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Financial Markets Regulatory Outlook 2023 - Confronting the polycrisis

Every year we take stock of the major regulatory themes that will dominate the strategy, risk and change agendas of financial services (FS) firms. The strapline for this year’s Outlook is “confronting the polycrisis”. Notwithstanding some recent positive economic developments, we concluded that “polycrisis” – a series of interlocking and simultaneous economic, geopolitical and environmental crises – still sums up what lies ahead in 2023 very well. The major challenge will be to navigate the choppy near-term waters without losing sight of the medium-term processes of structural change playing out in relation to geopolitics, technology and sustainability. However, firms face this challenge from a position of resilience and strength, having already successfully dealt with a period of significant disruption over the last three years.

TheRegulatory Outlook for 2023identifies 12 topics that we believe will be of strategic significance across the banking and capital markets, insurance, and investment management sectors. These are summarised below and analysed in detail in the full report.

Who should read the Outlook?

It is particularly relevant to all leaders of FS firms who must consider the impact of regulation in their roles – CEOs, CFOs, CROs, CCOs, COOs, Chief Sustainability Officers, Non-Executive Directors, Heads of Internal Audit, Heads of Regulatory Affairs and Heads of Strategy.

Key themes for 2023

Strengthening transition plans and disclosures

Tackling climate change for real

The near-term economic challenges have not substantially altered the commitment of regulators to ensure that FS firms engage actively with the net zero transition. Firms need to change gear on transition planning, from stating ambitions and setting targets to taking action. Supervisory focus will initially be on reviewing the credibility and effectiveness of transition plans in guiding risk management and business strategy.

Climate risk and the climate-nature nexus

Making managing environmental risk business as usual

2022 demonstrated the disruptive effects of both physical and transition risks, putting it beyond doubt that climate risks demand immediate and proactive risk management. Supervisory reviews conducted in 2022 highlighted that firms will need to make faster progress in integrating climate risks into their strategies and risk management frameworks.

At the same time, nature risk is rising in prominence. Fully incorporating nature risk into risk assessments will be challenging for firms, but a more tractable starting point is to focus on the climate-nature nexus, where nature interacts with climate.

Digital assets and payments

Policy implementation begins

Digital assets markets experienced significant disruption in 2022. While regulated firms’ interest has remained resilient overall, calls for swift and effective regulation have grown louder. Against this backdrop, EU and UK policymakers continue to shape their future digital assets regulatory frameworks, which will increase the oversight of digital assets firms and provide some level of detail to enable regulated firms to develop their medium-term strategies.

Operational resilience and critical third parties

A year of real tests

With EU and UK operational resilience policy frameworks largely in place, 2023 will be the year where focus turns to implementation, with supervisors expecting to see tangible evidence of firms’ progress in building resilience. Regulators are also looking at the sectoral resilience of FS more broadly and are designing critical third-party oversight frameworks. Nevertheless, firms will still have to address vulnerabilities stemming from their own third-party exposures.

Credit risk

Storm clouds forming

The gloomy credit outlook presents serious challenges for both consumers and firms. Borrowers face high inflation, higher interest rates and associated cost-of-living challenges, and in 2023 pent up credit pressure will start to translate into increased impairments for firms. Supervisors will expect firms to have the capacity, skills and resources in place to deal with rising insolvencies and distressed borrowers, all the while managing balance sheet impacts proactively.

Capital framework

More to come

Banks and insurers face significant re-design of their capital frameworks, the final form of which will come into focus in 2023. While this will reduce policy uncertainty, the reforms will herald a more fragmented regulatory landscape for cross-border groups. Firms will need to invest time to ensure they understand the strategic implications of changes to the relevant rules, and potential opportunities.

Capital markets

Renewed focus on market resilience

In the wake of serious disruptions to market liquidity and price volatility last year, we expect supervisors to focus on three separate, but related issues: firms’ counterparty credit risk management frameworks, margining practices and booking arrangements. Some banks will need to invest significantly to simplify booking models, and review associated risk management and control infrastructure.

Model risk management

Do you know what you’re looking for?

The ever increasing use of models in FS to aid business decisions and risk management has prompted supervisory concerns around the extent to which firms appreciate and manage the possibility that their models do not perform as expected. FS firms’ Boards and senior executives need to understand and explain to supervisors the level of their firm’s reliance on models, and their models’ strengths and weaknesses.

Financial crime

Running faster just to stay in place

Following several years of intense scrutiny, many firms’ financial crime operating models continue to fall short of supervisory expectations. Some recurring problems are basic, e.g. concerning ineffective on-boarding processes for certain clients and controls. Fixing these issues requires significant organisational change to eliminate silos, change resourcing models and leverage new technologies, in economic conditions where firms face pressure to control costs.

Plus spotlights on:

The new UK Consumer Duty

The cost-of-living crisis means that as firms are implementing the most material piece of UK cross-sectoral conduct regulation of the last decade, they will also face a real, market-driven stress test of how they treat their customers. In the short term, firms must consider how to enable good outcomes for the increasing number of their customers facing financial difficulty. In the medium term, firms need to streamline their Duty frameworks to manage the costs of ongoing implementation, including reviewing the use of data and technology.

Spotlight on the EU’s Digital Markets Act (DMA)

The EU’s landmark legislation to crack down on the anticompetitive behaviours of digital and technology platforms goes live this year, presenting opportunities for FS firms to capitalise on changing market structures. Some of the DMA’s measures may support competition in digital FS - firms’ 2023 strategy decisions will benefit from considering how the DMA could change their competitive landscape and how to respond.

The future UK regulatory framework

The Edinburgh Reforms represent the most significant package of regulatory changes since the UK left the EU. However, the reforms sit alongside an already sizeable portfolio of major regulatory change, including the Consumer Duty, updated bank and insurance capital regimes, and new sustainable finance regulations. The combined impact on strategy and resources will be material and require careful management and prioritisation.

To read more about all these issues, please click here to read or download a full copy of our Regulatory Outlook.