Key Regulatory Topics: Weekly Update 15 - 21 July 2022
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Capital Markets
Government announces Digitisation Taskforce terms of reference
On 20 July, the UK government announced that it had accepted all the recommendations of Mark Austin’s Secondary Capital Raising Review, launched a Digitisation Taskforce to modernise the UK’s shareholding framework, and published the terms of reference of the Taskforce. The Taskforce, under the chairmanship of Sir Douglas, has been asked to work with stakeholders across the financial services sector to build a broad consensus for change. In particular, it has been asked to: (i) identify immediate, and longer term, means of improving on the current intermediated system of share ownership so that: (a) investors as beneficial owners are better able to exercise rights associated with shares which intermediaries hold on their behalf; (b) issuers can identify and communicate more easily with investors as the underlying beneficial owners, including on secondary capital raising offers; and (c) efficiencies can be identified to reduce costs and time delays in the existing system; (ii) eliminate the use of paper share certificates for traded companies and mandate the use of additional options to cheques for cash remittances; and (iii) consider whether the arrangements for digitisation can be extended to newly formed private companies and as an optional route for existing UK private companies. The Taskforce will also consider the use of new processes and technologies in achieving these goals. It will engage with the government and regulators on progress, and advise on any legislative, regulatory or other changes required to support the programme. It has been asked to report on its progress and initial findings by spring 2023, and to publish final recommendations and an implementation plan by spring 2024.
Conduct and Governance
Please see the “Other Developments” section for the FCA 2022 perimeter report.
Financial Crime and Sanctions
Money Laundering and Terrorist Financing (Amendment) (No. 2) Regulations 2022 published
On 21 July, the Money Laundering and Terrorist Financing (Amendment) (No. 2) Regulations 2022 were made. Among others items, the Regulations amends the MLRs to: (i) remove outdated references to certain provisions of the Terrorist Asset-Freezing etc. Act 2010; (ii) widen the meaning of a trust or company service provider; (iii) implement, in respect of cryptoasset transfers, a recommendation of the Financial Action Task Force and inserts a new Part 7A (cryptoasset transfers) into the MLRs; (iv) remove from the MLRs the requirements in Part 5A for a centralised automated mechanism to identify persons holding or controlling bank accounts or safe deposit boxes through a bank account portal; (v) allow the FCA to object to an acquisition or change in control of a registered cryptoasset business before the acquisition takes place, and to publish notices relating to such objection. The regulation also makes provision for the FCA and HMRC to publish notices of refusals to register applicants for registration; and (vi) remove account information service providers (or AISPs) from the scope of the MLRs. The majority of the provisions come into force on 1 September, except as provided in paragraphs (2) to (4) of Article 1.
FATF report on data protection, technology and private sector information sharing
On 20 July, the Financial Action Task Force (FATF) published a report on the fight against financial crime, with a focus on data protection, technology and private sector information sharing. The FATF explains that collaboration and information sharing helps financial institutions to build a clearer picture of criminal networks and suspicious transactions, and better understand, assess, and mitigate their money laundering, terrorist financing and proliferation financing risks. It can also provide authorities with better quality intelligence to investigate and prosecute these crimes. However, such collaboration initiatives need to be designed and implemented responsibly, in accordance with data protection and privacy rules, so that the risks associated with increased sharing of personal data are appropriately taken into account. The report provides non-binding recommendations to avoid common pitfalls and assist countries that are considering increasing private sector information sharing to design and implement such initiatives responsibly and effectively. These recommendations are based on observations and lessons learnt across jurisdictions of the FATF's global network. Recommendations for the private sector include: (i) make use of privacy-enhancing technologies; (ii) ensure harmonised data; (iii) pursue data protection by design; (iv) establish early and ongoing engagement with data protection authorities; and (v) identify metrics to measure success. The FATF explains that there is no one-size-fits-all solution that addresses all the objectives of data privacy and protection, anti-money laundering, countering the financing of terrorism, and countering proliferation financing for all financial institutions globally. Each information sharing initiative needs to be considered on a case-by-case basis depending on their unique characteristics and the relevant data privacy and protection requirements.
Fintech
Please refer to the “Financial Crime and Sanctions” section for the Money Laundering and Terrorist Financing (Amendment) (No. 2) Regulations 2022. Please also see the “Other Developments” section for the Government policy paper, action plan and call for views on regulating AI, as well as the FCA 2022 perimeter report.
Fund Regulation
ESMA updates Q&As on application of UCITS Directive and AIFMD
On 20 July, ESMA published an updated version of its Q&As on the application of the UCITS Directive, as well as an updated version of its Q&As on the application of the Alternative Investment Fund Managers Directive (AIFMD). Three new questions have been added to the UCITS Directive Q&As: (i) section X: Depository. New Q&A 7 on the reconciliation frequency for funds trading on a daily basis, and new Q&A 8 on reconciliations with tri-party collateral managers; and (ii) section XIII: Delegation. New Q&A 1 on the responsibility to ensure compliance with the rules governing marketing communications. Three new questions have also been added to the AIFMD Q&As: (a) section VI: Depositaries. New Q&A 15 and Q&A 16 on reconciliations; and (b) section VIII: Delegation. New Q&A 4 on the responsibility for compliance with requirements for marketing communications.
Markets and Markets Infrastructure
Please refer to the “Regulatory Reform Post Brexit” for the Financial Services and Markets Bill 2022-23.
Please also see the “Other Developments” section for the FCA 2022 perimeter report.
Please see the “Prudential Regulation” section for the Financial Services Act 2021 (Prudential Regulation of Credit Institutions and Investment Firms) (Consequential
Amendments and Miscellaneous Provisions) Regulations 2022.
HMT consultation response on future regulatory framework for CCPs and CSDs
On 20 July, HMT published the response to its January consultation on an updated regulatory framework for central counterparties (CCPs) and central securities depositories (CSDs) as part of its ongoing Future Regulatory Framework (FRF) Review. The consultation proposed giving the BoE a general rule-making power over CCPs and CSDs. It also proposed the introduction of an updated set of statutory objectives and principles for the BoE to follow when regulating these firms, as well as strengthening the mechanisms which govern the BoE’s accountability to Parliament, its relationship with HMT and its engagement with stakeholders. The consultation response provides a breakdown of the key themes raised by respondents, as well as the proposals the government intends to take forward, including: (i) giving the BoE a general rule-making power in relation to CCPs and CSDs. The BoE’s use of this power will be subject to public consultation as well as to a range of accountability measures, including those introduced in the Financial Services and Markets (FSM) Bill; (ii) introducing a power for the BoE to impose requirements on individual CCPs and CSDs, similar to the FCA’s and PRA’s ability to impose requirements on the firms they regulate under section 55L and 55M FSMA. The BoE will be able to use this power where it is desirable to do so in order to advance its objective to protect and enhance UK financial stability; (iii) establishing the concept of a “systemic third country CCP” and to provide for the BoE to be able to apply its rulebook for domestic CCPs, in part or entirely, to these firms. The BoE will continue to have powers to defer to the home regulators of these firms where appropriate; (iv) adding a new secondary objective on innovation for the BoE; (v) new powers for HMT to be able to set ‘have regards’ that the BoE must consider when making rules in specific areas of regulation, and to be able to place obligations on the BoE to make rules in specific areas of regulation, in line with the approach taken for the PRA and the FCA; (vi) placing the BoE's FMI Board on a statutory footing; (vii) aligning the BoE’s approach on engagement with external stakeholders with the approach taken by the FCA and the PRA on these issues. For efficiency purposes, HMT proposes that the BoE use the same cost-benefit analysis panel as the PRA; and (viii) introducing a requirement for the BoE to report annually on the efforts it has made to engage with stakeholders outside of its direct regulation, such as users of CCP and CSD services, and to provide a summary of this engagement. The government’s final policy is laid out in the FSM Bill and the accompanying Impact Assessment and Explanatory Notes.
ESMA updates Q&As on MiFIR and SFTR data reporting
On 19 July, ESMA updated its Q&As on complying with reporting requirements under MiFIR and the Regulation on reporting and transparency of securities financing transactions (SFTR). Regarding the MiFIR data reporting Q&As, ESMA updated section 19 on the reporting of emission allowances. Concerning the SFTR data reporting Q&As, ESMA added new Q&As on the construction of a trade state report, and the reporting of valuation and collateral on the last day of a securities financing transaction.
ESMA 2021 annual peer review of EU CCP supervision
On 19 July, ESMA published a report on its 2021 annual peer review analysis of the supervision of EU Central Counterparties (CCPs) by National Competent Authorities (NCAs), in accordance with EMIR. The peer review measured the effectiveness of NCA supervisory practices in assessing CCP compliance with EMIR’s requirements on business continuity, in particular in remote access mode. The report summarises that participating NCAs have broadly met supervisory expectations. Some aspects of business continuity in remote access mode were not always specifically assessed. In most cases, this is because at many CCPs remote working was already common practice or part of existing business continuity arrangements. In this context, remote working did not introduce any new major risks to be re-assessed. Nevertheless, the report makes three observations: (i) NCAs could better clarify, when defining their risk-based approach, how operational risks related to remote access are addressed; (ii) from a supervisory perspective, CCPs could better clarify the risk-based scope of penetration testing and how risks related to remote access are addressed as part of this; and (iii) business continuity management plans could be improved by taking into account other extreme scenarios, where remote working arrangements could serve to ensure business continuity. The report also identifies ten best practices from NCAs’ supervisory activities and approaches. Implementing these best practices would address the three observations. Finally, while the new EU legislative proposal for Digital Operational Resilience Act (DORA) is going to establish a new regulatory framework applying also to CCPs, it could be considered whether there remain areas for improvement within the EMIR framework, in order to strengthen the enforcement of EMIR requirements with respect to business continuity (not addressed by DORA). ESMA suggests that this could be addressed via a review of the relevant RTS under EMIR. ESMA will follow up on the findings listed to identify, where relevant, the most appropriate tools to further enhance supervisory convergence. NCAs are expected to consider implementing the best practices outlined.
ESMA updates Q&As on MiFID II and MiFIR market structures topics
On 15 July, ESMA published an updated version of its Q&As on market structures under MiFID II and MiFIR. The updated Q&As include the following new questions on algorithmic trading: (i) do orders that are executed through trading functionalities which offer automated managing of the order qualify as algorithmic trading; and (ii) how should firms ensure compliance with the requirements in Article 17 of MiFID II and RTS 6 when using third party systems which offer algorithmic trading functionalities.
Implementing Regulation on format for third-country firms and competent authorities reporting under MiFID II
On 15 July, Commission Implementing Regulation (EU) 2022/1220 laying down ITS with regard to the format in which branches of third-country firms and competent authorities have to report the information referred to in Article 41(3) and (4) of MiFID II was published in the OJ. The Implementing Regulation will come into force on 4 August.
ESMA final report on revisions to guidelines and recommendations on scope of CRA
On 15 July, ESMA published its final report on revisions to its 2013 guidelines and recommendations on the scope of the CRA Regulation. The purpose of these guidelines is to deliver additional guidance in the specific case of private credit ratings. Among others, ESMA intends to amend the guidelines to clarify that: (i) a private credit rating should only be produced following an explicit order, formalised through a written agreement between the person placing the order and the rating provider. ESMA expects this agreement to contain a specific provision indicating the exclusive issuance of the rating to the person who placed the order, who should sign a non-disclosure undertaking, precluding the dissemination of the rating to more than a limited number of third parties; and (ii) the receiving party to a private credit rating should only share the private credit rating on a confidential basis and with a selected and definite number of natural or legal persons. This number should be limited and can never exceed a total of 150 persons. To ensure that this maximum limit is adhered to, appropriate controls should be implemented by the rating provider to allow for the monitoring of the distribution. The revised guidelines will apply 18 months following the date of their publication.
Payment Services and Payment Systems
Please see the “Other Developments” section for the FCA 2022 perimeter report.
PSR response to digital payments initiative report
On 21 July, the PSR published its response to the PSR Panel's digital payments initiative report. The PSR Panel's report highlighted barriers to people using digital payments, and made a range of recommendations for the PSR to address. The PSR welcomes the report's recommendations. Key points include: (i) a key element of the PSR's five-year strategy and current work programme is unlocking the potential of interbank payment systems – including by considering the potential benefits of open banking. To address barriers that restrict retailer and consumer adoption of open banking for use cases such as account-to-account-based retail transactions, the PSR has set out four priority issues that needs to be addressed: the system’s functional capability, dispute processes, access and reliability, and a sustainable funding model; (ii) the new Joint Regulatory Oversight Committee will consider the vision and strategic roadmap for further developing open banking. The PSR is keen to work closely with the industry and other key stakeholders through a strategic working group (SWG), and have asked that the SWG recommend to the committee how its four priority issues can be addressed. Following the SWG’s work, the PSR and the committee will consider what actions it needs to take. HMT is working with the PSR and the FCA on proposals for a permanent future regulatory framework for open banking, based on joint regulatory oversight by the FCA and PSR and backed by any necessary legislation; and (iii) tackling the causes of digital exclusion lies beyond the PSR's remit as the regulator of payment systems. However, it has a key role in challenging payment system operators to consider people with limited digital and financial skills and access when they design and implement digital payment services. The PSR will explore with consumer representatives what more card and other payment system operators could do to facilitate the availability and use of digital payment services that meet the needs of those with limited digital and financial access or skills. The PSR also has a role in monitoring and publicising progress towards its outcome that everyone has access to payment services that meet their needs; this informs its priorities on digital payments, and engagement with organisations who can address the causes of digital exclusion. Actions will be incorporated into the PSR's work programme where identified.
HMT consultation on payments regulation and systemic payments perimeter
On 21 July, HMT published a consultation and call for evidence on the government’s approach to reforms to the payments regulatory landscape, including the systemic payments perimeter of the BoE. The consultation discusses: (i) the rationale for expanding the BoE’s supervision of systemic risk relating to payments beyond payment systems and associated service providers, as set out in Part 5 of the Banking Act; (ii) the principles the government would apply to any reforms of the BoE’s regulatory responsibility for systemic payments activities, namely that of ‘same risk, same regulatory outcome’; (iii) what an amended regulatory perimeter would involve for regulating risk end-to-end throughout the payment chain; what criteria would apply to recognising new entities; and the continued role for HMT in determining which entities fall within the systemic regulatory regime; (iv) the changes that would be required to ensure the effective and proportionate deployment of the BoE’s supervisory powers; (v) how accountability could be enhanced in the event of any expansion of the BoE’s regulatory remit, drawing on the ‘Financial Services Future Regulatory Framework Review’; (vi) potential reforms to clarify the PSR’s regulatory framework; and (vii) the Senior Managers & Certification Regime’s potential application to the sector. This consultation closes on 11 October.
Payment and Electronic Money Institution Insolvency (England and Wales) (Amendment) Rules 2022 published
On 20 July, the Payment and Electronic Money Institution Insolvency (England and Wales) (Amendment) Rules 2022 were published on legislation.gov.uk, alongside an explanatory memorandum. The instrument corrects drafting errors in the rules for the special administration procedure established in The Payment and Electronic Money Institution Insolvency (England and Wales) Rules 2021. Under the 2021 Rules an administrator may apply to the court for an order of limited disclosure in respect of a statement of affairs or a statement of concurrence (rule 22), or any specified part of a statement of proposals (rule 27). Rule 2(2) and (4) amends rules 22 and 27 of the 2021 Rules so the phrase “as it thinks just” extends to all conditions to which a court may make a disclosure order subject. Rule 291 of the 2021 Rules made provision for remote attendance at, and the venue of, meetings held under the 2021 Rules. Rule 2(12) deletes rule 291(1) of the 2021 Rules, because provision on these matters was made by rules 63, 80 and 81 of the 2021 Rules and section 246A of the Insolvency Act 1986 (c. 45), as modified by the relevant row of the table in regulation 37 of the 2021 Regulations. The other paragraphs of rule 2 correct other minor drafting errors in the 2021 Rules.
Prudential Regulation
RTS on Pillar 2 add-ons for investment firms under IFD
On 21 July, the EBA published a final report on draft RTS on Pillar 2 add-ons for investment firms under the IFD. These draft RTS clarify how competent authorities should measure risks or elements of risks that investment firms face or pose to others, which are not covered or not sufficiently covered by the own funds requirements set out in Parts Three and Four of the IFR. The report follows the EBA's November 2021 consultation and a summary of the feedback is set out in chapter 4.2. Most of the comments touched upon three areas: (i) the assessment of risks that are excluded from own funds requirements; (ii) the expression of additional capital requirement; and (iii) the metrics relative to risks-to-clients. Changes have been made to the draft RTS as a result of the feedback. The draft RTS will be submitted to the EC for endorsement before being published in the OJ. The EBA want the technical standards to be in force when the SREP guidelines for investment firms under the IFD become applicable (see further below).
Guidelines on SREP common methodologies under IFD
On 20 July, the EBA and ESMA published a final report on joint guidelines on common procedures and methodologies for the supervisory review and evaluation process (SREP) for investment firms under the Investment Firms Directive (IFD). The final SREP guidelines set out the common process and criteria for the assessment of the main SREP elements, including: (i) business model; (ii) governance arrangements and firm-wide controls; (iii) risks to capital and capital adequacy; and (iv) liquidity risk and liquidity adequacy. The consistency and comparability of assessment is facilitated by the common scoring framework, differentiating between risks and viability scores. The scores of individual risks and SREP elements are brought together to form an overall SREP score, reflecting the assessment of the viability of the investment firm. The outcome of the assessment is the basis for taking any necessary supervisory measures to address specific risks and concerns. Therefore, guidance is provided on the application of supervisory measures, including quantitative capital and liquidity measures as well as other qualitative measures. The guidelines specify common procedures and methodologies for SREP which are proportionate to the different sizes and business models of investment firms, and the nature, scale and complexity of their activities. In particular, investment firms are classified into four distinct categories, which translate into different frequency, depth and intensity of the assessments, and the engagement of the competent authority. The guidelines will be translated into the official EU languages and published on the EBA and ESMA websites. The deadline for competent authorities to report whether they comply with the guidelines will be two months after the publication of the translations. The date of application remains to be “inserted by the editor” but the guidelines do state that they should be immediately applicable to the SREP exercises initiated in 2023.
EBA publishes 2023 EU-wide stress test methodology
On 21 July, the EBA published a draft version of its 2023 EU-wide stress test draft methodology, templates and template guidance, for discussion with the industry. The objective of the EU-wide stress test is to provide supervisors, banks and other market participants with a common analytical framework to consistently compare and assess the resilience of EU banks and the EU banking system to shocks, and to challenge the capital position of EU banks. The exercise is based on a common methodology and a set of templates that capture starting point data and stress test results. The EBA published draft versions of the: (i) methodological note. It aims to provide banks with adequate guidance and support for performing the EU wide stress test; and (ii) draft templates and guidance on the templates. The methodology covers all risk areas and builds on the one prepared for the 2021 EU wide stress test. Some aspects of the methodology have been improved based on the lessons from the 2021 exercise – for instance, the projections on net fee and commission income will be based on a top-down model. The 2023 exercise will assess EU banks' resilience to an adverse economic shock and inform the 2023 Supervisory Review and Evaluation Process. The final methodology will be published by the end of 2022. The EU-wide stress test will be launched in January 2023 and the results are expected to be published by the end of July 2023.
Financial Services Act 2021 (Prudential Regulation of Credit Institutions and Investment Firms) (Consequential Amendments and Miscellaneous Provisions) Regulations 2022 published
On 19 July, the Financial Services Act 2021 (Prudential Regulation of Credit Institutions and Investment Firms) (Consequential Amendments and Miscellaneous Provisions) Regulations 2022 were published on legislation.gov.uk, alongside an explanatory memorandum. The primary purpose of this instrument is to make amendments to legislation that are consequential on changes made by sections 1 to 5 of, and Schedules 1 to 4 to, the Financial Services Act 2021. This Act introduced the framework for the Investment Firms Prudential Regime (IFPR), and the transfer of certain prudential regulation set out in UK legislation to rules made by the PRA, enabling the future implementation of the Basel 3.1 standards. This instrument includes further consequential amendments following the introduction of the IFPR and Basel 3 standards on 1st January. In particular, this instrument: (i) repeals the Banking Act 2009 (Exclusion of Investment Firms of a Specified Description) Order 2014 as it is redundant following the removal of FCA-regulated investment firms from the UK resolution regime; (ii) makes transitional provision in respect of risk retention requirements for certain securitisations following the implementation of the IFPR. These requirements relate to the retention of a material net economic interest in a securitisation by the originator, sponsor, or original lender to better align their interests with those of investors; (iii) ensures that short-term liabilities owed to both PRA-regulated and FCA-regulated investment firms with permission to underwrite or deal on own account will continue to be exempt from bail-in; and (iv) addresses failures of retained EU law to operate effectively, and other deficiencies arising from the withdrawal of the UK from the EU. The Regulations will come into force on 17 August.
PRA prudential and resolution policy index published
On 19 July, the PRA published an Index of Prudential and Resolution Policies. This Index provides lists of currently applicable policies relating to the prudential regulation of financial services firms by the PRA and firms in scope of the UK resolution regime. This Index is intended to help firms identify which policies are relevant for their particular areas of business, and does so by grouping policies into sectors and topic area pages. The webpages are available from the following three sector pages: (i) banking, which sets out policies relating to banks, building societies, PRA-designated investment firms, branches, conglomerates and credit unions; (ii) insurance. This page compiles policies relating to Solvency II firms, non-Directive firms, branches, conglomerates and friendly societies; and (iii) other parties. Here, the webpage contains policies relating to Auditors and the FSCS. For each topic area, the Index provides a dedicated page listing links to related policies from sources including: (a) PRA rules (with waivers and modifications); (b) UK legislation and Technical Standards; (c) PRA Supervisory Statements, Statements of Policy and approach documents; (d) publications issued by the BoE as Resolution Authority; and (e) other relevant material, including Guidelines issued by the European Supervisory Agencies that remain applicable in the UK. Lastly, the PRA emphasises that the Index alone should not be regarded as the source of a complete, accurate or up to date list of those obligations. In particular, users should note that the inclusion of a link to an item of legislation does not indicate that the text linked to is the up to date version of the legislation. The PRA is seeking feedback and suggestions on the Index
Recovery and Resolution
Please see the “Prudential Regulation” section for the PRA prudential and resolution policy index and the Financial Services Act 2021 (Prudential Regulation of Credit Institutions and Investment Firms) (Consequential Amendments and Miscellaneous Provisions) Regulations 2022.
Regulatory Reform Post Brexit
Please see the “Markets and Markets Infrastructure” section for HMT consultation response on future regulatory framework for CCPs and CSDs.
HMT and CLC annual report on review of UK financial services sector
On 21 July, HMT published a report on the state of the UK financial services sector, produced jointly with the City of London Corporation (CLC). This first annual report sets out findings on the attractiveness and international competitiveness of UK financial services, in response to a recommendation from the 2021 Lord Hill’s UK Listing Review. The report is divided into chapters focused on individual themes that aim to capture the full spectrum of financial services policy priorities for the UK. The subsections compare the UK’s position with other major economies, using a selection of metrics that help illustrate the identified themes and outline historical developments over time, subject to data availability. The report emphasises the significant programme of work being taken forward by the government and the regulators to realise the opportunities presented by Brexit and build the coherent, agile and internationally-respected framework of financial regulation that is tailored for the UK’s markets. A particular focus of the government in the immediate future will be the passage of the Financial Services and Markets Bill 2022-23. HMT and CLC intend to use the report to monitor and comment on key performance indicators. By assessing where things are going well, and where they might want to do things differently, this report is intended to help inform policymaking and debate, and ensure that the UK positions itself to seize the opportunities ahead.
House of Commons (European Scrutiny Committee) report on retained EU law
On 21 July, the House of Commons European Scrutiny Committee published a report on retained EU law. The Committee welcomes the government's publication of the interactive dashboard of retained EU law, but questions whether it fully covers all categories of retained EU law and notes that it should feature consolidated texts. The report mentions the following points about the anticipated Financial Services and Markets Bill, referred to in the report as the Brexit Freedoms Bill: (i) the Bill should remove the principle of supremacy as it applies to retained EU law. It should provide that retained EU law cannot trump any incompatible UK statute. Supremacy is incongruous in the post-exit domestic legal framework and undermines certainty by effectively creating a second statute book; (ii) the Committee supports the use of secondary legislation to change the substance of retained EU law, given pressures on Parliamentary time. Wide amending powers should be carefully drawn and clearly conditioned; (iii) the Bill should include a ‘sunset’ provision with an ambitious timeframe after which all retained EU law is repealed. Thought should be given to replacement legislation needed to plug potential gaps in the statute book. A mid-point review in the Bill, coupled with clear prioritisation, could help keep tabs on progress; and (iv) the Bill may also make new provision for the interpretation of retained EU law by the courts. Changes should include revisiting the approach to retained general principles and abandoning the purposive approach of the Court of Justice of the EU.
HMT response to consultation on FRF review
On 20 July, HMT published its response to the second consultation relating to its Future Regulatory Framework (FRF) Review. This document provides a summary of the key themes raised by respondents, and notes HMT’s final policy position on the FRF Review reforms. Key points include: (i) a significant majority of respondents supported HMT’s proposal to introduce new secondary objectives about growth and competitiveness for the FCA and the PRA. The government intends to extend the accountability arrangements to the PSR, but does not propose to modify the PSR's statutory objectives as this would be duplicative; (ii) HMT intends to require the regulators to have regard to its commitment to achieve a net zero economy by 2050 by including a reference to this commitment in the regulatory principles; (iii) respondents generally welcomed the proposal of a power for HMT to direct the regulator to review rules where it is in the public interest. They nevertheless requested more clarity on when this power would be exercised and some respondents felt there should be further measures on accountability; (iv) the government intends to introduce a new statutory requirement for the PRA and the FCA to publish a statement of policy on how they review their rules, and for the PSR to publish a statement of policy on how it reviews its generally applicable requirements. It also intends to introduce a new statutory requirement for the PRA and the FCA to keep their rules under review and for the PSR to keep its generally applicable requirements under review; and (v) the government intends to take powers to set "have regards" that the regulators must consider when making rules in specific areas of regulation, and to place obligations on the regulators to make rules in specific areas of regulation. The government is legislating for these reforms through the Financial Services and Markets Bill and further detail is available in the accompanying Bill documents.
Financial Services and Markets Bill 2022-23 published and introduced to Parliament
On 20 July, the Financial Services and Markets Bill 2022-23 was published and introduced to Parliament, alongside explanatory notes. The Bill implements the outcomes of the Future Regulatory Framework Review and provides for the repeal of retained EU law in a way which facilitates a smooth transition to a comprehensive FSMA 2000 model. HMT does not expect to commence the revocation of retained EU law listed in the Schedule unless the regulators have drafted and consulted on rules that are ready to be enforced, where it is appropriate that these provisions are replaced. The Bill also introduces new secondary statutory objectives for the PRA and FCA to provide for a greater focus on growth and international competitiveness. Other areas of reform contained in the Bill include: (i) bringing stablecoins within regulation when used as a form of payment, paving their way for safe adoption in the UK; and (ii) creating a framework for reducing risk to the finance sector from critical third parties; (iii) implementing the outcomes of the Wholesale Markets Review; (iv) reforms following Lord Hill’s UK Listing Review, to make the UK’s prospectus regime simpler, more agile and more effective; (v) an equivalence regime for overseas STS securitisations; (vi) a new senior managers and certification regime for certain types of FMI; (vii) changes to the regulation of financial promotions; (viii) enabling regulatory action by the PSR to mandate reimbursement of victims of “authorised push payment” scams; (ix) establishing a framework for a Desigated Activities Regime; and (x) implementing recovery and resolution framework for CCPs. On the same day, the speech given by Nadhim Zahawi, Chancellor of the Exchequer, at the Mansion House on 19 July, was published. Discussing the Bill, he noted that there had been some speculation about the government taking further powers to intervene in financial regulation, in the public interest. He stated that this is "something we're looking at" and that he is "keeping an open mind". Nevertheless, he confirmed that no such powers are included in the Bill as he wants "time to consider all the arguments before making such an important decision". MPs will next consider the Bill at Second Reading on 7 September.
Sustainable Finance
FMSB spotlight review on ESG Ratings
On 20 July, the Financial Markets Standards Board (FMSB) published a spotlight review on ESG ratings. The review examines ESG ratings methodologies and data collection processes. The review builds on an existing body of work produced by regulators, standard-setters and industry participants and focuses on issues identified in the following areas: (i) output/objectives of ESG ratings; (ii) data inputs; (iii) methodology; and (iv) post-assessment rating process. This paper seeks to facilitate greater transparency of ESG ratings methodologies and data collection processes to enhance understanding of ESG ratings and facilitate comparability across ratings providers in wholesale financial markets. It acknowledges that these disclosures must be proportionate to the capacity of both rated entities and rating providers, and commercial sensitivity. The review concludes that ESG ratings remain an evolving product type. The methodologies of ESG rating providers and the transparency that they provide, have, and will continue to develop, as will the disclosure regimes for issuers that should improve the quality of the underlying data upon which they rely. As this area of the market further matures, a natural evolution might be an industry-led effort to refine the ‘proposals for ESG rating providers’ into a more focused list of disclosure requirements, creating a degree of convergence on the most important disclosures which should be provided by all rating providers, while keeping in mind the requirements for proportionality and phase-in. This could set a benchmark level of transparency across the industry as ESG ratings become a fully-embedded part of the capital markets landscape. Credit ratings are considered distinct from ESG ratings and are outside the scope of the review, though many “traditional” credit agencies also provide ESG ratings, which are included. The review also does not include ESG fund ratings, which are designed to measure ESG characteristics of a fund’s underlying holdings.
Delegated Regulation on specific public disclosures for gas and nuclear activities
On 15 July, Commission Delegated Regulation (EU) 2022/1214 amending Delegated Regulation (EU) 2021/2139 as regards economic activities in certain energy sectors and Delegated Regulation (EU) 2021/2178 as regards specific public disclosures for those economic activities was published in the OJ. The Delegated Regulation sets out the conditions under which nuclear and natural gas energy activities can be included in the list of economic activities covered by the EU Taxonomy Regulation. It also amends Commission Delegated Regulation (EU) 2021/2178 to require large listed non-financial undertakings and financial undertakings to disclose the amount and proportion of their activities linked to natural gas and nuclear energy. The Delegated Regulation will enter into force on 4 August, 20 days after its publication in the OJ, and will apply from 1 January 2023.
Other Developments
Joint transformation programme on data collection: Phase 1 recommendations with BoE and FCA response
On 21 July, the BoE published the Phase 1 recommendations of the transformation plan and joint transformation programme to transform data collection from the UK financial sector, alongside the BoE and FCA response. The joint transformation programme made seven recommendations to the BoE and FCA, aimed to target a selection of the issues identified by the delivery team. The recommendations relate to the following use cases: (i) BoE form DQ; and (ii) FCA financial resilience survey. In their joint response, the BoE and FCA accepted all of the recommendations made by the industry committees in principle. The stakeholders in both organisations were very supportive of the recommendations, which they felt provided a balanced mix of shorter term wins and longer term transformational improvements. For some recommendations, the BoE and FCA are keen to move to delivery of solutions immediately. For other recommendations, the joint transformation programme will need to explore the solutions further to understand how they might be delivered and the associated business case. If the BoE and FCA find that there is a business case, then they will add such recommendations to their future roadmap for transformation. No recommendations have been made for the commercial real estate use case at this stage.
EBA report on benchmarking of remuneration practices at EU level and data on high earners
On 21 July, the EBA published a report on benchmarking remuneration practices in EU banks for the financial years 2019 and 2020, as well as high earners data for 2020. The EBA has analysed the data provided for the financial year 2020 and compared them with the 2019 and, with regard to high earners, also 2018 data. The main results are: (i) the total aggregated figures in the EU for 2019 compared to 2020 show a material decrease from 4 963 to 1 383 high earners who were awarded EUR 1 million or more remuneration, due to the fact that 2020 figures do no longer include data for high earners in the UK, who accounted for 71% of all high earners in 2019. Additionally, the weighted average ratio of variable to fixed remuneration for all high earners fell from 129% in 2019 to 86.4% in 2020; (ii) for the EU27/EEA, there was a slight decrease in the number of high earners, from 1 444 in 2019 to 1 383 in 2020 (- 4.2%). The decrease is mainly caused by the reduction of the variable remuneration for certain staff in the context of the COVID-19 pandemic, also in line with the EBA recommendation to set variable remuneration of identified staff at a conservative level. An increase of the weighted average ratio from 85.9% in 2019 to 86.4% in 2020 was observed, which was mainly caused by large severance payments; and (iii) the regulatory framework for remuneration practices still appeared not sufficiently harmonised; in particular, the application of deferral and pay-out in instruments differs significantly among Member States (EU and EEA) and institutions, mainly in relation to differences in the national implementation of CRD. The implementation of CRD V on 28 December 2020, which introduced specific criteria for derogations to the requirement to pay out a part of the variable remuneration in instruments and under deferral arrangements, is expected to increase the level of harmonisation.
Discussion paper on operational resilience of Critical Third Party Service Providers
On 21 July, the BoE, PRA and FCA published a joint discussion paper on potential measures to oversee and strengthen the resilience of services provided by critical third parties (CTPs) to the UK financial sector. The government has included legislative proposals in the Financial Services and Markets Bill to grant the supervisory authorities powers to directly oversee the resilience of services that CTPs provide to the UK financial sector. The FCA, PRA and BoE welcome the proposals in the Bill, and are launching this discussion paper on how they could use their proposed powers, which include: (i) a framework for identifying potential CTPs, which would inform the supervisory authorities’ recommendations for formal designation by HMT; (ii) minimum resilience standards, which would apply to the services that designated CTPs provide to firms and FMIs including a requirement to develop and test financial sector continuity playbooks; and (iii) a framework for testing the resilience of material services that CTPs provide to authorised firms and FMIs using a range of tools, including but not limited to scenario testing, participation in sector-wide exercises, cyber resilience testing, and skilled persons reviews of CTPs. These measures would complement, not replace, firms’ and FMIs’ existing responsibilities to manage risks from contracts with third parties. The supervisory authorities would only oversee the systemic risks arising from the services CTPs provide to firms and FMIs. Comments are open until 23 December. Subject to the outcome of Parliamentary debates on the Financial Services and Market Bill, and having considered responses to this discussion paper, the supervisory authorities plan to consult on their proposed requirements and expectations for CTPs in 2023.
PRA speech on new challenges for investment banks
On 20 July, the PRA published a speech by Nathanaël Benjamin, PRA Executive Director, Authorisations, Regulatory Technology, and International Supervision, on new challenges faced by investment banks. Key points include: (i) in January, the PRA warned that future cyclical and structural changes could materially threaten profitability and sustainability of certain business models. Since then, events have unfolded, and geopolitical and macroeconomic uncertainty is translating into market volatility. Meanwhile, digitalisation continues at pace, as new technologies, products and partners enter the financial services ecosystem, and the risks from climate change loom and threaten to change the very nature of the environment banks operate in; (ii) risk concentration should not only be assessed on a client by client basis, but across all clients combined, and most importantly, across the client’s market-wide portfolio, not just the portion held with a single firm itself. Whilst this information may not be readily available, the onus is on firms to demand of their clients the information they need to assess the risks they are exposed to; (iii) it is important that market and counterparty risk lessons are learned, especially for business lines that have grown on the back of the post-crisis macro environment as well as less liquid activities; (iv) established banks must not let commercial pressure to adopt new technologies or enter digital asset markets get in the way of first ensuring that they can properly understand and manage the associated risks. The PRA places particular emphasis on its operational resilience expectations and how banks should use these to inform technology investment decisions; (v) over the last couple of years markets have exhibited a number of features that arguably demonstrate some of the future consequences of climate change, depending on how the climate transition pans out. Investment banks should take recent disruptions in commodities or supply chains as a sign of things to come, and get used to managing those; and (vi) if investment banks are to perform in this "new world", they will need to challenge themselves on their true capabilities, be forward-looking, anticipate changing conditions, and prepare to encounter unexpected events along the way. This will require honest introspection, hard work, and at times completely rethinking their future role in society.
FCA annual report and accounts 2021/22 – investigations and enforcement
On 19 July, the FCA published its annual report and accounts 2021/22, which outlines the work it has undertaken to achieve its key priorities, cross-cutting priorities and priorities within specific sectors. Among others, the report includes the following, which are relevant from an investigations and enforcement viewpoint: (i) 2021 market cleanliness (MC) statistics. For 2021, the MC measure was 7.7%, the abnormal trading volume measure was 7.1% and the potentially anomalous trading ratio was 6.1%. All of these were a decrease from the previous year, although the FCA cautions against year-on year comparisons and looks at these measures in the round. Indeed, MC data does not provide a complete picture of market abuse and needs to be read with caution. But the evidence supports a view that the UK market was resilient to market abuse despite navigating significant market events. Nevertheless, despite the relatively positive MC data, referrals for insider dealing and market manipulation from the FCA’s Enforcement teams increased. The FCA thus used non-enforcement actions, such as supervisory actions, where it felt they provided the appropriate deterrents; (ii) use of skilled person reports. In 2021/22, the FCA used the s166 power of FSMA in 38 cases, and appointed the skilled person firm in 6 of those cases. The reviews examined a number of regulatory issues, including financial crime, corporate governance and senior management arrangements, adequacy of advice, adequacy of systems and controls, client money and client asset arrangements, as well as risk management; and (iii) Regulatory Decisions Committee (RDC) annual review. 81 cases were referred to the RDC and 86 cases completed in the period, compared to 224 and 229 in the previous year. The reduction in case numbers is largely a result of the RDC’s recent change in remit. The majority of the cases the RDC dealt with over the past year came from the FCA’s Enforcement and Market Oversight Division, ranging from the most complex cases involving allegations of serious misconduct to more straightforward cases, where firms or individuals had failed to submit returns or pay fees due to the FCA. The RDC also dealt with a number of contested cases, which came from the FCA’s Authorisations Division and recommended by Supervision to give First Supervisory Notices.
Annual report and accounts 2021/22
FCA 2022 perimeter report
On 19 July, the FCA published its 2022 perimeter report. The report sets out the FCA's general approach to the perimeter, the challenges faced, and explains how it: (i) monitors and assesses the potential for harm linked to the perimeter as part of the normal course of its regulatory activities; (ii) shares insights and information with partner agencies; (iii) addresses fraud risks outside the perimeter of regulation but involving authorised firms; and (iv) works with the financial promotion and enforcement taskforce, which delivers an integrated approach to tackling scams, breaches of the perimeter and non-compliant financial promotions. The report also covers topics involving firms’ business models and the structures they choose to adopt, including: (a) unregulated debt advice lead generators; (b) appointed representatives; (c) outsourcing/ third-party service providers; (d) deposit aggregators; and (e) firms supervised under MLRs. The report also tackles technological changes. The FCA’s focus now resides in: (i) tackling online harms and fraud; (ii) monitoring digital markets; (iii) regulating the payments market by improving firms' resilience and consumer protection; (iv) supporting open banking, open finance and smart data; (v) maintaining access to cash; and (vi) regulating cryptoassets. On the senior managers and certification regime (SM&CR), the FCA notes that recognised investment exchanges, and credit rating agencies are not currently subject to the SM&CR. It believes extending the regime to them would deliver greater accountability and robust oversight of functions that promote market integrity. Extending the regime to payments and e-money firms would also strengthen individual accountability and governance in firms and strengthen its ability to supervise them. Regarding the overseas persons exclusion (OPE), the FCA is working closely with HMT in preparation for its consultation on the UK’s overseas framework, an issue that is becoming more pressing as firms consider their UK, European and global operating models. The consultation will consider whether the current operation of the UK’s regime for overseas firms appropriately balances openness while mitigating risks to the resilience and safety of financial markets, the protection of consumers and market integrity, and the promotion of competition. In its view, greater information requirements and powers along with greater visibility and oversight of firms using the OPE would be beneficial and the overseas perimeter would benefit from greater clarity about when a regulated activity is being carried on in the UK. The FCA states that its perimeter report webpage will be updated once a quarter.
Government policy paper, action plan and call for views on regulating AI
On 18 July, the government published a policy paper on establishing a pro-innovation approach to regulating AI with proposals for the regulation of AI, alongside an action plan that outlines the activities being taken by each government department to advance the government’s 2021 National AI Strategy. The government describes its approach as context-specific, pro-innovation, risk-based and coherent, but also as less centralised than the EU’s. The plan suggests that rather than establishing rigid, inflexible requirements, the government will engage with regulators to consider lighter touch options, such as guidance or voluntary measures, in the first instance. The government will develop a set of cross-sectoral principles that regulators will develop into sector or domain-specific AI regulation measures. The government’s proposals for these principles will be that: (i) businesses must ensure that AI: (a) is used safely, is technically secure, functions as designed, and is appropriately transparent and explainable; and (b) takes into account considerations of fairness; and (ii) regulators will have to make sure that legal persons can be identified as responsible for AI, and introduce rules clarifying routes to redress or contestability. Responses will be considered alongside further development of the framework in the forthcoming AI White Paper in late 2022, which will explore how to put the principles into practice. The call for views closes on 26 September.
FCA publishes Handbook Notice 101
On 18 July, the FCA published Handbook Notice 101, which describes the changes to the FCA Handbook made by the Board of the FCA on 23 June and 15 July. It reflects changes made by the following instruments: (i) Periodic Fees (2022/2023) and Other Fees Instrument 2022. This instrument publishes the 2022/23 periodic regulatory fees and levies for the FCA, the FOS, the Money and Pensions Service, the devolved authorities and HMT’s expenses in funding the teams that tackle illegal money lending. This instrument came into force on 1 July; (ii) Collective Investment Schemes Sourcebook (Side Pockets) (Russia) Instrument 2022. This instrument finalises Handbook rules to allow funds to use side pockets where their Russian, Belarusian and Ukrainian exposures are subject to financial sanctions, or cannot be valued or traded. This instrument came into force on 11 July; (iii) Funeral Plans (No 5) Instrument 2022. The instrument amends the Compensation rules relating to the Financial Services Compensation Scheme in relation to funeral plans and to the Funeral Plan: Conduct of Business sourcebook. This instrument comes into force on 29 July; and (iv) Dormant Assets Instrument 2022. This instrument ensures that the definitions relating to dormancy capture the widening of the Dormant Asset Scheme to include insurance and pensions assets. In addition, amendments to the Dispute Resolution: Complaints sourcebook will provide customers of insurers and pension providers with the same access to a dispute resolution service. This instrument comes into force on 1 August.
PRA consults on unvested pay, MRTs and public appointments
On 15 July, the PRA published a consultation paper setting out its proposed expectations in respect of unvested pay, material risk takers (MRTs) and public appointments, revising its supervisory statement on remuneration. The revisions focus on changes to the instruments or claims that comprise unvested, deferred sums awarded to MRTs as part of their variable pay. The paper considers, in particular, cases where a change is prompted by the need to manage a conflict of interest arising from a MRT seeking a senior public appointment linked to financial policy or financial services regulation. The PRA proposes to add a new section to the supervisory statement on remuneration to explain that: (i) in general, unvested, deferred claims that comprise the variable pay of MRTs should not be converted from an equity claim into a claim on other instruments (or vice versa) after an award has been made. This expectation should apply to all unvested, deferred sums, and not exclude amounts above the regulatory minima; and (ii) in exceptional circumstances, such as where there are potential conflicts of interest arising from a (proposed) public-sector appointment that cannot otherwise be sufficiently mitigated, it may be appropriate for a conversion to occur subject to the prior non-objection of the PRA, and on the basis that the relevant retention requirements remain unchanged. Moreover, the PRA considers that in wholly exceptional circumstances, where conversion to an award that comprises other instruments is not sufficient to mitigate conflicts, conversion to cash may be appropriate. Where conversion to cash would breach the minimum non-cash instruments requirement, this would require a waiver or modification, where the PRA would consider any application in each particular case in accordance with the statutory test. This consultation closes on 19 September. The PRA proposes that the implementation date for the changes resulting from this consultation paper would be 12 December.