Now that it is no longer part of the EU, the U.K. is engaged in a fundamental review of how financial regulation policy and rules should be made, reviewed and established in law. Traditionally, the U.K. included much of this body of law in regulatory rulebooks. However, those provisions were largely superseded by European Directives and Regulations, and those Directives and Regulations have become the purview of Parliament, amendable only by statutory instrument under the European Union (Withdrawal) Act 2018. It has widely been commented that the U.K. Parliament is probably an insufficiently expert or nimble body to keep these provisions fresh and under review in the long term.
Careful thought must therefore be given to how to achieve the government’s strategy of fortifying the U.K.’s position as a global financial centre, with best practice financial regulations and an open and agile market which provides an attractive and dynamic base from which to operate a global financial services business. With Brexit, the opportunity arises for the U.K. to embark on a programme of ‘better regulation’, applying its traditional legal method of high standards but fewer rules. It can remove unnecessary red tape and enhance legal and regulatory predictability so as to allow innovation to flourish. In our view, such reforms would be welcome and necessary. The task is enormous, but a framework has already started to develop. We set out here the core elements of the U.K.’s Financial Services Regulatory Framework Review and related proposals, with links, and directions to further detail and commentary. Related client notes are also available, as are details of related events and webinars.
The objective of the Future Regulatory Framework Review is to ensure that the U.K. financial services regulatory framework is fit for the future, particularly in light of four key challenges: (i) operating outside the EU after Brexit; (ii) new trading relationships; (iii) technological change; and (iv) wider global challenges, such as climate change.
At the heart of the FRF Review is the financial regulatory architecture. The return of the U.K.'s sovereignty means that the U.K. must establish a new way of formulating financial regulatory policy and implementing regulatory rules. Key features being considered include a clear division of responsibilities between Parliament and the financial regulators, enhanced transparency and accountability requirements for the FCA and PRA, and the inclusion of policy framework legislation for key regulated areas of activity that would set out the intended purpose of, and approach to, regulation.
In Restoring U.K. Law – Freeing the U.K.’s Global Financial Market, our partner Barney Reynolds advocated for reforms to the U.K. financial regulatory regime to be based on the common law method. This can be done by removing unnecessarily prescriptive rules and reformulating those which remain, along predictable, common law lines; increasing the use of case law precedent; renouncing the EU's purposive interpretation method; and applying the common law’s lessons to regulation, through enhanced Parliamentary scrutiny of regulators and greater judicial review of regulator actions. These recommendations have been reiterated in the report by the government's Taskforce on Innovation, Growth and Regulatory Reform, which went further by recommending the same approach is adopted for all regulated sectors, not only the financial services sector.
The Financial Services Act 2021 contains some of the measures linked to financial regulatory reform as well as changes to certain financial services legislation, including the U.K. Benchmark Regulation (providing for LIBOR transition powers), the U.K. Markets in Financial Instruments Regulation (focusing on the third-country regime and overlaps between equivalence and the Overseas Persons Exclusion) and the U.K. Market Abuse Regulation.
The recommendations made in the Kalifa Review of Fintech, the independent report on the U.K. Fintech sector led by Ron Kalifa, create a path for the U.K. to retain its global leadership in FinTech. Introducing a new regulatory regime for FinTech, starting a Scalebox for firms looking to scale innovative technology, making FinTech a fundamental part of the U.K.’s trade policy, launching an international Fintech Credential Portfolio to improve ease of doing business and setting up an international FinTech portal are just some of these much-welcomed proposals. For FinTechs and others operating in this space, there is the opportunity to steer the government towards implementing key recommendations that will attract investment for individual FinTechs, bolster the U.K.’s international competitiveness and raise the U.K.’s status as a global hub.
Next steps: Delivery of these recommendations will be led by the Centre for Finance, Innovation and Technology, which will be mandated by the Government but led by the private sector.
Related developments: Directly relevant is the Payments Landscape Review and HM Treasury’s proposal to regulate certain stablecoins, which would be a type of token which stabilizes its value by referencing one or more assets and that could be used as a means of exchange of value (i.e., as a means of payment). Some of the Kalifa recommendations touch on the U.K. listing regime, which is given fuller attention in the Lord Hill U.K. Listings Review. Consideration of the U.K.’s approach to international FinTech business should also feed into the discussion on the U.K.’s regime for overseas financial institutions to access the U.K. markets.
The main proposal is to bring stablecoins (tokens which stabilise their value by referencing one or more assets) into the U.K. regulatory perimeter by introducing a new category of financial instrument for regulated tokens, ‘stable tokens’. The approach would maintain the FCA’s approach to classifying tokens, as set out in its 2019 Guidance on crypto-assets. It is not intended (yet) that unregulated tokens or cryptocurrencies, such as Bitcoin, would become subject to the same proposed conduct and prudential regulation.
Next steps: The government will set out its response and detail how the proposals will be implemented in law. The U.K. regulators will produce more detailed rules, and consultations are expected later this year. The government will continue to monitor whether cryptocurrencies or other tokens or market participants should be brought within the regulatory perimeter in due course.
HM Treasury is also expected to confirm whether certain unregulated crypto-assets will be brought within the financial promotions regime. It is proposed that only crypto-assets that are both fungible and transferable would be within scope. If this goes ahead, an FCA consultation on the detailed rules could be expected later this year too.
Related developments: The most significant and recent development is the publication of the Kalifa Review (see above). It should also be noted that since 6 January 2021, the FCA has banned the marketing, distributing or selling of crypto derivatives in, or from, the U.K. to retail clients. The FCA began supervising crypto-asset business for AML purposes at the start of 2020.
A major overhaul of the U.K.’s listing regime has been recommended by Lord Hill in the U.K. Listings Review. A number of very significant reforms are proposed, several with a view to attracting more companies, particularly innovative technology and life sciences companies, to raise capital in London. The Review makes 14 specific recommendations to address the challenges to London’s position as a global capital markets hub coming from the increasingly competitive global capital market centres in Europe and Asia as well as the United States.
The Hill recommendations include changes to the FCA’s premium and standard segment listing rules and more general changes in relation to prospectuses. In addition, the Review identifies longer-term areas for reform, such as secondary capital raises and the greater empowerment of retail investors.
Next steps: HM Treasury and the FCA will be consulting on the legislative and regulatory changes that will be required to implement several of the reforms. The FCA's proposal to remove the presumption that it will suspend the listing of a SPAC when it identifies a potential acquisition target, provided the SPAC meets certain investor protection criteria, is broadly in line with the U.S. rules. The FCA’s consultation on amendments to the listing rules is expected in the summer, with amended rules in place by the end of the year.
Related developments: There is a degree of overlap between the Hill recommendations and those in the Kalifa Review.
The U.K. has long since operated an open financial market for wholesale business and equal rules for all customers, wherever they are located, making it particularly attractive for international business. The government is clear that it intends to continue to promote these concepts, and perhaps even improve on the current situation. There are a range of tools that HM Treasury could deploy to this end, such as incorporating into free trade agreements deference mechanisms (cf. the Japan-U.K. agreement) or mutual recognition provisions (cf. the Swiss-U.K. agreement) and the new equivalence regime. Traditionally, access to the U.K. markets has largely been based upon the Overseas Persons Exclusion (OPE). The OPE generally allows for cross-border wholesale business to and from the U.K., without parties outside the U.K. requiring a local licence. This provision has been instrumental to the success of the City of London; the OPE stands in stark contrast to the ‘regulatory perimeter’ of less successful closed financial markets, such as those in most of the EU, many of whom will only allow financial business to take place on a cross-border basis with even their largest institutions if the foreign counterparty is locally licensed (subject to very limited exceptions). In our view, it is critical that the OPE be retained and that this not be qualified by other processes, such as free trade agreements or equivalence structures.
Another strand to this is the approach of the U.K. regulators to supervising and regulating international firms. The U.K. is one of a few jurisdictions where the excellence and strength of the regulators allows for branches to be set up, instead of requiring subsidiaries. The FCA has confirmed its approach, and the PRA is firming up its final approach.
HM Treasury’s call for evidence on the use by firms of some of the access routes, focussed on the OPE, the equivalence regime for MiFIR investment firms and the recognition regime for overseas investment exchanges.
Next steps: HM Treasury will publish the action points arising from the responses to its call for evidence.
Related developments: The provisions on the third-country regime for non-U.K. investment firms in U.K. MiFIR have been amended under the Financial Services Act 2021. Some of the changes are concerning, to the extent that they might qualify the OPE. Moreover, those changes that simply seek to re-implement incoming EU changes, appear to be done in some cases without careful re-consideration of the impact on the U.K.’s position or best interests.
The U.K. funds regulation regime is another significant area, since the U.K. is a centre of asset management expertise and services. The U.K. government is seeking input into how the existing rules could be improved to encourage the establishment, administration and management of funds in the U.K., as well as fund managers, noting that, while much asset management is U.K.-based, many of the funds that are so managed are located in offshore jurisdictions, or in the EU (e.g., Ireland, Luxembourg). The policy issues being considered are wide-ranging and include consideration of tax and regulatory issues. Enhancements to existing fund structures and potential new fund structures are some of the options up for review. Consideration is also being given to whether the processes for fund authorization could be changed to speed up launching of funds, including how the U.K. fares compared to other jurisdictions.
Notably, the Financial Services Act 2021 establishes an Overseas Funds Regime which will allow overseas collective investment schemes to be marketed to U.K. investors where HM Treasury has granted ‘equivalence’ to the type of fund and to its home state. The OFR will introduce two equivalence regimes, one for retail investment funds and one for money market funds. An overseas fund that does not yet benefit from an equivalence assessment will need to obtain individual FCA recognition before it is marketed to U.K. retail investors. Some of the recognition requirements have been amended in the Act to make the process more efficient.
Next steps: Specific proposals will be set out in a future consultation by HM Treasury.
In the Payments Landscape Review, the government is conducting a review into the opportunities, gaps and risks that need to be addressed to support the U.K.’s position as being at the forefront of payments technology. One of the key issues to resolve is the complexity of the regulatory structure which leads to different rules applying to different types of entity carrying out payment services, including those on payments protection.
There are also proposals to change the insolvency regime applicable to payment institutions and e-money institutions that will help protect customers of an entity being put into insolvency. A proposed Special Administration Regime for payment institutions and electronic money institutions, drawing on the SAR applicable to investment banks, is to address these shortcomings.
Next steps: The government is expected to publish a summary of the responses it receives and to set out the next steps.
Related developments: The Kalifa Review into FinTech will play a large part in formulating future payments policy.
November 2020 saw the publication of Dame Elizabeth Gloster’s report on the FCA’s regulation of failed investment firm London Capital and Finance (LC&F), in particular the FCA’s failure adequately to supervise the issuance of ‘non-transferable bonds’. The report included a series of recommendations for improvements to FCA regulation and processes and for the regulatory perimeter to be clarified so as expressly to include securities like those issued by LC&F. As of 1 January 2021, the FCA permanently banned the marketing of speculative illiquid securities (like those issued to LC&F investors) to retail investors. In a recent judicial review case (Donegan & Ors, R (On the Application Of) v Financial Services Compensation Scheme Ltd  EWHC 760 (Admin)) brought by certain investors, the court found that the non-transfer clauses in bonds issued by LC&F were unfair and unenforceable against consumers.
Other recommendations for improving the FCA’s regulation and regulatory processes include ensuring that staff involved in the authorization and supervision of a firm considers its business holistically and are aware of, and take into account, in the day-to-day supervision of a firm, the current or emerging risks identified by the regulator, enhancing the Contact Centre policies so that consumers are not reassured about the unregulated activities of a regulated firm, written policies on action to be taken for repeated breaches of the financial promotion rules and that the training and culture of the FCA reflect its role in tackling fraud.
Next steps: Both the government and the FCA have accepted the report's findings and agreed to implement the report's recommendations. The government has launched a consultation on proposals expressly to regulate the issuance of non-transferable debt securities and has announced a compensation scheme for LC&F bondholders with an 80% recovery for investors, subject to the usual FSCS cap.