The Financial Services and Markets Bill and the future of UK financial regulation

At a glance:

• On 20 July, the UK Government unveiled the text of its Financial Services and Markets Bill (“the Bill”).

• The Bill implements all of the Future Regulatory Framework Review's proposals, including a secondary competitiveness and growth objective for the FCA and PRA.

• The Bill will give HMT a new power, whereby it can require the regulators to review aspects of their rules, but not to determine what they should do following the review.

• The Government is also considering whether HMT should have “further powers to intervene in financial regulation, in the public interest”, but these are not in the Bill, with the Chancellor stating that he wanted “time to consider all the arguments before making such an important decision.”

• The Bill will require the FCA and PRA to establish new statutory panels which will have the right to provide both pre- and post-publication scrutiny of the regulators’ cost-benefit analyses.

• The Bill also takes forward measures consulted on as part of the Wholesale Markets Review, including the removal of the share trading obligation and double volume cap.

• The Bill transfers the UK’s Solvency II legislation to the PRA’s rulebook, setting the stage for the PRA to undertake the UK’s forthcoming Solvency II reforms.

• Other measures within the Bill include proposals to bring stablecoins within the UK regulatory perimeter and to safeguard consumers’ ability to make use of cash payments.

• Overall, the contents of the Bill are broadly as we expected, and HMT has changed very little in response to the various consultations that have fed into it However, the Bill may be amended as it goes through Parliament.

• We expect the proposed secondary growth and competitiveness objective to be debated as the Bill progresses, with some arguing this should be a primary objective and others arguing it should not be included at all.

• Other provisions relating to the regulators’ independence are also likely to prove controversial, and we expect both HMT’s new rule review power and its ability to set “have regards” provisions for the regulators to attract attention.
  

Introduction

On 20 July, the UK Government unveiled the text of its Financial Services and Markets Bill. The Bill takes forward measures from a number of recent policy reviews including: the Future Regulatory Framework Review (FRFR), the Wholesale Markets Review (WMR), the Prospectus Regime Review and the Access to Cash Review.

The passing of this Bill will mark the final stage of the initial policy process initiated by then-Chancellor Rishi Sunak in his 2021 Mansion House speech. Mr Sunak promised "a new chapter for financial services" enacting an "open, green, and technologically advanced financial services sector" that is "globally competitive" and acts "in the interests of communities and citizens".

We have previously written a number of blogs covering the various policy reviews that have informed many aspects of the Bill. These include:

• The Future Regulatory Framework Review
• The Wholesale Markets Review

The Bill runs to 335 pages and this blog sets out our first impressions of its key measures and explores their implications for firms and for financial services regulation more generally.

Future Regulatory Framework Review

HMT established the FRFR to reform the UK’s financial services regulatory framework in light of the UK’s departure from the EU and the need to ensure the UK’s FSMA model of regulation remains fit for purpose. HMT published its consultation response to the FRFR alongside the Bill. The response makes clear that the Bill will take forward all the FRFR’s proposals,

Alongside the Bill, HMT also published a consultation on its approach to applying the FRFR to the payments regulatory landscape.

Secondary competitiveness and growth objective

As expected, HMT is seeking to introduce a secondary competitiveness and growth objective for the PRA and FCA. This would require the regulators to consider the effect of their actions, both regulatory and supervisory, on the UK’s international competitiveness. Significantly, the Bill also adds a clause to make clear that the secondary objective is “subject to aligning with relevant international standards”. This helps to allay concerns in some quarters that the new secondary objective could lead to a “race to the bottom”, with the UK seeking to discard international agreements in order to gain a competitive advantage. In our view, this strikes an appropriate balance between the need for the regulators to consider competitiveness without undermining their existing, primary statutory objectives, or international regulatory standards.

Transfer of retained EU laws to regulator’s rulebooks

In light of Brexit, the Bill also seeks to address the question of which institutions will take on responsibility for much of the financial services regulation previously devised at EU level. The Bill will give the UK’s financial services regulators (as opposed to Parliament) responsibility for setting many of the direct regulatory requirements which are currently set out in retained EU law. This means that many of these retained EU laws (relating to financial services regulation) will be transferred away from statute and into the regulators’ rule books. This should ensure the UK has a more agile system of regulation, where regulators can more easily update rules and regulations, without the need for Parliament to find time to make the necessary changes.

While the Bill gives greater power to the regulators, it also contains a number of measures designed to enhance their accountability to Parliament. The Bill will require the regulators to notify the relevant select committee (primarily the Treasury Committee) when they publish a consultation and will require the regulators to respond in writing to formal consultation responses they receive from Parliamentary committees. These measures are intended to ensure that while the regulators receive greater responsibility for regulatory rule making, this is still subject to democratic oversight and accountability.

HMT power to direct the regulators to review their rules

In the FRFR, HMT consulted on the merits of including a new power that would enable it to require the regulators to review their rules. This new power is included in the Bill. HMT may direct the regulators to review their rules and stipulate that the review be carried out by an independent person. However, the regulators themselves, rather than HMT, will oversee such reviews and their ultimate recommendations. While this does go some way to ensure HMT cannot impose rule changes on the regulators, we nonetheless expect this change to be controversial as, to some, this could be seen to be compromising the regulators’ independence.

Significantly, there was also speculation that the Government was considering whether HMT should have “further powers to intervene in financial regulation, in the public interest.” However, as the Chancellor, Nadhim Zahawi, confirmed in his Mansion House speech, these are not in the Bill. The Chancellor stated that he was looking at such further powers with an “open mind” and wanted “time to consider all the arguments before making such an important decision.”

Cost-benefit analysis panels

The Bill takes forward measures to require the regulators to publish policy statements on their cost‑benefit analysis (CBA) frameworks. It will also require the FCA and PRA to establish new statutory panels that will have the right to provide both pre- and post-publication scrutiny of the regulators’ CBAs. Each regulator must seek the CBA panel’s input as part of the development of CBAs before they publish a CBA as part of a public consultation.

However, due to concerns about the CBA panel’s pre-publication reviews slowing down the regulatory rule‑making process, the regulators will be given the power to set criteria for when certain CBAs do not need to go to before the panel. This - combined with the fact that in the pre-publication phase the panels will feed into the FCA and PRA’s own CBA processes, rather than conduct their own separate reviews - should ensure this additional scrutiny does not result in significant delays.

Designated Activities Regime

The Bill also introduces a new “Designated Activities Regime”. This will allow the regulators to write rules for certain activities without requiring the firm which carries out those activities to become a fully authorised FSMA‑regulated entity. This regime is being introduced to ensure continuity in the way certain onshored EU regulations, such as those related to short selling, work in practice. However, this regime could also be used more broadly; it would provide regulators with an attractive way of regulating products or services which become increasingly important to financial services without having to subject the companies which provide these to full FSMA regulation.

“Have regards” provisions

The Bill will enable HMT to establish “have regards” provisions and obligations for specific activities or pieces of regulation. The Financial Services Act 2021 introduced a number of these “have regards” provisions with respect to how the PRA implements Basel standards and the FCA makes rules concerning the Investment Firms Prudential Regime. These provisions will allow HMT greater ability to provide strategic direction on specific regulations, without involving itself in the details of rulemaking.

Wholesale Markets Review

Having left the EU, the UK Government committed itself to revisit various parts of the on-shored EU financial services regime in order to ensure these regulations are better tailored to the needs of the UK.

As part of this process the Government launched the WMR, which essentially amounted to a review of the UK’s onshored MiFID/MiFIR regime and the key regulations governing the UK’s capital markets. The Bill introduces all of the legislative reforms set out in delivery chapter of HMT’s previous consultation response.

Whilst firms based exclusively in the UK are likely to welcome HMT’s reforms, international firms with a presence in both the UK and EU will face an additional compliance burden from having to deal with two increasingly divergent sets of rules.

Equity Markets

As expected, the Bill removes the share trading obligation (STO) and double volume cap (DVC) from the UK's MIFID framework, rules that the UK regulators believe add extra costs and complexity without improving outcomes for end investors.

Removing the STO will mean that firms can trade shares on any trading venue in the UK or overseas, while removing the DVC scraps the caps it imposed on the use of two transparency waivers, the Negotiated Trade Waiver and the Reference Price Waiver. These reforms will give firms more freedom and flexibility to meet their best execution obligations and achieve better prices for end investors.

The Bill also delegates the pre-trade transparency waivers regime to the FCA, giving the regulator the power to make further changes to these rules should any be necessary.

Derivatives Markets

The scope of the derivatives trading obligation (DTO), which requires financial and some non-financial counterparties to trade certain classes of derivatives on UK authorised trading venues, or recognised overseas trading venues, is changing as a result of the Bill. The DTO will be aligned with the scope of the clearing obligation so any counterparty subject to the clearing obligation is automatically within scope of the DTO. In addition, post-trade risk reduction services are being exempted from the DTO. While we do not expect any more changes in the short term, the FCA will have a new permanent power as a result of the Bill to modify or suspend the DTO in future.

Similarly, the Bill also exempts post-trade risk reduction services from the clearing obligation.

Systematic Internalisers (SI)

The Bill also makes changes to allow SIs, investment firms that deal on their own account (i.e. use their own capital) when executing clients’ orders outside of a trading venue on a “organised, frequent, systematic and substantial basis”, to execute trades at the mid-point price. Further, the definition of an SI will no longer be based on a costly and complex instrument by instrument calculation, with the FCA being given a power to set out a new qualitative definition.

Data reporting service providers and consolidated tapes

The Bill makes a change to facilitate the development of consolidated tapes (CTs). CTs collate trading data for financial instruments from a variety of sources and consolidate them into a continuous electronic live data stream. Data Reporting Services Providers (DRSPs), a type of financial market infrastructure (FMI), currently sit outside the authorisation regime (meaning the FCA has no rule-making powers over them). The Bill will give the FCA a general rule-making power over DRSPs. CTs are one type of DSRP, which means the Bill will give the FCA the power to develop specific rules to encourage the development of CTs in the years ahead

Other WMR‑related reforms

Further reforms touch upon a wide range of areas, from commodities trading to reporting requirements and trading venues. Collectively, the Bill’s measures amount to a substantive divergence from the EU’s own MiFID/MiFIR framework, even before taking account of the additional changes the EU is likely to make as part of its ongoing MiFIR and MiFID reviews.

Innovation

As expected, the Bill advances three key innovation-related policy measures announced by HMT since 2021.

Regulation of stablecoins used as means of payment

The Bill takes forward the measures that HMT proposed in April 2022 – summarised in our blog – to bring stablecoins used as means of payment within the regulatory perimeter. As proposed in April, HMT will do this by creating a new category of “digital settlement asset” (DSA), drafted broadly to ensure regulatory flexibility.

Overall, our view is that this is a positive step in the development of the UK’s long-term crypto regulatory framework. However, stablecoin issuers and service providers – especially custody and exchange providers – will have to wait for the rules to emerge later this year to see the specific requirements for these activities. As some of these firms may be becoming regulated entities for the first time, they will benefit from understanding the detail as soon as possible to start developing a compliance strategy.

Both crypto startups and traditional financial services firms developing a crypto strategy also await clarity around the UK regulatory approach in two other key areas:

First, the UK’s approach to other unregulated cryptoassets, beyond stablecoins used for payments, including those used primarily for investment. The Bill confirms that HMT will consult on the approach to this broader set of cryptoassets later this year. The Treasury Committee is also running an inquiry on cryptoassets which may help inform the UK’s regulatory approach.

Second, the final framework to bring crypto promotions within the scope of the UK financial promotions regime. We still await HMT secondary legislation to bring “qualifying” cryptoassets into scope, while the FCA is expected to finalise detailed rules in Q3 2022.

FMI sandbox

Building on the success of the FCA’s existing regulatory sandbox, the Bill enables HMT to set up FMI sandboxes – announced in April 2021 – allowing participating firms to test and adopt new technologies and practices, including Distributed Ledger Technology (DLT). HMT will be able to disapply or modify temporarily certain FMI regulation – including UK CSDR and MiFIR – to allow FMIs in the sandbox to innovate and if deemed successful, may make (some of) the changes to the underlying regulation permanent.

Firms operating in the crypto ecosystem would welcome a DLT-focused sandbox and clarity on how to apply traditional frameworks (e.g. UK CSDR and MiFIR) to their activities (e.g. trading and settlement) since these frameworks were not designed with cryptoassets in mind. However, any permanent changes to these frameworks are unlikely in the short to medium-term since the first sandbox will only go live in 2023.

Critical Third Parties

As anticipated by HMT in its June Policy Statement, the Bill also includes a section on Critical Third Parties (CTPs), to the financial sector. CTPs refer to non-regulated third parties which provide important services to regulated firms, for example, cloud service providers. The new regime confers HMT with the power to designate certain service providers as “critical”, if – in its opinion – the failure or disruption of their services could threaten the stability of and confidence in the UK’s financial services sector. Following designation, the Bill allows the regulators to issue rules and directions in line with their objectives to require the CTPs to undertake – or refrain from undertaking – specific actions and gives them investigation and enforcement powers.

Overall, the new regime closely reflects the approach HMT set out last month. The Bill still leaves plenty of room for interpretation as concerns the designation process and the regulators’ new powers. On 21 July, the BoE, PRA and FCA released a Discussion Paper on CTP oversight setting out a more detailed regime that we will analyse in a separate note.

Consumer protection

Access to cash

The Bill also appoints the FCA as the lead regulator for access to cash, whereby HMT will designate firms to be subject to FCA oversight for the purpose of ensuring the continued provision of cash access. The FCA will be granted monitoring, supervision and enforcement powers over these designated firms to ensure a reasonable provision of cash access services continues. HMT will prepare a policy statement on cash access services, to which the FCA is required to have regard when performing this new function.

The Bill provides the FCA with the ability to impose requirements (including both rules and directions) on designated banks and building societies to require them to take such action as needed to ensure that there is reasonable provision of cash access services.

Authorised Push Payment (APP) scams and liability

The Bill introduces measures to enhance protection for victims of APP scams, where a person or business is tricked into sending money to a fraudster posing as a genuine payee. It enables the Payment Systems Regulator (PSR) to use its powers to require mandatory reimbursement by payment service providers in cases of APP scams.

Financial promotions

At present, financial promotions (i.e. adverts and other promotional materials) from unregulated firms must be approved by firms that are regulated by the FCA or the PRA. However, there are no specific tests or assessment that the regulated firm needs to meet in order to be able to approve the promotions of any unregulated firm.

In order to address the risks that arise from the existing process, the Bill establishes a regulatory “gateway”, which regulated firms must pass through before being able to approve the financial promotions of unregulated firms. Any regulated firm wishing to approve the financial promotions of unregulated firms will first need to obtain the permission of the FCA.

It remains to be seen which, or how many firms, will apply for this new form of authorisation, but given that these changes mean they will likely come under greater scrutiny for any adverts they approve, there are likely to be fewer firms with the power to authorise such financial promotions in future. This will likely slow the pace and quantity of unregulated firms’ financial promotions, potentially reducing the number of misleading adverts. But this also risks creating an environment where new market entrants may struggle to market their products and consequently to compete with incumbent firms.

Implications and next steps

Overall, the contents of the Bill were broadly as we expected, and HMT has changed very little in response to the various consultations that have fed into it. However, the Bill now has to go through Parliament, where it may of course be amended or subject to changes. The Bill will have its first reading in September and will likely become law some time in 2023.

We expect the proposed secondary growth and competitiveness objective to be debated as the Bill progresses. Some will argue that this should be a primary objective if it is to enact real change in the way the regulators behave, while others will argue it should not be included at all as it risks eroding important regulatory standards.

Other provisions relating to the regulators’ independence, such as HMT’s new rule review power and its ability to set “have regards” provisions for the regulators may also prove controversial and attract debate.

Whoever is Chancellor following the expected conclusion of the Conservative Party leadership contest will also have to decide whether they want to proceed with the introduction of any further powers for HMT to intervene in financial regulation, as per the current Chancellor’s Mansion House speech.

This Bill marks a significant moment in UK financial services regulation. It is the first major overhaul of the regulators’ powers, responsibilities and accountability mechanisms since the creation of the FCA and PRA in 2013. It also marks the first major step in the UK’s regulatory divergence from the EU, with the Bill paving the way for the UK to establish its own, differing version of MiFID/MiFIR and Solvency II. We will follow closely how its various reforms affect the UK’s regulatory landscape and whether they are ultimately successful in bringing about a more competitive and flexible UK regulatory regime.