Introduction
The U.K. Government announced on 9 December 2022 a series of initiatives, billed as the Edinburgh Reforms, to reform the laws for the U.K. financial services sector. In this note, we consider these reforms in detail and what they might mean for the direction of travel for financial services regulation in the U.K. The proposals discussed in this note are:
- Reforms to Ring-Fencing Regime
- Implementation of Post-Brexit Financial Regulatory Framework
- Growth and Competitiveness Remit for U.K. Regulators
- Reforms to Wholesale Markets
- Faster Settlement
- Senior Manager's and Certification Regime
- Changes to Promote Investment and Growth in Financial Services
- Sustainable Finance
- FinTech and Digital Assets
- Consumer Credit
1. Reforms to Ring-Fencing Regime
In the aftermath of the 2008 global financial crisis, and following the government rescue schemes for various banks, the U.K. introduced a ring-fencing regime[1]. The overall aim of this initiative was purportedly to limit future taxpayer liabilities in future crises by ring-fencing retail banking operations from other activities (including investment banking) of the largest retail banks. However, in practice the reforms were extremely stringent and the result has been to make the provision of retail banking by our main banks more capital-intensive and costly, with knock-on effects in the real economy and communities, such as a continuing and drastic reduction in the number of high street bank branches. Around the same time, and consistent with global reforms, U.K. banks became subject to resolution and recovery requirements, which aim to support a more orderly process for financial distress and alleviate the so-called "too big to fail" issue, among others.
The Edinburgh Reforms propose a range of amendments to the U.K.'s bank ring-fencing regime. A mandatory review of the regime was launched in 2021, two years after it came into force. The final report from the Independent Review on Ring-fencing and Proprietary Trading (the "Independent Review") was published in March 2022 and included a series of recommendations on the future of ring-fencing.
The Government has now published its response to the proposals and plans to launch a call for evidence in Q1 2023 on aligning the ring-fencing and bank resolution regimes. The two regimes were developed separately, with ring-fencing designed to protect retail banking from the risks inherent in investment banking operations, and bank resolution designed to ensure that banks could fail safely and maintain their critical functions. The Independent Review found that the ring-fencing regime prioritised ring-fenced banks ("RFBs") over non-ring-fenced banks ("NRFBs"), while the resolution regime recognized the importance of critical functions in both types of entities in the event of a bank failure. This has led to some inconsistency between the regimes, with the resolution regime being viewed as a more complete solution to the risks posed by bank failures. The Government's call for evidence will propose, amongst other options, the introduction of a new power for authorities to remove banks from the ring-fencing regime if they are judged to be resolvable. This would release considerable capital for growth in the provision of retail banking services.
The Government also plans to consult in mid-2023 on a series of other reforms to the regime. One proposal is to remove banks that do not have major investment banking operations from the ring-fencing regime entirely. The list of activities which RFBs are prohibited from undertaking will also be reviewed, with a view to allowing RFBs to conduct certain activities (e.g. providing inflation swaps to facilitate project finance and in certain cases taking equity stakes in certain FinTech companies that help the bank improve customer experiences). The prohibition on RFBs operating outside the European Economic Area may also be relaxed. The Government is also proposing to raise the threshold for banks to be caught by the regime from £25 billion to £35 billion in retail deposits. This latter amendment was not proposed by the Independent Review, which instead suggested that banks with retail deposits in excess of £25 billion should be exempt from ring-fencing where they conducted excluded activities up to a certain level.
Separately, a Financial Markets Law Committee ("FMLC") paper published in November 2021, to which Shearman & Sterling contributed, set out a series of very detailed potential reforms to make the ring-fencing regime more effective and eliminate uncertainties and difficulties with the regime.[2] The current proposals do not yet extend to addressing this level of detail.
2. Implementation of Post-Brexit Financial Regulatory Framework
The Government's Policy Statement on "Building a smarter financial services framework for the U.K." (the "Policy Statement") builds on the policy changes proposed under the Government's Future Regulatory Framework Review and taken forward in the Financial Services and Markets Bill 2022 ("FSM Bill").
The Policy Statement describes the Government's intended approach to future financial services regulation under the so-called "FSMA model". FSMA is the Financial Services and Markets Act 2000, the main U.K. legislation governing this area. It pre-dates the implementation of the EU's financial services action plan of the 2000s and post-global financial crisis and other reforms, but was amended heavily to implement those. The FSMA model proposes that:
(a) Parliament will establish the broad parameters of the U.K. regulatory framework through primary legislation;
(b) HM Treasury will be empowered by Parliament to determine which financial services activities should be regulated, and will set the regulatory perimeter through secondary legislation; and
(c) The financial services regulators (the Financial Conduct Authority (FCA), Prudential Regulation Authority (PRA), Bank of England (BoE) and Payment Systems Regulator (PSR)) will determine the detailed regulatory requirements that govern activities that fall within the regulatory perimeter.
This approach shifts responsibility for detailed rule-making (i.e. the content found currently in the EU's voluminous directives and regulations) to the U.K.'s financial regulators. This establishes the status quo ante before the EU's financial services action plan under FSMA, when the old Financial Services Authority ("FSA") held these rulemaking powers, albeit THE FSA was required to implement various (then high level) EU Directives. It is hoped that this reversion to a rules-based approach will allow the U.K.'s regulatory framework to adapt more readily to changing market innovations and global standards.
Prioritising the review of retained EU law
The Policy Statement sets out a clear trajectory for the U.K. Government's reforms to retained EU Law ("REUL") for the U.K. financial services industry. EU legislation that is deemed unnecessary for the U.K. will be repealed. REUL that continues to be appropriate will be restated in U.K. legislation or the financial regulators' rules. REUL that requires policy changes will be revised and replaced by either (or both of) legislation imposed by HM Treasury (where legislative changes are required) or rules imposed by the relevant regulator (where firm-facing requirements are required). The Annex to the Government's Policy Statement sets out the full list of REUL that is subject to review.
In its Policy Statement, the Government explains that, in considering its reforms, it will first focus on areas of retained EU law where policy changes can be made that will bring tangible benefits to the U.K. At the same time, it will ensure that the sequence of changes will make the U.K. regulatory framework easier to understand and avoid unnecessary disruption for business. HM Treasury is coordinating with an industry engagement group to ensure the proposals for reform are informed by the views of the market.
REUL is being reviewed in tranches. The first tranche included the U.K.'s onshored versions of the revised Markets in Financial Instruments Directive (MiFID II) (Directive 2014/65/EU), the Prospectus Regulation (Regulation (EU) 2017/1129), the Securitization Regulation (Regulation (EU) 2017/2402) and the Solvency II Directive (Directive 2009/138/EC).
The second tranche of REUL to be reviewed will include the ongoing implementation of changes to MiFID II (as proposed under the Wholesale Markets Review[3]) and Solvency II. Other aspects of REUL that will be considered are the U.K.'s onshored versions of: the Packaged Retail and Insurance-Based Investment Products Regulation ("PRIIPs") (Regulation (EU) 1268/2014); the Short Selling Regulation (Regulation (EU) 236/2012); the Taxonomy Regulation (Regulation (EU) 2020/852); the Money Market Funds Regulation (Regulation (EU) 2017/1131); the Payment Services Directive (Directive (EU) 2015/2366); the E-Money Directive (Direction 2009/110/EC); the Insurance Distribution Directive (Directive (EU) 2016/97) ; the Capital Requirements Regulation and Directive (Regulation (EU) 575/2013 and Directive 2013/36/EU); the Long-Term Investment Funds Regulation (Regulation (EU) 2015/760) and the consumer information rules in the U.K. Payments Accounts Regulations 2015 (SI 2015/2038). Consultations on the Short Selling Regulation, PRIIPs and the Payments Account Regulations 2015 have been published and are discussed in further detail below.
There is no hard deadline for changes under Tranches 1 and 2 to be implemented, but the Government hopes that "significant progress" will be made by the end of 2023.
Indicative draft legislation
The Government has published three sample Statutory Instruments to demonstrate how it plans to use some of its proposed powers under the FSM Bill. The draft SIs are for indicative purposes only and are not the subject of a formal consultation at this stage. They cover proposed reforms to the Prospectus Regulation, the Securitization Regulation and to the FCA's rulemaking powers in payments regulation. Despite their indicative nature, the draft Statutory Instruments offer an interesting insight into the direction of travel in these areas.
The draft Financial Services and Markets Act 2000 (Public Offers and Admissions to Trading) Regulations 2023 (the "Public Offers Regulations")[4] would use the proposed designated activities regime under the FSM Bill to implement a revised prospectus regime in the U.K. that would largely be governed by regulators' rules.
Currently, the U.K. Prospectus Regulation (which on-shores the EU Prospectus Regulation) governs prospectuses in the U.K. and requires a prospectus to be published before either an offer of transferable securities is made to the public in the U.K. or a request to admit transferable securities to trading on a regulated market is submitted. There are a range of exemptions from the requirement to publish a prospectus, largely aimed at professional investors who are deemed to require less protection.
The regime under the draft Public Offers Regulations would replace the U.K. Prospectus Regulation regime with a prohibition on: (i) offering "relevant securities" to the public; or (ii) admitting "transferable securities" to trading on a regulated market or primary multilateral trading facility, unless one of a series of specified exemptions applies. These exemptions mirror the existing list of activities for which publication of a prospectus is exempt under the U.K. Prospectus Regulation (e.g. offers made solely to qualified investors and offers addressed to fewer than 150 investors in the U.K. who are not qualified investors). Securities could therefore be offered to those who are "exempt" from the prohibition.
The draft legislation would also expand the range of securities which are restricted from public offers, capturing "transferable securities" as currently defined under the U.K. Prospectus Regulation, but also including other bonds and shares which need not be transferable for these purposes. This addresses one of the "lessons learned" from the London Capital & Finance scandal, where companies were purporting to offer "non-transferable bonds" to get round the prospectus requirement and the regulatory regime for dealing in securities more generally. The non-transfer clauses in such instruments were found to be unenforceable against consumers in subsequent litigation[5] and earlier this year HM Treasury proposed to clarify the law to bring such products expressly within the scope of regulation[6].
The draft legislation would also grant the FCA new powers to establish rules governing public offers of securities that are not being admitted to trading, as well as rules for the admission of securities to trading (including the circumstances in which a prospectus should be published). HM Treasury would be permitted to use new powers under the FSM Bill to require the FCA to "have regard" to the desirability of facilitating offers of transferable securities in the U.K. being made to a wide range of investors when making rules regarding admissions to trading on a regulated market or a primary multilateral trading facility.
The U.K. Securitization Regulation will also be repealed by the FSM Bill. The draft Securitization Regulations 2023 (the "Securitization Regulations")[7] set out proposals for the new securitization regime. As with the prospectus regime, the majority of requirements will be determined by the regulators via the designated activities regime. The substance of the regime is expected to remain broadly the same. The only significant policy change would make the FCA, as opposed to The Pensions Regulator, responsible for supervising the provision of securitizations by occupational pension schemes. The Pensions Regulator would remain responsible for supervising investment in securitizations by such schemes.
The Payments Services Regulations 2017 and Electronic Money Regulations 2011 will also be revised on an interim basis to hand greater rulemaking power to the regulators. The Government plans to repeal and replace the EU payments and e-money regime in future, but is proposing to make changes to the existing, EU-inherited regime in the meantime to ensure the FCA (and Payment Systems Regulator ("PSR")) have greater powers to regulate the sector effectively. The draft Electronic Money and Payment Services (Amendment) Regulations 2023[8] will expand the FCA's ability to set rules for payment services and e-money providers, including by permitting it to make rules for the payments sector without having to act in the same way for credit institutions. The Government will bring forward separate draft regulations to expand the PSR's powers at a later date. These expanded powers of the FCA and PSR will be retained in the final U.K. regime.
All new rulemaking will involve a need on the part of the FCA to reflect the new "international competitiveness" objective, which requires the FCA to have regard to the sustainable growth of the U.K. economy in the medium to long term.
Short-Selling Regulation
The EU Short-Selling Regulation (Regulation (EU) 236/2012) prohibits so-called "naked" short selling and imposes a reporting regime for short transactions on listed securities and government bonds. The Government plans to repeal the U.K.'s onshored Short-Selling Regulation, to be replaced with a framework better suited to the U.K. market. As part of the Edinburgh Reforms, it has published a call for evidence on the future regulatory framework in this area seeking views from market participants on the need for, and scope of, short selling regulation. It also seeks input on whether:
- the current provisions restricting uncovered short selling are adequate;
- changes should be made to the disclosure requirements for short selling;
- the current market maker exemption process may be streamlined, allowing market makers to more efficiently receive an exemption from the regulatory requirements; and
- changes should be made to improve the functioning of the FCA's short selling bans, including whether alternative arrangements should be put in place.
Responses to the consultation should be submitted by 4 March, 2023.
Packaged Retail and Insurance-based Investment Products Regulation
The Packaged Retail and Insurance-based Investment Product Regulation ("PRIIPs") originally was intended to establish a standardized disclosure regime for manufacturers and distributors of more complex retail investment products, but is perhaps the prime example of a poorly-conceived and badly drafted EU law having unintended consequences. In particular, it essentially ended the possibility of retail participation in bond transactions in Europe, counter to all the aims of the EU's capital markets union[9].
The U.K. has already addressed a number of the unintended consequences of PRIIPs through rulemaking and amendments. The government now plans to repeal the U.K.'s on-shored version of PRIIPs entirely. It has published a consultation paper on a future framework to govern retail disclosure. The consultation paper identifies various problems with the existing PRIIPs Regulation such as: that its overly prescriptive nature can actually exacerbate confusion among retail clients; that its attempt to make PRIIPs products comparable is misleading; and that the regulatory framework is currently spread across a combination of legislation and FCA rules which leads to a complex and confusing regulatory landscape for firms.
The paper goes on to propose a range of measures to deal with these issues, including:
- Allowing the FCA to determine requirements for the format and presentation of disclosure to retail investors;
- Removal of the comparability requirements under the former PRIIPs regime, to be replaced with a narrower set of mandatorily standardised information, such as on costs, to be determined by the FCA;
- Moving all regulatory requirements regarding retail disclosures to the FCA's rulebook, as opposed to being spread across rules and legislation.
- The consultation paper is also seeking views as to whether the FCA requires any additional delegated powers in order fully to implement an appropriate retail disclosure regime. The consultation closes on 3 March 2023.
The FCA has, in light of the Edinburgh Reforms, subsequently published a separate discussion paper on its future disclosure framework for retail investors. The discussion paper seeks views on various aspects of the FCA's proposed regime, including how and by whom disclosure should be delivered to retail investors and the presentation and content of that disclosure. Responses to the FCA's discussion paper should be submitted by 7 March 2023.
Payment Accounts Regulations 2015
The Government has published a consultation paper on proposed changes to the Payment Accounts Regulations 2015 (the "PARs"). The PARs implement the EU Payment Accounts Directive in U.K. law, which governs various issues relating to payment accounts, including the payment of fees for day-to-day transactions, switching of accounts and access to basic accounts.
Under the PARs, a Fee Information Document and Statement of Fees must be published including detailed information specified under a Schedule to the PARs. Many of these requirements are felt to be too prescriptive for U.K. purposes, in part due to fewer fees and account charges associated with U.K. account usage compared to many EU countries. The consultation seeks views on these aspects of the PARs and potential for reform.
Responses to the consultation should be submitted by 17 February 2023.
3. Growth and Competitiveness Remit for U.K. Regulators
The Chancellor of the Exchequer, Rt Hon Jeremy Hunt MP, has written to the FCA and Prudential Regulation Committee, recommending that the regulators should have regard to the Government's priorities of medium to long-term economic growth and the promotion of the U.K.'s international competitiveness when pursuing their objectives and applying regulatory principles.
The FSM Bill plans to enshrine in law the need to have regard to international competitiveness by means of a secondary objective for the regulators. In the meantime, it is in the regulators' discretion whether they choose to act on the recommendations. However, future proposed amendments under the FSM Bill would require the regulators to respond to recommendations in writing, notifying the Treasury as to the action they intend to take in response to recommendations or, if they do not intend to act, why not.
4. Reforms to Wholesale Markets
The U.K. Wholesale Markets Review previously proposed a raft of changes to the U.K.'s onshored version of MiFID II, which governs wholesale capital markets in the U.K. MiFID II included an often unpopular and unwieldy package of measures which the Wholesale Markets Review has sought to cut down and tailor to U.K. markets.
As part of the Edinburgh Reforms, the Government has published the Markets in Financial Instruments (Investor Reporting) (Amendment) Regulations 2022 (the "MiFIR Regulations"), which will come into force on 7 June 2023. The MiFIR Regulations remove the obligation for firms that offer portfolio management services to retail clients to inform those clients when the portfolio depreciates by 10 per cent or multiples of 10 per cent thereafter. Instead, firms will be entitled to agree with their clients as to the levels at which they should report losses. This reflects the equivalent changes to reporting requirements for professional clients that were introduced in 2021. Under the MiFIR Regulations, electronic (as opposed to paper) communications will also become the default method of communication with retail clients.
In his written statement, the Chancellor also announced plans to bring forward legislation in Q1 2023 to lessen the regulatory burden upon firms that trade commodities as an ancillary activity, and to implement a regulatory regime for a consolidated tape by 2024. The Government will also launch a review into investment research with a view to enhancing the competitiveness of the U.K. capital markets.
5. Faster Settlement
The Government has established an industry-led taskforce to assess the potential for faster settlement of financial trades in the U.K. The Accelerated Settlement Taskforce, chaired by Charlie Geffen, will explore the potential for moving to a T+1 settlement cycle, and also the viability in future of moving to a T+0 cycle. Other jurisdictions, including the U.S., are also investigating faster settlement cycles supported by innovative technology and it is understandable that the U.K. would want to do the same. The Taskforce's recommendations will include how changes could be implemented by industry, regulators and government, and a proposed implementation timetable. The Taskforce will report its initial findings by the end of 2023, and its final report and recommendations will be made by December 2024.
6. Senior Manager's and Certification Regime
The Government has announced that a review will be launched in Q1 2023 into the Senior Manager's and Certification regime. The SMCR provides for essentially automatic personal liability of individuals at financial institutions where breaches of rules occur on their watch. The regime is somewhat of an outlier compared to other jurisdictions, lacking material mental elements or levels of culpability for enforcement action.
The SM&CR initially only applied to banks and large investment firms. The SMCR was originally implemented for U.K. banks in 2016, extended to all U.K. authorized firms in December 2019, and further extended to U.K. benchmark administrators in December 2020. The FSM Bill provides for the extension of the SMCR to U.K. CCPs and CSDs and enables HM Treasury to further extend the regime to credit rating agencies and exchanges. In its latest Perimeter Report, the FCA called for the SMCR to be extended to CRAs, exchanges and payment services firms.
HM Treasury's review will consider the legislative framework, including the regime's effectiveness, scope, proportionality and potential areas for improvements. The FCA and PRA will review the regulatory aspects.
7. Changes to Promote Investment and Growth in Financial Services
The Edinburgh Reforms also discuss a series of changes aimed at encouraging investment and growth in U.K. financial services. These include a consultation paper on the VAT treatment of fund management services, responses to which should be submitted by 3 February 2023. Other planned changes announced in the Chancellor's written statement include a consultation on a new Value for Money framework for pension schemes, which is expected to set requirements in areas like investment performance and quality of service, and amendments to the tax rules for Real Estate Investment Trusts.
8. Sustainable Finance
The Chancellor's written statement highlights the Government's plans to bolster the U.K.'s role as a global leader in sustainable finance. It plans to publish an updated Green Finance Strategy and a consultation on regulating environmental, social and governance ratings early in 2023.
9. FinTech and Digital Assets
The U.K. Government has already made clear its intention to position the U.K. as a hub for financial technology and digital assets. However, this view may not be shared entirely by the financial regulators, who have been slow to act in processing applications for new businesses and have concerns about the volatility in crypto-markets and the probity and procedures of some actors in the sector. The government has taken steps to pursue its agenda for growth under the FSM Bill, which sets out a proposed regulatory regime for stablecoins and establishes a legislative framework for an FMI Sandbox allowing financial market infrastructure providers to test out technologies. The Chancellor's written statement announced further proposals, including a new wholesale market venue that would operate on an intermittent basis to improve the access that companies have to capital before they publicly list. The Government is also planning to launch a consultation on a U.K. central bank digital currency in the coming weeks.
10. Consumer Credit
The Government has published a consultation paper on changes to the framework governing consumer credit. Consumer credit rules are currently split between the Consumer Credit Act 1974 (as revised to accommodate EU Consumer Credit Directive changes) and the FCA rules, which has led to a complex and fragmented regulatory system. In line with the general approach to hand more power on detailed rulemaking to regulators, the Government proposes to transfer responsibility for the regime to the FCA, with a limited range of provisions potentially remaining in legislation.
