On 20 July 2022, the Financial Services and Markets Bill (the Bill) was introduced into Parliament. The Bill is the largest piece of financial services legislation for over two decades and covers a wide range of topics. However, it contains very few surprises because all of its main proposals have been anticipated for some time.
What are the ‘big ticket items’ in the Bill?
(1) Future Regulatory Framework:
The main driver for the Bill was to sort out the mess left on the statute book by the mass-onshoring of EU legislation in the lead up to Brexit. The Bill establishes HMT’s Future Regulatory Framework, giving the FCA and PRA new powers and objectives and providing the legislative architecture for the repeal of EU retained law and its transfer to the FCA and PRA rulebooks.
Retained EU law
When the UK left the EU, the body of EU legislation that applied directly in the UK at the point of exit was transferred onto the UK statute book by the EU Withdrawal Act and became known as ‘retained EU law’. This approach was just a quick fix to ensure the UK legislation worked in the immediate period after Brexit and was never meant to be a long-term solution, particularly because, under this structure, the PRA and FCA are unable to make changes to rules set out in retained EU law. The Bill sets up the legislative architecture to allow a smooth transition to a comprehensive FSMA model. The regulators will make and consult on rules in the usual way and conduct cost benefit analyses (although there are some exemptions from these requirements) and HMT will repeal the relevant pieces of retained EU law at the same time as the corresponding FCA and PRA rules come into force. Public consultation will be required even if HMT and the regulators conclude that the most appropriate course of action is just to replace the retained EU law with rules that are materially the same as those revoked. The Government expects it will take ‘a number of years’ to fully compete the process and undoubtedly it will be a significant programme of work for the regulators. In the meantime, the regulators will be restricted in the rule changes they can make and the Bill therefore provides HMT with a power to make targeted modifications to retained EU law during this transitional period. To increase accountability, the regulators will be required to keep their rules under regular review and publish statements of policy on how they will do this. HMT will have the power to require a review of certain rules and a power to require a regulator to use their rule-making powers to make rules.
The Bill also includes various ‘patches’ to fix the gaps where EU powers and activities do not quite match those under the FSMA regime (for example, the Designated Activities Regime which is a new regime for the regulation of certain activities outside the FSMA authorisation process that are covered by retained EU law and the power for the BoE to make rules for Financial Market Infrastructures and to oversee them).
New objectives for the regulators
There will be new growth and international competitiveness secondary objectives for the PRA and FCA, and a new requirement for the regulators to ‘have regard’ to climate change and a net zero economy.
The competitiveness objective in particular was a much debated proposal, with the Treasury Select Committee fearing it would lead to watered down regulatory standards and result in a bonfire of investor protection, but the Government has decided to proceed, focussed on its aim to make the UK an attractive jurisdiction for financial services in a post-Brexit world. In a nod to the Treasury Select Committee’s concerns, the Government has made it a secondary objective making clear that financial stability and consumer protection should be prioritised over the UK’s competitiveness. The competitiveness objective aims to provide greater focus on medium to long-term growth and international competitiveness. The Government wants to ensure that giving the regulators a legal basis for advancing medium to long-term growth and international competitiveness does not detract from their existing objectives of financial stability, competition in the interests of consumers and consumer protection. The Bill therefore enables the FCA and the PRA to act only in a way which facilitates growth and international competitiveness in the medium to long-term. The Government does not want the PRA and the FCA to act in a way which benefits short-term competitiveness at the cost of long-term growth.
The Government wants to further strengthen the regulatory regime relating to climate and has therefore chosen to give consideration of the UK’s climate target a statutory basis, having received significant support from respondents to its November 2021 consultation on the Future Regulatory Framework. The November 2021 consultation proposed amending the regulator’s existing sustainable growth principle to incorporate the UK’s statutory climate target. Following feedback to the consultation, and given the regulators will have new secondary objectives to facilitate international competitiveness and growth in the medium to long-term, the Bill will remove the existing sustainable growth principle for the regulators to avoid unnecessary duplication. The Bill also introduces a new regulatory principle for the FCA and PRA, when discharging their general functions, to have regard to the need to contribute towards achieving compliance with section 1 of the Climate Change Act 2008. The net zero regulatory principle seeks to cement the Government’s long-term commitment to transform the economy in line with its Net Zero Strategy by ensuring the regulators must have regard to these considerations when discharging their functions.
(2) Critical Third Parties:
HMT recently announced its plans to allow the Bank of England, FCA and PRA to directly oversee and supervise unregulated firms delivering certain critical services to the financial services sector (see our previous article). As expected, the Bill presses ahead with those plans, containing provisions enabling HMT to designate a third party as ‘critical’ and confirming that designations will be based on (a) the materiality of the services which a third party provides to firms and (b) the number and type of firms which use a third party. The Bill will give the regulators the power to make rules, gather information, and take limited enforcement actions in respect of CTPs, and a Discussion Paper was published alongside the Bill setting out how these new powers will be exercised in practice.
(3) Financial Promotions:
The Bill implements the Government’s plan to create a ‘regulatory gateway’, which authorised firms must pass through before being able to approve the financial promotions of unauthorised firms (see our previous article). Any authorised firm wishing to approve the financial promotions of unauthorised firms will need permission from the FCA, which may be granted subject to limitations (e.g. restricting firms to approving promotions which are within their field of expertise).
Following on from the Government’s consultation on the UK’s approach to the regulation of cryptoassets, the Bill brings activities facilitating the use of certain stablecoins within the regulatory perimeter, where they are used as a means of payment. The Bill confirms that this will be done primarily via amendments to the existing electronic money and payment system regulatory frameworks. The Bill introduces a definition of ‘digital settlement asset’ and gives HMT a power to amend the definition to ensure it keeps pace with developments. The Bill also puts in place a regime that allows for the clear identification of the applicable regulatory requirements (for example, in relation to prudential rules) where a payment system using digital settlement assets or digital settlement asset service provider is recognised as being systemic by HMT. The Government has sought to reflect the Financial Stability Board’s recommendations on the regulation of global stablecoin arrangements and the CPMI-IOSCO consultation report on the application of the Principles for Financial Market Infrastructures to stablecoin arrangements, and will leave room to update the regulatory framework as international standards are developed.
The Government intends to consult on its regulatory approach to wider cryptoassets, beyond stablecoins used for payments, including those primarily used as a means of investment (such as Bitcoin) later in 2022.
(5) Access to Cash:
Following concerns surrounding the ability of vulnerable customers to access cash, the Bill contains provisions to ensure the continued provision of cash withdrawal and deposit facilities, and grants the BoE powers to oversee the wholesale cash industry.
(6) Wholesale capital markets regulation:
The Bill delivers the priority measures identified through the Wholesale Markets Review consultation and aims to improve competitiveness and increase the flexibility of wholesale markets regulation by making nine changes to the MiFID II framework: (1) Removing the Share Trading Obligation; (2) Replacing the pre-trade transparency waiver regime and removing the Double Volume Cap; (3) Changing the definition of a systematic internaliser; (4) Removing restrictions on midpoint crossing for trades; (5) Aligning the Derivatives Trading Obligation with the EMIR Clearing Obligation; (6) Exempting for post-trade risk reduction services from the DTO; (7) Giving the FCA a permanent power to modify or suspend the DTO; (8) Simplifying the transparency regime for fixed income and derivatives; (9) Simplifying the position limits regime.
(7) Regulation of Financial Market Infrastructures:
As much of the regulatory framework for FMIs sits within retained EU law, the Bill contains provisions for the BoE and the FCA to become the primary FMI regulators once the relevant retained EU law is revoked. The BoE is granted a general rule making power in respect of CCPs and CSDs (which are, at present, regulated primarily by EMIR and the CSDR). The Bill also introduces the concept of a ‘systemic third country CCP’. The BoE will have the power (in accordance with criteria which will be set out in secondary legislation and a BoE statement of policy) to designate a third country CCP as ‘systemic’. Once designated, the CCP can be made subject to the BoE’s domestic rulebook, in whole or in part. The FCA will become the primary regulator for Data Reporting Service Providers and Recognised Investment Exchanges.
(8) The application of the SM&CR to Financial Market Infrastructures:
Having previously announced its intention to introduce a regulatory regime for individual conduct within FMIs (see our previous report), the Bill introduces a new SM&CR that can be applied to CCPs and CSDs. As expected, the regime is similar to the SM&CR for banks, insurers and other regulated firms, and consists of: (a) a Senior Managers Regime (giving the BoE and the FCA the power to approve senior individuals), (b) a Certification Regime (requiring firms to certify individuals performing ‘specified functions’ as fit and proper); and (c) conduct rules applying to all employees. The Bill also gives the Government the power to apply the regime to Credit Rating Agencies and Recognised Investment Exchanges in the future. Although some had considered the SM&CR regime unnecessary given the different risk incentives for individuals within FMIs as compared to some other parts of the financial services industry, the close mirroring of the existing SM&CR regime will come as no surprise.
(9) Central Counterparties in financial difficulty:
The Bill expands the resolution regime for Central Counterparties (CCPs), granting the BoE powers to stabilise a CCP allowing the CCP to provide critical clearing services and making sure clearing members, rather than public funds, bear the losses arising from the failure. The measures include, amongst other things, the power for the BoE to place a CCP into resolution before the CCP’s own recovery measures have been exhausted, where certain conditions are met, temporarily restrict or prohibit any remuneration of equity for CCP shareholders or variable remuneration for the CCP’s senior staff, and to take control of the CCP and to direct a CCP to remove or replace directors and senior managers.
(10) Insurers in financial difficulties:
Although insurer insolvencies are uncommon, the consequences can be severe and the Government announced in April 2022 that it was planning to amend the insolvency arrangements for insurers. The Bill follows this through and makes a series of amendments which:
- clarify and expand the never-before-used Section 377 of FSMA 2000, which grants a court with the power to reduce the value of one or more of the contracts of an insurer which has been ‘proved to be unable to pay its debts’, as an alternative to making a winding-up order (known as a ‘write-down’ of liabilities).
- affect contractual termination rights by introducing a new moratorium temporarily preventing suppliers and some financial contract counterparties from exercising rights to terminate contracts while an insurer is undergoing certain insolvency or write-down procedures.
- affect policyholder surrender rights, introducing a temporary moratorium on life insurance policyholder surrender and switching rights which will apply in the same circumstances as the moratorium on contractual termination rights.
Under the UK Securitisation Regulation, securitisations with originators and sponsors established outside the UK (or the EU until 31 December 2022) cannot be designated as Simple, Transparent and Standardised (STS). As a result, CRR firms and Solvency II firms cannot get preferential capital treatment for investing in those securitisations originated overseas, even if this is appropriate to reflect their adherence to STS criteria. This limits the availability of STS securitisations for UK investors, which can have a negative impact on their liquidity and on the STS securitisation market as a whole. The Bill aims to increase choice for UK investors in the market for STS securitisations, by allowing for STS equivalent non-UK securitisations to be recognised in the UK, with appropriate safeguards, provided they are originated in a jurisdiction that has an equivalent framework for STS securitisation to the UK. The Bill creates a framework under which HMT can designate other jurisdictions as having an STS securitisation framework equivalent to that of the UK.
When can we expect to see progress?
Giving the timing of the Bill’s introduction into Parliament the day before the summer recess began, we will now have to wait until 5 September for the announcement of the new Prime Minister and for Parliamentary debate on the proposals to begin. Although none of the proposals have come as a huge surprise, it was still interesting to see a clear direction of travel for UK financial services before the summer recess began.