The Edinburgh Reforms: what they are and what they mean for financial services

On Friday, 9 December, HM Treasury (HMT) unveiled its “Edinburgh Reforms” - an extensive package of regulatory reforms for the UK financial services sector. The package builds on the reform agenda that HMT is taking forward through the Financial Services and Markets (FSM) Bill, setting out a series of measures that aim to make the UK financial services sector “open, sustainable and technologically advanced”.

At a glance

• The Edinburgh Reforms represent the most significant and extensive package of regulatory change since the UK left the EU, covering a very broad range of financial services regulations.
• We see the package as a collection of individual and diverse initiatives, some of which are potentially significant and far-reaching, rather than a cohesive whole.
• This does not yet amount to a full blueprint for the future of financial services regulation in the UK, largely because, in many cases, HMT has not yet set out concrete proposals for reform but has instead launched a series of consultations and calls for evidence.
• These consultations and calls for evidence will present a huge opportunity for the industry to provide its views on a range of issues and shape the future of UK financial services regulation, from how well the SM&CR is working to the intricacies of the Short Selling Regulation.
• The intentional absence of detail in many of the reforms has given commentators a blank canvas – some have painted a picture of widespread deregulation and a significant weakening of the post-crisis regulatory framework. Our view is that, in many cases, it is simply too early to tell – we will have to wait and see what emerges from the consultations and subsequent legislative and rule-making processes.
• All this will take time. Some of the potentially most significant changes (such as recommendations on settlement arrangements for transactions in UK financial markets) will only emerge at the end of 2024, and we expect that others will also stretch beyond the date of the next General Election.
• One element of the package does take immediate effect – the new remit letters which the Chancellor has sent to the FCA and the PRA. These reinforce two Government priorities. First, the importance HMT attaches to the regulators facilitating the competitiveness of UK financial markets (in effect anticipating the secondary objectives in the FSM Bill). Second, that the regulators should support the provision of finance - venture and growth capital, sustainable finance and finance for infrastructure. We have also seen the latter priority emerge in HMT’s Solvency II reforms.
• The reforms, as they stand, address some opportunities for growth, but the UK will have to strike a delicate balance in terms of consistency with ongoing international initiatives. For example, the digital assets-related initiatives are largely as expected, and deliberately do not front-run the FSB’s efforts to establish global standards.
• This extensive package of reforms will require significant industry input and engagement in order to shape the final outcomes. HMT and the regulators are in “listening mode”, and the new remits open the door for policy initiatives that will promote UK growth and competitiveness.
• These initiatives coincide with ongoing major regulatory change programmes, including the Consumer Duty, the new bank and insurance capital regimes and a range of new sustainable finance regulations. And there is more to come, such as an updated Green Finance Strategy and various consultations on digital assets. We expect regulators to press ahead with all these major initiatives. But we may see some reprioritisation of other initiatives when the Regulatory Initiatives Grid is updated early next year.

Overview of the Edinburgh Reform package

The list of the reforms is lengthy, comprising around 30 items of correspondence, draft policy papers, and other documents and announcements. In this blog, we summarise and give our initial assessment of the financial services regulatory reform elements of the package.

In Table 1, we have organised the various initiatives included in the package into three broad groups:

• initiatives with a significant and immediate effect;
• policy consultations or announcements; and
• statements of intent, including calls for evidence.

For each group we indicate which financial services sector(s) will be primarily affected, as well as the degree of impact we expect. We also highlight which of these reforms have been previously announced (“expected”) and those that have been communicated for the first time in this package (“new”). The timeline accompanying this blog sets out the communicated milestones for these initiatives.

Table 1 – List of Edinburgh Reforms by type, sector, and impact*

Strategic approach to post- Brexit FS regulation

The package is a key milestone in setting out and implementing the UK’s strategic approach to post-Brexit FS regulation. Two overarching initiatives stand out in this context, both of which are likely to have a significant and almost immediate effect.

First, the Chancellor issued new remit letters to the Financial Conduct Authority and Prudential Regulation Committee. The letters anticipate the forthcoming secondary competitiveness objectives, which the FSM Bill will enact when it takes effect (expected to be spring 2023). They are significant as the Government is for the first time formally asking both regulators to facilitate the international competitiveness of the UK economy and its growth in the medium to long term, subject to aligning with relevant international standards. The letters also outline some of the Government's other priorities for the regulators to take into account, including:

• swiftly repealing retained EU law with rules designed for the UK;
• actively embracing new technologies such as AI and cryptoassets;
• and supporting economic growth by facilitating the provision of finance to the UK economy (venture and growth capital for UK scale-up companies, sustainable finance, and finance for infrastructure projects).

Second, HMT set out its approach to repealing and replacing retained EU law (REUL) on financial services. HMT plans to deliver this programme by dividing REUL into tranches, the first tranche of which is already underway with the delivery of outcomes from the Wholesale Markets Review, Lord Hill’s Listing Review, the Securitisation Review, and the Review of the Solvency II Directive. The second tranche will focus on areas with the biggest potential benefits to economic growth, including the ring-fencing regime and accelerated settlement. Alongside its overall approach, HMT also published a number of illustrative draft Statutory Instruments (SIs) to evidence how it will use the powers within the FSM Bill to replace REUL with home-grown reforms. See below for more details on these initiatives.

The approach document also gives useful insights into HMT’s thinking concerning REUL, including a set of prioritisation principles reflecting the need to:

• update the rules to reflect the specific features of UK markets;
• sequence changes logically to support the design of an accessible and streamlined framework; and
• ensure that the pace and cost of regulatory change is manageable for the Government, regulators and industry.

The last principle will be particularly important given the volume of regulatory change expected over the next several years. The document also emphasises the various ways the Government will be able to direct the regulators, notwithstanding its decision not to pursue the new intervention power. These include the ability to set “have regards” that the regulators must consider when making rules, and the power to require regulators to make or review rules to address specific key regulatory challenges or when it is in the public interest.

Policy consultations/annoucements

Banking

The most significant development is HMT’s confirmation that it will consult on the reforms to the ring-fencing regime in mid-2023 with a view to bringing forward secondary legislation in the latter part of the year.

The reforms HMT plans to make broadly match those produced by the Skeoch independent review and could have significant implications for some UK banks. They include:

• taking banking groups without major investment banking operations out of the ring-fencing regime;
• removing blanket geographical restrictions on ring-fenced banks operating subsidiaries or servicing clients outside the EEA; and
• assessing whether certain activities now restricted for ring-fenced banks could be undertaken safely from within the ring-fence in order to improve the supply of financial services (e.g., hedging mortality risk, giving greater flexibility to restructure loans through the debt for equity swap exemption).

Alongside these measures, HMT will also consult in mid-2023 on plans to increase the deposit threshold at which ring-fencing becomes mandatory from £25 billion to £35 billion.

Taken together, these changes are intended to make the regime more flexible and compatible with the resolution framework. Their effect will be either to take some banks with de minimis investment banking activities – such as some challenger banks - completely outside the scope of ring-fencing or reduce the point at which ring-fencing becomes mandatory. These banks should benefit from lower compliance costs, and this may in turn lead to greater competition on prices and services within the retail banking market.

HMT also agreed with the Skeoch review’s recommendation that the authorities should have a power to remove firms from the regime that are judged to be resolvable. HMT will review the practicalities of aligning the ring-fencing and resolution regimes, publishing a “wide-ranging” call for evidence in Q1 2023.

The package also includes two other, targeted policy consultations.

First, HMT is proposing to amend the Payment Accounts Regulations 2015, which implemented the EU 2014 Payment Accounts Directive. The Government proposes to reduce some regulatory requirements (e.g., concerning information documents and rigid presentational formats) that it believes are too prescriptive or unnecessary in a UK context, where fees and charges associated with payment accounts are usually lower than in EU countries.

And second, following the Call for Evidence Response to the Consultation on Amendments to the Building Societies Act 1986, HMT will legislate to exclude four types of funding – i.e. specific Bank of England (BoE) liquidity facilities, senior non-preferred debt instruments raised to meet MREL, repurchase agreements of high-quality liquid assets, and deposits from SMEs with a turnover of up to £6.5 million - from their wholesale funding limit calculation. This will provide greater flexibility for societies to manage their balance sheets, including through periods of financial stress. The Government also announced its intention to modernise corporate governance requirements for building societies in line with the Companies Act 2006.

Capital Markets

HMT confirmed it will continue to take forward the Wholesale Markets Review and announced four further policy measures to strengthen the UK’s position as a global wholesale capital markets centre:

1. A commitment to having a regulatory regime in place by 2024 to support a consolidated tape for market data. Access to one continuous feed bringing together market data from multiple platforms would be a significant development - however, as the EU’s experience on their consolidated tape has shown, turning this ambition into reality is likely to be challenging.
2. The establishment of an Accelerated Settlement Taskforce to explore the potential for faster settlement of financial trades in the UK. This will include examining the case for moving to a “T+1” standard settlement period - as US and Canada intend to do by 2024. The Taskforce will also consider the feasibility of moving to a “T+0” settlement adoption in the long term, for example, by using new technologies such as blockchain. The Taskforce will publish its initial findings by December 2023, with a full report and recommendations made by December 2024. A mandated move to T+1 or T+0 would be significant for all firms operating in the capital markets sector and would deliver benefits such as reduced counterparty risk and increased liquidity. This may also pose challenges such as settlement across time zones and risk of market fragmentation. However, in practice any changes will not take place until 2025 at the very earliest. In addition, the Taskforce has been explicitly asked to consider the actions of other jurisdictions, and we expect any future measures to align with emerging international standards.
3. Legislation - laid before Parliament last week - to streamline rules for firms’ reporting items to retail investors (such as falls in the value of their portfolio).
4. Commitment to bring forward secondary legislation in Q1 2023 to remove burdens for firms trading commodities derivatives as an ancillary activity, for example, when manufacturers seek to fix the future price of their purchases of specific raw materials.
   

The last two initiatives aim to reduce the administrative and regulatory burden on capital markets participants.

Separately, HMT also published an illustrative draft SI proposing to repeal and replace the inherited EU securitisation regime with a UK-tailored framework. The new UK framework would leverage the new Designated Activities Regime in the FSM Bill, to give the FCA and PRA powers to regulate securitisation activities undertaken by otherwise unauthorised entities. It would also introduce a regime to enable recognition of Simple Transparent Securitisations issued by non-UK entities. For now, however, it would not change the scope of firms subject to requirements, and does retain the requirements for retention of risk, due diligence, disclosures.

Consumer Credit

HMT issued its initial proposals to modernise and simplify the Consumer Credit Act (CCA) to facilitate innovation in products and easier market entry. This consultation is the first step of that journey, with the ultimate aim to move much of the CCA from statute to FCA rules. However, the CCA is complex and, consequently, HMT expects the reform process to take “several years”. HMT also confirmed the intention to bring Buy Now Pay Later (BNPL) agreements into regulation ahead of CCA reform and details of how this will be implemented are expected in 2023.

Key aspects of the CCA reform being consulted on include definitions and scope, information requirements, rights and protections, and sanctions. The consultation closes on 17 March 2023, following which HMT will provide a summary of responses and set out next steps for CCA reform.

Investment Management

HMT intends to repeal the on-shored Packaged Retail and Insurance-Based Products (PRIIPs) Regulation, on the basis that it is not “fit for purpose”. According to HMT, PRIIPs Key Information Documents (KIDs) do not help retail investors make sense of a complex investment landscape due to being unnecessarily prescriptive – this can lead to information being presented to investors in unhelpful or misleading ways.

HMT is now consulting on a new, UK-specific framework for retail disclosures, underpinned by two principles: (i) retail investors should have access to clear and useful information to make evidence-based decisions; and (ii) disclosures should be proportionate to the risk that investment products pose. However, in line with the Government’s strategic approach to post-Brexit FS regulation, the FCA will be responsible for setting detailed disclosure rules, on which the regulator is already seeking views.

Firms in scope are likely to welcome the new framework for two reasons. First, there have been widespread concerns across the industry regarding lack of clarity around scope and performance scenarios under the PRIIPs regime. Secondly, once the “UCITS exemption” expires on 31 December 2026, firms would have to produce both UCITS KIID and PRIIPs KID disclosures. HMT’s intention to integrate both regimes into a single, simpler regime is likely to allow firms to reach a larger retail market with fewer concerns about regulatory risk.

Separately, HMT also committed to work with the FCA to examine the boundary between regulated financial advice and financial guidance to improve access to support, information and advice, while maintaining strong protections for consumers. This commitment complements the FCA’s existing consultation on broadening access to financial advice for mainstream investments.

Payments

Empowering the FCA to react more dynamically to payment innovation has been on the cards for a while. To evidence how it intends to enable this, HMT published an illustrative draft SI to give the FCA more responsibility for regulatory requirements in areas of retained EU payment services law. Specifically, the illustrative draft SI amends the Payment Services Regulation 2017 and the Electronic Money Regulation 2011 to extend the application of FCA rulemaking powers under the Financial Services and Markets Act 2000 to payment services and e-money markets. These new powers will enable the FCA to update regulatory requirements to respond effectively and in a timely manner to emerging dynamics and innovation in the payments and e-money sectors, without waiting for Parliament to amend primary legislation. Once finalised, the SI will be implemented through the FSM Bill. HMT also indicated that it would progress a similar SI for the Payment Systems Regulator.

HMT also noted that the FSM Bill will bring stablecoins used as a means of payment within the regulatory perimeter. In light of these reforms, payments and e-money firms should prepare for a more dynamic regulatory environment that could potentially start diverging from the EU relatively quickly if and where FCA sees the necessity.

HMT’s efforts to explore the use case for a Central Bank Digital Currency (CBDC) will also continue with a consultation in the coming weeks on the case for and potential design of a CBDC. The BoE will also release a Technology Working Paper setting out cutting-edge technology considerations informing the potential build of a UK CBDC.

Statetment of intent/call for evidence

Cross-sector

The announcement regarding the review of the Senior Managers & Certification Regime (SM&CR) has drawn significant attention but there is no detail at this stage. HMT confirmed it will publish a call for evidence in Q1 2023 to gather views on the regime’s effectiveness, scope, proportionality and views on potential improvements and reforms. The impact of this initiative will depend on the final policy proposals that emerge. However, given the time and resources financial services firms have spent on complying with the current SM&CR requirements, the industry is unlikely to welcome any changes to the regime that would require any substantial implementation work or changes to policies and procedures for only marginal benefits.

Banking

The Government announced an impending PRA consultation on removing rules for the capital deduction of certain non-performing exposures (NPEs) held by banks. Under current EU rules, there are clear thresholds, above which NPEs must be written off after prescribed time periods. The consultation will likely propose a regime that allows the PRA to take a more bespoke approach to discussions with banks around management of their NPE positions. However, until more details are available it is not possible to assess its potential impact.

Capital Markets

HMT is seeking evidence on how effectively the EU’s Short Selling Regulation (SSR) is working and how to tailor it to provide a better fit with UK markets, supporting market integrity and bolstering the competitiveness of UK financial markets. There are 26 questions covering all aspects of the SSR, starting with the fundamental question of whether short selling should be regulated at all in the UK and going all the way through to detailed issues concerning reporting thresholds. The call for evidence runs until 31 March 2023. It is too early to tell how significant this will prove, especially given the breadth of questions. HMT will have to balance the benefits of introducing any changes specific to the UK with the costs to firms of having to change their IT and reporting systems, while maintaining the ability to continue to report under EU rules where they are subject to them.

HMT also reaffirmed its commitment to implementing a Financial Markets Infrastructure (FMI) sandbox in 2023, the framework for which is set out in the FSM Bill. The FMI sandbox will enable firms to test and adopt new technology and innovations, such as distributed ledger technology, in providing the infrastructure services that underpin markets. We expect to see consultations from HMT, BoE and FCA in early 2023 on the detailed rules that would implement this Sandbox.

Finally, HMT announced it will work with regulators and market participants to bring forward a new class of wholesale market venue, which would operate on an intermittent trading basis to act as a bridge between public and private markets.

Investment Management

HMT has announced the launch of an independent review of investment research and its contribution to the effectiveness of UK capital markets. It will include the effects of the EU’s MiFID unbundling rules, which HMT notes are not applied in other leading non-EU markets (e.g., the USA, where the SEC’s No-Action Relief in this regard expires on 3 July 2023).

Changes to the rules in this area could provide benefits such as a reduced regulatory burden on firms and greater flexibility for the purchase of investment research. The FCA will likely be interested in ensuring that any changes do not lead to an increased potential for conflicts of interest. We expect that many market participants will be interested in participating in the review, given the numerous discussions over recent years on rule changes in this area. We will also be interested to see to what extent this review considers other potential provisions that could help to increase the production of investment research to support investors in their decision-making.

ESG providers and Green Finance

HMT has announced it will consult in Q1 2023 on bringing Environmental, Social, and Governance (ESG) ratings providers into the regulatory perimeter. HMT will also join the industry-led ESG Data and Ratings Code of Conduct Working Group, recently convened by the FCA, as an observer.

ESG data and ratings services are used widely by firms to inform investment decisions and to assess sustainability risks. HMT wants to ensure that there is transparency around the methodologies of ratings, good governance and sound conflict management.

FS firms need to be aware of these initiatives, as they will have implications for their future use of third-party ESG ratings and data. However, the immediate implications of ratings providers being brought within the regulatory perimeter are principally a concern for those providers.

In addition, HMT has announced it will publish an updated Green Finance Strategy in early 2023.

Pensions

HMT is committed to accelerating the pace of consolidation in Defined Contribution (DC) pension schemes. In 2023, the Department for Work and Pensions (DWP) will consult on a new Value for Money framework with the FCA and the Pensions Regulator. This will clarify required metrics and standards in key areas such as investment performance, costs and charges and quality of service that all schemes must meet. This follows HMT’s earlier consultation on reforms to remove well-designed performance fees from the pensions regulatory charge cap (see consultation here) and will finalise regulation on this in early 2023.

HMT also announced that it will consult on new guidance to the Local Government Pension Scheme (LGPS) in England and Wales on asset pooling. Alongside this, HMT will also consult on requiring LGPS funds to ensure they are considering investment opportunities in illiquid assets such as venture and growth capital, as part of a diversified investment strategy.

Other

The package also includes initiatives relating to tax policy and to primary capital markets, which we have not analysed. These are:

• Illustrative draft SI to reform the UK’s prospectus regulation to enable the government to implement recommendations from Lord Hill’s UK Listing Review.
• Plans to repeal the regulations for the European Long Term Investment Fund, without replacement, in light of the newly established Long Term Asset Fund regime.
• Amending tax rules for Real Estate Investment Trusts.
• Reforms to the VAT treatment of fund management
• Plans to expand the Investment Manager Exemption to include cryptoassets.