In our 2022 Outlook, we identify 10 trends and developments in UK financial services regulation likely to define the regulatory year. We will further develop our analysis of these trends throughout the year.
1) The FCA: a more assertive regulator and a more awkward one?
The regulatory environment is informed not only by formal rules and guidance but also by the approach of the regulators. Nikhil Rathi became CEO of the FCA in October 2020, since when he has declared, amongst other things, that the FCA is becoming a “more assertive” and “tough” regulator.
Complaints of backlogs at the FCA and a less facilitative approach have become more common in recent months. At the same time, the FCA has also transferred to its management, powers to make decisions that previously rested with the independent Regulatory Decisions Committee.
Most practitioners would not object to robust regulation of nefarious activity. However, there are concerns that strong words are cover for a less responsive regulator, and, moreover, one that is less concerned about the health of the financial services industry, an essential motor of the UK economy after Brexit.
2) The shape of post-Brexit regulation
A year has passed since EU law ceased to apply in the UK following the end of the Brexit transition period. The UK and the EU had agreed to establish structured regulatory co-operation on financial services including in relation to the process of adoption, suspension and withdrawal of equivalence decisions. To this end, an MoU was expected to be signed in March 2021 supporting the framework for this co-operation. This has been delayed by the EU and there is no sign that the EU is willing to make “equivalence” determinations in the few areas of FS where it is possible – beyond GDPR data transfers and the two time-limited equivalence decisions relating to central counterparties and central securities depositories.
Issues related to UK access to EU financial services markets are driven by politics with the European Commission, the European Central Bank and the European Supervisory Authorities (the EBA, ESMA and EIOPA) continuing to apply pressure to UK-based firms operating in the EU to increase the substance of their EU offices and subsidiaries. As things stand, any, even minimal, restoration of the market access rights that the UK lost because of Brexit is years away.
The Brexit dividend?
In the absence of movement from the EU on equivalence, an opportunity presents for the UK to competitively distinguish its regulatory environment. While the EU (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.
While in 2020, the Chancellor, Rishi Sunak, spoke of a “Big Bang 2.0” for the City referring to the first “big bang” of 1986 which deregulated elements of the City, progress has been slow with some regulatory initiatives very likely to add to, rather than reduce, the regulatory burden. Addressing first the positive signs of new initiatives which have been completed, or which are in train, many of which seek to lighten the regulatory load:
UK Regulatory framework: HM Treasury has been consulting in 2021 on the appropriate post-Brexit regulatory architecture and how regulatory policy should be made. Given that the PRA and FCA will be given primary responsibility for (changing / diverging from) ‘onshored’ EU regulation, a key focus of the consultations has been how the regulators should be properly accountable.
A potentially significant development would be the introduction of a Designated Activities Regime which would allow the regulators to make rules for firms outside the regulatory perimeter which carry on particular business designated by HM Treasury – similar to the EU’s short-selling regime.
In a more promising development, the UK would 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 (although the FCA was apparently opposed).
Mutual recognition: The UK is seeking cooperation with other financial centres. The UK has begun negotiating an outcomes-based mutual recognition agreement with Switzerland which, would ideally, represent a model for certain other jurisdictions.
Meanwhile, HM Treasury has yet to report following its call for evidence on the UK’s overseas regime including the operation of the overseas persons exclusion which gives relatively liberal access to some UK markets – the exclusion may become unavailable after a period to jurisdictions granted equivalence by the UK.
- The Listing regime: Following the UK Listing Review, chaired by Lord Hill, and the Kalifa Review of UK FinTech, the FCA introduced new rules that came into force on 3 December 2021. According to the UK Listing Review, the number of listed companies in the UK had fallen by about 40% from a peak in 2008, and between 2015 and 2020, the UK accounted for only 5% of IPOs globally. The new rules are designed to make London a more attractive location for listings by technology companies in particular. The changes included:
- Allowing a targeted form of dual class share structures within the premium listing segment to encourage founder-led companies onto public markets sooner; and
- Reducing the amount of shares an issuer is required to have in public hands (i.e. free float) from 25% to 10%.
The FCA had also earlier adopted another recommendation to relax the Listing Rules in relation to SPACs by removing, once certain conditions are met, the pre-existing presumption in the Listing Rules that the listing of a SPAC would be suspended when it announces a potential acquisition.
- The UK’s wholesale capital markets regime: HM Treasury’s consultation on reforms intended to improve the post-Brexit regulation of capital markets closed in September 2021. The extensive package of reforms seeks to create a simpler and less prescriptive regime including by:
- Clarifying the regulatory perimeter and conditions governing trading venues and systematic internalisers;
- Removing requirements that limit firms’ ability to execute transactions, for example by removing the share trading obligation and double volume cap;
- Recalibrating the transparency regime for fixed income and derivatives markets;
- Reviewing the commodities regime to ensure that market activity is not unnecessarily restricted; and
- Amending the market data regime to enable participants to identify the best available prices.
- Funds review: HM Treasury is still undertaking its review of the UK funds regime covering tax as well as regulatory considerations. It will consider whether any policy changes might be needed to make the UK a more attractive location for the establishment, administration and management of funds.
- Solvency II: HM Treasury and the PRA have been consulting throughout 2021 ahead of a comprehensive package of Solvency II reforms for consultation in early 2022. It is expected that the major changes will be to the risk margin and the matching adjustment with the potential to free up significant capital for insurers.
Politically driven regulation
At the same time as talking-up deregulation of the City, new regulation continues to be introduced, much of it more politically driven rather than responding to regulatory or market need:
- Sustainability disclosures: On 22 June 2021, the FCA published two consultation papers, CP21/18 on extending climate-related disclosure requirements to standard listed companies and CP21/17 on enhancing climate-related disclosures by asset managers, UK life insurers and FCA-regulated pension providers – introducing Taskforce on Climate-related Financial Disclosures (TCFD)-aligned disclosure requirements for asset managers, life insurers and FCA-regulated pension providers. The proposals follow the introduction of climate-related disclosure requirements for premium listed companies in December 2020 which are aligned with the recommendations of the TCFD. Both consultations closed on 10 September 2021 with rules expected this year. The rules will add to the regulatory burden for in-scope firms, particularly if there are inconsistencies with the EU SFDR – or even gold-plating in the case of product labelling.
- Diversity & Inclusion: On 7 July 2021, the FCA (jointly with the BoE and PRA) published a Discussion Paper on diversity and inclusion which it described as “critical to [its] work on culture and governance, particularly for boards and senior management”. The paper pointed to “evidence of correlations” in research between diversity and inclusion and positive outcomes in risk management, good conduct, healthy working cultures, and innovation; and posited that diversity of certain characteristics would also result in “diversity of thought” combatting “group-think”. The link between the possible measures discussed in the paper and the regulators’ statutory objectives is tenuous. If the proposals have merit, then they are surely a matter for primary legislation rather than financial services regulation.
3) Crypto regulation: caution versus opportunity
There has been something of a hiatus in the regulatory development around Cryptoassets as the Government and the FCA balance considerations of consumer detriment with a desire to facilitate innovation – or, at least, not become out of step with international regulation. In its July 2021 document: “A new chapter for financial services”, the Treasury stated that it wanted to “Harness the benefits of new technologies like cryptoassets and stablecoins” while at the same time, the FCA has been warning of the dangers of buying cryptoassets.
The current UK position is that cryptoassets which amount to security tokens or e-money tokens, and derivatives which reference cryptoassets, are regulated financial instruments. The UK Money Laundering Regulations 2017 (MLRs) also now apply a registration requirement to UK-based “cryptoasset exchange providers” and “custodian wallet providers”. However, the application of the MLRs, and financial services regulation more generally, to non-fungible tokens (NFTs), decentralized exchanges, peer-to-peer platforms and decentralised autonomus organisations is not clearcut – requiring legal advice analysing the particular facts.
HM Treasury is still considering feedback on two consultations in the crypto sphere: a proposal to bring a wider range of unregulated cryptoassets (e.g. exchange tokens) into scope of the financial promotion regime (a July 2020 consultation); and a consultation and call for evidence on the regulatory approach to cryptoassets and stablecoins with the potential to bring certain types of stablecoin within the regulatory perimeter (a January 2021 consultation).
The Bank of England and Treasury are to consult in 2022 on launching a Central Bank Digital Currency. The high-level consultation would inform a decision on whether the UK moves to development of a CBDC.
4) Payments regulation: regulatory focus continues
The ‘Open banking’ initiative continues to enable the development of nimbler fintechs in various FS market niches while hot money remains available to prospects in the sector. However, the regulatory climate for payments firms has become much more onerous in recent times:
- Payments Approach Document: In 2021, the FCA tightened its guidance for payments firms in its Payments Approach Document incorporating temporary guidance on safeguarding relevant funds and prudential risk management.
- Operational resilience: Payment institutions and E-money institutions (including smaller firms) are preparing to apply operational resilience requirements from March 2022 which otherwise only apply mainly to banks, insurers and enhanced scope SMCR firms.
- SMCR: The FCA has proposed to work with HM Treasury on extending the Senior Managers & Certification Regime (SMCR) to payments firms in its latest perimeter report.
- Payment systems: HM Treasury is to consult on bringing systemically important firms in payments chains under the supervision of the Bank of England.
- Strong customer authentication (SCA): Strong customer authentication rules will apply to e-commerce transactions from March 2022 following several delays.
5) Revisiting the Appointed Representative Regime
The Appointed Representative (AR) Regime allows an unauthorised firm to carry on regulated activity under the responsibility of an authorised firm (the principal). The AR regime has expanded since its inception in 1986 as a way for insurers and other product providers to distribute products. There are around 40,000 ARs operating under around 3,600 principals. Models include networks (where a principal has a group of ARs that share a common commercial objective in the same market, such as IFAs or mortgage intermediaries) and regulatory hosting arrangements (where, broadly, rather than carrying on any regulated activities itself, the principal oversees the use of its permissions by ARs).
The AR regime provides a range of benefits including: cost effective, speedy and flexible entry to the FS markets rather than following an increasingly costly and time-consuming FCA authorisation process; and thereby supporting competition and innovation. However, the FCA has found evidence of harm, most often arising because principals do not undertake adequate due diligence before appointing an AR, and from poor ongoing control and oversight. In consequence, in December 2021, it published CP21/34 which closes on 3 March, with the intention of publishing final rules in the first half of 2022. In summary, the FCA’s key proposals are:
- that principals should provide the FCA with more information on their ARs and the business these ARs conduct at least 60 days before an AR appointment takes effect;
- additional prescriptive guidance in SUP 12 requiring the principal to have adequate controls and resources to oversee the AR, and on the circumstances in which it may be necessary to terminate an AR relationship;
- requirements that principals, at least annually, review senior management at ARs and aspects of ARs’ business and activities; and
- requirements that principals complete an annual self-assessment of compliance with relevant rules and guidance for ARs.
Although the FCA describes most of the changes as an elaboration of existing requirements, some of these measures will add significantly to the burden of principals and have the potential to make the AR Regime less flexible and useful. Further, the requirements may require principals to review existing AR agreements – there is currently no mention of transitional arrangements.
At the same time as the publication of CP21/34, HM Treasury published a Call for Evidence following the Treasury Select Committee’s “Lessons from Greensill Capital report” which found that the AR regime may be being used for purposes which are beyond those for which it was originally designed (although it was noted that ARs were not a factor in the failure of Greensill Capital). The Call for Evidence is more positive in tone than the FCA’s consultation but floats possible changes to the AR Regime which would restrict its scope; apply regulatory requirements (e.g. SMCR) directly to ARs; or introduce some form of authorisation gateway for ARs.
6) Operational resilience requirements go live
Although the financial services industry coped remarkably well with Covid disruption, operational resilience remains a focus for regulators. By 31 March 2022, relevant in-scope firms, which, as well as banks, insurers and enhanced scope SMCR firms, includes payments firms, must have identified their important business services, set impact tolerances for the maximum tolerable disruption, and carried out mapping and testing. Firms must also have identified any vulnerabilities in their operational resilience.
7) Time to draft ICARAs: IFPR implementation
For investment firms, January 2022 brings the implementation of the Investment Firms Prudential Regime (IFPR). While the immediate need is to ensure that sufficient capital and liquid resources are in place to meet the increased requirements; and apply for any available transitional relief, firms will now be turning to their ICAAPs which will need to be transformed into ICARAs to meet the reporting date self-selected by the firm late last year.
Firms will also need to ensure that they update risk mitigation systems and controls, and implement new IFPR Remuneration Code requirements.
8) Financial Promotions Regime: narrower exemptions and wider coverage
In December 2021, HM Treasury published a consultation, that will run to 9 March 2022, proposing changes to exemptions from the Financial Promotions Restriction found in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (FPO) which enable unauthorised individuals or businesses to communicate financial promotions without requiring the approval of an authorised firm. The particular exemptions are those for:
- Certified high net worth individuals (Article 48 of the FPO)
- Sophisticated investors (Article 50)
- Self-certified sophisticated investors (Article 50A)
The consultation outlines 5 proposals for how the exemptions could be updated:
- Increasing the financial thresholds for high net worth individuals;
- Amending the criteria for self-certified sophisticated investors;
- Placing a greater degree of responsibility on firms to ensure individuals meet the criteria to be deemed high net worth or sophisticated;
- Updating the high net worth individual and self-certified sophisticated investor statements; or
- Updating the name of the high net worth individual exemption.
In April 2021, the FCA published a discussion paper, ‘Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions’. The discussion paper examined several possible changes to the FCA’s financial promotion rules including the classification of high-risk investments; the segmentation of the high-risk investment market and the role of authorised persons who approve financial promotions. The FCA intend to publish a consultation paper with specific proposals early in 2022.
As mentioned, HM Treasury will report this year on its proposal to bring a wider range of unregulated cryptoassets (e.g. exchange tokens) into scope of the financial promotion regime.
Although unlikely to apply until 2023, HM Treasury and the FCA will progress proposals to implement some form of permission gateway for authorised firms that wish to approve third party financial promotions.
At the time of writing, the Online Harms Bill is likely to include a responsibility on social media platforms to verify that financial services adverts are not scams.
9) FCA pushes forward with a Consumer Duty of Care
After a long gestation period the FCA appears to be proceeding with the introduction of a consumer duty of care for firms. The FCA published its second consultation on 7 December 2021 and expects any new rules to be made by 31 July 2022 with implementation sometime after that. The FCA states that the consumer duty as a whole is designed to establish a higher standard of conduct for firms in relation to their retail market activities.
It represents a ramping up of the FCA’s (and before it, the FSA’s) longstanding commitment to Treating Customers Fairly (TCF). The better view is that the FCA already has sufficient rules and powers to address most of the mischiefs that the duty seeks to address. The duty would comprise a new Consumer Principle supported by cross-cutting FCA rules and 4 new outcomes defining FCA expectations (the Four Outcomes).
It is reassuring that the FCA is not, at this stage, making any specific proposals on a private right of action (to allow aggrieved consumers to take court action), while it solicits further views. Such a right would, subject to the level of generality of the concepts adopted as part of the Consumer Duty, give rise to significant legal uncertainty. It would also result in significant additional costs to firms in managing litigation, much of it driven by claims management companies, as well as their current Financial Ombudsman Service (FOS) workload.
The Consumer Principle
The FCA is seeking views on 2 options for the wording of the Consumer Principle:
Option 1: ‘A firm must act to deliver good outcomes for retail clients’
Option 2: ‘A firm must act in the best interests of retail clients’
The industry preference is for Option 2 (so long as it is clearly acknowledged that it does not give rise to a fiduciary duty), as the wording of Option 1 would result in unreasonable expectations and significant uncertainty requiring as it does the delivery of “good outcomes”.
Cross-cutting rules would require firms to:
- act in good faith;
- take all reasonable steps to avoid foreseeable harm to consumers; and
- take all reasonable steps to enable consumers to pursue their financial objectives.
There are concerns regarding the possible wording of these rules as, for instance, requiring a firm to “take all reasonable steps to enable customers to pursue their financial objectives” does not establish clear expectations for firms, not least, as many firms would not know a customer’s financial objectives unless they undertake advised sales or portfolio management. It would otherwise be particularly onerous to expect firms to identify and enable customers to pursue “their financial objectives”.
The Four Outcomes
The Four Outcomes would cover how firms design, sell and service products and services. The first 3 – Communications; Products and Services; and Customer Service – relate to what is provided by firms to consumers. The last outcome, Price and Value, relates to payments consumers make to firms.
Communications: The FCA proposes to introduce rules that require firms to communicate in a way that, in addition to being fair, clear and not misleading, is understandable and facilitates informed consumer decisions, especially around costs, risks and benefits.
Products and Services: Building on FCA product governance rules, the FCA will introduce rules to further require that products and services are specifically designed to meet the needs of consumers, and sold to those whose needs they meet.
Customer Service: The FCA considers that consumers should be able to realise the benefits of products and services without undue hindrance especially around post-sale service and exit from a product or service.
Price and Value: The FCA expects that products and services should represent fair value for consumers. The FCA considers that “markets do not always function well and that can result in consumers receiving poor value“. The FCA will require that firms should be able to demonstrate that the benefits of their products and services are reasonable relative to their price. Although the FCA states that it is “not proposing to set the levels at which firms should price their products or services….In future we may need to use our regulatory tools to make such interventions where markets are failing to deliver fair value“.
Concerning trends in retail FS
The trend towards price regulation in financial services is concerning. It is worth noting that there are many markets that may not be regarded as functioning according to ideal criteria without being subject to the threat of price regulation; and that price regulation very often does more damage than the mischief that it is supposed to cure – the results may be perverse. For instance, the new FCA insurance pricing rules which came into effect this month, which provide that renewing home and motor insurance consumers are quoted prices that are no more than they would be quoted as a new customer through the same channel, are already resulting in significant off-setting price rises.
The Consumer Duty is being introduced against the backdrop of the FCA’s recent “clarification” of its expectations around the fair treatment of vulnerable consumers in its finalised guidance published in February 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. A real 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.
Clearly, those firms operating in the retail space face increasingly onerous and expensive burdens – costs which ultimately must be passed on to customers.
10) Anti-Money Laundering: cost of non-compliance increases
2021 witnessed an upswing in AML enforcement action, the most notable being the high-profile criminal prosecution of NatWest. While, as previously discussed, the NatWest case may not set a precedent for further criminal prosecutions, there is evidence of increasing rigour in the FCA’s policing of poor AML systems and controls – 2021 established a trend for greater use by the FCA of its supervisory powers to address AML risk using its own-initiative powers to shut down wealth manager Dolfin for financial crime controls issues and Binance’s UK entity for poor regulatory engagement related to AML controls.
HM Treasury’s wide-ranging review of the UK AML/Counter-terrorist regime is due to report in June 2022 and is likely to give rise to a number of changes to the AML/CTF regime.