A Boost for UK Financial Services

The U.K.’s newest Financial Services and Markets Act of 2023 (“FSM Act”) received Royal Assent on 29 June 2023. Certain parts came into force on its passing, others will come into effect two months after that, and the remainder will enter into force in accordance with regulations to be made. The first commencement regulations were made on 10 July 2023^[1] (the Commencement Regulations), bringing into immediate force certain provisions, and others from 29 August 2023 and 1 January 2024. Further such commencement regulations are expected.

The FSM Act brings about numerous changes to U.K. financial services law across a wide range of areas and triggers a further implementation phase of the government’s post-Brexit Future Regulatory Framework Review and the Edinburgh Reforms.^[2] It revamps the existing regulatory model under the Financial Services and Markets Act 2000 (“FSMA”) and provides a framework for the revocation of retained EU law (“REUL”) in financial services. It gives new delegated powers to the U.K.’s regulators for detailed rulemaking, subject to enhanced oversight by Parliament and HM Treasury. The FSM Act also contains new provisions on a broad range of issues, all discussed in this note, including regulatory accountability, sustainability and environmental matters, a revamp of the U.K.’s legacy MiFID II and securitisation rules, a new regulatory framework for stablecoins and cryptoassets, financial market infrastructure, insurance and alternative investment fund regulation and consumer protection rules, including on access to cash at ATMs.

In this client note, we provide an overview of the FSM Act. We also discuss the main changes that were introduced to the Financial Services and Markets Bill (“FSM Bill”) and catch up on developments since publication of the Act.

Revocation of Retained EU Law

The FSM Act creates the framework for implementing the government’s post-Brexit policy of revoking financial services REUL, establishing a separate process for the revocation or replacement than that provided for in the Retained EU Law (Revocation and Reform) Act 2023.

Creating the concept of “EU-derived legislation,” the FSM Act revokes most REUL for financial services, including the statutory instruments that amended REUL in the “onshoring” process. The revocation clause is only effective upon regulations being made. The Commencement Regulations revoked, from 11 July 2023, the Money Market Funds Regulations 2018^[3] and certain provisions of the Sustainable Investment Regulation that require Treasury to make regulations. Further, the Commencement Regulations provide for the repeal of 98 statutory instruments on 29 August 2023, although many of these are regulations that were passed to amend separate U.K. legislation or REUL to ensure they remain operable post-Brexit. Accordingly, that legislation has achieved its purpose already and therefore the legal effect of these revocations is limited. Further revocations are provided for from 1 January 2024 including the European Long-Term Investment Funds Regulation, the related SI and tertiary legislation,^[4] and revoking a provision from the Capital Requirements Regulation so as to allow the Bank of England (“BoE”) more flexibility to set internal Minimum Requirements for Own Funds and Eligible Liabilities for U.K. subsidiaries of non-U.K. global systemically important banks.

The list of revoked law is set out in Schedule 1 to the FSM Act and includes many EU Regulations, for example, the Markets in Financial Instruments Regulation (“MiFIR”)^[5], the Short Selling Regulation,^[6] the European Market Infrastructure Regulation (“EMIR”)^[7], the Central Securities Depositories Regulation (“CSDR”)^[8], the Capital Requirements Regulation^[9], the Market Abuse Regulation^[10], the Prospectus Regulation, the Packaged Retail and Insurance-Based Investment Products (“PRIIPs”) Regulation^[11] and the Sustainability Disclosures Regulation^[12] - and U.K. subordinated legislation that implemented EU Directives, such as the Settlement Finality Regulations^[13], the Payment Services Regulations^[14], the Alternative Investment Fund Managers Regulations^[15] and the Bank Recovery and Resolution Order.^[16]

HM Treasury has set a clear path for implementation of the revocation and restatement process which will occur over several phases.^[17] The government will divide the legislation listed in Schedule 1 of the FSM Act into different tranches, and prioritize the revocation and replacement of those where new legislation will most benefit the U.K. The first of these have been identified as the Prospectus Regulation^[18], the Securitisation Regulation,^[19] the Data Reporting Service Regulations 2017^[20] and the Solvency II Directive.^[21] Draft statutory instruments and policy notes have been published for each of these and the government intends to lay the legislation before Parliament before the end of the year (subject to Parliamentary timings). Details of these draft SI are discussed below.

A new SI extends the powers of the Financial Conduct Authority (“FCA”) and the Payment Systems Regulator (“PSR”) in the payments area to ensure that they have the appropriate powers in relation to retained EU payments law.^[22]

New UK Regulatory Architecture

The FSM Act implements the government’s policy of establishing a comprehensive set of U.K. legislation for financial services. The U.K. traditionally had its own financial services statute covering all sectors, but this was added to by the U.K.’s sector-by-sector approach to implementing EU Directives, and the direct effect of EU Regulations (which were later onshored into U.K. domestic law following Brexit). The U.K. government’s policy is to revert to a universal model based upon a single coherent and consolidated legislative framework.

This has been accomplished by bringing some areas currently covered by REUL into the FSM Act, transferring the responsibility for making detailed rules to the U.K.’s regulators and strengthening Parliament’s oversight of the regulators. Transferring the detailed rules to the U.K. regulator’s rulebooks will allow for a nimbler approach by expert regulators, compared to the EU process in which considerable detail was found in Directives and Regulations made by the EU’s legislative bodies (at a level traditionally dealt with in the U.K. in regulator rulebooks, not statutes), making it harder to amend or address unforeseen consequences.

The FSM Act also grants new rulemaking powers to the U.K.’s regulators for those areas where they did not previously have such powers. For example, a general rule-making power is given to the BoE in respect of central counterparties (“CCPs”) and central securities depositories (“CSDs”) and the FCA will have the power to make rules for Data Reporting Service Providers (“DRSPs”) and Recognised Investment Exchanges (“RIEs”).

The Designated Activities Regime

The FSM Act creates a new “Designated Activities Regime” (“DAR”) for the regulation of activities related to the financial markets. The DAR sits alongside the regulated activities regime for specific regulated financial services. Designated activities are those activities in respect of which financial services rules will apply, but where the person carrying on the activity does not need a regulatory authorisation. This gives statutory force to the regulators making rules applicable to firms other than authorised (regulated) financial institutions.

The DAR, which comes into force on 29 August 2023, will operate in a conceptually similar way to the existing regime for regulated activities under the Regulated Activities Order (“RAO”), in the sense that HM Treasury is empowered to designate activities relating to financial markets and exchanges, and to designate instruments, products or investments. However, unlike the RAO model, HM Treasury is able to set certain requirements directly and then provide for certain areas to be covered by the FCA’s rules. The FCA is only able to make rules relating to specific designated activities; its remit will not extend to the wider unrelated or unregulated activities of those carrying out a designated activity, making it a narrower scheme than that for authorised firms. A person carrying on a designated activity must comply with the applicable requirements in the DAR or regulator’s rules unless there is an applicable exemption.

Schedule 3 of the FSM Act creates a new Schedule 6B to FSMA, which sets out the initial activities that will become designated activities from 29 August 2023 (under the Commencement Regulations), which are:

• Activities related to entering into derivatives contracts and holding positions in commodity derivatives.
• Short selling.
• In a securitisation, acting as an originator, sponsor, original lender or a securitisation special purpose entity and selling a securitisation position to a U.K. retail client.
• Offering securities to the market and admission of securities to trading on a securities market.
• Using a benchmark and contributing to a benchmark.

This brings under U.K. legislation various requirements on non-financial companies covered presently by the U.K.’s onshoring of the EU’s EMIR, the Short Selling Regulation, Securitisation Regulation, Prospectus Regulation, Transparency Directive^[23] and Benchmark Regulation^[24].

HM Treasury will be able to designate further activities. The FSM Act clarifies that cryptoassets may be considered to be instruments, products or investments. This change was adopted during the passage of the FSM Bill. The government has further proposed to regulate the activities of admitting (or seeking the admission of) a cryptoasset to a cryptoasset trading venue and making a public offer of cryptoassets (including Initial Coin Offerings).^[25] We discuss cryptoasset regulation under the FSM Act below.

The New Public Offers and Admission to Trading Regime

The proposed Prospectus SI^[26] will implement the government’s policy to revise the existing prospectus framework and will

• Introduce a new framework for public offers, consisting of a general prohibition on public offers of securities with a number of exceptions e.g., for securities admitted to trading on a U.K. regulated market or MTF.
• Enhance the FCA’s powers to make rules for the admission of securities to trading on U.K. regulated markets, and hand additional powers to the FCA currently contained in the onshored Prospectus Regulation; for example, requirements relating to prospectus content, persons responsible for a prospectus and withdrawal rights etc.
• Grant the FCA rulemaking powers over “primary” MTFs (i.e., those which operate as primary markets, allowing companies to issue new capital), including requiring an “MTF admission prospectus” for issuances on primary MTFs open to retail investors and, in relation to “retail or non-retail” primary MTFs, requirements on the admission prospectus responsibility, withdrawal rights and the application of the prospectus advertising regime. Primary MTF operators will be responsible for setting specific content requirements for MTF admission prospectuses when an admission prospectus is required (otherwise than by the FCA in the case of “retail” primary MTFs) and the process for approving prospectuses.
• Revise the liability threshold for certain categories of forward-looking statements in prospectuses to one based on fraud or recklessness in the preparation of prospectuses and or statements made for admission to MTFs.
• Revise the regime for public offers of securities that are not admitted to trading. The existing prospectus regime requires public offers of €8 million or more to be accompanied by a prospectus (unless certain exemptions apply, such as offers to sophisticated investors or to fewer than 150 natural persons, etc.). This has tended to restrict those willing to raise capital above this threshold. Under the new rules, no prospectus will be required, but offers of £5 million or more must be made through a public offer platform (or rely on other exemptions, many of which reflect the exemptions currently available under the existing regime). Operating a public offer platform will become a new regulated activity.
• Bring certain non-transferable securities within the scope of the new regime for public offers if they are not otherwise subject to appropriate supervision and may cause harm to investors. Offers of such securities over £5 million must be made through a public offer platform. HM Treasury and the FCA have implemented certain other changes to the regulation of non-transferable securities in the wake of the London Capital & Finance scandal, in which 11,500 retail investors lost around £237 million investing in such products issued by the alleged Ponzi scheme.^[27]

Responses to the draft Prospectus SI can be submitted until 21 August 2023. The FCA has published a series of engagement papers^[28] relating to the new prospectus regime, responses to which may be submitted by 29 September 2023. The FCA will provide feedback on those in Q4 2023.

The Lighter-Touch Short Selling Regime

HM Treasury has published its Short Selling Regulation review response,^[29] following a call for evidence published in December 2022. The Treasury plans to:

• Increase the net short position disclosure threshold from 0.1% to 0.2%.
• Replace the existing requirement to publicly disclose all short positions over 0.5%, which reveal the identity of the short seller, with an aggregated short positions disclosures model. Under the new regime, the FCA will aggregate and publish short positions in the shares of each company, giving the market a clearer view of short positions for each issuer but keeping individual net short positions private. Individuals will still be required to report short positions of 0.2% or above to the FCA, but they will not be identified in any public disclosures.
• Enable the FCA to make rules:
  • About exempt share arrangements (i.e., shares principally traded overseas), including moving to a “positive” list of shares that are within scope of the U.K. Short Selling Regulation, rather than the current “negative” list of shares that are out of scope (which suffers from not being updated regularly enough, resulting in disclosures that should otherwise not be required).
  • Streamlining the market maker exemption requirements, taking into consideration, among other things, industry calls to reduce administrative burdens for firms when submitting exemptions.
  • Prohibiting uncovered short selling.
• Require the FCA to set out its approach on using emergency intervention powers under the U.K. Short Selling Regulation, which in HM Treasury’s view should only be used in exceptional circumstances. The FCA will consult on its approach in due course.

Several of these proposals will be positive for the industry, contributing to a more efficient and effective regime that is less onerous for firms from an administrative perspective. The changes, however, have not yet been implemented and for the time being, firms should continue with their normal short position calculations and filings. Further detail will be set out in a draft statutory instrument (to be published before the end of 2023) and FCA rules, which will be consulted on in 2024. No further indication is provided on timing for the effective date of the new regime.

HM Treasury has separately published a consultation^[30] on sovereign debt and credit default swaps under the Short Selling Regulation. The Treasury is proposing to scrap all Short Selling Regulation requirements for short positions in sovereign debt and sovereign CDS, which the U.K. has long argued have the potential to negatively impact liquidity in sovereign debt markets. Under the proposals, the FCA would retain power to intervene in sovereign debt and CDS markets in exceptional circumstances, including powers to request information or ban short selling of instruments. Responses to the consultation may be submitted until 7 August 2023.

New oversight powers over unregulated “critical third parties”

In parallel with the designation regime, the regulators will have new direct powers over third parties that provide critical services to authorised firms, their service providers and FMIs. These regulatory powers have until now been limited. From 29 August 2023 (per the Commencement Regulations), HM Treasury is able to designate an entity as a “critical third party” if its failure would pose financial stability or confidence risk to the U.K. In addition, the Commencement Regulations bring into force, from 29 August 2023, the powers of the FCA, Prudential Regulation Authority (“PRA”) and BoE, among other things, to:

• make rules governing the services those critical third parties provide to authorised firms, relevant service providers and FMIs;
• direct critical third parties to, or prohibit critical third parties from, taking certain actions;
• publicly censure a critical third party for rule breaches;
• impose disciplinary measures against the critical third party, including banning them from providing their services to regulated entities, preventing authorised firms, relevant service providers and FMIs from availing themselves of services from the critical third party and imposing conditions on the provision of the critical third party’s services. The regulators are required to publish a policy statement on how they intend to use their disciplinary powers.

The BoE, PRA and FCA are expected to consult this year on their proposed requirements and expectations for critical third parties, taking into account responses to their 2022 discussion paper and related survey.^[31]

Regulatory Accountability

The additional rulemaking responsibility for the regulators significantly increases their powers. How and whether those powers should be constrained or overseen has been subject to much debate. The FSM Act makes provision to strengthen the regulatory accountability framework. HM Treasury will be empowered to require either the PRA or FCA to make rules but may not specify the content or outcomes that such rules should seek to accomplish. HM Treasury is also empowered to require a regulator to review its rules (or appoint an independent reviewer) where HM Treasury considers it is in the public interest, for example, in response to market developments or if the rules do not appear to realise their purpose. The regulators will be required to keep their rules under review and to publish a statement of policy on how they conduct such reviews. These provisions were amended during the legislative process to provide that the policy statement must state how representations can be made to the regulator and how those representations will be considered. The PRA is consulting^[32] on its proposed approach to reviewing its rules, including a proposed statement of policy. Responses to the consultation may be submitted until 29 September 2023. The FCA has also published its draft Rule Review Framework^[33] for comment.

The PRA and FCA must also notify relevant Parliamentary Select Committees when they launch a consultation on proposed rules, publish proposals on how they exercise their general regulatory functions or consult on proposals under a duty imposed by legislation. The FSM Act requires the regulators to respond in writing to any formal response to a consultation by a Parliamentary Committee.

The original provisions introducing the requirement for each regulator to appoint a Cost Benefits Analysis Panel have been maintained in the final FSM Act. Those panels will now need to include at least two individuals from two different authorised firms. Furthermore, this panel, and others that are required to be established, may not include any individuals that are remunerated by the FCA, the PRA, the BoE, the PSR or HM Treasury. Strengthening industry involvement and instilling independence in the cost-benefit aspect of consultation processes are auspicious additions to the FSM Act.

These provisions will apply from 29 August 2023 under the Commencement Regulations.

New Growth and International Competitiveness Secondary Objective

The FSM Act introduces a new secondary statutory objective, obliging the FCA and PRA in carrying out their functions to support the long-term growth and international competitiveness of the U.K.’s economy in the medium and long term. This obligation is in force from 29 August 2023, under the Commencement Regulations.

For the PRA, the new growth and international competitiveness objective will operate in conjunction with its existing secondary objective to facilitate effective competition in the markets for services provided by PRA-authorised firms (being banks, large investment firms, insurers and credit unions). For the FCA, the new objective will go together with the FCA’s three existing operational objectives of consumer protection, market integrity and competition. It is hoped that this new objective will provide motivation for the FCA in particular to improve on its slow turn-around times for new business for authorisations and other regulatory processes.

There is a duty (introduced during the Bill’s passage) on each of the regulators to report at two intervals to HM Treasury setting out how it has complied with its duty to advance the new objective. The reports are due 12 and 24 months after the new objective applies (29 August 2024 and 29 August 2025 respectively. Each regulator must already report annually to HM Treasury on, among other things, how it has advanced its objectives. Furthermore, HM Treasury is empowered to issue a direction at any time requiring a regulator to report on, among other things, how it has advanced its objectives, discharged its functions and considered the applicable regulatory principles.

HM Treasury is currently able to recommend to each regulator that it takes into account the government’s economic policy when considering how to comply with its strategic and operational objectives. This power will now extend to how the regulator discharges its duty to advance the new growth and international competitiveness objective.

Both of the regulators will also need to provide information to relevant Parliamentary Committees regarding how any of their proposals that are subject to consultation will advance the new secondary objective.

The FCA has recently published a statement^[34] setting out how its work to support the ‘key drivers’ of productivity will aide delivery of this new secondary objective and how it intends to report on progress embedding the new objective.

New Net Zero Regulatory Principle

There is a new regulatory principle requiring the FCA and the PRA to have regard to the need to achieve the U.K.’s statutory climate target, which is in force from 29 August 2023 according to the Commencement Regulations. During the passage of the FSM Bill, that obligation was extended to include the conservation and enhancement of the natural environment, which extended part will come into effect at a later date once the regulators have considered how they will operationalise the obligation.

To avoid duplication, the FSM Act removes the existing sustainable growth principle for both regulators. The PSR’s objectives are not changing and therefore its sustainable growth principle will remain; however, the net zero regulatory principle will be integrated into that sustainable growth principle. This change will apply from 29 August 2023 under the Commencement Regulations.

New Financial Inclusion factor

Going forward, the FCA, in considering the degree of consumer protection that is appropriate, will need to take into account financial inclusion. This is an additional consideration for the FCA that was not included in the original FSM Bill.

Financial Regulators Complaints Commissioner

Regulatory accountability became a controversial topic during the passage of the legislation. Following heated debates and numerous amendments proposed on this topic during the Parliamentary process, the FSM Act introduces amendments to the Financial Services Act 2012 which will, from 29 August 2023, bolster the powers of the Financial Regulators Complaints Commissioner (“FRCC”) and enhance its independence. The FRCC reviews complaints about the actions or inactions of the U.K.’s financial services regulators (the FCA, PRA, PSR and, on certain issues, the BoE).

These amendments stem from those tabled in the House of Lords by Lord Peter Lilley, which themselves are based upon work and consultation led by Shearman & Sterling, involving a diverse set of stakeholders, including leading barristers, regulated firms and advocacy groups. Market participants have previously voiced concerns that the FCA and PRA are not subject to effective or sufficient controls or balances.^[35] These concerns were heightened by proposals under the FSM Bill (which have since passed into the FSM Act) to transfer significant new rule-making powers to the U.K.’s regulators, since an effective check and balance on those new powers was needed.

The need for reform over the FRCC’s role was recently highlighted following a challenge to FCA rulemaking in its “Remedies Statement,”^[36] in which the FCA sought to introduce new principles governing its own liabilities to consumers. The FRCC found the Remedies Statement to be inconsistent with statute and to have been introduced without following the correct process.^[37] However, the FCA ignored the FRCC’s findings and even today the FCA Remedies Statement still stands as published. The FCA has now gone one step further and enshrined a key principle of the criticised Remedies Statement in its revised formal Complaints Scheme, which will take effect from 1 November 2023 and which the regulators (namely the FCA, PRA and Bank of England) are obliged to follow.^[38] The FCA’s actions show it was clearly unsustainable to foist new rulemaking powers on the FCA when it had recently been found to have introduced rules unlawfully and then to have ignored the relevant findings of the FRCC.

Following the amendments, the FRCC will be appointed by and accountable to HM Treasury (as opposed to the regulators, as was previously the case). The regulators will also have to explain themselves where they do not accept the FRCC’s recommendations. The FCA will have to summarise the cases in which it has decided not to follow the FRCC’s recommendations and give reasons for not doing so. This reasoning will be laid before Parliament, together with the FRCC’s annual report. HM Treasury will also be granted a new power to specify additional matters that should be included in the FRCC’s annual report, contributing to greater accountability for the regulators.

Rulemaking without consultation

Another change relating to regulatory accountability from the Parliamentary process involves a new requirement for regulators to publish a statement where they make changes to rules without consultation, with particular regard to the development of legacy EU laws. In such a statement, the regulators must now set out the provisions of legislation that have been restated, describe how EU obligations have been amended by rules and specify the EU obligations that have been removed through revocation. Furthermore, where there have been material amendments that only reduce regulatory burdens, the regulators must explain how the proposed rule changes are consistent with their objectives, including the new growth and international competitiveness secondary objective. A regulatory burden for these purposes includes, but is not limited to, a financial cost, an administrative inconvenience, an impediment to trade or innovation or to efficiency, productivity and profitability.

Sustainability and Green Economic Reforms

Sustainability Disclosure Requirements

Under the FSM Act, HM Treasury is entitled (though not obliged) to prepare a policy statement on sustainability disclosure requirements. Sustainability is defined broadly for these purposes, including matters relating to: (i) the environment (including climate change); (ii) social, community and human rights issues; (iii) tackling corruption and bribery; and (iv) governance in relation to the prior three matters. The FSM Act requires the Treasury to consult the FCA and PRA when preparing the policy statement and to keep it under review. The regulators will then need to have regard to the policy statement when preparing any of their own rules or guidance on sustainability disclosures. They will also need to publish statements in their annual reports on how they have complied with this obligation.

Forest risk commodities

Forest risk commodities are those derived from plant, animal or other living organisms, the production of which involved the conversion of forest into agricultural land. The Government is yet to pass legislation specifying the commodities that fall within this provision, but they are expected to include products such as beef, leather, cocoa, palm oil, rubber and soya. Under a new provision introduced at a late stage of the FSM Bill’s progress, HM Treasury is required to conduct a review into how well U.K. financial regulation is equipped to eliminate financing of the use of these “forest risk commodities” and publish a report setting out its conclusions and the steps it proposes to improve U.K. financial regulation for these purposes. These obligations will apply from 29 August 2023 under the Commencement Regulations. The forest risk commodities provision is substantially diluted from the original FSM Bill drafting, which had envisaged a prohibition on regulated activities that supported commercial activities relating to forest risk commodities (or products derived from those commodities), unless relevant local laws were complied with, and imposed due diligence obligations.

MiFID II-Based Rules - Reforms for Wholesale Markets

The U.K. originally “on-shored” the Markets in Financial Instruments Regulation into U.K. law as REUL with only minor amendments following its exit from the EU. The FSM Act includes a new set of amendments that aim to tailor this unwieldy package of European measures for the U.K. market. The changes, made through a transitional regime rather than the revocation route, herald some welcome relief to those acting in the wholesale markets, with the reduction of some of the more burdensome requirements across a raft of areas regulated under the U.K.’s Markets in Financial Instruments package, as prefaced by the Wholesale Markets Review^[39]