In our 2021 Outlook, we identify 5 trends in UK financial services regulation likely to define 2021. They are by no means the only trends or matters on which the regulators will be engaged but they do represent some overarching themes:
1) Beyond Brexit – new opportunities?
At 11pm on 31 December 2020, EU law ceased to apply in the UK following the end of the Brexit transition period. As an automatic consequence of the UK’s departure from the single market, passporting rights to and from the UK ended. A Trade and Co-operation Agreement (TCA) came into effect but the provisions in the TCA relating to financial services (FS) are limited to high-level commitments, similar to those in other recent EU FTAs.
The UK had been concerned that any concessions by the EU on financial services in the TCA would have been contingent on the UK becoming a “rule-taker” which became a UK red-line.
Alongside the TCA, the UK and the EU agreed to establish structured regulatory co-operation on financial services including in relation to the process of adoption, suspension and withdrawal of equivalence decisions. The parties are committed to establishing an MoU by March 2021 supporting the framework for this co-operation. To date, the EU’s willingness to make equivalence determinations, in the few areas of FS where it is possible, has generally been limited. In connection with Brexit, the EU has made two time-limited equivalence decisions relating to central counterparties and central securities depositories but any further decisions are likely to be driven primarily by politics. The European Commission has stated that it is unlikely to consider equivalence assessments for MiFID financial services in the short to medium term. In contrast, the UK has made wide-ranging equivalence declarations in respect of EEA member states, allowing EU firms access to UK markets to the extent permitted in onshored EU legislation.
One area where a positive decision is likely is data transfer. A positive data adequacy decision is expected from the European Commission on the UK’s data protection standards. Currently, flows of data from the EU to the UK benefit from a 6 month grace period.
European Supervisory Authorities (the EBA, ESMA and EIOPA) and the European Central Bank have indicated that national regulators should guard against “letter-box” firms with insufficient substance delegating / outsourcing material operations to the UK. In particular, the UK asset management sector will be concerned that the model for delegation of investment management to the UK is not disrupted (although such moves would be met with resistance from other third countries and from within the EU, in particular from fund originators, Ireland and Luxembourg).
Opportunities from divergence
While the European Union (Withdrawal) Act 2018 effectively ‘onshored’ EU regulation so that, to all intents and purposes, it is identical to the regulatory regime prior to the end of the transition period, the UK now has scope to diverge from this regime. The appetite to do so will be driven by a number of factors, not least whether the UK anticipates reaching an agreement with the EU on equivalence which would allow UK firms a sufficient degree of predictability – currently equivalence decisions can be withdrawn by the European Commission with 30 days’ notice.
In the meantime, the Chancellor, Rishi Sunak, has spoken of a “Big Bang 2.0” for the City referring to the first “big bang” of 1986 which deregulated elements of the City. A number of initiatives are in train looking at how the UK FS sector can benefit from life outside the EU’s single market, including:
- UK Regulatory framework: The government is currently undertaking a review of the post Brexit regulatory framework (it intends to publish a white paper on FS at some point after March 2021); and the Treasury Select Committee opened an inquiry into the future of financial services in November 2020. Amongst the issues that will be considered is whether the UK should return to the regulatory principle, jettisoned after the 2008 financial crisis, that the regulators should have regard to the international competitiveness of the UK financial regime.
- Mutual recognition: The UK is seeking cooperation with other financial centres. Already the UK has begun negotiating an outcomes-based mutual recognition agreement with Switzerland and reversed a 2019 EU decision to prevent share trading in Swiss companies. It has been further proposed that the UK could enter into “passporting” arrangements with other financial services centres, such as Singapore, to allow for similar access as is possible within the EU single market. Meanwhile, HM Treasury has launched a call for evidence on the UK’s overseas regime including the operation of the overseas persons exclusion – the exclusion may become unavailable after a period to jurisdcitions granted equivalence by the UK.
- Listing regime: Lord Hill is reviewing the UK’s listing regime looking at: Free float requirements; Dual class share structures or other owner-control mechanisms; Track record requirements; Prospectuses requirements; and Dual and secondary listings. The review is expected to facilitate changes which will make London a more attractive location for listings by technology companies in particular. The call for evidence closed on 5 January 2021.
- Fintech review: A fintech review is being led by Ron Kalifa, former chief executive of Worldpay. The intention of this review is to establish priority areas for industry, policy makers, and regulators to explore as part of continuing to foster an environment for the ongoing success of UK fintech.
- Funds review: A review of the UK funds regime is underway covering direct and indirect tax, as well as relevant areas of regulation. It will consider whether any policy changes might be needed to make the UK a more attractive location for funds.
2) Building resilience in FS
Although the financial services industry coped remarkably well with Covid disruption, both financial and operational resilience remain a focus for regulators.
The FCA stated this month that 4000 of its (small and medium sized) firms have “low financial resilience and are at heightened risk of failure, though many will be able to bolster their resilience as and when economic conditions improve”.
Larger firms however appear more resilient. While credit losses are likely to affect banks’ loan books, they remain well capitalised not least because of regulatory restrictions on their ability to make distributions. In the asset management sector, some investment funds witnessed reductions to the valuations of commercial property interests and many continue to face margin pressure, not least because the regulatory drive towards greater transparency on fees. However, this will continue to drive consolidation rather than collapse.
The FCA, the PRA and the Bank of England want to strengthen the resilience of financial institutions and financial market infrastructures and protect the wider financial sector and UK economy from the impact of operational disruptions. To do this, they are in the process of developing a new policy framework for operational resilience. Following an initial joint discussion paper published in July 2018, they consulted in December 2019 on introducing new rules and guidance. The FCA and the PRA expect to publish their policy statements and final rules in early 2021. See more here.
In summary, their key proposals are that firms must:
- Identify their important business services.
- Set their impact tolerances and remain within them.
- Have in place strategies, process and systems to enable them to comply with their obligations.
- Carry out mapping exercises.
- Carry out scenario testing and lessons learned exercises.
- Undertake self-assessments.
- Have a communications strategy.
- Ensure that their boards and senior management approve and review their operational resilience documentation.
3) The rise and rise of Fintechs – continued technological disruption
Covid has hastened pre-existing trends in the digitalisation of financial services and the decline of cash. The ‘Open banking’ initiative continues to enable the development of nimble fintechs in various FS market niches while hot money remains available to prospects in the sector. Meanwhile, traditional banking continues to be challenged by legacy systems; low (negative) interest rates compressing margins; and fintech competition (e.g. in FX) and regulatory restriction (e.g. in overdraft fees) chipping away at sources of profit.
While technological disruption has hitherto been seen primarily in the field of payments, other FS sectors are potentially exposed. For example, the investment management sector comprising managers, custodians, administrators, brokers and other service providers is ultimately susceptible to disintermediation by a form of tokenisation (protected by a blockchain) leaving only truly active management in place. Further, with vastly more data available, insurance is also becomes susceptible to new levels of product customisation and price competition.
Upcoming 2021 regulatory developments in the Fintech space include:
- Payment systems: The Payment Services Regulator plans to launch a consultation on its long-term strategy following engagement with the industry in 2020 on three key themes: (i) innovation and future payment methods; (ii) competition; and (iii) choice and availability of payment methods. The development of the New Payments Architecture to provide a core clearing and settlement infrastructure for interbank payments (replacing, inter alia, BACS and Faster Payments) continues.
- Payments Approach Document: The FCA will undertake a consultation on the guidance it provides payments firms in its Approach Document. This will include proposing to incorporate in the Approach Document temporary guidance on safeguarding relevant funds and prudential risk management which was issued to payments firms in 2020. See more here.
- Strong customer authentication (SCA): SCA rules under PSD2 were delayed to allow the industry more implemetation time and will now apply from 14 September 2021.
- Payments Landscape Review: HM Treasury feedback is expected on the Payments Landscape Review. It sets out the Government’s aims for payments networks in the UK, assesses how well the present system is operating and considers the opportunities and risks that need to be addressed.
- Open finance: The FCA is expected to advance its plans for ‘Open finance’ which will build on the UK’s ‘Open banking’ framework enabling consumers to give access to their payment accounts and related data to third-party providers (Account Information Service and Payment Initiation Service providers) to access new services. Open finance would extend the model to a wider range of financial services including savings, insurance, mortgages, investments, pensions and consumer credit.
- Cryptoassets: On the 7th January 2021, HM Treasury published a consultation paper titled “UK regulatory approach to cryptoassets and stablecoins: consultation and call for evidence”. It seeks views on how the UK can ensure that its regulatory framework is facilitative of innovation and competition, while mitigating risks to consumers and stability. Meanwhile, the FCA’s prohibition of retail crypto-derivatives will apply from 6 January 2021.
4) Value – flirting with price controls?
Since introducing rules requiring authorised fund managers to assess value for money of funds from September 2019, the concept of value is one that the FCA is starting to apply in other sectors.
On 22 September 2020, the FCA published a consultation paper following its general insurance market study (CP20/19). The FCA intends to publish a policy statement in Q2 2021. In CP20/19, the FCA set out proposals including amending PROD to ensure that firms have processes in place to deliver products that offer ‘fair value’ to customers.
While the developing focus on value is short of more direct price regulation (seen in the regulation of high-cost credit), it does involve the FCA in regulating the commercial aspects of firms’ operations increasing the reach and burden of regulation.
5) Vulnerability – Duty of Care by the back door?
The FCA has introduced regulatory expectations around a very broad concept of vulnerability. These can be seen as both an extension of the FCA’s longstanding commitment to Treating Customers Fairly (TCF) and a partial response to those calling for a new ‘Duty of Care’ on firms dealing with retail customers. Regarding the latter, the FCA has stated that it remains committed to reviewing the regulatory framework, particularly the Principles for Businesses, with a view to strengthening and clarifying firms’ duties to consumers.
On 29 July 2020, the FCA published the second stage of a consultation on draft guidance on the fair treatment of vulnerable consumers (GC20/3). The FCA intends to finalise the guidance early in 2021. The guidance is relevant to all firms involved in the supply of products and services to retail customers who are natural persons, even if they do not have a direct client relationship with the customers.
Broadly, a vulnerable consumer is defined as someone who, due to their personal circumstances, is especially susceptible to harm. The particular challenge for firms is that in the FCA’s ‘Our Financial Lives 2020 survey’, it found that just under half (46%) of UK adults 24.1 million people), display one or more characteristics of vulnerability. Given the expectations on firms in identifying and accounting for vulnerability, this places a new set of onerous burdens on firms in the retail space. This guidance will also likely create expectations that inform the decisions of the Financial Ombudsman Service as to what it considers fair treatment.