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On leaving the EU, the U.K. engaged in a fundamental review of EU-inherited financial regulation (Future Regulatory Framework Review). There has been an in-depth examination of and consultation on how regulatory rules should now be made, reviewed and established in law. Traditionally, the U.K. included much of this body of law in regulator rulebooks and the rules of self-regulatory organisations. However, whilst the U.K. was within the EU, those provisions were largely superseded by EU Directives and Regulations, which are legislative in nature and capable of being amended only by statutory instrument under the European Union (Withdrawal) Act 2018. It has been observed that this approach is unwieldy and that the U.K. legislature is insufficiently nimble to maintain these provisions and ensure they are kept up to date.
Careful thought has therefore been given to how to maintain best practice in financial regulation, given the U.K.’s role as a global financial centre, with markets open to the world. There is a need for the U.K.’s approach to be agile, and for it to continue to provide an attractive and dynamic base for firms seeking to operate their worldwide businesses here. With Brexit, the opportunity now arises for the U.K. to embark on a programme of ‘better regulation’, applying its traditional approach involving high standards with fewer rules. It can remove unnecessary red tape and enhance legal and regulatory predictability so as to allow innovation to flourish. The Financial Services and Markets Act 2023 implements elements of the Future Regulatory Framework Review by establishing a revised blueprint for financial services regulation. The FSM Act revamps the existing regulatory model, under the Financial Services and Markets Act 2000 (FSMA), and provides a framework for the revocation of retained EU law (REUL) in financial services. The financial services regulators have been delegated powers for detailed rulemaking, while being subject to enhanced oversight by Parliament.
At the heart of the government’s Future Regulatory Framework Review was reform of the U.K.’s financial regulatory architecture. Under the FSM Act, the U.K. has established a new way of formulating financial regulatory policy and implementing regulatory rules. This includes a clear division of responsibilities between Parliament and the financial regulators, enhanced transparency and accountability requirements for the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA), and the implementation of policy framework legislation for key regulated areas of activity which will be supplemented by detailed rules made by the regulators.
The FSM Act establishes a comprehensive FSMA model for financial services regulation. This is accomplished by expanding the scope of FSMA to include market-related activities by the creation in FSMA of a Designated Activities Regime (DAR). The Act also provides for the revocation of most REUL for financial services (by creating the concept of “EU-derived legislation”).
The EU-derived legislation will be subject to a transitional regime, which for each piece of legislation will end upon revocation. During the transitional regime, HM Treasury will use new powers to restate existing legislative provisions and to transfer responsibility for making detailed rules to the regulators. The much-welcomed changes arising from HM Treasury’s Wholesale Markets Review will be implemented this way. These changes include wide-scale changes across a raft of areas formerly regulated under the EU’s MiFID II regime. Furthermore, measures are intended to strengthen Parliament’s oversight of the regulators.
New secondary statutory objectives have been introduced by the FSM Act, obliging the FCA and PRA in carrying out their functions to support long-term growth and international competitiveness. It also introduces a new regulatory principle of having regard to the need to achieve the U.K.’s statutory climate target of net zero by 2050 which the FCA and the PRA will be required to observe.
In addition, the regulators have been granted powers to fill gaps in regulation. For example, the regulators’ direct powers over third parties that provide critical services to authorised firms, their service providers and FMIs are currently limited. The FSM Act grants HM Treasury the power to designate an entity as a critical third party if it provides services to authorised firms, relevant service providers (authorised e-money institutions, payment institutions and registered account information services) or FMIs and its failure would pose financial stability or confidence risk to the U.K. The FCA, PRA and Bank of England will make rules governing the services those critical third parties provide to authorised firms, relevant service providers and FMIs.
The recommendations made in the Kalifa Review of Fintech, the independent report on the U.K. Fintech sector led by Ron Kalifa, proposed a path for the U.K. to retain its global leadership in FinTech. The government and regulators have acted on some of the Review’s findings and proposals, including collaborating with the FinTech community to establish the Centre for Finance, Innovation and Technology, making the FCA’s Digital Sandbox permanent and introducing the “scale-up” visa system which businesses (including FinTechs) can use to fast-track visa applications. The government has also announced plans to introduce a new class of wholesale market venue, operating on an intermittent trading basis, to improve the access that companies have to capital before they publicly list. For FinTechs and others operating in this space, there is further scope to steer the government towards implementing actions that will attract investment for individual FinTechs, bolster the U.K.’s international competitiveness and raise the U.K.’s status as a global hub.
The issuance or facilitation of the use of “digital settlement assets” used as a means of payment are brought into the U.K. regulatory perimeter. DSAs are tokens which stabilise their value by referencing one or more assets, and include stablecoins. A separate regime has been introduced for the recognition of payment systems using digital settlement assets or a digital settlement asset service provider posing potentially systemic risks.
The FSM Act separately makes the carrying on of certain cryptoasset activities a regulated activity,meaning FCA-authorization will eventually be required for those wishing to conduct such activities. “Cryptoassets” are broadly defined to capture a wide range of assets. They may qualify as digital settlement assets, depending on their characteristics. The financial promotion restriction has also been extended to the marketing of certain cryptoasset activities under the new regulatory regime.
In addition, the FSM Act clarifies that cryptoassets and digital settlement assets may be considered to be instruments, products or investments under the designated activities regime.
Since 6 January 2021, the FCA has banned the marketing, distribution or sale of crypto derivatives in, or from, the U.K. to retail clients. The FCA also began supervising crypto-asset business for anti-money laundering purposes at the start of 2020.
A major overhaul of the U.K.’s listing regime was recommended by Lord Hill in the U.K. Listings Review. A number of very significant reforms were proposed, several with a view to attracting more companies, particularly innovative technology and life sciences companies, to raise capital in London. The Review made 14 specific recommendations to address the challenges to London’s position as a global capital markets hub coming from the increasingly competitive global capital market centres in Europe and Asia as well as the United States.
The Hill recommendations are being taken forward by HM Treasury and the FCA, with changes already made, such as the removal from special purpose acquisition companies (SPACs) the automatic suspension of listing that they previously faced when undertaking their de-SPAC transaction, allowing dual class share structures for premium listed companies subject to a number of strict conditions and reducing the free float requirement for both premium and standard listings to 10 percent (from 25 percent).
The existing prospectus framework is being revised and will:
The U.K. has long since operated an open financial market for wholesale business and equal rules for all customers, wherever they are located, making it particularly attractive for international business. The government is clear that it intends to continue to promote these concepts, and perhaps even improve on the current situation. There are a range of tools that HM Treasury could deploy to this end, such as incorporating into free trade agreements deference mechanisms (cf. the Japan-U.K. agreement) or mutual recognition provisions (cf. the Swiss-U.K. agreement) and the new equivalence regime. Traditionally, access to the U.K. markets has largely been based upon the Overseas Persons Exclusion (OPE). The OPE generally allows for cross-border wholesale business to and from the U.K., without parties outside the U.K. requiring a local licence. This provision has been instrumental to the success of the City of London; the OPE stands in stark contrast to the ‘regulatory perimeter’ of less successful closed financial markets, such as those in most of the EU, many of whom will only allow financial business to take place on a cross-border basis with even their largest institutions if the foreign counterparty is locally licensed (subject to very limited exceptions). In our view, it is critical that the OPE be retained and that this not be qualified by other processes, such as free trade agreements or equivalence structures.
Another strand to this is the approach of the U.K. regulators to supervising and regulating international firms. The U.K. is one of a few jurisdictions where the excellence and strength of the regulators allows for branches to be set up, instead of requiring subsidiaries. The FCA and PRA have each confirmed their final approaches to the supervision of international branches.
HM Treasury’s call for evidence on the use by firms of some of the access routes focused on the OPE, the equivalence regime for MiFIR investment firms and the recognition regime for overseas investment exchanges. A response to the call for evidence was published in July 2021. Further consultations on these issues are expected.
The U.K. funds regulation regime is another significant policy area, as the U.K. is a centre of asset management expertise and services. The U.K. government sought input into how the existing rules could be improved to encourage the establishment, administration and management of funds in the U.K., as well as fund managers, noting that while much asset management is U.K.-based, many of the funds that are so managed are located in offshore jurisdictions, or in the EU (e.g., Ireland, Luxembourg). The wide-ranging policy considerations include certain tax and regulatory reforms. Some changes are being taken forwards, such as the introduction of a new unauthorised contractual scheme fund structure (closed-ended and non-listed) aimed at professional investors, allowing distribution of capital by authorised funds and clarity on the process for fund authorisation.
Notably, the Overseas Funds Regime (OFR) allows overseas collective investment schemes to be marketed to U.K. investors, including to retail investors, where HM Treasury has granted ‘equivalence’ to the type of fund and to its home state. The OFR introduced two equivalence regimes, one for retail investment funds and one for money market funds, although no equivalence decisions have been made.
In the Payments Landscape Review, the government reviewed the opportunities, gaps and risks that need to be addressed to support the U.K.’s position as being at the forefront of payments technology. One of the key issues to resolve is the complexity of the regulatory structure which leads to different rules applying to different types of entity carrying out payment services, including those on payments protection. The Kalifa Review into FinTech has also played a large part in formulating future payments policy.
Some of the policy initiatives are included in the FSM Act. For example, to enhance consumer protection the Act enables the Payment Systems Regulator to require mandatory reimbursement by payment service providers of victims of authorised push payment (APP) fraud. The FSM Act also includes provisions to protect access to cash. Firms designated by HM Treasury will be obliged to ensure reasonable access to withdrawal and deposit facilities, such as ATMs, for individuals and reasonable access to deposit facilities for small and medium enterprises. Furthermore, there are measures to preserve the U.K. wholesale cash infrastructure.
The government has launched a review into the future of payments, which considers how payments will be made in the future and any actions needed to ensure the U.K. continues to deliver world-leading payment services for consumers.
November 2020 saw the publication of Dame Elizabeth Gloster’s report on the FCA’s regulation of failed investment firm London Capital and Finance (LC&F), in particular the FCA’s failure adequately to supervise the issuance of ‘non-transferable bonds’. The report included a series of recommendations for improvements to FCA regulation and processes and for the regulatory perimeter to be clarified so as expressly to include securities like those issued by LC&F. As of 1 January 2021, the FCA permanently banned the marketing of speculative illiquid securities (like those issued to LC&F investors) to retail investors. In the judicial review case of Donegan & Ors, R (On the Application Of) v Financial Services Compensation Scheme Ltd [2021] EWHC 760 (Admin) brought by certain investors, the court found that the non-transfer clauses in bonds issued by LC&F were unfair and unenforceable against consumers. The lacuna in regulation for non-transferable bonds (to the extent the same can even be issued today, following that case and tightening of FCA rules) will be further narrowed through the introduction of the new public offers regime that is replacing the existing prospectus regime .
Other recommendations in the Gloster Review for improving the FCA’s regulation and regulatory processes include ensuring that staff involved in the authorisation and supervision of a firm consider its business holistically and are aware of, and take into account, in the day-to-day supervision of a firm, the current or emerging risks identified by the regulator. The FCA was also required to enhance its contact centre policies so that consumers are not reassured about the unregulated activities of a regulated firm, to implement written policies on action to be taken for repeated breaches of the financial promotion rules and to ensure that the training and culture of the FCA reflect its role in tackling fraud. The FCA has introduced stronger financial promotion rules for high-risk investments as a direct result of the LC&F scandal.
Following concerns raised about the FCA’s response to complaints made against it, including in the wake of the LC&F scandal, the FSM Act has bolstered the role of the Financial Regulators Complaints Commissioner, who will now be appointed by and accountable to HM Treasury (as opposed to the regulators). The regulators will be required to explain themselves where they do not accept the FRCC’s recommendations, giving reasons for their decisions which will be laid before Parliament.
The government is taking forward its plans to use FMI sandboxes to assess the existing legislative framework in a technologically-neutral manner. The FSM Act gives HM Treasury powers to establish individual sandboxes through statutory instrument, to temporarily modify certain legislation and rules and to disapply the existing requirements for FMIs approved for participation in an FMI sandbox.
Several measures under the FSM Act strengthen the existing regime for financial market infrastructure. These include extending the Senior Managers’ and Certification Regime to U.K. CCPs and CSDs and broadening the existing regime for the recovery and resolution of CCPs that are failing or have failed.
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