This article, written for Financial Regulation International, looks at a selection of key regulatory developments in 2015 and those that will affect firms in 2016.
In last year's regulatory update, Emma Radmore looked at several key changes which had either already taken place in the UK, or were on the horizon. This year, the regulators have remained busy, but to some extent the year has been about consolidation of recently implemented measures, while planning for significant new laws. Many changes took effect in 2014, with others finalised and ready to take effect in 2016. And, of course the cycle of regulatory change continues for 2017 and beyond. This year's top ten is a mixture of changes that took effect during the year, the effects of changes that were already in force, and a look ahead to priorities for 2016.
Five 2015 Developments
1. AIFMD: close to full implementation, and looking to the third country passport
Almost all jurisdictions in the EU have now implemented the Alternative Investment Fund Managers Directive (AIFMD). Notably, though, it has still not formally been included within the European Economic Area (EEA) Agreement, so Norway, Iceland and Liechtenstein still cannot technically implement it, though all have brought their standards up to and as close to AIFMD as possible. The main news in 2015 was the European Securities and Markets Authority (ESMA) review on:
- how the AIFMD passport has functioned for EU AIFMs managing and/or marketing EU AIFs;
- how EU AIFMs have marketed non-EU AIFs;
- how non-EU AIFMs have managed or marketed AIFs under the NPPR; and
- application of the passport to the marketing of non-EU AIFs by EU AIFMs and the management or marketing of AIFs by non-EU AIFMs.
Following ESMA's views, the Commission could decide to implement a passport for marketing of non-EU AIFs and management and marketing of AIFs by non-EU AIFMs to operate initially alongside NPPR and potentially, from 2018 onwards, to replace the NPPR regime.
There are a number of problems that stop the current regime working as well as it might. Chief among these are:
- obstacles in the current national private placement regime, which allows Member States to permit marketing of non-EU AIFs in their jurisdictions, caused by differences in conditions and fees between Member States. Non- EU fund managers, or EU fund managers wishing to market non-EU AIFs cannot implement a consistent marketing policy, as some Member States are permissive and others have gold-plated the AIFMD minimum requirements in such a way as effectively to make private placement impossible;
- differing interpretations, or lack of regulatory guidance, on what is "reverse solicitation" – the method that allows marketing without notification;
ESMA's predominant view is that it is too soon after implementation of the AIFMD to give a definitive opinion on how the various NPPR have been working, and whether there should be a third-country passport, and ESMA recommended a further report after a longer period. It assessed Guernsey, Hong Kong, Jersey, Singapore, Switzerland and the US. It concluded the passport could be extended now to Jersey and Guernsey, and also to Switzerland as legislative change there will remove any outstanding hurdles. However, it is still working through certain concerns in relation to the other three jurisdictions and wants to assess several more. In view of this, it thinks the Commission may delay extending the passport until it can introduce it for a "batch" of jurisdictions.
2. Consumer Rights Act – overhaul of Unfair Terms in Consumer Contracts
The Consumer Rights Act 2015 (CRA) has overhauled many aspects of UK consumer protection regulation. Key to the financial services sector is that , from 1 October, the CRA replaced the Unfrair Terms in Consumer Contracts Regulations, and the Competition and Markets Authority (CMA) has published new guidance on unfair terms in consumer contracts that replace what FCA had previously published.. CMA has published a suite of documents, giving differing levels of guidance, and has also explained the new legal provisions and looked at terms which have previously been considered unfair. The guidance replaces the former Office of Fair Trading guidance and sets out CMA’s understanding of the law, the terms it might consider unfair and what the consequences of a term being unfair might be. The guidance covers:
- CMA’s understanding of the requirements of fairness and transparency, including:
- CMA’s approach to interpreting the three elements that make up the fairness test – “significant imbalance”, “consumer detriment” and “good faith”;
- the factors the CRA requires be taken into account when assessing fairness, and the nature of the “grey list” of terms that may be regarded as unfair; and
- the meaning of the requirement of transparency and what CMA would consider compliant;
- the scope of the exemptions from the fairness assessment of certain types of consumer contract terms and consumer notices:
- the “core exemption”: the guidance looks at its purpose, the type of fairness assessment excluded for terms that fall under it, and the conditions terms must comply with to benefit from the exemption, including the “prominence” condition; and
- the “mandatory statutory or regulatory” exemption: again, CMA looks at its purpose and what it covers;
- detail on the terms that are inherently objectionable and are therefore “blacklisted”, making them automatically ineffective without the need to consider the fairness test;
- why CMA considers that certain kinds of terms and notices have the potential for unfairness, with reference to terms on the “grey list”; and
- enforcement powers.
The guidance makes it clear the CRA regime applies only to contracts entered into on or after 1 October 2015. Contracts already in effect will still be protected by the current laws.
3. The first English Deferred Prosecution Agreement
Since February 2014, UK enforcement agencies have had the power to agree deferred prosecution agreements (DPAs) with corporates who commit a range of offences, including offences under the Bribery Act 2010 and money laundering legislation. Following a court hearing on 30 November, the Serious Fraud Office (SFO) confirmed the approval of the first DPA. The DPA relates to Standard Bank plc (now ICBC Standard Bank plc). Standard Bank was the joint lead arranger, with a Tanzanian sister company, on a fund-raising for the Tanzanian government. Two senior executives of the sister company appointed an agent, with the promise of paying it 1% of the amount raised.Two of the three shareholders of the agent were related to the government, and the transaction moved swiftly after the agent’s appointment. Shortly after completion, the agent removed most of the funds relating to its payment from its account with the Tanzanian sister company, at which stage the company made a report to its parent, which in turn alerted Standard Bank. Standard Bank appointed lawyers and made reports to SFO and the then Serious Organised Crimes Agency. Standard Bank did not have in place appropriate procedures or training, which meant that no-one in the UK entity appreciated the need to carry out due diligence on the agent, nor to act on the red flag indications. SFO and the relevant judge agreed there was no prospect of Standard Bank claiming it had adequate procedures, and that it had therefore breached s7 Bribery Act. SFO and the judge took into account the factors that would tend towards a DPA rather than an immediate prosecution, and agreed them. Provided Standard Bank meets the conditions of the DPA, the prosecution, currently stalled, will be dropped in three years’ time.
SFO said that the case had proved where the “high bar” for co-operation could be. SFO had previously indicated that in order for it to consider a DPA might be appropriate there would need to be a high degree of willingness to co-operate and that this should prove to be the case in fact. SFO advised any company considering this route should take note that, although “adequate procedures” were not discussed in this particular case, the important thing is to view facts as they occur. Regardless of what any procedures might say, if a red flag seems obvious, it should be treated as such. The judge's comments on how Standard Bank had acted once it became aware of the problem were also of key importance. SFO has suggested its conduct was a prime reason for SFO deciding a DPA was appropriate, and stressed it will not be planning to make most corporate actions DPA arrangements. It will use DPAs only when a narrow set of specific factors suggest it is the best route.
While we still await the first prosecution or DPA that analyses whether procedures were "adequate" for the purposes of the defence to the failure to prevent offence, this case is the first illustration of how DPAs are likely to operate in future.
4. Reduction in deposit protection
PRA has implemented changes to the depositor compensation the Financial Services Compensation Scheme (FSCS) provides. The changes result from the Deposit Guarantee Schemes Directive revisions (DGSD2) and mean that:
- the £85,000 limit on deposit protection must decrease to £75,000, but existing depositors who would have benefited from the higher limit could do so until 31 December 2015;
- the new limit of £75,000 applied immediately to some categories of depositor who fall under FSCS protection for the first time, such as large corporates;
- depositors with temporary high balances have protection for up to £1 million for six months from the date on which they receive money in their account or become entitled to it; and
- holders of all long-term insurance policies, professional indemnity insurance policies, and claims arising from death or incapacity will benefit from 100% cover.
PRA put in place rules to help manage the impact of the change on depositors who are contractually tied into products with balances above the new limit, and made available a "modification by consent" to firms. This allowed some firms extra time to make required notification, but in principle the new regime should take full effect by the beginning of 2016.
5. Solvency 2 takes effect
After many years, Solvency 2 finally falls to be implemented from the beginning of 2016. PRA has published its final rules implementing Solvency 2 into its rulebook, and has separate sections in its rulebook for insurers who are covered by Solvency 2 (which is the vast majority of insurers). It published, alongside the rules, a policy statement explaining how it will implement the "long-term guarantees package", and supervisory statements that firms should read alongside the rules. The new rules cover:
- General Application;
- Technical Provisions;
- Own Funds;
- Solvency Capital Requirement - General Provisions;
- Solvency Capital Requirement Standard Formula;
- Solvency Capital Requirement - Internal Models;
- Minimum Capital Requirement;
- Undertakings in Difficulty;
- Conditions Governing Business;
- Insurance Special Purpose Vehicles;
- Group Supervision;
- Third Country Branches;
- Transitional Measures;
- Surplus Funds;
- With-Profits Instrument;
- Actuaries Instrument; and
- Run-off Operations.
While PRA is responsible for the bulk of the Solvency 2 burden, FCA also a policy statement and to cover:
- transposition of Solvency 2: the key items relate to FCA's decision to keep the list of assets for permitted links, require incoming EEA firms to appoint a claims representative and amend the rules on information for policyholders;
- changes to the Conduct of Business Rules: with-profits and unit-linked business;
- other consequential changes to the Handbook, mainly to prudential and systems and controls requirements but also to the Supervision manual; and
- governance in insurance firms.
Five 2016 Priorities
1. Senior Managers and Senior Insurance Managers Regimes
Following the Financial Services (Banking Reform) Act 2013 (Banking Reform Act) and a review by the PRA and FCA, new regimes on accountability for senior managers, and an overhaul of the current "approved persons" regime for almost all PRA-regulated firms, takes effect in March 2016.
The regime applies to banks, building societies, credit unions and investment firms who are regulated by PRA, with a mirroring regime for insurance companies.
The Senior Managers Regime (SMR) as it applies to all affected firms except insurers (to whom the Senior Insurance Managers Regime (SIMR)) applies, has three key strands:
Although the SMR is a PRA-led initiative, FCA, in its role as conduct regulator, has an equally active role to play. The rules take effect from 7 March 2016, although there are some transitional provisions. PRA has made several new instruments in its new-look Rulebook, and published a supervisory statement. FCA has made rules amending its Senior Management Arrangements, Systems and Controls Sourcebook, its Fit and Proper Test for Approved Persons and its Supervision Manual, and is bringing in a new Code of Conduct Sourcebook. Affected firms must notify PRA and FCA of which of their approved persons will be senior managers under the regime and can comply with a set of grandfathering requirements to migrate current approved persons to the SMR. However, firms must be aware that there will often not be a direct and clear map between current controlled functions and SMFs, and those with overseas parents should be aware that overseas individual may be caught. As part of their mapping exercise, firms must prepare short statements of responsibility so it is clear what each individual's remit is. All affected firms should, by the end of 2015, be well advanced in their mapping and documentation exercises and have in place compliance plans to ensure they meet the new requirements.
- the identification by firms of, and approval of the regulator for, individuals carrying on one or more specified senior management functions (SMFs). Only these individuals will be individually approved by the regulator and be directly accountable to the regulator;
- a certification regime, which requires firms to assess which of their employees could pose a risk of significant harm to customers. Rather than the current approved persons regime, which would require most of these individuals to be approved by the regulator, often in the controlled "customer function", firms themselves must now certify that these individuals are fit and proper to carry on their fucntions; and
- a set of conduct rules, which will apply, at least at some level, to most employees of relevant firms. Some rules, though, will apply only to those in SMFs.
2. Implementation of the Mortgage Credit Directive
The EU's Mortgage Credit Directive (MCD) must be implemented in Member States of the EU by 21 March 2016. The MCD has four main aims in imposing regulation on those who lend on consumer mortgages:
- affordability assessments, so that lenders must properly consider whether borrowers can afford mortgages they request;
- disclosure to borrowers, in the form of a standardised information sheet – the European Standard Information Sheet or ESIS;
- mortgage advice, to ensure a consistent standard of advice is given to customers; and
- training and competence of staff in mortgage firms.
The UK made most of its legislation implementing the MCD in March 2015, so firms have had nearly a year to make necessary preparations. In principle, few UK lenders and intermediaries will need to make wholesale changes to their business, but there are a number of administrative and procedural changes that may require firms to seek variations in their regulatory permissions and will require changes to internal and customer facing documentation. Firms are already able to comply with the MCD rules, if they wish. Among the key changes are:
- while mortgages entered into before 21 March 2016 will not be subject to the MCD rules, any mortgage entered into on or after that date, whether a first or second charge mortgage, will be subject to FCA's rules in its Mortgages and Home Finance: Conduct of Business Sourcebook (MCOB). Currently, only first charge mortgages are subject to MCOB, with second charge mortgages falling under FCA's consumer credit mantle;
- the MCD is wider than current UK regulation in respect of certain consumer buy-to-let mortgages, and the UK has introduced a registration system that FCA will operate, for firms that fall within the MCD's provisions on this type of business but outside the Financial Services and Markets Act;s scope;
- all firms will of course need to devise an ESIS, and also will need to set up an Annual Percentage Rate of Charge (APRC) simulator, to ensure they meet the European Commission's expectations on calculation methodology; and
- firms will need to consider changes FCA has made to its rules on affordability and advisory requirements. However, many of the changes MCD requires were anticipated to a large extent in the UK's Mortgage Market Review, with which firms must already comply.
3. UK financial regulation: structural and cosmetic change
A number of initiatives are underway which may require quick reactions from the industry during 2016 and which relate to change in the structure and scope of UK regulation.
- The Bank of England (BoE) published Fair and Effective Markets Review final report and recommendations in June 2015. The Review looked at deficiencies in the markets and their root causes, examined progress to date (such as in regulation of benchmark activities) and at where gaps remain. There are 21 recommendations, all aimed at raising standards in the wholesale fixed income, currency and commodity (FICC) markets. Some are aimed at individuals, some at firms and some at regulators. Key recommendations include:
- extending criminal sanctions for market abuse to a wider range of instruments and increasing the maximum sentence to 10 years' imprisonment; and creating a new civil and criminal market abuse regime for spot foreign exchange;
- mandatory qualification requirements and disclosure requirements for references, that will prevent the "recycling" of individuals with poor conduct records;
- creating an FICC Market Standards Board and encouraging international action from the International Organisation of Securities Commissions (IOSCO) to create a set of common standards for trading practices across FICC markets;
- extending the Senior Managers Regime to a wider range of firms;
- working towards a single global FX code;
- looking at a global solution to aligning remuneration with conduct risk; and
- improving forward-looking supervision of FICC markets.
- Treasury introduced the Bank of England and Financial Services Bill (BoE Bill) in October 2015. The Bill will, among other things:
- improve the accountability and governance of BoE by making its court of directors a smaller, more focused unitary board;
- move the Monetary Policy Committee (MPC) to a schedule of a minimum of eight meetings a year;
- bring PRA within BoE, ending its status as a subsidiary, and establishing a new Prudential Regulation Committee (PRC);
- make changes to the Financial Policy Committee (FPC) including making it a statutory committee of BoE, in line with the MPC and the new PRC;
- bring BoE within the purview of National Audit Office value for money studies;
- further strengthen coordination arrangements between the Treasury and BoE in protecting taxpayers and the wider economy from bank failures;
- extend the SMR to all FSMA authorised persons, and introduce a duty of responsibility, superseding the reverse burden of proof (this was the original proposal, but it was challenged at an early stage of the Parliamentary process). Treasury has published a supporting policy paper detailing the measures required to achieve this;
- FCA and PRA have consulted on ring-fencing guidance during 2015. The Banking Reform Act requires banks, by 2019, to "ring-fence" their retail deposits, so that they separate key core banking services from wholesale and investment banking services. This will be a long process and one that affected banks should be planning well in advance. Legislation has already been made both amending the Financial Services and Markets Act to set the regime on a statutory footing, and to set out:
- Which bodies are "ring-fenced bodies" and what are core activities; and
- What and who is excluded from the general regime and prohibitions.
FCA and PRA are now consulting on their approach to implementing ring-fencing and ring-fencing transfer schemes. During 2016 we can expect further clarity so banks can start more detailed planning for structural changes and how to deal with affected business and customers.
4. Implementation of the Market Abuse Regulation
Treasury and FCA are consulting on the changes it will need to make to its Handbook to support the implementation of the new market abuse regime under the Market Abuse Regulation (EU MAR), which takes effect on 3 July 2016 . UK primary legislation and FCA’s rules will need to change, so they are not incompatible with EU MAR.
Treasury will make secondary legislation amending the Financial Services and Markets Act 2000 (FSMA). Treasury has published the draft statutory instrument setting out proposed changes to UK legislation that will primarily remove the current market abuse offences and powers for FCA to make the Code of Market Conduct from the Financial Services and Markets Act 2000 by deleting sections 118-122 (and to amend the Financial Services Act 2012 in respect of the misleading statements offences) and giving FCA the necessary powers to require information and take a range of inspection, corrective and enforcement actions under EU MAR. It makes a number of consequential amendments to several pieces of primary and secondary legislation to reflect application of EU MAR.
FCA’s consultation assumes certain changes to FSMA will take effect. The key parts of FCA’s consultation are:
- to seek views on aspects of EU MAR where Member States have implementation options, specifically: whether to require firms systematically to provide an explanation whenever they disclose a delay in disclosure of inside information. FCA proposes that firms should provide an explanation only if FCA asks them to do so, but seeks views on how burdensome it would be to provide explanations in all cases, and on how many notifications firms would expect to make each year;
- what threshold to apply for the disclosure of managers’ transactions. EU MAR sets a €5,000 threshold but Member States may increase this to €20,000 if justified and ESMA agrees. FCA currently applies no threshold under the Disclosure and Transparency Rules (DTR) and proposes to adopt the €5,000 threshold, but seeks data on how many transactions would be notifiable under either the €5,000 or €20,000 threshold;
- its general approach to changing the Handbook, which ranges from removing provisions where there is an equivalent in EU MAR, through amending and conforming existing provisions to make them consistent with EU MAR, to leaving unchanged provisions that are relevant and not addressed by EU MAR;
- how it proposes to amend its Market Conduct Sourcebook (MAR): FCA understands Treasury will remove the requirements in FSMA for FCA to make the Code of Market Conduct (CoMC). However, it understands many people find the CoMC useful so would propose to keep as much of the content as remains relevant, but no longer describe it as a Code. The consultation includes detail on FCA’s proposed action in relation to chapters 1, 2 and 8 of MAR;
- how it proposes to amend relevant parts of the Conduct of Business Sourcebook and the Supervision Manual;
- how it proposes to amend the DTR, Listing Rules and Model Code. FCA proposes to replace the current provisions of the Model Code with rules and guidance on systems and procedures for companies to have clearance procedures for managers’ transactions.
The consultation period closes in February, so there is not long for the regulators to make rules before EU MAR takes effect. However, the key provisions are already set at EU level, and UK firms should be preparing to comply with them.
5. MiFID 2: planning for 2017 starts now
The EU's revised Markets in Financial Instruments Directive and Regulation (MiFID 2) package is due to take effect on 3 January 2017. It needs several key pieces of supporting legislation and standards at an EU level, with some national implementation before it can take effect, and the implementation deadline is now in doubt. Both ESMA and the European Commission have missed deadlines for publication of key papers. Without these, the UK regulators can do little meaningful, but both Treasury and FCA have consulted on their overall approach.
Treasury is consulting on the principles it will use when implementing MiFID 2 into UK law. Overall, it will:
- make changes to existing legislation to maintain consistency;
- use the copy-out approach wherever possible; and
- consult on changes as early as possible.
All firms will be affected by MiFID 2, which impacts on:
- commodity derivatives – by extending the scope of instruments covered by MiFID and therefore requiring some firms to seek authorisation for the first time;
- transparency – by introducing new and detailed pre- and post-trade transparency requirements to a wide range of instruments;
- high frequency and algorithmic trading – by setting new requirements to prevent abuses of the markets;
- market structure – by introducing a new type of trading facility, the organised trading facility (OTF) to operate alongside existing facilities;
- organisational requirements – for all types of investment firm and market infrastructure participants;
- trade reporting – to put in place new templates and timescales for reporting, again with a view to detecting and preventing abuses;
- conduct of business rules – to make some changes to customer classification and introduce new standards for advice and independence as well as new restrictions on inducements and commissions and new requirements on costs and charges disclosure; and
- transaction reporting – again to require new formats on reporting, with an EU wide system of Approved Reporting Mechanisms and duties to report transactions carried out by firms not subject to MiFIR.
It now seems likely there will be a delay in at least parts of MiFID 2's application, if not a wholesale delay in application of any of it. However, Treasury and FCA have already issued papers on their initial thoughts and approach to implementation, and plan to issue more at the end of 2015 and early 2016. In some cases FCA has suggested it might apply MiFID 2 principles more widely than necessary. Its sole paper to date, a Discussion Paper covered several matters, including:
- applying MiFID 2 rules to insurance-based investment products and pensions: FCA already applies many of its rules to these products, although they are not subject to the current MiFID. It thinks these products are "substitutable" for MiFID 2 products and, bearing in mind the current rules, and the fact that MiFID 2 makes it clear there should be consistent consumer protections between all products, it would propose to apply its COB rules to them, excepting those on costs and charges;
- receipt of commissions and other benefits for discretionary investment managers: FCA notes MiFID 2 will effectively apply requirements similar to the Retail Distribution Review (RDR) adviser charging rules to discretionary investment management (DIM). It sought views on whether it should include the MiFID 2 concession to DIM of allowing firms to accept commissions and benefits, provided they rebate them back to the client, or apply the RDR restrictions and ban it. It suspects many DIM firms already apply RDR standards and wants to ensure regulatory consistency;
- adviser independence: FCA asked for views on how different the MIFID 2 standard is from its current standard. It looked at the overlap between its "retail investment products" (RIPs) to which the RDR rules apply and the set of products to which the MiFID independence standard will apply, and asked for views on how it should deal with any inconsistencies, for example by applying the highest standards to all products;
- applying remuneration requirements to non-MiFID firms: FCA considers its current rules that aim to ensure a firm's remuneration policies do not encourage individuals to act in a way that is not in the customer's interests. It also looks at approaches under various Directives. It thinks the best way forward is to introduce common and consistent provisions and in principle would favour applying MiFID 2 requirements to non-MiFID firms.
- inducement standards: FCA proposes to apply MiFID 2 inducement standards to both independent and restricted advice, as well as to DIM and to both retail and professional clients. In principle it would apply these standards also to insurance-based investments and pension products and seeks views on whether it should; and
- complex and non-complex products and application of the appropriateness test: FCA's understanding the Commission is taking a strict interpretation of the criteria for establishing whether a product is complex or non-complex, which will significantly reduce what is considered non-complex. It is aware of firms' concerns, and wants to work with firms to assess how to apply the necessary tests in different product contexts.
FCA plans further consultations for December 2015 and then the first quarter of 2016. There may be more, if MiFID 2 is delayed, but the key message for affected firms is that, if there is a delay, it is because there is a recognition of the time the changes will take to implement – so firms should not down tools but should continue to work towards MiFID 2 compliance.