Key Regulatory Topics: Weekly Update 17-23 June 2022
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This week in the UK, HM Treasury has published its response to its consultation on regulating interest free buy-now pay-later credit products, the Treasury Committee has published a report on future parliamentary scrutiny of financial services regulation, and the Payment Systems Regulator has announced two market reviews into card fees. In Europe, the European Banking Authority has replied to the European Commission’s call for advice on the review of the PSD2, and the Council of the EU has agreed its position on the proposed Directive amending the AIFMD and the UCITS Directive.
Consumer/Retail
HMT response to consultation on regulation of BNPL credit products
On 20 June, HMT published its response to its consultation on regulating interest free Buy-Now Pay-Later (BNPL) credit products. HMT consulted on regulating BNPL credit products in October 2021, proposing a proportionate approach to regulation. HMT has analysed the responses to its consultation and used them to develop its policy approach. HMT’s response includes the following points: (i) the scope of regulation should capture BNPL and other currently exempt agreements (referred to as short-term interest-free credit (STIFC)) when they are provided by third-party lenders; (ii) HMT is minded to extend this scope to also capture STIFC provided directly by merchants where it is offered online or at a distance. Further stakeholder engagement is necessary to fully understand the scale of the merchant-offered STIFC market. Therefore, stakeholders are invited to provide further information by 1 August. Comments are particularly welcome in relation to the sectors in which responses to date indicate such credit may be offered, such as dentistry, healthcare, education, sports clubs, vehicle repair and potentially SME retailers; (iii) HMT will allow exemptions for specific agreements where there is limited risk of potential consumer detriment, and where regulation would otherwise adversely impact day-to-day business activities; and (iv) HMT’s approach to regulatory controls for agreements that will be brought into regulation will tailor the application of the Consumer Credit Act 1974 to these products, and the elements of lending practice most linked to potential consumer detriment. Given the complexity of this regulation, HMT aims to publish a second consultation to seek views on the detail of draft legislation, alongside a final decision about extending the scope of the regulation to merchant provided STIFC, online or at a distance, by the end of 2022. Following the second consultation, HMT aims to lay secondary legislation in mid-2023, confirming the scope and framework of the new regulatory regime. This will enable the FCA to consult on its approach for the new regime and undertake a cost-benefit analysis.
FPC response to consultation on withdrawal of mortgage affordability test recommendation
On 20 June, the BoE published the response from the Financial Policy Committee (FPC) following its consultation paper on the withdrawal of the mortgage affordability test recommendation. Introduced in 2014, the test specifies a stress interest rate for lenders when assessing prospective borrowers’ ability to repay a mortgage. In the consultation paper, published in February, the FPC sought views on its proposal to withdraw the affordability test recommendation and on the potential impact this might have on the mortgage and housing markets. It received 27 responses, including from four trade bodies that collectively represent the majority of mortgage providers and intermediaries in the UK mortgage market. The majority of responses were supportive of withdrawing the affordability test, and agreed with the FPC’s assessment that the loan to income flow limit and the FCA’s Mortgage Conduct of Business (MCOB) framework ought to provide the appropriate level of resilience. The consultation feedback did not provide any evidence to suggest that removing the affordability test would have a significant impact on the mortgage or housing markets. As a result, the FPC has decided to withdraw the affordability test recommendation with effect from 1 August. The withdrawal of the FPC affordability test recommendation does not place any requirement on lenders to take action, as existing affordability assessment practices are subject to the FCA’s MCOB framework, and will remain so. It will be up to individual lenders as to whether they wish to make any changes to their own lending practices and to determine the timing of any such changes after this date. The response paper sets out the background and rationale for the FPC’s decision. It also sets out the FPC’s response to the feedback received and how this feedback has been factored into its decision.
FCA announces funeral plan providers likely to be authorised
On 17 June, the FCA published a list of providers it intends to authorise when the pre-paid funeral plans industry comes under its regulation from 29 July. There are 24 firms on the list, including the largest funeral plan providers. These firms hold approximately 87% of existing customer plans. The FCA is still assessing a small number of providers’ applications and will give an update on these as soon as possible. Until regulation comes into force, all of the providers in this market remain unregulated, meaning that customers do not have access to the Financial Services Compensation Scheme, and the FCA has limited powers. The FCA continues to work with the industry to find longer-term solutions for customers of providers that have not applied for authorisation or have withdrawn.
Financial Crime and Sanctions
ESMA updates MAR Q&A
On 23 June, ESMA published an updated version of its Q&A on the Market Abuse Regulation (MAR). The new Q&A 9.2, in the section on market soundings, is on the scope of Article 11(1a) of MAR. ESMA explains that the scope of Article 11(1a) of MAR is limited to the communication of information to the potential qualified investors who negotiate the terms and conditions to subscribe to the bonds only. Article 11(1a) sets forth an exception from the market soundings regime provided in Article 11(1), which has to be interpreted narrowly. The communication of information to potential investors contacted after the terms and conditions have been determined therefore falls in the scope of Article 11(1), as it takes place prior to the announcement of a transaction, in order to gauge the interest of potential investors in a possible transaction and the conditions relating to it. Further, Recital 6 of Regulation (EU) 2019/21151 clarifies that the aim of the communication of information in that negotiation phase is to structure and complete the transaction as a whole, and not to gauge the interest of potential investors as regards a predefined transaction. This reasoning is based on the fact that the negotiation phase of the transaction essentially differs from the communication of information to gauge the interest of potential investors. Therefore, the exception provided in Article 11(1a) relates only to private placements being the result of negotiations between an issuer and a limited number of potential qualified investors, aiming to determine the contractual terms and conditions of the transaction.
Revised guidance on use of SAR glossary codes and reporting routes
On 17 June, the UK Financial Intelligence Unit (UKFIU) of the National Crime Agency (NCA) published revised guidance on the use of Suspicious Activity Report (SAR) glossary codes and reporting routes. The use of glossary codes is considered good practice. They are crucial for enabling the UKFIU and wider law enforcement to conduct analysis to identify money laundering trends, high risk cases for development, and take immediate action where necessary. They also enable the production of feedback to reporters on trends and patterns identified in SARs. The following key points are highlighted: (i) the SARs regime is not a route to report crime or matters relating to immediate risks to others. The SARs regime is for reporting knowledge or suspicions of money laundering, or belief or suspicions relating to terrorist financing. As such, in addition to a SAR, reporters may have to report the matter via other routes to ensure the right information gets to the right organisation; (ii) when submitting a SAR, the relevant glossary code should be included in the ‘Reason for Suspicion’ text space; and (iii) it is acceptable to have a SAR with several codes. If in doubt as to whether a particular code applies, always work on the basis that it is better to include one than not. It is also possible that a code does not match the set of circumstances faced by the reporter, so in some cases it is acceptable that “no codes apply” be populated into the ‘Reason for Suspicion’ text space.
FCA’s update on market abuse and manipulation work
On 17 June, the FCA published an update about its work on market abuse and manipulation. The press release responds to recent reports about the FCA’s approach, outlining the work the FCA does to tackle insider dealing and manipulation. Among other things, the press release highlights how the FCA: (i) prioritises a data-led approach. It undertakes daily monitoring to ensure the timeliness and accuracy of the disclosure of inside information. Firms and venues send over 30 million transaction reports and over 100 million order reports a day, which are analysed by its market data processor. This processor allows the FCA to oversee the market in close to real time, with dedicated software and algorithms to detect potential issues. The data collected is complimented by suspicious transaction and order reports (STORs) sent by market participants when they have ‘reasonable grounds’ to suspect market abuse, which are assessed by the FCA’s specialist team; (ii) regularly publishes the findings of its oversight work in Market Watch publications, which share good practice and highlight weaknesses likely to be common in firms’ systems and controls. These notes provide up to date information for firms that also facilitates their scrutiny of the market, which, in turn, improves the quality of the STORs received; (iii) takes enforcement action when detecting market manipulation, including criminal prosecution. The FCA notes that the burden of proof in a criminal case is high, however, in many of the reports or concerns reviewed, strong suspicion is often matched by weak or non-existent evidence. The challenge of building a criminal case begins well before the case reaches court, and the FCA needs to conclude a court would be more likely than not to convict before a suspect is charged. The FCA also makes use of its civil enforcement powers, which has a different standard of proof; and (iv) collaborates with international partners to disrupt the activity of suspected serial market abusers. Recently, the FCA worked with the DFSA in Dubai and the AMF in France and shared intelligence with colleagues in the US.
Outcomes from June 2022 FATF plenary
On 17 June, the Financial Action Task Force (FATF) published the outcomes from its June 2022 plenary meeting. Among other things, the FATF: (i) finalised a report that shares good practices and recommendations for combating money laundering and terrorist financing by sharing information while adhering to data protection and privacy. This is the first report that provides tangible examples of information sharing initiatives with analysis of the data protection implications. It highlights the importance of collaboration and cooperation between anti-money laundering and data protection authorities. This report is due to be published in July; (ii) discussed a targeted update on the implementation of the FATF Standards to prevent the misuse of virtual assets and virtual asset service providers (VASPs) for money laundering, and the financing of terrorism and proliferation. The report focuses on the implementation of the FATF’s travel rule, which requires VASPs to collect or send information on the identities of the originator and beneficiary with virtual asset transfers. The report stresses the urgent need for jurisdictions to implement and enforce the travel rule. In addition, the report provides a brief update on emerging risks and market developments that the FATF continues to monitor, such as decentralised finance, non-fungible tokens, and unhosted wallets. The report will be published at the end of June; (iii) discussed progress in developing guidance that aims to help countries implement the FATF Standard on beneficial ownership information for legal persons. Delegates agreed to seek views from targeted stakeholders before finalising the guidance in October; (iv) considered amendments to strengthen Recommendation 25, which aim to ensure a balanced and coherent approach to beneficial ownership in the FATF Recommendations. The FATF is releasing a white paper for public consultation and welcomes views particularly on the scope of legal arrangements, risk assessment and foreign trusts; obligations of trustees; definition of beneficial owners; approach in collecting beneficial ownership information; adequate, accurate and up-to-date information; and obstacles to transparency. The deadline for comments is 1 August; and (v) heard the key priorities of the Singapore Presidency, which starts on 1 July. These include a particular focus on strengthening asset recovery and international cooperation in combating cross-border financial crime, such as cyber-enabled fraud and ransomware. The FATF will also work to strengthen the use of data analytics and public-private partnerships to better combat money laundering and terrorism financing. The FATF will publish the FATF priorities under its Singapore Presidency on 1 July.
Fintech
Please see the ‘Financial Crime and Sanctions’ section for the outcomes from the June 2022 Financial Action Task Force (FATF) plenary meeting.
Fund Regulation
Council Presidency final compromise text of proposed Directive amending AIFMD and UCITS Directive
On 21 June, the Council of the EU published a note containing the Presidency’s final compromise text of the proposed Directive amending the AIFMD and UCITS Directive regarding delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services and loan origination by alternative investment funds. The Council announced on 17 June that it had agreed its general approach (see below).
ECON adopts amendments to ELTIF Regulation
On 20 June, the European Parliament's Economic and Monetary Affairs Committee (ECON) adopted its report on the proposed amendments to the Regulation on European long-term investment funds (ELTIFs). These new rules aim to facilitate the flow of funds towards the real economy, including green and digital priority areas. The following aspects of the amendments are highlighted in the press release: (i) protecting investors. All ELTIFs marketed in the EU have to be authorised. In addition, ESMA will have to keep and update quarterly a central public register of authorised ELTIFs with updated links to their annual reports and where available, the Key Information Document, so that investors can analyse and compare existing ELTIFs; and (ii) greener investments. It is necessary to clarify that ELTIFs can also invest in European green bonds. To this end, it is proposed to complement the existing rules so that green bonds and financial products that aim to make sustainable investments are explicitly included in the list of investment assets eligible for ELTIFs. The ECON negotiators are now ready to start talks with the Council of the EU, which has already adopted its position.
Council of the EU agrees position on proposed Directive amending AIFMD and UCITS Directive
On 17 June, the Council of the EU agreed its position on the proposed Directive amending the AIFMD and the UCITS Directive regarding delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services and loan origination by alternative investment funds. In a related press release, the Council: (i) stresses the importance of consistent harmonisation in the area of liquidity risk management. In particular, it underlines the need to improve the availability of liquidity management tools, with new requirements on managers to provide for the activation of these instruments. This will help ensure that fund managers are well equipped to deal with significant outflows in times of financial turbulence; (ii) supports the creation, as proposed by the EC, of an EU framework for loan-originating funds, supplemented with several requirements to alleviate risks for financial stability and to ensure an appropriate level of investor protection; and (iii) further clarifies the rules for outsourcing and the delegation of certain functions by fund managers to third parties. It also increases the supervisory cooperation in this area, and introduces new reporting requirements on delegation arrangements for the purpose of an improved monitoring and supervision of the application of the EU regulatory framework. The Council considers that precise reporting obligations on outsourcing will reduce the possibilities for creating letterbox companies. Other key issues for the Council concern the framework for the provision of cross-border services by depositaries, new reporting obligations for UCITS for the purpose of risk monitoring, and new transparency rules to enhance investor protection. Now that the Council has agreed its position on the proposal, it will enter trilogue negotiations with the EP to agree on a final version of the text. The Council published a note containing the Presidency’s final compromise text of the proposed amending Directive on 21 June (see above).
Markets and Markets Infrastructure
Please see the ‘Financial Crime and Sanctions’ section for ESMA’s updated version of it Q&A on the Market Abuse Regulation.
FCA updates webpage on accessing and using wholesale data
On 23 June, the FCA updated its webpage on accessing and using wholesale data. Following the FCA’s January feedback statement on accessing and using wholesale data, its trade data review is underway, and the FCA has therefore updated its webpage. As set out in its feedback statement, the FCA has concerns that ownership of trade data by trading venues, which include UK regulated markets, multilateral trading facilities and organised trading facilities, may give market power, resulting in: (i) increases in data charges that may be increasing costs to end investors above those expected in a competitive market; (ii) a level and structure of data charges that may be affecting asset managers’ investment decisions and so limiting competition between asset managers; and (iii) a level and structure of data charges that may be limiting the efficiency of trading activity in a way that affects price formation. The FCA is also concerned that current regulatory provisions for free delayed data may not be effective. The review is looking at these areas, and, if the FCA finds evidence that competition is not working well for users of trade data, it will assess the harm caused and propose remedies. The FCA has sent information requests to a sample of trade data suppliers in relation to equities, fixed income and derivatives, and will issue a questionnaire to users of trade data in July. The FCA aims to publish its trade data review findings and any next steps in January 2023. It will publish more information on its planned work on competition in the markets for benchmarks and credit rating data later in 2022.
EC adopts EMIR equivalence decisions for CCPs in China and Israel
On 22 June, the EC adopted two Implementing Decisions on the equivalence of the regulatory framework for central counterparties (CCPs) in China and Israel under EMIR. The Implementing Decisions will allow CCPs in these jurisdictions to apply for recognition by ESMA. Once recognised, these CCPs will be able to provide central clearing services in the EU to EU clearing members and trading venues. The Implementing Decisions were published in the OJ on 24 June and will come into force 20 days following this date.
Delegated Regulation on fees for supervising DRSPs under MiFIR published
On 17 June, Commission Delegated Regulation (EU) 2022/930 supplementing MiFIR by specifying fees relating to the supervision by ESMA of data reporting service providers (DRSPs) was published in the OJ. The Delegated Regulation covers the details of: (i) application and authorisation fees; (ii) annual supervisory fees; (iii) how to calculate applicable turnover; (iv) payment of fees; and (v) transitional provisions. The Delegated Regulation entered into force and applies from 20 June. There are also transitional provisions for 2022, when a fixed fee will be charged, and for 2023.
Payment Services and Payment Systems
EBA replies to EC’s call for advice on PSD2 review
On 23 June, the EBA published an opinion and report in response to the EC’s call for advice on the review of the Second Payment Services Directive (PSD2). The opinion, together with its annexed report, outlines a large number of issues identified in the implementation and application of the PSD2, and specific proposals on how to address these issues. The EBA observes that, overall, the objectives of the PSD2 have started to materialise, however, there are still many issues and challenges that need to be addressed. The EBA’s key proposals include: (a) merging the PSD2 and the Second Electronic Money Directive (EMD2); (b) clarifying the application of SCA and the transactions in scope; (c) addressing new security risks for customers, such as social engineering fraud, where customers are tricked into initiating a payment transaction; (d) addressing concerns about authentication approaches that have led to exclusion of certain groups of society from using payment services online; (e) addressing underlying issues and obstacles to the provision of payment initiation services (PIS) and account information services (AIS), including the proposals for AIS providers to apply their own SCA with their customers instead of relying on the authentication procedures by banks, empowering customers to remain in control of their data, and supporting the development of high-quality interfaces across the EU; (f) moving from 'Open Banking’ to ‘Open Finance’, or the expansion from access to payment accounts data towards access to other types of financial data, which is an opportunity to build on the sharing of data enabled by the PSD2; (g) addressing the enforcement shortcomings in relation to the implementation and application of SCA for e-commerce card-based transactions and the removal of obstacles to the provision of AIS and PIS; (h) addressing unwarranted de-risking practices by banks affecting payment and e-money institutions; and (i) adjusting the prudential requirements, in particular in relation to initial capital, own funds, the use of professional indemnity insurance, the proposal for recovery and wind-down for significant payment institutions and possible consolidation group supervision.
PSR announces market reviews into card fees
On 21 June, the PSR published draft terms of reference for its plans to carry out two market reviews focusing on card fees. The two market reviews will look at card scheme and processing fees, and at cross-border interchange fees. The market review of card scheme and processing fees (Market review 1) will focus on Mastercard and Visa, as these two card payment system operators account for 99% of debit and credit card payments in the UK. Market review 1 will examine the: (i) scheme and processing fees set by Mastercard and Visa (the levels, structures and types of scheme and processing fees), including any changes in the fee levels; and (ii) payments that Mastercard and Visa make to service-users including, for example, marketing assistance payments or rebates on scheme and processing fees. The PSR may look at levels, structures and types of payments made. It plans to focus on the period from 2014 to present day, allowing it to build on the analysis and data collected in its card acquiring market review. At this stage, the PSR does not limit the scope of the market review to the scheme and processing fees paid by any particular types of service-users. The PSR is planning to review whether there are factors that mean that Visa and Mastercard have market power and face weak constraints in setting scheme and processing fees, and the impact of this. It is also planning to consider the differences in the structure and levels of scheme and processing fees levied on different participants (including issuers and acquirers), and their impact on competition, innovation and service-user interests. The second market review focuses on UK-EEA consumer cross-border interchange fees (Market review 2). Cross-border interchange fees have increased significantly in the last year. This affects fees for certain card transactions between the UK and the EEA, where the cardholder is not present (such as payments made by phone or online). Since the UK left the EU, Visa and Mastercard have increased the interchange fees (IFs) rate by a factor of five. The PSR wants to understand the rationale behind these increases and whether they are an indication that the market, or aspects of the market, is not working well. To investigate these potential concerns, the PSR proposes to examine the following issues: (i) the potential drivers and justifications for the increases in these IFs since the UK’s withdrawal from the EU. As part of this, it will examine the reasons provided by the card scheme operators and the considerations that Visa and Mastercard took into account when assessing the opportunity to increase these fees, including strategic, competition and regulatory aspects; and (ii) the impact of the increases for UK-EEA consumer debit and credit card-not-present transactions on competition, innovation and service users. The deadline for feedback on both draft terms of reference is 2 August.
Prudential Regulation
EC adopts Delegated Regulations on RTS and ITS on authorisation of credit institutions
On 20 June, the EC adopted an Implementing Regulation and a Delegated Regulation with regard to the provision of information in applications for authorisation of a credit institution under the CRD IV Directive. The EC adopted: (i) an Implementing Regulation, and accompanying Annex, containing ITS with regard to the provision of information in applications for authorisation of a credit institution under the CRD IV Directive; and (ii) a Delegated Regulation, and accompanying Annexes, supplementing the CRD IV Directive with regard to RTS specifying the information to be provided in the application for the authorisation as a credit institution, and specifying the obstacles which may prevent the effective exercise of supervisory functions of competent authorities. The Council of the EU and the EP will now scrutinise the Delegated Regulations. If neither object, they will enter into force 20 days after their publication in the OJ.
EBA clarifies use of COVID-19-impacted data for internal credit risk models
On 21 June, the EBA published four draft principles to support supervisory efforts in assessing the representativeness of Covid-19-impacted data for banks using internal ratings-based (IRB) models. These principles will be part of a supervisory handbook, which the EBA will publish later in 2022, with the objective of ensuring a harmonised approach in the use of Covid-19 data, especially where the use of moratoria and other public measures may have led to changes in default rates. The principles relate to: (i) the assessment of data representativeness. The guidance laid down in the EBA's guidelines on probability of default (PD) and loss given default (LGD) should apply; (ii) IRB risk parameters. A significant decrease in applied IRB risk parameters compared to the pre-crisis levels indicates a potential lack of representativeness and should be analysed in more depth; (iii) default and loss rates. The third principle deals with the default and loss rates observed during the pandemic and clarifies that in case of non-representativeness of such rates, a recalibration should be postponed to lower long-run averages; and (iv) validation and recalibration of downturn LGD. The fourth principle tackles the validation and recalibration of downturn LGD in the context of the pandemic. Here, the EBA recommends that potential downward recalibrations be postponed at least until the effects of the crisis have fully materialised in the observed loss rates.
BoE consults on MRM principles for banks
On 21 June, the BoE published a consultation paper setting out the PRA’s proposed expectations regarding banks’ management of model risk, alongside accompanying appendices. The PRA has developed a proposed set of principles, which it considers to be key in establishing an effective model risk management (MRM) framework. It considers MRM as a risk discipline in its own right, and proposes to embed these principles, in a proportionate manner, as supervisory expectations for all regulated UK-incorporated banks, building societies, and PRA-designated investment firms. The MRM principles are intended to address specific shortcomings currently observed in UK banks. Although the proposed expectations would not apply to third-country firms operating in the UK through a branch, the PRA considers that those firms would find the proposed principles useful and would be welcome to consider them to manage model risk within their firm. The proposed expectations on MRM are set out in a proposed new supervisory statement titled ‘Model risk management principles for banks’, a draft of which is in the appendices. The PRA proposes all firms to adopt five principles, which it considers key in establishing an effective MRM framework. The proposed principles are intended to complement existing requirements and supervisory expectations in force on MRM, and relate to: (i) model identification and model risk classification; (ii) governance; (iii) model development, implementation and use; (iv) independent model validation; and (v) model risk mitigants. In the future, the PRA may seek to rationalise existing references to MRM under a single overarching policy framework, where the proposed broad expectations would be applicable to all model and risk types and where specific requirements and any more detailed expectations in relation to specific model types (current and prospective) would be seen as model or risk-specific chapters. The consultation closes on 21 October.
Regulatory Reform Post Brexit
Treasury Committee report on future parliamentary scrutiny of financial services regulations
On 23 June, the House of Commons Treasury Committee published its second report of session 2022-23 on future parliamentary scrutiny of financial services regulation. The Treasury Committee announced it will be establishing a new Sub-Committee to scrutinise regulatory proposals for financial services. The Treasury Committee outlines that new forms of scrutiny will be required, given that the number of regulatory initiatives is likely to grow as regulators assume additional responsibilities following the UK’s exit from the EU. The Sub-Committee on Financial Services Regulations will take the lead on scrutiny of financial regulatory proposals and will have powers to “send for persons, papers and records” and agree reports for submission to the main Committee for consideration. The Treasury Committee believes it would be most effective to intervene at the consultation paper stage of the financial services regulatory proposal process, where proposals have crystallised into draft texts but when there is still scope for influence. The new Financial Services Scrutiny Unit will include staff members of the Treasury Committee, and a legal adviser from the Office of Speaker’s Counsel. Specialist advisers will also be appointed to provide detailed and expert knowledge in the field. The Unit will assess each regulatory proposal, and offer advice to the main Committee on the likely impact, fitness for implementation, and on the appropriate level of scrutiny for each proposal. The Sub-Committee will focus on assessing regulatory proposals which contain texts that would have legal effect. The Sub-Committee will consider: (i) if the policy is justified and desirable? Is the balance between service providers, consumers and others the right one? Do the benefits outweigh any drawbacks; (ii) if the regulator is acting within their delegated power; and (iii) is the drafting of the necessary standard. The Sub-Committee will then take a decision on whether the proposal merits closer examination.
House of Lords European Affairs Committee report on UK-EU financial services relationship
On 23 June, the House of Lords European Affairs Committee published a report on the UK-EU relationship in financial services. Financial services are an important component of the UK economy, and the EU is an important trading partner in this sector. Among others, the Committee’s key findings include: (i) equivalence. The Committee found that the absence of EU equivalence decisions reflects a political, rather than technical, approach on the part of the EU, and that the UK is being held to a higher standard than other countries. However, the Committee concludes that it would be unwise for the government to base its strategy for financial services on a process that it cannot control, and which currently seems unlikely to bear fruit; (ii) regulatory co-operation. The Committee regrets that the Memorandum of Understanding (MoU) between the UK and the EU has still not been signed or entered into force. However, it acknowledges that this does not appear to have caused major problems so far, particularly as a series of other MoUs for technical co-operation between regulators are in place. Nevertheless, the Committee believes the MoU would still have value as a mechanism for strategic dialogue. It therefore calls on the government to step up its political and diplomatic financial services engagement with the EU; and (iii) regulatory reform and divergence. The Committee recognises that the UK's onshoring process has resulted in a complex and unwieldy regulatory framework. It notes the government's plans to give more powers to financial services regulators and calls for this to be accompanied by appropriate mechanisms for scrutiny and accountability. It has also asked the government to clarify how the proposed additional competitiveness objective would operate in practice. The Committee agrees with its witnesses that divergence between the UK and the EU is inevitable and may present the UK with opportunities to innovate and tailor regulation to its own interests. However, it also stresses that the government needs to weigh up the benefits of divergence against the costs of implementing new rules. The UK has inevitably lost influence in the development of future EU rules post-Brexit, however, the Committee is concerned that the government appears unwilling to utilise the influence it still has in the EU and has asked the government to clarify its position.
Sustainable Finance
FCA report on digital sandbox sustainability pilot
On 23 June, the FCA published a report on the second digital sandbox pilot focused on solving regulatory challenges related to ESG data and disclosure. This report provides an overview of the digital sandbox sustainability pilot, discusses the lessons learned, and outlines the FCA’s current thinking for the future of the sandbox. The report identifies several key lessons learned: (i) participants and mentors praised the sustainability pilot for bridging the gap between financial services and sustainability. However, ESG data and disclosures is also a broad theme that can sometimes be difficult to link with financial services. Due to the breadth of the field, the quality of the synthetic data assets and the ability to meet all mentor requests from participants sometimes suffered; (ii) ESG reporting and disclosures is a relatively new field in which open and rich datasets are not always readily accessible. When selecting focus areas for future digital sandbox initiatives, due consideration should be made of the data available in the field to ensure that there is enough quality data to meet participants’ testing requirements; (iii) the process of tailoring synthetic datasets required longer timescales than the approach used for the first pilot, resulting in some data assets not being available at the start of the sustainability pilot. Future iterations of the sandbox should consider how to balance producing bespoke data sets in the timescales available, and whether it is more appropriate to generate generalised synthetic data assets before the pilot starts; (iv) the teams experienced challenges in collaborating with other teams, particularly as the pilot progressed. A more structured approach towards facilitating collaboration between different teams may be helpful for future iterations of the digital sandbox; (v) continued access to the digital sandbox’s platform and services, particularly the data assets, would generate significant benefits for participants; and (vi) both the usage statistics and participants’ feedback suggest that, while some features of the platform provided value for users, the platform itself was not widely used over the course of the pilot. The FCA is committed to establishing a permanent operating model for a digital testing environment based on the principles, and improved by the experience and feedback, of the Digital Sandbox initiative. It is currently doing further research and industry engagement to ensure that this future service meets the needs of its end-users, and the potential use this initiative could support. The FCA is exploring further potential use for the initiative, including more regulatory collaboration in, for example, developing supervisory technology solutions. It is also exploring methods to make the digital sandbox data assets openly accessible in a way that complies with data protection laws.
Other Developments
The FCA has gained a new power to vary or cancel regulatory permissions held by firms that are not using them, via a faster process. The power reflects the FCA’s intention to become a more assertive regulator. The FCA expects that this will enhance consumer protection, but what impact will this new “use it or lose it” approach have in practice? Please see here for our blog post on the ‘FCA's power to remove firms not using regulatory permissions, a cancel culture of a different kind’.
FCA Data Strategy 2022 update
On 23 June, the FCA published an update on its Data Strategy. The update sets out where the FCA has made progress, where it has more to do, and where it has increased its focus. The FCA: (i) has deepened its understanding of markets and consumers. It has created Data Science Units which work closely with sector experts to analyse risk, triage cases and automate processes. The FCA has combined social media and information that is available online to increase its understanding of how firms market products and services to consumers online. It has also introduced analytical tools to help spot and intervene when it sees consumer harm. The FCA is using advanced analytics and new sources of data to identify high-risk financial adverts. It has collected more liquidity data meaning it can monitor the risk of firm failure and act early to improve consumer protection. Analytics have developed and implemented sanctions screening tools to support the monitoring of the effectiveness of a firm’s controls in identifying organisations or individuals that have been sanctioned; (ii) is becoming a digital and intelligence led regulator. The FCA has improved the management of its data to work quickly and efficiently with large, complex datasets and spot trends or areas for investigation across firms, sectors and products. The improvements include migrating its physical data centre to a cloud-based service, developing a Data Lake, a central data store for all FCA data, implementing Analytics tools, Data Science tooling and a new Decision Hub; (iii) has improved firm data collection. Last year, the FCA migrated 52,000 firms from Gabriel to RegData, a flexible and scalable data collections platform; and (iv) is building an innovation culture. The FCA has built a world-leading reputation for regulatory innovation, with its programmes such as the Regulatory Sandbox copied around the world. While pleased with the progress made in its Data Strategy over the past year, the FCA is pursuing its efforts to become a digital regulator. The FCA will publish further updates to explain its progress and how the outcomes the FCA delivers continue to support the transformation vision set out in 2021, and the priorities set out in its Business Plan 2022/23.