On 9 December 2022, Jeremy Hunt, the Chancellor of the Exchequer, announced a programme of reform designed to drive growth and competitiveness in the financial services sector: Financial Services: The Edinburgh Reforms – GOV.UK (www.gov.uk).
In this blog, we answer 4 key questions regarding the programme.
What happened to Big Bang 2.0?
In early 2021, Rishi Sunak, as Chancellor, heralded a “Big Bang 2.0” drawing parallels with the “Big Bang” liberalisation of UK financial markets in 1986. This Big Bang instigated by then PM Margaret Thatcher, amongst other things, had the effect of allowing banks and brokers to merge to become dual capacity businesses (that could act as either agents or principals). This liberalisation prompted significant foreign investment in the City where many British institutions were bought out.
Jeremy Hunt has pulled back from describing this package of reform as a “Big Bang”. The more modest labelling of the programme may be a recognition that many of the reforms are unlikely to impact competitiveness. If the relabelling does suggest a scaling back of the government’s estimation of their likely impact, it continues to describe the aim as having the UK be the world’s “most innovative and competitive global financial centre” balancing “dynamic, proportionate regulation”, “appropriate consumer protection” and “a sector that embraces the latest technology”.
What is proposed by the government?
The reforms represent 31 measures or projects, some already underway or long trailed, such as implementing changes arising from the Wholesale Market Review; and others that will take years of work and aren’t designed to increase competitiveness, such as reform of the Consumer Credit Act 1974 (CCA).
Although not forming part of the 31 measures, the government has now published various final consultations on plans to reform Solvency II, unlocking more than £100bn pounds for UK insurers to invest in long-term productive assets. It has also previously announced a relaxation of bankers’ bonus caps and a reduction from 1 April 2023 of the banking surcharge rate (from 8 to 3 percent).
The Financial Services and Markets Bill 2022-23 (the FSM Bill) already proposes a new blueprint for financial services regulation, revising the existing model under the Financial Services and Markets Act 2000 (FSMA) and providing the framework for the revocation of retained EU law.
We summarise the Edinburgh Reform proposals below under the broad headings attributed by HM Treasury:
- Ring-Fencing Regime: Reforming the Ring-Fencing Regime for ring-fenced banks (RFBs). The government agrees with the independent review on ring-fencing that the benefits of the ring-fencing regime would likely reduce over time as the resolution regime is embedded offering a more comprehensive solution to addressing the problems of ‘too big to fail’. In consequence, the Treasury will issue a call for evidence as to the practicalities of aligning the ring-fencing and resolution regimes, with a view to introducing a new power for the authorities to remove banks from the ring-fencing regime that are judged to be resolvable. Apart from this potentially bold move, in summary, the proposed reforms to the regime are tweaks to (1) narrow the scope of the rules by increasing the deposit threshold from £25 billion retail deposits to £35 billion and taking banking groups without major investment banking operations out of the regime; and (2) modify the restrictions that apply to RFBs by allowing them to provide services to some smaller “Relevant Financial Institutions” e.g. IFAs; removing blanket geographical restrictions on RFBs operating subsidiaries or servicing clients outside the EEA; and potentially updating the list of activities which RFBs are restricted from carrying out e.g., allowing RFBs to provide inflation swaps to facilitate more project finance, including infrastructure and greater flexibility to restructure loans through the debt for equity swap exemption.
- Regulators’ growth and international competitiveness objective: Issuing new remit letters for the PRA and FCA with clear, targeted recommendations for how the regulators should have regard to the government’s economic policy on growth and international competitiveness building on the new secondary statutory objective for the regulators.
- Prospectuses: Overhauling the UK’s regulation of prospectuses representing further work from Lord Hill’s UK Listing Review.
- Packaged Retail and Insurance-based Investment Products (PRIIPs): Repealing the PRIIPS Regulation, and consulting on an alternative framework for retail disclosure in the UK. This move had been trailed and will hopefully result in a wider and more “joined-up” approach to retail disclosures.
- UK Long-Term Asset Fund (LTAF): Intending to repeal EU legislation on the European Long-Term Investment Fund (ELTIF), reflecting that the new LTAF provides a better fund structure for the UK market. The LTAF regime would be yet more attractive if, as is proposed by the FCA in CP22/14, access to retail investors is broadened.
- Short selling: Launching a Call for Evidence on reforming the Short Selling Regulation recognising that short selling can play an important role in the efficient functioning of financial markets and potentially diverging from the EU’s stricter short selling rules.
- Payments regulatory powers: Publishing a draft Statutory Instrument to give the FCA rulemaking powers over its retained EU payments legislation. An administrative change which won’t, in itself, impact competitiveness.
- Payment Accounts Regulations: Consulting on removing customer information requirements related to bank accounts set out in the Payment Accounts Regulations 2015.
- Bank capital rules: Welcoming the PRA consultation on removing rules for the capital deduction of certain non-performing exposures (NPEs) held by banks. This would allow the PRA to apply a judgement-led approach to address the adequacy of firms’ provisioning for NPEs.
- Wholesale Markets Review (WMR): Bringing forward secondary legislation to implement WMR reforms, in particular, to the Markets in Financial Instruments Directive (MiFID) framework. The WMR makes substantial amendments to various parts of the MiFID framework, many of which are implemented in the FSM Bill. The government plans to remove both EU requirements related to reporting rules and certain regulatory requirements for firms trading commodities derivatives as an ancillary activity.
- Senior Managers & Certification Regime (SMCR): Commencing a review on the SMCR in Q1 2023 to solicit views on the regime’s effectiveness, scope and proportionality, and to seek views on potential improvements and reforms.
- Trade settlement times: Establishing an Accelerated Settlement Taskforce with a view to reducing settlement times from the current industry standard of two days.
- Investment Research Review: Committing to establish an independent Investment Research Review and its contribution to UK capital markets competitiveness.
- Consolidated tape: Committing to having a regime for a UK consolidated tape for market data in place by 2024.
- REITs: With effect from April 2023, new rules will remove the requirement for a REIT to own at least three properties, where they hold a single commercial property worth at least £20 million; and amend the rule that applies to properties disposed of within three years of significant development activity, to ensure that this rule operates in line with its original intention.
- Building Societies: Announcing changes to the Building Societies Act 1986 to give building societies greater flexibility to raise wholesale funds and compete on a more level playing field with retail banks, while retaining their mutual model.
- Local Government Pension Scheme: Consulting, in early 2023 on issuing new guidance on Local Government Pension Scheme asset pooling and considering investment opportunities in illiquid assets such as venture and growth capital.
- Defined Contribution pension schemes: Increasing the pace of consolidation in Defined Contribution pension schemes setting required metrics and standards in key areas such as investment performance, cost and charges and quality of service that all schemes must meet.
- Secondary Capital Raising Review: Delivering the outcomes of the Secondary Capital Raising Review and more broadly on reforms to corporate governance, to further enhance the attractiveness of UK public markets.
- VAT treatment of fund management: Consulting on reform to the VAT treatment of fund management intended to codify existing policy to give legal clarity and certainty (not to make policy changes).
- Reforming the Securitisation Regulation.
The government states that it sees the financial system playing a major role in the delivery of the UK’s net-zero target and is “acting to secure the UK as the best place in the world for responsible and sustainable investment”. To this end, the government will in early 2023:
- publish an updated Green Finance Strategy; and
- consult on bringing ESG ratings providers within the regulatory perimeter.
Technology and innovation
To further its drive towards innovation, the government proposes to:
- set up a Financial Market Infrastructure Sandbox in 2023 enabling firms to test and adopt new technology and innovations, such as distributed ledger technology, in providing the infrastructure services that underpin markets;
- work with the regulators and market participants to bring forward a new class of wholesale market venue, which would operate on an intermittent trading basis and act as a bridge between public and private markets, boosting the UK as a destination for companies to raise finance;
- establish a safe regulatory environment for stablecoins – which may be used for payments – and ensure the government has the necessary powers to bring a broader range of investment-related cryptoasset activities into UK regulation.
- Publish its formal response to the consultation on expanding the Investment Manager Exemption to include cryptoassets, which will facilitate their inclusion in the portfolios of overseas funds managed in the UK. The government intends for this change to be made through HMRC regulations this year; and
- publish a consultation in the coming weeks to explore the case for a central bank digital currency (CBDC) – a sovereign digital pound – and consult on a potential design. The Bank of England will also release a Technology Working Paper setting out technology considerations informing the potential build of a digital pound. While a CBDC could potentially give the UK a first mover advantage, programmable digital money presents many civil liberties challenges.
In the sphere of consumer regulation, the government:
- has published a consultation, Reforming the Consumer Credit Act 1974, with the intention of updating and rationalising the CCA creating a simpler, more focused regulatory regime for consumer credit;
- has consulted on reforms to remove well-designed performance fees from the pensions regulatory charge cap and will lay regulations in Q1; and
- will work with the FCA to examine the boundary between regulated financial advice and financial guidance, with the objective of improving access to helpful support, information and advice, while maintaining strong protections for consumers.
Do the reforms represent a deregulatory agenda?
Some have claimed that this package of reforms represents a “race to the bottom”. In fact, many of the reforms are not deregulatory at all and some may result in more regulation, for instance, regulation related to ESG.
In fact, those measures that may lighten the regulatory burden around ring-fencing, PRIIPS, WMR and prospectuses are likely to be modest in their effect.
Will the reforms be effective in “moving the dial” for the competitiveness of the City?
It is certainly welcome to have the government recognise that regulation can be an unnecessary drag on business and the UK’s competitiveness. However, there are a number of reasons why these measures are likely to be insufficient to “move the dial”:
- Much EU regulation is our regulation: while this package of reform will represent the first major divergence from EU rules, there is likely a limit to how far the City would choose to diverge given both that the UK was originally the prime mover behind much EU regulation of financial services and, generally, harmonised rules are easier for international firms to manage. Even those EU directives which the UK originally opposed, such as the AIFMD, are now entrenched and have their sponsors.
- Regulators continue to produce regulation: the FCA / HM Treasury continues to introduce new regulation and gold-plate international standards. For example, the Consumer Duty was arguably an otiose piece of politically driven regulation; the FCA continues to push a definition of “vulnerability” that potentially applies to the majority of the population; the Payment Systems Regulator’s response to Authorised Push Payment fraud risks serious moral hazard and the end of “free” banking; ESG is a fecund area of regulation; and D&I regulation which is in the FCA’s pipeline promises to add further employment regulation to the list. Further, the gold-plating of the definition of crypto-asset from the Fifth Money Laundering Directive set up the UK to be one of the less welcoming jurisdictions for crypto development (although, in the light of FTX, some may regard that as a blessing).
- Too modest: arguably, the measures are too modest. If the government was serious about the regulatory burden, it would consider a rule that for every new regulation, two should be up for elimination.
- Tax and other regulation: the City’s competitiveness is, of course, not only a function of regulation but, those factors that the government can influence, for instance, tax, employment regulation and trade access to new markets, are all trending in the wrong direction.
- A question of practical regulatory approach: often it is not the black letter rule but rather the FCA’s approach that is problematic. For example, in the context of SMCR, it is the practical approach to SMCR and the FCA’s expectations (particularly when looking retrospectively) as to the omniscience of senior management that is often the issue, or the FCA’s increasing focus on behaviour in individual’s private lives, rather than the SMCR itself which was broadly a rebranding of the Approved Persons Regime (with some increased documentary requirements). Another example is the FCA’s approach to new authorisation applications which has become erratic and unhelpful.a