assets, including stablecoins. - Regulatory principle for stablecoins: “same activity, same risks, same regulatory outcomes” (as per HMT 2021 consultation). - Proposed regulatory framework aims to support stablecoins’ dual functions as means of payment and as a way of storing wealth. - Financial Policy Committee regulatory expectations: 1. Payment chains that use stablecoins should be regulated to standards equivalent to those applied to traditional payment chains and firms in stablecoin-based systemic payment chains that are critical to their functioning should be regulated accordingly. 2. Systemic stablecoins should meet standards equivalent to those provided by commercial bank money in relation to stability of value, robustness of legal claim and the ability to redeem at par in fiat. - Thresholds for new participants of stablecoin arrangements to be classified as systemically important have already been proposed by HM Treasury at consultation. - Potential regulatory approaches for backing stablecoins include backing with non-liquid assets like loans, liquid assets such as government bonds and certain corporate securities, reserves held with a central bank, high-quality liquid assets (HQLA), central bank liabilities equivalent to reserves, or deposits placed at commercial banks acting as custodians. - Criteria for recognizing payment systems as systemic are included in Part 5 of the Banking Act 2009 and would apply to recognizing systemic stablecoins under the Treasury’s proposed regime. ### CBDC exploration and design considerations - A decision to issue a CBDC has not been taken, but authorities have made progress analyzing models, design options, and trade-offs. - Authorities announced a consultation to take place in 2022 as part of a “research and exploration” phase to inform a decision to advance to a “development” phase. - The earliest possible date for a U.K. CBDC would be in the second half of the decade. - BOE (2020) proposes a “platform” model: - Public sector would issue a CBDC and provide an infrastructure with basic functionality. - Private payment providers would serve customers directly and innovate to add value through additional functionalities and services. - A public-private partnership model could help limit market power of large private payment providers by offering a new public alternative digital form of money. - CBDC challenges for central banks include design choices, building capacity and operational risks, and containing any adverse effect on the existing financial system’s ability to provide credit to the economy. - BOE is considering use of limits on digital money during any transition period as one option to contain financial stability risks and help achieve policy objectives, though no decision has been made. - Possible retail CBDC design options mentioned: a non-remunerated CBDC, a penalized remuneration (negative rates), a tiered remuneration, or putting caps to holdings and/or transactions. ### Evolving financial stability issues and risks - Changing structure of the financial system could put banks’ business models under pressure: - CBDC and new private digital money may compete with deposits at commercial banks if perceived as convenient and safe. - To avoid shrinking deposit bases, banks may increase deposit remuneration, raising funding costs, lowering margins, and potentially causing loss of consumer relations and transaction data. - This could depress bank lending and lower bank-funded investment. - BOE (2021) finds these effects may be manageable but with a large range of uncertainty around potential demand for new forms of digital money. - Threats to sustainability of existing financial system may require development of new toolkits: - Need for new methods including general equilibrium analysis, modifications to stress tests and sensitivity analysis, and exercises where banks respond dynamically to shifts in deposit demand. - Calibration challenges due to lack of historical precedents. - Safer stablecoins and tokenization could lead to new asset classes and intermediation methods, with potential systemic risks: - Stablecoins may become mainstream for settlement and collateral once regulated. - Tokenization of traditional assets may increase liquidity and transaction ease, accelerating innovation and new markets. - Risks arise from poor understanding, interconnectedness with core financial institutions, leverage in opaque positions, and potential underestimation of risks. - Potential for stablecoins to scale rapidly raises issues of systemic risk and concentration of economic power; may require interoperability standards and restrictions on affiliation with other commercial activities. - Effective frameworks will require sufficient resources in budget, staffing, and skill sets. - Cross-border implications: - Rapid adoption of digital money could reshape international monetary and financial systems. - Digital money enables seamless cross-border payment and financial services, potentially leading to rapid adoption and limited time for policymakers to adapt. - Lower transaction costs and frictions likely increase gross capital flows and capital flow volatility, posing challenges to financial stability and monetary policy effectiveness. - This could sharpen the “policy trilemma” and increase international contagion risks, with heightened challenges for countries with weaker policy frameworks and for financial centers intermediating capital flows. *Italic: Content adapted from IMF country report material for the United Kingdom.* ### 133. International cooperation on design, regulation, and interoperability should be ### 133. International cooperation on design, regulation, and interoperability should be ### International cooperation, CFMs, and cross-border digital money - Capital flow measures (CFMs) are part of the macroprudential tools used by some countries to manage capital flows volatility. - Design of CBDCs or private stablecoins issued by regulated entities could accommodate CFMs when digital monies cross borders and may provide opportunity to make CFMs more targeted and efficient. - Even countries with sluggish adoption of digital money may still experience spillover effects from shifts in the international monetary and financial system—highlighting the pressing need for international collaboration to leverage benefits of new technology without compromising global financial stability. - The United Kingdom’s authorities recognize the need of ensuring that CBDCs do not harm and the need for continued cooperation to minimize spillovers. - Establishing international standards for regulation of private digital money will help manage risks domestically and across borders. - Ensuring interoperability of cross-border payment systems and broad agreement on legal and regulatory principles for new forms of digital money may help avoid fragmentation of the international monetary system. - Liquidity backstops and prudential regulation for systemic players in the digital ecosystem will be crucial to safeguard global financial stability and limit contagion. ### G7 and principles for CBDC - Under the U.K.’s Presidency, the G7 published a report on Principles for CBDC that stresses: - issuer countries should design their CBDC to avoid risks to the international monetary and financial system; - issuer countries should collaborate to enhance cross-border payments with CBDC; and - issuer countries should preserve international and recipient countries’ monetary sovereignty and financial stability. ### Box 4 — A Digital Pound Sterling? (U.K. CBDC Taskforce) - 19 April 2021: Bank of England (BOE) and HM Treasury announced the joint creation of a retail CBDC Taskforce to coordinate exploration of a potential CBDC. - A decision has not yet been made; the Taskforce is engaging widely with stakeholders to gather input on pros, cons, and practicalities. - Taskforce responsibilities include: - Coordinating exploration of the objectives, use cases, opportunities, and risks of a potential retail CBDC. - Guiding evaluation of the design features a CBDC must display to achieve U.K. goals. - Supporting a rigorous, coherent, and comprehensive assessment of the overall case for a CBDC. - Monitoring international CBDC developments to ensure the U.K. remains at the forefront of global innovation. - BOE has sought to identify opportunities and challenges of CBDC and analyze how those stack against BOE’s objectives to extract principles. - BOE is agnostic about technology choices and is evaluating traditional centralized technologies alongside distributed ledger technologies (DLT). - To meet BOE’s objectives of maintaining monetary and financial stability, payments must be reliable and resilient; payments should be fast and efficient, innovative, and open to competition. - Potential benefits of a CBDC: - Increase availability and usability of central bank money. - Help support monetary policy and financial stability. - Help avoid risks of new forms of private money (like stablecoins). - Support a resilient, innovative, and competitive payments landscape and help meet future payments needs. - Potential challenges and design mitigants: - If commercial banks’ deposit balances move from commercial banks to CBDC, implications for banks’ balance sheets and credit provision could arise; design features could be added to contain this. - Possible design options include: non-remunerated CBDC; penalized remuneration (negative rates); tiered remuneration (see Bindseil (2020)); caps to holdings and/or transactions. - CBDC could change demand for base money, potentially impacting implementation of monetary policy. - Digital money could give authorities access to user identity and transaction data—benefits for financial integrity oversight but raising digital surveillance and privacy concerns. - Operational considerations: identify and assess cybersecurity risks, system resilience and integrity, infrastructure security, and identity and access management including privileged roles and credential recovery mechanisms. - BOE (2020) proposed a “platform” model: BOE provides secure infrastructure with minimum functionality; Payment Interface Providers run the front-end, delivering customer-facing CBDC payment services and value-added services (programmability, smart contracts, micro payments). - 2022: HMT and the BOE will launch a consultation to set out their assessment of the case for a U.K. CBDC and merits of further work to develop an operational and technology model. - The consultation will inform a decision on whether to advance into a ‘development’ phase which would span several years. - A technical specification would follow the consultation explaining proposed conceptual architecture and could involve in-depth testing of design and feasibility. - If the ‘development’ phase results are satisfactory, the earliest date for launch of a U.K. CBDC would be in the second half of the decade. ### Climate-related disclosures — executive summary and recommendations - A wide range of initiatives on climate-related disclosures have been taken by the U.K. authorities; the U.K. plays a leading role in pursuit of global sustainable development. - “Greening the financial system” strategy involves three phases: informing investors and consumers; acting on information; shifting financial flows to align with the U.K. net zero commitment. - Sustainability-related disclosures are a key component of phase 1. Transition towards mandatory-aligned TCFD disclosure is well under way in the United Kingdom. - An integrated framework for disclosures on sustainability across the U.K. economy has been announced. - Banks’ climate disclosures remain incomplete across the TCFD’s four pillars. - Planned mandatory TCFD-aligned disclosures and detailed supervisory expectations for all banks have produced positive progress. - Challenges for banks: data gaps; lack of widely accepted methodologies (e.g., scenario analysis is new and evolving); difficulty developing forward-looking metrics to translate climate developments into financial impacts. - Wide range of practices across the banking industry in the United Kingdom, with clear differences between large banks and smaller firms. - Recommendation summary (Table 5): - Continue enhancing sustainability disclosure and reporting requirements to improve consistency, comparability, and quality of climate-related information, including quantification of financed emissions, in accordance with emerging best practices and internationally agreed standards. - Priority: High; Timeline: MT (within 1 to 3 years). ### Climate-related disclosures — regulatory actions and implementation in the U.K. - 2017: FSB’s Task Force on Climate-related Financial Disclosures (TCFD) provided overarching recommendations around four thematic areas (governance, strategy, risk management, metrics and targets). - Reporting standards for sustainability will be developed by the International Sustainability Standards Board (ISSB) established by the IFRS Foundation, building on TCFD work. - 2019: United Kingdom committed in law to net zero greenhouse gas emissions by 2050; U.K. government published the Green Finance Strategy. - October 2021: Chancellor announced that “the U.K. plans to become the world’s first net zero aligned financial centre”. - April 2019: Prudential Regulation Authority (PRA) issued supervisory expectation (SS3/19) that PRA-regulated firms should consider engaging with TCFD framework and wider initiatives. - July 2020: PRA Dear CEO letter emphasized banks and insurers should develop capability for producing robust, decision-useful disclosures; set deadline of year-end 2021 for firms to have fully embedded PRA's supervisory expectations on climate. - PRA embeds climate change related financial risk in supervisory approach and will keep supervisory tools available where progress is insufficient at individual firms. - U.K. joint Government-Regulator TCFD Taskforce (November 2020) introduced a Roadmap towards mandatory TCFD-aligned disclosures across financial and non-financial sectors over the next five years. - December 2020: Financial Conduct Authority (FCA) issued final rules to introduce a rule for premium-listed companies to include a statement in annual financial report on TCFD consistency on a comply or explain basis. - New rule applies for accounting periods beginning on or after January 1, 2021. - First annual financial reports including disclosures subject to the rule will be published in Spring 2022. - FCA extended climate-related disclosure requirements to issuers of standard listed companies, asset managers, life insurers and pension providers. - November 2021: FCA published a Primary Market Bulletin (PMB36) with details of its supervisory strategy and a consultation on a new Technical Note to provide more guidance on disclosure expectations. - PRA will review firms’ published disclosures after the year-end 2021 deadline and determine whether additional measures are required to improve quantity, quality or consistency. - September 2021: PRA sent Dear CFO letter to firms and auditors providing thematic feedback from its review of written auditor reports received in 2021 and requesting auditor views on robustness of firms’ climate-related risk assessments and quality of underlying data, models, and processes. - FCA and PRA jointly established and co-chair the Climate Financial Risk Forum (CFRF), which produced guides in June 2020 and further guides in October 2021 (risk appetite statements, managing legal risk, climate data and metrics dashboard, disclosure case studies). *Source: IMF staff analysis and U.K. authorities materials as presented in the chapter.* ### 140. An integrated framework for disclosures on sustainability across the U.K. economy has ### An integrated framework for disclosures on sustainability across the U.K. economy has ### Overview - The U.K. government published in October 2021 its Roadmap to Sustainable Investing, setting out details on new Sustainability Disclosure Requirements (SDR) and on the U.K. Green Taxonomy. - An indicative path towards “integrated economy-wide disclosure” under the SDR framework has been proposed. - One objective is to require the most "economically significant" U.K.-registered and U.K.-listed companies to incorporate Green Taxonomy and ISSB disclosures in their company annual reports within one to two years of the Royal Assent of primary legislation. ### Scope and implementation of the integrated disclosure regime - Intended coverage: corporates, asset managers, asset owners, and investment products. - Seeks to bring together existing climate reporting requirements and initiatives, including the U.K.’s commitment to implement mandatory reporting aligned with the TCFD via FCA rules (subject to consultation) and obligations under the Companies Act, while requiring wider information. - Expected reporting instruments: - U.K. registered, and U.K. listed companies will be required to make sustainability disclosures in their annual reports, using global baseline reporting standards and metrics to be developed by the ISSB. - Initially, asset managers, regulated asset owners and listed companies would also have to disclose transition plans to net zero. - A ‘gold standard’ for transition plans will be developed by a new Transition Plan Task Force. - Legislative and regulatory route: - Framework expected to be implemented through legislation. - Financial regulators and relevant government departments will set sector-specific requirements through their usual rule-making processes. - Coverage milestones cited: - 57 percent of assets are owned by banks that are subject to the FCA rule in 2021. - Coverage will reach 94 percent of banking assets in 2022 (source: Final TCFD Roadmap). ### U.K. Green Taxonomy - Purpose: set criteria that specific economic activities must meet to be considered environmentally sustainable. - Disclosure requirements: firms in scope must disclose the proportion of their activities which are Taxonomy-aligned; providers of investment funds and products must disclose the same for assets in which they invest. - Structure and alignment: - Draws on the EU approach and follows a similar structure to the EU Taxonomy. - Uses the same six environmental objectives, to be underpinned by Technical Screening Criteria (TSC), introduced in a sequenced manner. - The six objectives comprise: climate change adaptation, climate change mitigation, water use and marine resources, circular economy, pollution, and biodiversity. - Governance and advisory: - The Green Technical Advisory Group (GTAG) established to provide independent, non-binding advice to the Government on developing and implementing a green taxonomy in the UK context, comprised of TSC on economic activities. - HMT, the FCA, the BOE and other relevant Government departments and regulators are observers to GTAG. - Consultation timeline expectations: - Consult on UK draft TSCs on the climate change mitigation, and climate change adaptation objectives in the first quarter of 2022. - Consult for the remaining four environmental objectives during the first quarter of 2023. ### Progress in U.K. banks’ climate disclosures - Positive developments: - Most large banks have formally endorsed the TCFD framework on a voluntary basis. - Significant increase in disclosure of TCFD-aligned information in banks’ annual reports and/or in dedicated TCFD reports. - Governance and targets: - Banks have embedded climate risks in governance structures; disclosure quality on board oversight, governance and management’s role has improved. - Most large banks have agreed to achieve reductions in greenhouse gas emissions and set a net zero target for 2050, which includes their financed emissions. - A growing number of banks have identified and disclosed metrics and targets focused on sustainable financing, operational emissions and financed emissions. - Risk disclosure improvements: - More detailed information disclosed on exposures to physical climate risks, identifying high-risk sectors and geographies (e.g., flood risk). - As more detailed composition data on credit portfolios becomes available, market participants and research analysts can conduct more in-depth analysis comparing banks’ exposures. ### Remaining challenges, data gaps and methodological issues - General completeness and quality: - Banks’ climate disclosures remain incomplete across the TCFD’s four pillars to varying extents; a wide range of practices exists across the banking industry with clear differences between large banks and smaller firms. - Many disclosures remain qualitative; limited detail in financial statements on how climate change may impact key metrics such as Expected Credit Losses (ECLs). - Specific data and methodology challenges: - Data gaps, lack of widely accepted methodologies, limited availability of tools/methodologies and lack of capacity constrain firms’ ability to meet supervisory expectations. - Difficulty in quantifying financed emissions: different methodologies for calculating intensity-based financed emissions exist; widely accepted methodologies are not available for all activities (lending, capital market, advisory). - Forward-looking portfolio adjustment metrics are at an early stage of development. - Scenario analysis design and disclosure is limited: limited information on the type of scenarios used and little disclosure of outcomes. - Model risk from third-party data and models is significant. - Tradeoff between accuracy and comprehensiveness: firms must choose between full coverage of exposures and subsets with good data. - Physical risk assessment challenges: - Banks have made progress on asset location data but struggle to: - map asset location with relevant physical risk information needed to assess preparedness to deal with natural disasters and insurance coverage; and - capture risks arising from disruptions to corporate clients’ supply chains. - Physical risk is not sector-linked and depends on location, supply chain geography, and infrastructure dependence. - Standard & Poor’s: almost 60% of companies in the S&P 500 (total market capitalization of $18.0 trillion) and more than 40% of companies in the S&P Global 1200 (market capitalization $27.3 trillion) hold assets at high risk because of the physical hazards created by climate change. - Transition risk assessment challenges: - Assessing transition risks requires considering exposure to carbon prices and policies and corporates’ planned strategies to respond to transition risks. - Financed emissions are commonly used as a proxy for transition risk but the relationship is not linear. - Precision in measuring exposure to carbon-related assets is challenging when non-financial groups combine different businesses (fossil fuel-based energy production, distribution, renewable energy). - Granular activity-level data are not widely available. - Corporate transition plans are not consistently disclosed or lack sufficient detail (assumptions lacking, scope unclear), making it difficult to understand commitments and carbon pathways. - Confusion exists in NFC disclosures between transition plans and diversification of activities. - The most advanced NFCs conduct scenario analysis but usually do not disclose results. - Methodologies for science-based decarbonization targets exist (e.g., Science Based Targets initiative (SBTi)), but NFC willingness to disclose detailed transition plans may be lacking. ### Policy implications and recommended next steps - Moving to mandatory disclosures is essential but unlikely to be sufficient; increased standardization and more detailed expectations around disclosure content will be desirable to: - ensure comparability of disclosures across firms (financial and non-financial); - support pricing of climate-related risks; and - facilitate monitoring of financial stability risks arising from climate change. - Authorities should specify regulatory standards and guidance with sufficiently detailed requirements and expectations, including: - specific reporting requirements and practical content of transition plans (defining scope, clarifying a base year and a target year, imposing units); - harmonization of key metrics; and - building on existing work in accordance with international standards under development. - The U.K. joint Government-Regulator TCFD Task Force “expects that it may be necessary, in due course, to consider setting more detailed expectations for disclosures to supplement the TCFD recommendations”. - The Task Force considers that achieving a high level of comparability across U.K. firms and across jurisdictions “if arrived at sufficiently quickly” would optimally be achieved through international standards for climate-related and other sustainability disclosures. - The United Kingdom has been actively promoting internationally coordinated efforts, including the establishment of the ISSB. - The FCA has been co-chairing IOSCO’s workstream on sustainability related disclosures. - The U.K. Government and regulators issued a joint statement of support for the IFRS Foundation’s planned direction of travel. - The FCA indicated in Policy Statement PS21/23 from December 2021 that “...once the ISSB’s future standards are endorsed for use in the UK, [FCA] expects, subject to consultation that both the Companies Act and Listing Rules will reference the endorsed international standards...” *Source: Excerpt from IMF staff report chapter on United Kingdom — “An integrated framework for disclosures on sustainability across the U.K. economy has been announced.”* ### Annex II. Equivalence Provisions Currently in Use Under EU ### Annex II. Equivalence Provisions Currently in Use Under EU Financial Services Legislation as of 10/02/2021 ### Overview of equivalence provisions by instrument - Directive 2013/34/EU - Accounting Directive - Art.47 - Country-by-country reporting - Directive 2009/138/EC on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) as amended - Art.172 - Title I-for third country reinsurers in the EU: equivalent treatment of their activities - Art.227 - Chapter VI of Title I-for EU insurers in third countries: solvency rules for calculation of Capital Requirements and Own Funds - Art.260 - Title III-for third country insurers in the EU: equivalence of group supervision by third country supervisory authorities - Regulation (EU) N° 600/2014 on markets in financial instruments (MIFIR) - Art.1(9) - Exemption central banks - Art.28(4) - Trading venues for the purposes of trading obligation for derivatives - Directive 2014/65 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (MiFID 2 - recast) - Art.25(4)[a] - Trading venues for the purposes of trading obligation for shares, in conjunction with Art. 23 of Regulation (EU) N° 600/2014 on markets in financial instruments (MIFIR) - Directive 2006/43/EC on statutory audits of annual accounts and consolidated accounts (Statutory Audit) - Art.46(2) - Equivalence of audit framework (5) - Art.47(3) - Adequacy of competent authorities (5bis) - Directive 2003/71/EC on the prospectus to be published when securities are issued (PD-Prospectus Directive) - Art.7(1) - Third country GAAP with IFRS - Regulation (EC) n° 1060/2009 on credit rating agencies, as amended by Regulation (EU) n° 462/2013 (CRAs) - Art.5(6) - Legal and supervisory framework - Regulation (EU) No 575/2013 on prudential requirements for credit institutions and investment firms (CRR) as amended - Art.107(4) - Credit Institutions - Art.107(4) – Exchanges - Art.107(4) - Investment firms - Art.114(7) - Exposures-Credit institutions - Art.115(4) - Exposures-Credit institutions - Art.116(5) - Exposures-Credit institutions - Art.142(2) - Credit institutions - Art.142(2) - Investment firms - Regulation (EU) No 648/2012 on OTC derivatives, central counterparties, and trade repositories (EMIR), as amended - Art.13(2) – Transaction Requirements - Art.25(6) – CCPs - Art.2a - Regulated markets - Regulation (EU) No 909/2014 of the European Parliament and of the Council of 23 July 2014 on improving securities settlement in the European Union and on central securities depositories, as amended - Art. 25(9) – CSDs - Regulation (EU)No 596/2014 on insider dealing and market manipulation (MAR Market Abuse Regulation) - Art.6(5) - Exemption public bodies and central banks - Directive 2004/109/EC - Transparency Directive - Art.23(4) [third] - Third country GAAP/Transitory regime - Art.23(4) [third] - Third country GAAP with IFRS - Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts - Art.30(3) - Specific administrators or benchmarks ### Source of equivalence mapping - Source: European Commission Equivalence Decisions Overview Table - February 2021. *Annex II. Equivalence Provisions Currently in Use Under EU Financial Services Legislation as of 10/02/2021* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1gbrea2022008.pdf_