Future of Financial Services Regulation in the UK

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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 However, those provisions were largely superseded by European Directives and Regulations, and those Directives and Regulations have become the purview of Parliament, amendable only by statutory instrument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 initiatives.

The Future Regulatory Framework Review

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 issues 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

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.

FinTech

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.

Crypto-assets Regulation

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.

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.

Capital Markets

A major overhaul of the U.K.'s listing regime was recommended by Lord Hill in the U.K. Listings Review. A number of very significant reforms were proposed, several with a view to attracting more companies, particularly innovative technology and life sciences companies, to raise capital in London. The Review makde 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 are being taken forward by HM Treasury and the FCA, with changes to legislation and the FCA's Handbook rules expected.

Access to UK Markets

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  and PRA have each confirmed their final approaches to the supervision of international bank branches.

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. Further consultations on these issues are expected.

Funds Regulation

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.

Payments

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. The Kalifa Review into FinTech will play a large part in formulating future payments policy.

The Gloster Review

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 the judicial review case of Donegan & Ors, R (On the Application Of) v Financial Services Compensation Scheme Ltd [2021] 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.