1. Setting the scene
UK regulation is at an important crossroads. The decisions that the UK Government and regulatory authorities take during this year and next will determine the course of UK regulation for the remainder of the decade. The starting point is that the UK is, to a certain extent, free to navigate its own regulatory course having left the EU. However, the UK finds itself in a very different world to that of the 2016 Brexit referendum having to deal with the economic fallout from the COVID-19 pandemic and also important global themes like diversity, fintech and climate change.
2. The future relationship with the EU
When the European Parliament ratified the UK/EU Trade and Cooperation Agreement (TCA) at the end of April, the move was purely symbolic marking what Boris Johnson called the “final step in a long journey”. There were no practical ramifications as the TCA had been operating provisionally since January but its psychological impact was significant. As the UK’s chief Brexit negotiator, Lord Frost, said, the vote “brings certainty and allows us to focus on the future”.
At the time of writing, the whole issue regarding equivalence and the UK/EU future relationship on financial services was still unclear. For example, the Memorandum of Understanding (MoU), which was agreed in a Joint Declaration on Financial Services Regulatory Cooperation alongside the TCA has so far not been formally concluded. HM Treasury announced in March that the technical discussions on the MoU had finished but that formal steps were needed before it could be signed. Since the HM Treasury announcement, there have been no further updates.
Notwithstanding this, it is clear that the MoU will not re-establish EU market access for UK financial services firms nor will the EU grant equivalence in it. However, it will mark an important step in UK-EU regulatory engagement post Brexit on the basis that whilst not a legally binding document it will provide a formal channel in which problems and solutions may be found to cross-border issues including money laundering and financial stability. Also, it will provide the setting where equivalence decisions will be discussed before adoption and withdrawal.
The UK has already granted the EU a package of equivalence decisions whilst the EU has so far not reciprocated and instead has only granted a time-limited equivalence determination for UK clearing houses so that EEA firms can use them for derivatives transactions. Generally the mood music on the EU granting equivalence has not been positive and more recently Lord Frost stated that the EU was still mulling over the thousands of pages of equivalence assessments sent by the UK almost a year ago. He also added that the City should “get on and do its own thing”. The only reasonable conclusion is that politics rather than any regulatory motivation is what is driving EU decision making. This is not surprising and was in many ways well trailed but it has been a disappointment to those in London who thought that it would be possible to have a relationship based on a rational regulatory calculus.
The interesting issue this raises is what the UK response should be. The UK has had the most open borders approach of any developed financial market through the effect of the overseas persons exclusion under Article 72 of the Regulated Activities Order. This has effectively permitted EU and other providers to service UK institutional clients without any form of regulatory oversight. It now seems clear that there will be no reciprocation from the EU side although a small number of EU states such as Belgium, Ireland and Luxembourg have fairly broad exclusion regimes. The obvious question for UK policy makers is whether to stick to the current approach or to move to a regime more akin to that in most other jurisdictions that distinguishes service users from providers and impose some licence or notification requirements on the latter at least. HM Treasury’s paper on the overseas regime touched on some of these issues but the policy outcome remains to be seen.
To some extent since leaving the EU, the UK has in fact got on and done its own thing meaning that regulatory divergence has become a reality.
The first specific announcement about UK divergence occurred in June last year when in a written statement from the Chancellor Rishi Sunak it said that “the UK will not be taking action to incorporate into UK law the reporting obligation of the EU’s Securities Financing Transactions Regulation for non-financial counterparties… which is due to apply in the EU from January 2021”. In another paragraph from the same statement a second major divergence was announced being that the UK would not be implementing the EU’s new settlement discipline regime (as set out in the Central Securities Depositories Regulation and starting in February 2021).
Since the Chancellor’s written statement there have been further instances of the UK’s divergence from the EU regime, for example with regard to certain aspects concerning the implementation of the Investment Firm Prudential Regime. Further change will come from the Future Regulatory Framework Review which HM Treasury is currently working on.
Whilst starting from a position of close alignment, the EU and UK regulatory regimes have started to move apart and businesses will need to be ready for further divergence.
Linked to divergence is perhaps the recalibration of existing regulation.
Having left the EU, UK regulators only have to take into account the firms that operate within the UK whereas EU regulators need to consider all of the different types of firm that operate in the Single Market. In light of this, the UK has already started to adopt a more nimble approach to regulation seeing if existing regulatory standards that may be burdensome for smaller entities may be recalibrated. A good example of this is PRA Discussion Paper 1/21: A strong and simple prudential framework for non-systemic banks and building societies (DP1/21). The PRA’s intention behind DP1/21 is to develop a strong and simple prudential framework that is fully consistent with the Basel Committee on Banking Supervision’s Core Principles for Effective Banking Supervision, but simpler than the Basel standards that apply to large and internationally active banks. The PRA’s long-term vision is of a strong and simple framework in which requirements expand and become more sophisticated as the size and/or complexity of firms increase.
5. International firms
The UK has also been turning its attention to international firms that wish to operate in the UK.
On 11 March 2021, HM Treasury’s call for evidence on the UK framework for financial services firms based overseas closed. This call for evidence has primarily been an information exercise for HM Treasury so that it can get to grips with real concerns regarding the overseas framework that includes the overseas persons exclusion. More is to come with a statement delivered by the Chancellor in November last year stating that the call for evidence would be a precursor to a new approach by HM Treasury to the overseas framework, to be published later this year.
Both the PRA and the FCA have also been looking closely at their supervision of internationally headquartered banks. To some extent this should not be surprising as the PRA has estimated that a fifth of global banking activity takes place in the UK and almost 50% of UK banking assets are held by international banks. In February 2021, the FCA published its ‘Approach to international firms’ which sets out its approach to the authorisation and supervision of international firms and the circumstances in which they may need to establish a UK subsidiary rather than a branch. The PRA is in the process of consulting on a new supervisory statement on its approach to branch and subsidiary supervision and expects to publish a final policy in Q2 2021.
It is clear that the retail sector is high on the agenda of both the UK and the EU.
In May 2021, the Commission issued a public consultation on a retail investment strategy which it plans to adopt in early 2022. In line with the Commission’s stated objective of “an economy that works for people”, the Commission is seeking to ensure that a legal framework for retail investment is suitably adapted to the profile and needs of consumers. Arguably, the UK is more advanced in its work on the retail sector. This year has already seen the FCA issue two key publications, with a consultation paper setting out proposals for a new consumer duty and a discussion paper focussing on possible changes to the financial promotion rules for high-risk investments. The FCA plans to issue a second consultation paper on the new consumer duty by the end of this year with the final rules going live by 31 July 2022.
Fuelling the debate on retailisation of regulation has been developments such as Gamestop. As noted in a recent FCA speech (Locking down market abuse, 8 March 2021) Gamestop has drawn attention to the increase in retail trading accounts in the UK during 2020.The trend preceded the lockdown but accelerated during the first lockdown in particular, perhaps fuelled by people spending more time online, more time at home and the increase in so-called commission free trading. While many of these accounts were opened but appear not to have been used the FCA is alive to the risk that new retail investors may become subject to misleading online marketing.
The retailisation of regulation will be one of the big themes for this year and next and the fall-out from the COVID-19 pandemic will also be a significant factor in this.
7. The fallout from COVID-19 pandemic
With the UK slowly emerging from the COVID-19 pandemic, there will be a number of things that the regulatory authorities will be looking at and this will include the treatment of customers particularly vulnerable customers.
In February 2021, the FCA issued its latest Financial Lives survey covering the impact of the COVID-19 pandemic. The findings from the survey were worrying. The research found that, even before the first lockdown, over 20 million adults could only continue to cover their living expenses for less than three months, if they lost their main source of household income. By October 2020, 20 million people reported that their financial situation was worse than before lockdown, and 3.7 million more than in February 2021 had characteristics of vulnerability. In addition, the pain was not being felt equally; both younger adults and BAME adults were disproportionately represented among the growing number of vulnerable consumers – and so at greater risk of harm. Moving forward since the survey, it is inevitable that the picture for consumers will have got worse.
Boards will also be acutely aware that their conduct during the pandemic and its immediate aftermath will be in the spotlight due to the senior managers’ regime. Whilst both the FCA and the PRA did not expect firms to designate a single senior manager to have responsibility for the response to the pandemic they did expect a clear framework for allocating responsibilities to various senior managers for different aspects of their response to coronavirus. To minimise their exposure to supervisory action a number of firms are already undertaking “lessons learned” reviews in order to demonstrate and evidence that they have appropriately learned from issues that have occurred due to the pandemic.
There have already been a number of FCA speeches this year on diversity which provide some insight into the regulator’s current thinking on this important topic. In particular, these speeches note that the FCA is considering introducing a sixth conduct question for firms: is your management team diverse enough to provide adequate challenge and do you create the right environment in which people of all backgrounds can speak up?
To support efforts in moving the dial in the financial sector, the FCA and PRA will be issuing a joint discussion paper on diversity and inclusion in June. This will be followed by a consultation paper in Q1 2022 and a policy statement in Q3 2022. The FCA and PRA will also issue a one off data request to a statistically significant selection of FCA and PRA regulated firms in mid-2021.
Fintech will also continue to be one of the big themes going forward.
More recently the European Securities and Markets Authority has issued a call for evidence on digital finance and the proposed EU Regulation on markets in crypto-assets continues to be negotiated in trilogue. In the UK, an independent report on fintech was published by Ron Kalifa OBE in February. The Government has welcomed the Kalifa report and its key recommendations.
One of the key themes from the Kalifa report is the importance of harnessing data. In particular, it recommends that the UK develop and implement a data strategy as part of its digital finance package. Among other things this would provide for the development and adoption of common data standards, the continuation of open finance but within the framework of a wider initiative to facilitate user-driven data-sharing with authorised third-party service providers on a cross-sectoral basis and a consideration of the regulatory implications of artificial intelligence, including to provide specific guidance about the application of existing rules in the context of AI.
Central bank digital currency and the regulation of crypto-assets will also remain important fintech related topics. In relation to the former the Bank of England has already announced earlier this year that it was setting up a Central Bank Digital Currency (CBDC) taskforce to coordinate the exploration of a potential UK CBDC.
The focus on environmental, social and governance (ESG) issues continues to grow. The EU has been particularly active in this area passing two significant ESG-related regulations: the Sustainability-Related Disclosure Regulation (SFDR) and the Taxonomy Regulation. However, neither the SFDR nor the Taxonomy Regulation are being imported into UK law.
In November last year the UK Government announced a ten point plan for a “green industrial revolution” to simulate recovery from the COVID-19 pandemic and create up to 250,000 jobs. The plan included, in line with the recommendations of the Task Force on Climate-related Financial Disclosures, an intention to “introduce mandatory reporting of climate related financial information across the economy by 2025, with a significant portion of mandatory requirements in place by 2023.” This policy was also covered in UK Chancellor Rishi Sunak’s statement to Parliament on 9 November 2020. In addition to the mandatory reporting of climate-related financial information, the Chancellor’s Statement also stated the UK’s intention to implement its own “green taxonomy.” The Chancellor went on to explain that this taxonomy will use the scientific metrics adopted in the EU taxonomy as its basis, subject to the review of a newly established UK Green Technical Advisory Group to assess the appropriateness of the EU’s scientific metrics to the UK market.
The FCA has already issued a consultation paper seeking views on proposals to mandate climate-related financial disclosures by publicly quoted companies, large private companies and limited liability partnerships. Pages 7 to 10 of the latest regulatory initiatives grid noted the following additional developments this year which include:
- FCA Consultation paper in June 2021 on climate related disclosures – asset managers, life insurers, and FCA regulated pension schemes.
- FCA consultation paper in June 2021 on climate related disclosures – listed issuers.
- Technical screening criteria for a UK green taxonomy to be finalised by end 2022.
This article first appeared on Thomson Reuters Regulatory Intelligence.