Key Regulatory Topics: Weekly Update 20 - 26 Jan 2023
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This week, TheCityUK published a report on improving the regulatory efficiency of FCA and PRA authorisations. The FCA published feedback on good and poor-quality applications made by cryptoasset businesses for registration under the MLRs, and also the findings of a multi-firm review into consumer duty implementation plans. In Europe, the European Parliament’s Committee on Economic and Monetary Affairs adopted reports on the CRD VI and CRR III, as well as on proposed Directives amending the AIFMD, the UCITS Directive, and the Consumer Rights Directive.
Consumer/retail
Please see the Other Developments section for a speech given by Mairead McGuinness, European Commissioner for Financial Services, Financial Stability and Capital Markets Union, on the European Commission’s upcoming and ongoing initiatives, and for the European Economic and Monetary Affairs Committee’s vote to adopt draft reports, including on the proposed Directive amending the Consumer Rights Directive concerning financial services contracts concluded at a distance and repealing the Distance Marketing Directive.
FCA multi-firm review into consumer duty implementation plans
On 25 January, the FCA published the findings of a multi-firm review into consumer duty implementation plans of larger ‘fixed’ firms with a dedicated FCA supervision team that primarily operate in retail financial services markets. Many of the plans indicated that firms have understood and embraced the shift to focus on consumer outcomes, established extensive programmes of work to embed the Duty, and are engaging with the substantive requirements, including the four outcome areas. However, some firms may be further behind in their thinking and planning for the Duty. The FCA sets out examples of good practice, and also some areas for improvement in relation to governance and oversight, culture and people, deliverability, third parties, the four outcomes, and data strategies. The FCA highlights three key areas where firms should particularly focus their attention during the second half of the implementation period (to 31 July): (i) effective prioritisation – firms should make sure they are prioritising appropriately, focusing on reducing the risk of poor consumer outcomes and assessing where they are likely to be furthest away from the requirements of the Duty; (ii) embedding the substantive requirements – some plans suggested that firms may have considered the requirements superficially or are over-confident that their existing policies and processes will be adequate. The FCA urges firms to carefully consider the substantive requirements of the Duty, as set out in its final rules and guidance; and (iii) working with other firms – to implement the Duty on time, many firms need to work and share information with other firms in the distribution chain. The FCA will soon be sending a survey to a sample of firms to help it understand the progress they are making in implementing the Duty, and will carry out targeted engagement with smaller firms. The FCA will also issue letters to firms, highlighting its key expectations on implementing the Duty, and some of the key risks and consumer harms the FCA is concerned about in their sectors.
Financial crime
LIBE report on proposed Directive on access to centralised bank account registries through single access point
On 25 January, the EP’s Civil Liberties, Justice and Home Affairs Committee (LIBE) published its report on the proposed Directive amending Directive (EU) 2019/1153 as regards access of competent authorities to centralised bank account registries through the single access point. The report details the Committee’s suggested amendments to the proposed Directive.
NCA SARs annual report 2022
On 24 January, the NCA published its annual Suspicious Activity Reports (SARs) annual report for 2022. Figures from the report show that: (i) a record amount of 901,255 SARs were received and processed in the last financial year – a 21% increase on the previous year. The NCA notes that a contributing factor is new SAR reporters in the FinTech and cryptocurrency sectors; and (ii) £305.7 million was denied to suspected criminals as a result of Defence Against Money Laundering (DAML) requests – a 120.6% increase on 2020-21. The NCA explains that the increase in funds denied reflects a rise in high monetary-value DAML opportunities submitted by reporters, the increased use of Account Freezing Orders by law enforcement, and improved DAML quality.
Fintech
Please see the Prudential Regulation section for the adoption of draft reports on CRR III and CRD VI by the European Economic and Monetary Affairs Committee, which include proposals relating to the prudential treatment of cryptoassets.
FCA feedback on good and poor-quality applications from cryptoasset businesses
On 25 January, the FCA published feedback on good and poor-quality applications made by cryptoasset businesses for registration under the MLRs. The feedback covers the whole process of completing an application, from information to be read prior to preparation of an application, to actions to take while the application is under assessment. The FCA focuses on the information to be included as part of an application, which includes: (i) business plans that describe the applicant’s business model, roles and responsibilities of business partners, sources of liquidity, detailed customer journey and flow-of-funds (fiat and cryptoassets both) charts. Applicants should not submit business plans that do not include forecasts, or which provide unrealistic forecasts on financials, staffing, marketing plans, customer breakdown or any other component of the plan; (ii) a comprehensive description of products and services including, where applicable, a cryptoasset token vetting policy, detailed description of how dependent it is on external ecosystems for liquidity, custodian services, and underlying smart contracts/DeFi implementations; (iii) a thorough understanding of the risks from dealing in cryptoassets and design a business wide risk assessment (BWRA) that is tailored to its business model; (iv) policies, systems and controls that appropriately manage and mitigate the risks identified in the BWRA. The FCA will also expect applicants to adequately evidence their assessment of the strength of these controls. The FCA will not approve an application where the applicant has an underdeveloped AML framework or a weak governance structure; and (v) that the applicant should demonstrate that it has effective transaction monitoring and blockchain analysis, adequate for its size and complexity. The applicant should not have compliance staff that lack the skills to carry out blockchain investigations despite having blockchain analytics tools.
Fund regulation
Please see the Other Developments section for the European Economic and Monetary Affairs Committee’s adoption of draft reports on the proposed Directive amending AIFMD and the UCITS Directive.
Markets and markets infrastructure
FCA and ESMA agree MoUs on co-operation arrangements under UK and EU BMR
On 25 January, the FCA published two MoUs it has agreed with ESMA relating to co-operation arrangements in respect of third-country benchmark administrators: (i) establishing a co-operation arrangement for the purposes of Article 30(4) of the UK BMR, to provide a framework for the exchange of information in relation to EU critical benchmarks and non-critical benchmarks provided by administrators of EU critical benchmarks supervised by ESMA; and (ii) concerning the recognition of UK benchmark administrators in the EU, to establish a co-operation arrangement under Article (32(5) of the EU BMR for an efficient exchange of information. This MoU also confirms that the effective exercise of ESMA's supervisory functions under the EU BMR is not prevented by UK laws and that there is no limit on the FCA's ability to exercise the supervisory or investigatory powers awarded to it under the UK BMR in respect of UK benchmark administrators applying for recognition or recognised in the EU.
FCA further update to ancillary activities exemption for commodity derivatives
On 24 January, the FCA provided an update on the ancillary activities exemption for commodity derivatives. In March 2022, the FCA stated that firms do not need to perform the ‘market share test’, as set out under Article 2 of UK MiFID RTS 20, as part of determining their eligibility to use the ancillary activities exemption from authorisation as a MiFID investment firm for firms trading commodity derivatives, emission allowances and emission allowance derivatives. In Handbook Notice No 99, the FCA also specified that a firm could use figures relating to 2018, 2019 and 2020 as their numerator for the purposes of its remaining main business test calculations. The FCA also stated that firms could use corresponding figures relating to 2019, 2020 and 2021. For the avoidance of doubt, provided data from 2018-2020 were used, the data period was the same for both the numerator and denominator. If it could meet the main business test, a firm could continue to rely on the ancillary exemption in 2022, provided it met the other conditions of the exemption as set out in PERG 13 Q44. HMT has proposed a Statutory Instrument that will make changes to the ancillary activities test removing the current quantitative aspects of the test, although these changes will not take effect until the end of this year. Therefore, the FCA will continue to apply the approach described in Handbook Notice No 99, enabling firms to continue using the ancillary activities exemption for the year ahead (2023-2024) where they were able to rely on the exemption for 2022-2023 based on trading relating to the last previous published information (2018 to 2020), and maintain the additional flexibility enabling firms alternatively to have regard to their daily trading activity of the previous 3 years (2020-2022) for the purposes of continuing to rely on the ancillary exemption.
ESMA report on effects of market correction mechanism on EU natural gas derivative market
On 23 January, ESMA published a preliminary data report on the effects of the market correction mechanism (MCM) on the EU’s natural gas derivative market. The MCM was established to protect EU citizens and the economy against excessively high prices. It will start applying from 15 February. The report: (i) describes the structure and main participants in the EU natural gas derivative market. It focuses on market indicators aimed at assessing the potential effects of the adoption of the MCM; (ii) finds that based on available data, there have not been significant impacts resulting from the adoption of the MCM Regulation. ESMA notes that the potential effects in the trading and clearing environment may only unfold when the activation of the MCM is imminent rather than in the current environment; and (iii) identifies the potential consequences of the MCM on market participants’ trading behaviour and the effect it may have on the ability of market participants to effectively manage their risks. In that regard, it includes a more qualitative analysis of the possible risks to CCP risk management and the potential impact on the clearing of derivatives. ESMA will submit an effects assessment of the adoption of the MCM to the EC by 1 March. This will include a more detailed analysis based on more granular indicators, covering a longer period after the adoption of the MCM, and expand on the qualitative assessment of the adoption of the MCM.
Payment services and payment systems
Please see the Other Developments section for a speech given by Mairead McGuinness, European Commissioner for Financial Services, Financial Stability and Capital Markets Union, on the European Commission’s upcoming and ongoing initiatives.
Prudential regulation
ECB signs MoU with NCAs of six EU Member States not part of EU banking supervision
On 25 January, the ECB announced that it has signed a MoU with NCAs of the six EU Member States that are not part of European banking supervision: Czech Republic, Denmark, Hungary, Poland, Romania and Sweden. The MoU provides a framework for sharing information on supervisory matters and issues concerning cross-border supervised institutions, as well as on supervisory methodologies, approaches and priorities. The MoU also encourages the ECB and the NCAs to inform one another of planned measures that may be of relevance to another authority’s tasks. The MoU is concluded in accordance with the legal requirement for the ECB and the competent authorities of the EU to sign a supervisory MoU, as outlined in Article 3(6) of the SSM Regulation.
ESRB recommendation and report on vulnerabilities in EEA commercial real estate sector
On 25 January, the ESRB issued a recommendation (dated 1 December 2022) on vulnerabilities in the commercial real estate (CRE) sector in the EEA. The ESRB recommends that: (i) EU and national authorities improve the monitoring of systemic risks stemming from the CRE sector. Monitoring vulnerabilities related to this sector is key to identifying potential risks to financial stability and to assessing possible responses; (ii) based on the findings from monitoring, EU and national authorities should ensure that financial institutions providing financing for CRE have prudent risk management practices in place; (iii) EU and national authorities should ensure that risks and vulnerabilities related to the CRE sector are adequately addressed; and (iv) the EC should assess the current macroprudential framework and ensure that consistent rules for addressing risks related to CRE exposures are applied across all financial institutions when they perform the same activities, taking into account their specificities. The recommendation is based on an assessment of vulnerabilities identified in the CRE sector that could be a source of risk to financial stability. The findings show that the sector is currently vulnerable to cyclical risks related to heightened inflation, a tightening of financial conditions limiting the scope for refinancing existing debt and taking new loans, and the pronounced deterioration in the growth outlook following Russia’s invasion of Ukraine. Furthermore, the ESRB’s analysis shows that adverse developments in the CRE sector can have a systemic impact on the financial system and the real economy. Such vulnerabilities can be amplified by spillovers across countries and through interlinkages between financial institutions.
ECON adopts draft reports on CRR III and CRD VI
On 24 January, the European Economic and Monetary Affairs Committee (ECON) announced the adoption of draft reports on the EC’s legislative proposals for CRR III and CRD VI. Changes to the proposals on which ECON agreed include: (i) that the “output floor” setting lower limit on the capital requirements calculated by banks using their internal models should be consolidated at the EU level in order to have comparable risk weights and avoid variations in capital levels. A competent authority should be able to address inappropriate distribution of capital among banking groups and propose a capital redistribution. Transitional arrangements for low risk exposures secured by mortgages on residential property have been agreed on, though any transitional period must not be extended beyond four years; (ii) mandating the EBA to assess whether a dedicated prudential treatment of ESG exposures would be warranted through a separate legislative proposal; (iii) that banks must disclose their exposure to cryptoassets and cryptoasset services, as well as a specific description of their risk management policies related to cryptoassets. The EC is invited to submit a legislative proposal by June on a dedicated prudential treatment for exposures to cryptoassets; (iv) amending the CRD, to require that the suitability of members of management bodies should be sufficiently diverse and gender-balanced; and (v) establishing a third country branches supervisory regime. ECON has also confirmed that it has voted to enter into interinstitutional negotiations with the Council of the EU.
Recovery and resolution
Please see the Other Developments section for a speech given by Mairead McGuinness, European Commissioner for Financial Services, Financial Stability and Capital Markets Union, on the European Comssion’s upcoming and ongoing initiatives.
EC adopts amendments to Delegated Regulation on ex ante contributions to resolution financing arrangements under BRRD
On 20 January, the EC adopted a Delegated Regulation (Amending Regulation) amending Delegated Regulation (EU) 2015/63 on ex ante contributions to resolution financing arrangements under the BRRD. Delegated Regulation (EU) 2015/633 provides that for the determination of total liabilities the value of liabilities arising from derivative contracts should be calculated in accordance with Articles 429, 429a and 429b of the CRR. These articles specified that institutions should use a mark-to-market method called the Current Exposure Method. However, these articles were replaced by CRR II, and the Standardised Approach – Counterparty Credit Risk (SA-CCR) method replaced the former method. The EC explains that as the SA-CCR method was developed for assets rather than liabilities, it would create distortions in the calculations of liabilities arising from derivatives. The amendments therefore reinstate the former methodology for this calculation. The Council of the EU and the EP will now scrutinise the Amending Regulation. It will apply retroactively as of 1 October 2022.
Sustainable finance
Please see the Other Developments section for a speech given by Mairead McGuinness, European Commissioner for Financial Services, Financial Stability and Capital Markets Union, on the European Commission’s upcoming and ongoing initiatives.
Other Developments
TheCityUK recommendations on improving regulatory efficiency on authorisations
On 26 January, TheCityUK published a report on improving the regulatory efficiency of FCA and PRA authorisations. The report focuses on firm Part 4A authorisations, variation of permission, changes in control, and the approval of senior managers. The report finds that financial services regulatory authorisations can be slow, inefficient and unpredictable. This can undermine firms’ confidence in the regulators’ operational efficiency, create additional operating costs, and raise concerns about the long-term impact on UK competitiveness. While recognising and welcoming that both the FCA and PRA are already taking forward measures to improve their authorisations processes and reduce backlogs, the report sets out a series of recommendations for further action, including: (i) adopting a more commercially aware, efficiency-focused mindset by following through on the ambitions set by regulators’ senior leaders to be more commercially aware in firm-facing operations and by developing a better understanding of the impact of the authorisations process on firms; (ii) embracing transparency, accountability, and external engagement by publishing better performance data on authorisations, by offering more comprehensive guidance to firms on the process, and by enhancing engagement and communications with firms; (iii) enhancing internal coordination, capabilities and case management by improving internal coordination and information sharing, by adopting a digital-first approach to authorisations, by implementing better training for authorisation staff, and by streamlining processes to improve efficiency. TheCityUK urges HMT to use its proposed new powers under the FSM Bill to set performance metrics and require regulators to report against them regularly and publicly.
ECON adopts draft reports on proposed Directive amending AIFMD and UCITS Directive, Consumer Rights Directive and Whistleblowing Directive
On 24 January, the European Economic and Monetary Affairs Committee (ECON) published a document revealing that it has voted to adopt draft reports on: (i) the proposed Directive amending AIFMD and the UCITS Directive relating to delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services, and loan origination by AIFs. ECON has voted to enter into interinstitutional negotiations with the Council of the EU; (ii) the proposed Directive amending the Consumer Rights Directive concerning financial services contracts concluded at a distance and repealing the Distance Marketing Directive; and (iii) the proposed Directive on Corporate Sustainability Due Diligence and amending the Whistleblowing Directive.
EC speech on upcoming and ongoing initiatives
On 24 January, the EC published a speech given by Mairead McGuinness, European Commissioner for Financial Services, Financial Stability and Capital Markets Union, on its upcoming and ongoing initiatives. Points of interest include: (i) sustainable finance – the EC hopes to conclude negotiations at the next trilogue on the European Green Bond. The EC is considering a staged approach to legislation on activities under the EU taxonomy, firstly focusing on activities that it can finalise quickly which don't raise specific issues or technical difficulties. Ms McGuinness considers that there are some real concerns around usability that the EC is being asked, which are important to address; (ii) new proposals – in the next few months, the EC intends to adopt new proposals in relation to the bank crisis management and deposit insurance framework under the BRRD, the SRM and the DGSD; a regulation on key principles of a digital euro; and on an open finance framework, together with the PSD2 review; (iii) retail investment strategy – the EC intends to publish the strategy in the coming months. It will include new rules on distribution, information requirements, and financial advice particularly in relation to inducements.