In this briefing note we consider the Financial Services Bill (the Bill) which the UK Government presented to Parliament on October 21, 2020. The Bill will be of interest to all financial institutions that conduct business in the UK as it sets out the UK’s blueprint for a post-Brexit financial services regime. At the time of writing the Bill is expected to receive ratification from Parliament before the UK leaves the Single Market at the end of December.
The Bill was first announced by the UK Government during the Queen’s Speech in October 2019. A background note to the speech explained that the purpose of the Bill would be twofold in that it was to ensure that the UK maintained its world leading regulatory standards and also remained open to international markets after it left the EU. The note also described three key elements of the Bill in that it would: simplify the process for overseas investment funds to be sold in the UK; implement the international Basel III standards to strengthen the regulation of global banks; and allow long-term market access to the UK for financial services firms in Gibraltar.
Following the Queen’s Speech, HM Treasury started to prepare the ground for the Bill. It published various policy documents regarding the Bill’s key elements. This included two consultation documents, one setting out proposals on new market access arrangements for financial services between the UK and Gibraltar and, another, setting out the UK Government’s proposal for a new process for allowing investment funds domiciled overseas to be sold to UK investors. HM Treasury also issued, following a consultation, a policy document confirming the UK Government’s intention to implement the internationally agreed Basel III banking standards. In light of these papers much of the content of the Bill should not come as much of a surprise.
Purpose of the Bill
The Bill’s purpose is described in its explanatory memorandum. Unsurprisingly, its purpose has not deviated much from the three key components that were originally described in the briefing note to the Queen’s Speech. The three key components remain but where prudential standards and the implementation of the final Basel III standards are mentioned there is also a nod to a new prudential regime for investment firms and giving the Financial Conduct Authority (FCA) the powers it needs to oversee an orderly transition away from the LIBOR benchmark.
Prudential and financial stability measures
To enhance the UK’s prudential standards and promote financial stability the Bill contains measures dealing with the:
- Implementation of the remaining Basel III standards.
- Implementation of the Investment Firms’ Prudential Regime (IFPR).
- Extension and clarification of the FCA’s powers to ensure the orderly wind-down of the LIBOR benchmark.
- Extension of the transitional period for third-country benchmarks from end-2022 to end-2025.
The UK played an active role in finalising the Basel III standards and therefore the UK Government’s commitment to them should come as no surprise. The Bill adopts two approaches to implementation recognising that not only legislation will need to change but also regulatory rules. To facilitate changes to legislation, HM Treasury is given the power to repeal those elements of the onshored Capital Requirements Regulation (CRR) that need to be updated. The Bill also modifies the approach the Prudential Regulation Authority (PRA) must take when updating its rules. To implement changes to its rules the PRA currently relies on its general rulemaking power in the Financial Services and Markets Act 2000 (FSMA). The PRA is required to have regard to the regulatory principles in section 3B of FSMA when discharging its general functions. The Bill specifies new considerations the PRA must have regard to when making rules implementing the outstanding Basel III standards (which the Bill refers to as CRR rules).
Such considerations include:
- The likely effect of the rules on the relative standing of the UK as a place for internationally active credit institutions and investment firms to be based or to carry on activities. For these purposes the PRA must consider the UK’s standing in relation to the other countries and territories in which, in its opinion, internationally active credit institutions and investment firms are most likely to choose to be based or carry on activities.
- The likely effect of the rules on the ability of CRR firms to continue to provide finance to businesses and consumers in the UK on a sustainable basis in the medium and long term.
- Relevant standards recommended by the Basel Committee on Banking Supervision from time to time.
When making CRR rules, the PRA must also consider, and consult HM Treasury about, the likely effect of the rules on relevant equivalence decisions.
Furthermore the Bill gives powers to the PRA to make rules which apply to approved holding companies, including sub-consolidated and consolidated prudential requirements and rules regarding matters such as governance and group-risk. The powers are being granted to the PRA to ensure that the approved holding companies’ provisions, which were introduced through the transposition of the EU Capital Requirements Directive V (CRD V), can be maintained effectively over time, including for the purpose of the implementation of the final Basel III standards.
The EU Investment Firms’ Prudential Regime (IFPR) comes into effect after the end of the transition period and as such is not part of retained EU law in the UK. However, the UK played an instrumental role in designing the regime and the UK Government remains supportive of its intended outcomes. However, the UK is diverging from the EU IFPR in an important way.
The EU IFPR requires systemic investment firms – that is investment firms which by their size, activities and interconnectedness with the rest of the financial system are considered to pose a risk to the stability of financial markets – to re-authorise as non-deposit taking credit institutions. The EU regime recognises that these firms present risks which are similar to those posed by large credit institutions and as such should be supervised by their relevant banking authority. The UK will not be requiring systemic investment firms to apply for authorisation as credit institutions. The reasoning for this is that the UK’s approach to such investment firms involves them being prudentially regulated and supervised under the CRR/CRD IV by the UK’s banking authority (PRA) achieving the same outcome.
The majority of the UK IFPR will be specified in FCA rules and the Bill places an obligation on this regulator to introduce prudential rules for FCA investment firms in areas such as capital, liquidity, exposure to concentration risk, reporting, public disclosure, governance arrangements and remuneration policies. When making these rules the FCA will be required to have regard to a new list of matters that are further specified in the Bill. These matters relate to public policy considerations which include relevant international standards, the relative standing of the UK as a place for internationally active investment firms to carry on activities, and financial services equivalence, granted by and for the UK, along with any further matters that HM Treasury may specify in regulations. However, these matters will not change the status of the FCA’s strategic and operational objectives as established in FSMA. The FCA has already solicited views on its proposed approach to the UK IFPR through the publication of a discussion paper1 earlier this year. An FCA consultation paper is expected in December 2020.
In terms of timing for both the UK IFPR and the implementation of the final Basel III standards, a joint HM Treasury, PRA and FCA statement stated that the target implementation date for both would be January 1, 2022, six months later than the EU regime.
The Bill introduces a number of powers for the FCA which are intended to assist in the facilitation of a smooth transition from LIBOR beyond the end of 2021. The provisions2 will amend the UK’s onshored Benchmarks Regulation (UK BMR) to (amongst other things) give the FCA powers to extend the maximum period it can compel a benchmark administrator to continue to publish a critical benchmark from five to ten years, and requires the FCA to conduct assessments to assess whether the designated benchmark properly measures the underlying market or economic reality when using its compulsion power.
Additionally, the Bill grants the FCA the power to “designate” a critical benchmark where it has become or is at risk of becoming unrepresentative, following which its use will be prohibited. Importantly, however, the FCA will be permitted to make an exception for “legacy use” of the benchmark. It is anticipated that this could be relevant to contracts where there will not be appropriate alternatives to LIBOR when it ceases to be published, and so (in its Impact Assessment for the Bill) the UK Government will seek to allow the use of LIBOR in circumstances where it has otherwise been prohibited. Where a critical benchmark has been designated the FCA will be able to impose requirements on the administrator (such as on how the benchmark is calculated) to ensure an orderly wind-down.
There are also interesting provisions which grant powers (their use to be subject to the affirmative procedure) to HM Treasury to make regulations specifying how provisions of UK BMR will apply to so-called ‘umbrella benchmarks’, such as LIBOR.
Extension of transitional period for third country benchmarks
The Bill proposes an extension to the third-country transitional provisions so that UK supervised entities will be permitted to use benchmarks provided by third-country administrators until end-2025. This means that by end-2025, third country benchmarks will need to have applied for endorsement of a specific benchmark(s), for recognition as an administrator or benefit from an equivalence determination made by HM Treasury for their benchmark(s) to continue to be used in the UK. This represents an extension to the previous deadline of end-2022.
The policy reason behind the extension relates to industry concerns about the lack of clarity around the legal framework for endorsement and recognition prescribed in the EU Benchmarks Regulation (EU BMR). As of June 2020, the European Commission (Commission) had adopted only two equivalence decisions pertaining to three financial benchmarks administered in Australia and Singapore.
In the absence of a positive equivalence determination, third country benchmark administrators can apply to access UK markets through endorsement or recognition (the current EU BMR access routes):
- In the first instance, the endorsing entity, which must be a UK administrator approved under the UK BMR or a UK supervised entity, takes on a degree of responsibility for a benchmark(s) and ensures that it fulfils requirements which are at least as stringent as the UK BMR.
- To attain market access through recognition, the third country administrator must appoint a UK legal representative that is accountable to the FCA with regard to the administrator’s obligations under UK BMR.
HM Treasury considered that the previous deadline of December 2022 would not provide sufficient time to resolve the concerns or ensure that UK markets continue to have access to third country benchmarks. The UK Government felt that this was problematic, especially where there are few alternatives to replace third country benchmarks in the UK (e.g. foreign exchange spot rate benchmarks that are provided by third country benchmark administrators). Losing access to these benchmarks could have serious repercussions given their widespread use by UK firms for risk management, treasury financing and overseas investment.
Openness between UK and international markets
The measures designed to promote openness between the UK and international markets are threefold:
- Overseas funds regime. The Bill introduces a new equivalence regime for retail investment funds and money market funds, which will simplify the process for investment funds that are domiciled overseas to market to UK consumers.
- Gibraltar Authorisation Regime. The measures in the Bill will deliver long-term market access between the UK and Gibraltar for financial services firms on the basis of alignment and cooperation, now that the UK and Gibraltar have left the EU.
- Markets in Financial Instruments Regulation (MiFIR). The Bill updates the regime which regulates the services and activities of third-country firms in the UK, following an equivalence decision. This will ensure the FCA has an appropriate degree of oversight over firms that could register under the regime.
Overseas fund regime
The Bill introduces3 an overseas funds regime (OFR) which enables overseas investment funds under “equivalent” jurisdictions to be marketed in the UK following an application process for recognition. In a move away from the existing route to individual recognition through section 272 of FSMA, funds are expected to be able to “self-certify” their eligibility for recognition under the OFR as part of a new streamlined application process.
Separate equivalence regimes have been created for retail funds4 and money market funds (MMFs)5. In this context, MMFs that wish to market to both retail and professional clients must be based in jurisdictions deemed equivalent under both regimes and apply for recognition through the retail funds regime. Notably, the applicability of the equivalence regimes are not limited to EEA jurisdictions under the Bill.
In determining whether a jurisdiction is “equivalent” to the UK and provides at least the same level of investor protection, HM Treasury intends to adopt an “outcome-based” approach. This means that it will determine equivalence based on whether the overall regulatory regime achieves the desired regulatory objectives, instead of whether the overseas funds in question are subject “line-for-line” to the same regulations as those in the UK. This flexible approach is expected to bring a broad range of funds into the ambit of the OFR.
The new section 271E of FSMA to be inserted by the Bill allows HM Treasury to impose additional requirements with which certain types of funds in the OFR may be required to comply as part of their recognition. There have been industry concerns over the uncertainty of the substance of these requirements, particularly whether these might disadvantage overseas funds against their UK counterparts. While the new section 271E(2) of FSMA requires HM Treasury to have regard to rules that apply to comparable UK funds when imposing any such requirements, the question remains open whether requirements will still be imposed where overseas funds are already subject to similar rules in their home jurisdiction.
In line with HM Treasury’s stance following its consultation, the Bill will not extend the jurisdiction of either the Financial Ombudsman Service or the Financial Services Compensation Scheme to cover overseas funds recognised under the OFR, which has been welcomed by the industry.
Separately, the Bill5 also simplifies the existing individual recognition framework for funds by setting out numerous changes to sections 272 and 277 of FSMA. Among these changes, the matters to which the FCA must have regard in assessing an application for recognition will be more limited and well-defined, and the amended section 277(1) of FSMA will require written notice of any proposed change to the fund only in case of material changes.
The Bill establishes a Gibraltar Authorisation Regime (GAR) so that Gibraltarian financial services firms and UK-based firms can access the UK and Gibraltarian market respectively. The GAR will be underpinned by the principle that the relevant law and practice of the UK and Gibraltar are sufficiently aligned.
HM Treasury will specify by statutory instrument the UK regulated activities for which market access is available (approved activities), and the corresponding activities in Gibraltar's law that a firm wishing to participate in the UK market must be authorised to carry on by the Gibraltar Financial Services Commission (GFSC). It is expected that the approved and corresponding activities will reflect the regulated activities that are carried on by Gibraltarian firms under the transitional UK market access arrangements which the GAR will replace.
Under the new regime, Gibraltar-based firms intending to operate in the UK will have to notify the GFSC of their intention and obtain the GFSC’s consent to carry on an approved activity in the UK. Firms already operating in the UK through arrangements that the GAR will replace will also be required to notify the GFSC of their intention to continue operating in the UK. The GFSC will then convey this information to the relevant UK regulator, enabling them to update the public register of firms operating in the UK. As market access is a sovereign matter, it will be the responsibility of the Government of Gibraltar to legislate in its own domestic legislation for the reciprocal market access for UK firms.
Generally, the GAR has a number of interesting features, which might be a model for the developing relationships between the UK and third countries in the context of the UK’s Global Financial Partnerships strategy. The regime is based on principles of compliance with certain general objectives, including consumer protection and financial stability, alignment of law and practice between the UK and Gibraltar and cooperation amongst executive and regulatory bodies, including through information exchange. Although the GFSC would continue to supervise Gibraltarian firms, the UK regulators have powers to protect UK consumers or financial stability in certain circumstances. Whilst authorisations for the GAR would be granted by the GFSC, the UK regulators would have powers to impose requirements, or to vary or cancel a GAR permission in certain circumstances and would maintain their current FSMA powers over Gibraltarian firms.
MiFIR7 contains a market access regime, enabling equivalent third country investment firms to provide cross-border services to per se professional clients and eligible counterparties. In the UK MiFIR will form part of retained EU law from the end of the transition period (UK MiFIR).
Under UK MiFIR, HM Treasury is empowered to make an equivalence determination in favour of a third country. On the basis of this determination and subject to certain criteria, firms from that third country which register with the FCA are permitted to provide investment services to per se professional clients and eligible counterparties in the UK without needing to be authorised under Part 4A of FSMA.
The Bill8 makes amendments to UK MiFIR to broadly reflect the changes the EU introduced to its own regime following the introduction of the IFR/IFD. The Bill introduces amendments to UK MiFIR relating to the equivalence regime for third country investment firms. More specifically it:
- Grants the FCA the power to specify reporting requirements for firms that register under the equivalence regime and allow HM Treasury to impose requirements on registered firms.
- Amends the equivalence assessment criteria to reflect the changes to the UK’s prudential rules as a result of provisions in the Bill.
- Introduces additional powers for the FCA to impose temporary restrictions or prohibitions on, or withdraw the registration of, firms that register under the regime.
- Clarifies the scope of the reverse solicitation exception, which allows third country firms to service UK clients at the client’s own initiative, without relying on the equivalence regime.
Maintaining an effective financial services regulatory framework and sound capital markets
The Bill contains numerous measures that are designed to maintain the effectiveness of the UK’s financial services framework and sound capital markets. These include:
- Amending the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation. The measures are intended to improve the functioning of the onshored PRIIPs Regulation by enabling the FCA to clarify the rules regarding the scope of the Regulation and removing reference to performance scenarios. They also enable HM Treasury to further extend the exemption currently in place for Undertakings for the Collective Investment in Transferable Securities (UCITS) funds.
- Amendments to the Market Abuse Regulation (MAR). Two amendments to MAR are designed to bolster the effectiveness of the regime while reducing some of the administrative burden on issuers.
- Extending the criminal penalties for market abuse. Provisions in the Bill increase the maximum prison sentence for market abuse from 7 to 10 years in line with other sentences for financial crimes, as recommended by the 2015 Fair and Effective Markets Review.
- Increasing beneficial ownership transparency for trusts. The Bill introduces changes that seek to clarify the UK Government’s ability to enforce and make changes to extra-territorial trust registration powers.
- Completing the implementation of EU Regulation (EU) 2019/834 amending Regulation (EU) No 648/2012 (otherwise known as EMIR Refit). The measures that the Bill introduces will ensure that clearing members and clients that offer clearing services do so on a fair, reasonable, non-discriminatory and transparent (FRANDT) basis.
- Amendments to the Banking Act 2009 in relation to the Financial Collateral Arrangement Regulations. These Regulations will stand on a sound statutory footing providing certainty to markets.
- Cancellation of the authorisation of firms. The Bill introduces measures that will streamline the FCA’s process for removing a firm’s authorisation and taking them off the public register, to improve accuracy and reduce the risk of fraud.
Amendments to the PRIIPs Regulation
The PRIIPs Regulation is directly applicable in UK law, and will be onshored following the end of the transitional period under the European Union Withdrawal Act 2018 (as amended). The Bill has sought to take advantage of the UK’s regulatory autonomy post-Brexit to make the following amendments to the onshored PRIIPs Regulation:
- The FCA has been provided with additional powers to enable it to clarify the scope of the UK PRIIPs Regulation. Notably, this provides the FCA with the ability to clarify whether certain investment products should or should not fall within scope of the UK PRIIPs Regulation.
- The requirement for specific performance scenarios within the PRIIPs Key Information Document (KID) is replaced with a more general requirement for “appropriate information on performance”. The FCA is also provided with further powers to clarify what information is likely to be appropriate on performance for the purposes of the KID.
- HM Treasury has been granted the power to extend the exemption for UCITs from the PRIIPs Regulation for up to a further five years. UCITS funds are currently exempted from the PRIIPs Regulation until 31 December 2021, and instead subject to the requirements under the UCITS Directive to produce Key Investor Information Documents (KIIDs).
The FCA has not provided any indication on when it would seek to make rules for the purposes above under its new powers granted by the Bill.
Amendments to MAR
As mentioned above, the Bill makes two key changes to the onshored version of MAR. These changes relate to the responsibility of the issuer and timeframes by which issuers and emission allowance market participants are required to disclose transactions to the public.
As regards the responsibility of the issuer, MAR currently requires issuers or any person acting on their behalf or on their account to maintain an insider list. The use of “or” has caused some uncertainty in the market with some issuers’ advisers not sure whether they are required under MAR to draw up their own insider list (i.e., separate to the issuer’s insider list). The Bill clarifies this for the onshored version of MAR establishing that issuers and any person acting on their behalf or on their account are all required to maintain an insider list.
Where persons discharging managerial responsibility such as senior managers, as well as persons closely associated with them, notify the issuer or emission allowance market participant and the FCA of transactions specified under Article 19 of EU MAR, the notification should be made to the issuer no later than three business days after the date of the transaction. The issuer is then also required to notify the public of such transactions no later than three business days after the transaction. To reduce the burden on issuers the Bill adjusts the notification timetable of the onshored version of MAR so that issuers will be required to disclose transactions by their senior managers to the public within two working days of those transactions being notified to them by the senior managers or the persons closely associated with them.
Extending the criminal penalties for market abuse
The Bill extends the maximum criminal sentence for market abuse from seven to ten years, bringing it broadly in line with other sentences for financial crimes, and as recommended by the 2015 Fair and Effective Markets Review. Whether the criminal sentence will be extended again to 14 years to bring it into line with the maximum default sentence under the Proceeds of Crime Act 2002 remains to be seen.
Increasing beneficial ownership transparency for trusts
The Sanctions and Anti-Money Laundering Act 2018 (SAMLA) establishes a framework which enables the UK to impose sanctions and money laundering regulations post-Brexit. Some of the sanctions-related regulations came into force in 2018, although no date is set for the anti-money laundering provisions at present. The Bill amends schedule 2 to SAMLA by extending the scope of the money laundering and terrorist financing regulations to capture UK-linked overseas trusts. In particular, the effect of this extraterritorial application means that SAMLA will capture any person who is a trustee of a trust that has links to the UK, provided the property subject to the trust is situated in the UK, the trustee enters into a business relationship with a relevant person or the income of the trust is from a source in the UK.
The amendments will mean HM Revenue and Customs will continue to have access to information regarding the ownership and beneficiaries of overseas trusts which has links to the UK. Notably, the changes brought by the Bill with respect to money laundering generally reflect the changes introduced by the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2019 around trust registration and information, which is now broadly reflected in SAMLA.
Completing the implementation of EMIR Refit
Article 1(2)(b) of the EMIR Refit inserts a new Article 4(3a) into the European Markets Infrastructure Regulation (EMIR) requiring clearing members and clients that provide clearing services to provide those services under "fair, reasonable, non-discriminatory and transparent commercial terms". The Commission has power to adopt a delegated act to specify what would be considered to be fair, reasonable, non-discriminatory and transparent terms. In October 2019, the European Securities and Markets Authority published a consultation paper on draft technical advice to the Commission on how to specify the conditions under which commercial terms are to be considered to be fair, reasonable, non-discriminatory and transparent (FRANDT) when providing central counterparty (CCP) clearing services to clients in accordance with Article 4(3a) of EMIR. This provision applies from June 18, 2021.
The Bill makes amendments to the onshored version of EMIR (UK EMIR) so as to require firms offering clearing services to do so in accordance with FRANDT terms. The FCA will be given the power to make rules outlining the grounds on which commercial terms will be considered to satisfy FRANDT. Trade repositories (TRs) will also be required to put in place procedures to improve data quality and policies to ensure the orderly transfer of data between themselves, where necessary. The FCA will be given the power to adopt rules relating to this amendment.
Amendments to the Banking Act 2009 in relation to the Financial Collateral Arrangement Regulations
The Financial Collateral Arrangement (No.2) Regulations 2003 (FCARs) were passed to implement the Financial Collateral Arrangements Directive, but subsequent litigation had raised the question of whether the FCARs had exceeded the powers in the European Communities Act 1972, as the FCARs applied obligations to a wider class of persons than the Directive. The Bill retroactively provides that the FCARs are effective and that any act taken under or in reliance on them is to be treated as unaffected by any deficiencies in how they were passed. The Bill also makes amendments to the Banking Act 2009 which ensure that there is sufficient Parliamentary scrutiny applied when HM Treasury makes secondary legislation relating to financial collateral arrangements.
Cancellation of the authorisation of firms
The Bill introduces an additional streamlined process by which the FCA may cancel the authorisation of a firm where the regulator suspects that the firm may no longer be carrying on any regulated activity to which their permissions apply. Examples where the new procedure may be used include where the firm fails to pay its fees or file returns, contrary to its obligations under FCA rules, or repeated failure to respond to FCA correspondence. The cancellation mechanism introduced by the Bill is intended to improve public trust and transparency, particularly around the accuracy of the FCA public register and to reduce the risk of fraud, which is integral to protecting consumers.
In addition, the Bill contains provisions that will allow the FCA to reinstate a firm’s authorisation or varied permission upon application by the firm, provided the FCA considers it appropriate, just and reasonable to do so. Where the firm’s authorisation or varied permission is restored under this process, the intended effect is that the authorisation will be deemed to have continued without cancellation.
When does the Bill come into effect?
The majority of the Bill’s provisions do not have defined dates for entering into force. Instead HM Treasury is empowered to set this date (or, in the case of clause 31 dealing with the application of money laundering regulations to overseas trustees, HM Treasury or the Secretary of State).
There are some substantive clauses in the Bill which will come into force on the day on which the Bill becomes law. For financial services firms, the most pertinent clause would be the one dealing with financial collateral arrangements9, There are also other clauses that come into force two months after the Bill becomes law, this includes the clause relating to insider lists and managers’ transactions10.
The Bill is the UK’s Government’s first step in delivering a UK regulatory framework post Brexit and therefore it will be closely monitored by firms. However, there is more to come in 2021. In particular, later in 2021 the UK Government will report back on the second phase of its Future Regulatory Framework Review, which considers how the regulatory framework for financial services needs to adapt to be fit for the future.