The Future of Financial Regulation in the UK

The following sections offer an overview and commentary on key aspects of the major consultations. These amendments cover the full spectrum of financial services regulation, from the FS Act (which aims to lay the groundwork for the future approach to regulation in the U.K.) to the U.K.’s regulatory approach to crypto-assets and stablecoins. It seems likely that the future regulatory regime will devolve to the financial services regulators power in large part to make detailed rules which will form the substance of firms’ regulatory obligations. Also on the cards is an initiative to reduce the length of rulebooks which have grown with the proliferation of EU legislation. In doing this, the government should ensure that it establishes a regulatory regime that is safe and achieves regulatory predictability in the same way that common law achieves legal certainty.

The UK’s Approach

The U.K.’s intended approach was signposted in a recent speech by Edwin Schooling Latter, Director of Markets and Wholesale Policy at the U.K. Financial Conduct Authority (FCA). The FCA intends to tailor the U.K. regulatory framework to allow U.K. and global users to thrive. Mr. Schooling Latter stressed that this wouldn’t mean “change for the sake of change” or “seeking low standards in pursuit of competitive advantage,” but that “where regulation has imposed costs without beneficial outcomes to justify that cost, then we will want to use our new ability to change direction.”^[1] HM Treasury has already demonstrated its willingness to diverge from EU rules. Examples include its decision not to extend the application of the Securities Financing Transactions Regulation (as implemented in the U.K.) to non-financial companies, contrary to the rules that recently came into force in the EU, or to implement the EU Central Securities Depositories Regulation’s settlement discipline regime. The FCA has also indicated where its rules will be amended to avoid unnecessary regulation.^[2] This demonstrates the U.K.’s commitment to avoiding unnecessary regulation for the financial services industry but must be weighed against the benefit of future U.K./EU equivalence determinations and the need to avoid burdensome compliance with two different regimes for companies that operate in both jurisdictions.

The House of Lords’ European Union Committee recently published a report^[3] on U.K. trade in services after Brexit. The report emphasizes the importance of the U.K. and EU maintaining close financial services regulatory cooperation to avoid a fractured relationship in the future. However, it also stresses that the benefits of equivalence, while certainly desirable (particularly in the regulation of central counterparties, which are crucial to financial stability), are subject to limitations. The EU is able to withdraw its equivalence determinations with just 30 days’ notice, and determinations may be time-limited. The report also questions whether equivalence is worth the loss of rulemaking autonomy that is likely to be a condition of any EU determination. The longer that equivalence decisions are delayed, the less valuable they will become to the U.K., as firms adapt to the post-Brexit landscape.

The EU’s equivocation around equivalence is in part attributed to concerns about looser U.K. regulation in the future. However, the U.K. has no plans for a “bonfire” of regulatory rules. It is generally accepted that it is in the U.K.’s best interests to maintain the highest global standards. The opportunity for the U.K. is to enforce those standards in a better way.

Legislation, Consultations and Reviews

The Financial Services Act 2021

The FS Act^[4] received Royal Assent on April 29, 2021. Some provisions came into force on that date, with a limited number following on June 29, 2021. The majority of the FS Act will come into force on a date specified in regulations yet to be made by HM Treasury.

Key aspects of the FS Act include:

Financial services policy and statutory objectives

The Financial Services Act requires the regulators to consider new matters when making rules for the prudential regulation of banks and investment firms (in addition to the statutory objectives^[5] they must currently take into account). The FCA, for example, must consider international standards, the U.K.’s standing as a financial center for international investment firms and the likely effect of any proposed rules on financial services equivalence. The PRA must consider similar matters as well as the likely effect that the rules will have on firms’ ability to sustainably provide finance to U.K. businesses and consumers. The FCA and PRA will be expected to explain how they have had regard to the new matters discussed above and, once finalized, will have to publish a summary of the purpose of any new rules.

The FCA has also been mandated to conduct a consultation on whether it should make rules specifying that authorized persons owe a duty of care to consumers. The consultation must be conducted, and analysis of responses published, before January 1, 2022. The FCA is currently planning to consult on the duty of care in May 2021.^[6] The FCA should make such general rules as it considers appropriate in this regard before August 1, 2022.

HM Treasury will continue to set financial services policy but will enhance the regulators’ responsibility for creating rules to implement policy. The transfer of power to the U.K.’s regulators is advocated by Shearman & Sterling partner Barney Reynolds in his book “Restoring UK Law—Freeing the UK’s Global Financial Market.”^[7] The vast bulk of financial regulation should be addressed through statutory instruments, with regulators adopting a clear specification of rules for industry. These rules should be based on desired outcomes, and regulators should make use of guidance where possible to avoid excessive red tape. Key aspects of the FS Act directly impacting financial institutions are set out below.

Prudential regulation of banks and investment firms

The FS Act introduces the U.K. Investment Firms Prudential Regime (U.K. IFPR), governing investment firms that are prudentially regulated by the FCA. The U.K. IFPR is intended to mirror the EU’s new Investment Firms Regulation and Investment Firms Directive, which will largely apply across the EU from June 2021. Like the EU regime, the U.K. IFPR will ensure that the U.K. has a more effective prudential regime for investment firms, but will not cover systemically important investment firms, which will continue to be regulated by the PRA. The majority of the U.K. IFPR will be specified through rules made by the FCA. The FCA issued a separate discussion paper in June 2020 on its proposed rules and has since issued two out of three proposed consultations on the detailed rules.^[8]

The provisions in the FS Act reflect the consultation and policy statement on the proposed prudential regime issued by HM Treasury earlier in 2020.^[9] The FCA will introduce rules for capital, liquidity, exposure to concentration risk, reporting, public disclosure, governance arrangements and remuneration policies.

The FS Act will implement those aspects of Basel III that were introduced into the EU Capital Requirements Regulation but that did not apply across the EU until after the end of the U.K. transition period, and consequently have not yet been implemented in the U.K. It will also implement Basel 3.1, which sets out a series of further reforms intended to restore credibility in the calculation of risk-weighted assets and improve the comparability of banks’ capital ratios that have not yet been implemented by either the EU or the U.K.

Benchmarks

The FS Act amends the U.K. Benchmarks Regulation (U.K. BMR) by providing the FCA with additional powers to manage an orderly wind-down of a critical benchmark. This is to deal with perceived deficiencies in the existing U.K. BMR which does not adequately manage the risks arising from an unrepresentative LIBOR or tough legacy contracts linked to the transition from LIBOR to risk-free rates. The FCA will be given enhanced powers to: (i) assess a benchmark’s representativeness; (ii) “designate” a benchmark and thereby require the administrator to change the methodology for determining the benchmark; (iii) prohibit all use of a benchmark by supervised entities once it has been “designated,” subject to an exemption for legacy use for a period that is within the FCA’s discretion; (iv) compel a benchmark administrator to continue publication of a benchmark for 10 years (up from the existing five years in the U.K. BMR); and (v) review and approve a benchmark administrator’s procedures for dealing with changes to, or the cessation of, a benchmark. The FS Act also extends the transitional period for U.K.-supervised entities to use third-country benchmarks from December 31, 2022 to December 31, 2025.

The FCA has published its final policy on designating unrepresentative benchmarks^[10] and requiring changes to critical benchmarks.^[11] It plans to consult on its approach to: (i) prohibition of the use of designated benchmarks; and (ii) permission for the legacy use of designated benchmarks in Q2 2021. The FCA has also announced the dates for future cessation and unrepresentativeness for all LIBOR settings.^[12] The majority of settings will cease or become unrepresentative immediately after December 31, 2021. Some U.S. dollar settings will follow later, immediately after June 30, 2023.

Markets in Financial Instruments Regulation

The U.K. onshored the EU Markets in Financial Instruments Regulation (EU MiFIR) as it was in force on December 31, 2020 and in doing so adopted the EU’s access provisions for third-country firms. U.K. MiFIR provides that an overseas firm may provide services to eligible counterparties and professional clients without establishing a branch if the firm is registered with the FCA. An overseas firm may apply for FCA registration if, among other things, its home country’s supervisory and regulatory regime has been determined by HM Treasury to be equivalent to the U.K.’s regime.

The FS Act makes a series of changes to U.K. MiFIR, many of which reflect the EU’s incoming changes to the third-country regime (from June 2021), even though the U.K. is under no obligation to adopt these requirements. This may be a cause for concern and full consideration should be given to the impact of the changes in the U.K. context. The FS Act requires FCA-registered overseas firms to keep the data relating to all orders and transactions in the U.K. in financial instruments which they have carried out, whether on their own account or on behalf of a client, for a period of five years, and provide these to the FCA if requested. The FS Act also gives the FCA powers to set reporting requirements for overseas firms. This differs to a certain extent from the EU approach. EU MiFIR stipulates that a registered third-country firm must annually provide to the European Securities and Markets Authority (ESMA) information relating to its EU business, including its scale, the scope of activities and turnover, as well as the policies and procedures in place for governance arrangements, risk management and investor protection. Further details are set out in Technical Standards. The U.K. approach is to delegate to the FCA the power to make rules on reporting requirements, which allows the regulator to adopt a proportionate regime for smaller firms and to minimize the burden on registered overseas firms by requiring only information which is not provided through home-host regulator cooperation arrangements.

The FS Act also proposes to give HM Treasury powers to impose additional requirements on FCA-registered overseas firms through regulations, and the FCA will be given powers to impose temporary restrictions or prohibitions on registered overseas firms or to withdraw their registration. The FCA will be required to monitor the regulatory regimes of other countries to ensure continued equivalence. The FS Act clarifies that the reverse solicitation exemption for overseas firms will not apply if the firm (or a firm acting on its behalf) solicits a U.K.-established eligible counterparty or professional client. This change will align the EU and U.K. reverse solicitation regimes.

The U.K. has also, in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (Regulated Activities Order), restricted the use of the Overseas Persons Exclusion (OPE) by an overseas firm for the activities it carries on under U.K. MiFIR, where an equivalence decision has been made and either (i) the firm is registered with the FCA or (ii) the firm is providing services on the basis of reverse solicitation. The restriction will only apply three years after an equivalence decision is made, but this limitation of the use of the OPE is a concerning development. The OPE relieves an overseas firm of the authorization requirement where it enters into certain regulated activities (such as dealing in derivatives as principal or agent) from outside the U.K. and does not conduct regulatory activities through a permanent place of business in the U.K., to the extent that such firm enters into transactions: (i) with or through an authorized or exempt firm; or (ii) as a result of a legitimate approach.

Overseas Funds Regime

The FS Act extends the U.K. temporary marketing permissions regime for EEA funds (specifically undertakings for collective investment in transferable securities, known as UCITS), enabling them to continue marketing in the U.K. until the end of 2025. The FS Act also 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 the relevant overseas jurisdiction. An overseas fund will be equivalent if it is deemed to be subject to rules that achieve similar outcomes to the U.K. regime. Following an equivalence determination, individual funds within the relevant jurisdiction will need to apply for FCA recognition if they intend to market to U.K. retail investors (or, in the case of money market funds, must be recognized as suitable for marketing to retail investors under s272 of the Financial Services and Markets Act 2000 (FSMA)).

Cancellation of regulatory permissions

The FS Act provides the FCA with a mechanism to cancel or vary FCA-regulated firms’ authorizations more quickly, where a firm ceases to provide a regulated activity, and to restore authorization upon a firm’s application where it is just and reasonable to do so. These changes will not apply to dual-regulated firms (which are subject to regulation by both the FCA and PRA).^[13]

Insider dealing, money laundering and market abuse

The FS Act makes certain clarifications and amendments to the U.K. Market Abuse Regulation (U.K. MAR). The FS Act clarifies that the obligation to maintain an insider list applies to both issuers and any person acting on their behalf or on their account. The FS Act also amends the notification timetable for transactions by senior managers. Issuers will need to publicly disclose transactions in their financial instruments by persons discharging managerial responsibility within two working days of those transactions being notified to them by the senior managers (as opposed to the current timetable, which may require issuers to make the disclosure on the same day that they are notified of the transaction).

The FS Act will also increase the maximum prison sentence for market abuse to 10 years (up from the current limit of seven years).

Certain changes are also made to the Proceeds of Crime Act 2002 (POCA) and the Anti-terrorism, Crime and Security Act 2001 (ACSA), extending aspects of that legislation to electronic money institutions (EMIs) and payment institutions (PIs). In particular, exemptions under POCA from the activities of concealing criminal property, entering into arrangements to facilitate the acquisition or retention of criminal property and acquiring, using or possessing criminal property are extended to EMIs and PIs where those offences are conducted in connection with an account maintained by the EMI or PI and the value of the property doesn’t exceed a certain threshold amount. Certain provisions on the forfeiture of money under POCA and ACSA have also been extended to those institutions.

Access to financial markets between U.K. and Gibraltar

The FS Act establishes a permanent market access regime (known as the Gibraltar Authorization Regime (GAR)), which will preserve Gibraltarian financial services firms’ access to U.K. wholesale and retail markets and will facilitate access to the Gibraltarian market for U.K. firms (although market access for U.K. firms will ultimately be a matter for the Gibraltarian government). Under the GAR, ongoing access to the U.K.’s financial markets will depend on alignment between law and practice in the U.K. and Gibraltar.

Other Matters

The FS Act proposes amendments to the U.K. European Market Infrastructure Regulation, including to require firms to offer clearing services on FRANDT terms and requiring trade repositories to establish procedures to improve data quality and ensure orderly transfer of data between repositories.

Some clarifications are also being made to the U.K. Packaged Retail and Insurance-based Investment Products Regulation (PRIIPs) to address the uncertainty around the scope of the requirements and the potential harm to consumers arising from the disclosure of information on performance.^[14] The U.K. PRIIPs Regulation will be amended so that: (i) the FCA is empowered to clarify the scope of the rules on whether a product or category of product falls within the Regulation; and (ii) the requirement for Key Information Documents to give a brief description of performance scenarios will be replaced with a brief description of information on performance and the assumptions made to produce them. Furthermore, the exemption for UCITS retail schemes will be extended to December 2026. The government also intends to conduct a comprehensive review of the disclosure regime for U.K. retail investors.

Financial Services Future Regulatory Framework Review

The Financial Services Future Regulatory Framework Review was announced in 2019 and aims to assess whether the U.K. financial services regulatory framework is fit for purpose and able to support future growth, particularly in light of challenges such as Brexit and climate change. Phase I of the Review began in July 2019 when a call for evidence was published seeking evidence on how the U.K. government and regulators work together to ensure the best outcomes for the financial services sector. The government’s response to Phase I was published in March 2020 and prompted the establishment of the Financial Services Regulatory Initiatives Forum (consisting of the Bank of England (BoE), U.K. Prudential Regulation Authority (PRA), FCA, Payment Systems Regulator (PSR) and Competition and Markets Authority). It also led to the creation of the Regulatory Initiatives Grid (the Grid), which sets out the financial services regulatory pipeline.

A consultation on Phase II of the Review was launched in October 2020. Phase II seeks to establish a blueprint for financial services regulation, ensuring a clear division of responsibilities between government, Parliament and the regulators, providing for appropriate policy input by democratic institutions and allowing regulation to adapt to changing conditions. A series of adaptations to the U.K.’s existing model have been proposed, including;

• A clear division of responsibilities between Parliament, which is responsible for setting policy, and the financial regulators, who are mandated to establish detailed rules implementing policy for a wide range of financial market participants;
• Enhancing the existing framework under FSMA by introducing ‘policy framework’ legislation for key regulated activities—for example, setting out the purpose of, and approach to, regulation by which the regulators should be constrained;
• New accountability and transparency requirements applicable to the financial regulators, and requiring the FCA and PRA to demonstrate that they are paying heed to the public policy established by Parliament in the framework legislation; and
• A systematic consultation between HM Treasury and regulators at an early stage in the policy-making process.

Responses to the consultation are now under consideration. The second part of Phase II, consisting of a final package of proposals, will be consulted on later in 2021.

More recently, Chancellor of the Exchequer Rishi Sunak published a ministerial statement^[15] which made a series of commitments in response to the recommendations set out in the U.K. Listings Review (discussed in detail below). The Chancellor committed to consider a “growth” or “competitiveness" objective for the FCA as part of the Future Regulatory Framework Review, to commence a public consultation on the U.K.’s prospectus regime in 2021 and to convene a group to consider how the raising of further capital by listed companies may be made more efficient.

Listings Regime

On March 3, 2021, the U.K. government published the report by Lord Hill on the U.K. Listings Review (the Listings Review).^[16] The report assesses how, following Brexit, the existing U.K. listing regime could be reformed to attract more companies, particularly innovative technology and life sciences companies, to raise capital in London. In the context of Brexit, the U.K. is considering the challenges to London’s position as a global capital markets hub. The Review makes 14 specific recommendations to address these challenges, including changes to the FCA’s premium and standard segment listing rules on which the FCA will be asked to consult and more general changes in relation to prospectuses on which HM Treasury will need to consult. In addition, the Listings Review identifies longer-term areas for reform, such as secondary capital raises and the greater empowerment of retail investors. Some of the specific recommendations included in the Listings Review are:

• dual-class share structures to be eligible for a premium listing subject to the super voting shares having certain restrictions as to their life, ratio and voting matters, etc.;
• removing the current listing suspension rule as it applies to special purpose acquisition companies, known as SPACs (or to SPACs of a certain minimum size) and replacing that with minimum disclosures that must be made when announcing the de-SPAC and SPAC investor rights to vote on, and redeem their SPAC investment on, the acquisition taking place;
• reducing the existing 25 percent minimum free float requirement (of an issuer’s shares in public hands) to 15 percent in both listing segments;
• significant changes to the prospectus requirements aimed at making a prospectus a much more useful and less onerous document for investors to read and issuers to prepare; and
• a full review of the onshored U.K. Prospectus Regulation and other listed company regulations, such as U.K. MAR.

The FCA has said that it is carefully considering Lord Hill’s recommendations and has prioritized its response to them.^[17] It has launched a consultation on the proposed changes to the listing rules for SPACs^[18] with an intention for new rules and/or guidance to be in place by the summer. A further consultation on other aspects of the Hill recommendations is expected in the summer. The FCA is also reviewing the wider capital markets framework, including the onshored revised Markets in Financial Instruments Directive rules for secondary markets. Among other things, the FCA is consulting on changes designed to address unnecessary red tape, similar to those of the EU’s recent MiFID “Quick Fix,” which was intended to help mitigate economic strain arising from the COVID-19 pandemic, but the FCA proposals go further. In particular, the FCA is proposing to introduce exemptions to the unbundling research rules for research on SMEs, FICC-related research and for independent research. In addition, certain best execution reporting obligations for trading venues and certain investment firms may be scrapped.^[19] The consultation closes on June 23, 2021, and the FCA is expected to publish its response and final rules in the second half of this year.

Kalifa Review

On February 26, 2021, the highly anticipated Independent Strategic Review of U.K. Fintech (the Kalifa Review),^[20] led by Ron Kalifa OBE was published. The recommendations are designed to ensure the U.K.’s competitiveness, attract investments for individual fintechs and raise the U.K.’s status as a global hub. Recommendations are made in five key areas: (i) policy and regulation; (ii) skills and talent; (iii) investment; (iv) international attractiveness and competitiveness; and (v) national connectivity. The delivery of these recommendations is to be led by the proposed Centre for Finance, Innovation and Technology, which would be mandated by the government but led by the private sector. Here we focus on the policy and regulation discussion.

The key policy and regulation recommendations are:

• a Digital Finance Package to launch a new regulatory framework that prioritizes new areas of growth and cross-industry challenges, as well as adopting specific policy initiatives. The package would comprise:
  • a Fintech strategy, which would focus on cross-sectoral issues and key areas that require specific support, such as regtech, cyber security and public infrastructure;
  • policy initiatives, such as the development of a data strategy, digitizing financial services to improve the environment for fintech, improve services to consumers and drive efficiency in the financial sector. These would include developing a Central Bank Digital Currency, supporting the digitization of financial markets infrastructure by, for example, full implementation of the dematerialization of securities, reviewing key legislation governing securities settlement and insolvency protections and supporting environmental, social and governance objectives;
  • a review of fintech and payments regulation, including assessing the navigability of the regulators’ rules;
  • using fintechs to support financial inclusion and capability, including incentivizing fintechs to focus on certain demographics or areas to improve financial inclusion and for incumbents to engage in financial inclusion;
  • establishing a Digital Economy Taskforce mandated to deliver the government’s objectives for fintech, to develop its fintech strategy and to effect an implementation plan; and
  • developing fintech expertise—the government and regulators could improve their technical understanding of fintechs’ business models and markets.
• Scalebox, an initiative building on the FCA’s regulatory sandbox, which would build on the FCA’s efforts with a focus on supporting fintechs in their growth phase and in relation to “Priority Fintech Areas” (determined by the U.K. government). Recommendations for Scalebox include enhancing the regulatory sandbox, creating a digital sandbox to support innovation at proof of concept stage, supporting partnering with fintech and regtech firms and providing additional regulatory and supervisory support for regulated firms in the growth phase.
• Developing a coherent and consistent global U.K. trade policy in relation to fintech and digital matters, to include existing or better commitments in ongoing and future trade agreements and bilateral mechanisms.

The Chancellor recently announced the government’s plans for implementing many of these recommendations.^[21] Along with the implementation of the Scalebox initiative and the launch of the second phase of the FCA’s Digital Sandbox, the proposed Centre for Finance, Innovation and Technology will identify and address challenges to the fintech sector. The Department for International Trade is also creating a new Export Academy to provide free advice to selected high potential firms on legal, tax, regulatory, accounting and market entry issues.

UK Regulatory Approach to Crypto-Assets and Stablecoins

The government is also assessing the U.K. approach to crypto-assets and stablecoins and launched a consultation in January 2021 to gather evidence on the subject from market participants.^[22] The key proposal is to bring stablecoins into the U.K. regulatory perimeter. Following the consultation, the government will consider the responses and publish further details on how the approach would be implemented in law. If the policy approach is followed, the regulators, namely the FCA, the BoE and the PSR, would consult further on rules for firms.

HM Treasury is proposing to introduce a new category of regulated tokens (known as “stable tokens”) to bring stablecoins within the regulatory perimeter. The approach would maintain the FCA’s approach to classifying tokens, as set out in its 2019 Guidance on crypto-assets.^[23]

Stable tokens would be tokens which stabilize their value by referencing one or more assets and could be used as a means of exchange of value (i.e. as a means of payment). The proposed regulation of stable tokens would include new rules for firms undertaking certain activities in relation to stable tokens, including:

• issuing, creating or destroying asset-linked tokens or single fiat-linked tokens;
• value stabilization and reserve management, including providing custody or trust services for those assets;
• validation of transactions;
• facilitating access of participants to the network or underlying infrastructure;
• transmission of funds and final settlement of transactions, thereby limiting counterparty and default risk;
• custody and administration of a stable token for a third party;
• executing transactions in stable tokens; and