The Financial Services and Markets Bill 2022-23 – A second 'Big Bang'?
On 20 July 2022, the Financial Services and Markets Bill 2022-23 (the Bill) was introduced into Parliament. At over 330 pages, the Bill is the largest piece of financial services legislation since the Financial Services and Markets Act 2000 (FSMA) was passed more than two decades ago.
Before the Bill was introduced into Parliament, government sources indicated that we should expect a second ‘Big Bang’ to echo the wide-ranging deregulatory changes introduced in 1986. Whilst many of the proposed changes to onshored Single Market legislation are indeed liberalising in nature, the main proposals were long expected, and the bigger story is the extent to which the government itself is seeking to exert greater control over regulatory standards. Following the first Big Bang, liberalisation of foreign ownership rules led to widescale consolidation of ownership of UK brokerages, with many legacy firms being bought out by US banks and other international firms. This time around the debate is again about ownership, but this time it is ownership of regulatory policy that is the focus, rather than ownership of firms themselves. This extends not just to ownership of rulemaking powers by the UK rather than the EU, but also the desire for HM Treasury to have greater control over post-Brexit rulemaking by the PRA and the FCA.
Balance of powers
Unusually, the focus on the eve of the Bill’s publication was on what isn’t in the Bill, rather than what is. In his speech at Mansion House on 19 July 2022, the current Chancellor of the Exchequer, Nadim Zahawi, confirmed that the much-rumoured new “call-in” powers allowing ministers to intervene in regulators’ decisions “in the public interest” have not made it into the Bill. The Chancellor stated that he was “keeping an open mind” as to whether such powers were appropriate, but the sensitivity of such proposals were clear, bearing in mind the extent to which the Bank of England and the Prudential Regulation Authority (PRA) value their independence, something that was made very clear by the current Governor of the Bank of England in his own Mansion House speech the same evening.
Notwithstanding the absence of the call-in powers, the Bill does, however, contain a number of provisions that are cut from the same cloth. The Bill would introduce a new obligation under Section 3RA of FSMA for each UK regulator to keep their rules under general review, and if a regulator either fails to do so (or else proposes to do so in a way that HM Treasury does not view as “appropriate”), the Treasury can appoint an independent third party to review the regulator’s rules for them. In addition, the proposed new secondary objective for the FCA and the PRA to facilitate the growth and international competitiveness of the economy of the United Kingdom – “including in particular the financial services sector” – is designed to foster a more “UK PLC” approach to the discharge of regulatory obligations, including in the development of rules. Whilst some commentators have suggested that a new competitiveness objective could lead to a ‘dangerous’ refocusing away from financial stability, the objective has been framed in such a way that it would not require either the PRA or the FCA to act in a way that is inconsistent with their primary objectives – which include protecting the stability of the UK financial system – so these concerns are arguably overstated, even if they do introduce more creative tension into the UK rulemaking process.
Prudential standards – Reforming Solvency II
A key purpose of the Bill, as championed by the Chancellor, is that it will enable the UK to proceed with its plans to reform Solvency II and move towards a Solvency UK regime. The Government wants to reduce the risk margin insurers are required to include in their technical provisions to take account of the additional cost of transferring their liabilities to a willing third party. It wants to increase the range of assets available for the "matching adjustment" they are able to apply where they have liabilities with predictable outflows (e.g. under annuities), and change the calculation of the "fundamental spread", which seeks to reflect the risk of default or downgrade represented by the matching adjustment assets. More generally it is looking to reduce a range EU-derived reporting, administrative, and other regulatory requirements. The Government hopes its package of reforms will mean that around 10-15% of the capital currently held by UK life insurers can be released allowing them to put tens of billions of pounds into long-term productive assets (e.g. green infrastructure projects), whilst safeguarding policyholder protection. Other hoped for advantages include reducing the incentives for UK insurers to reinsure internationally – so premium is retained in the UK economy - and reducing the cost to UK consumers of, in particular, long-term insurance products like annuities.
These proposed changes continue the same theme, insofar as they show the government’s willingness to reform regulatory standards to ensure UK competitiveness, noting that here, HM Treasury are not just thinking about the insurance sector themselves, but about freeing up capital and delivering benefits for the real economy, and ultimately for consumers. The focus for the Government is perhaps obvious. The UK’s needs around infrastructure spending and the green transition more generally, are too significant to have disproportionate amount of capital locked away in lower risk assets, and there is a strong political imperative to demonstrate gains from post-Brexit regulatory freedom. The PRA in particular will be keen to ensure that the dial does not move too far away from financial prudence and that the new liberalising mindset does not sow the seeds of the next financial crisis.
Future Regulatory Framework (FRF)
Sections 3, 4 and 5 of the Bill contain broad powers for HM Treasury to modify or restate retained EU onshored legislation and replace legacy references to EU directives. It is clear that there is a cosmetic angle to this as well as a functional one, with an eye on the usability and comprehensibility of legislation. One of the criticisms of the process of onshoring EU legislation in advance of the UK’s exit from the EU Single Market was that it left behind a relatively complex web of complex interpretive provisions and cross-referencing. That the Treasury now has the power to amend onshored legislation and related references to EU directives for “the purpose of making the law clearer or more accessible” will be welcome to many working in the regulated sector, and should be welcomed by customers as well, if it allows them to more easily navigate the protections from which they benefit.
As regards the proposed changes to primary and secondary markets, that there are fewer surprises; in many cases, the proposals in the Bill match the changes to primary legislation that have already been identified by the Treasury as being necessary to implement the UK’s Wholesale Markets Review and the UK Listings Review, although in the secondary markets space it is notable that matters previously baked into primary legislation are instead being delegated down to either HM Treasury or the FCA, which is in keeping with the Chancellor’s theme of agile regulation. This can be seen in giving the FCA power to frame waivers from post-trade transparency requirements, via a replacement Article 4 of the UK onshored Markets in Financial Instruments Regulation (MiFIR), as well as giving the FCA rulemaking power over both pre- and post-trade transparency requirements for both fixed income instruments and derivatives. It is worth noting that there is no such discretion in respect of the UK Share Trading Obligation (STO) – the Bill would delete the STO directly, along with most of Article 23 of UK onshored MiFIR, leaving behind only the requirement for firms that operates an internal matching system which executes client orders equities and equity-like instruments on a multilateral basis to get authorised as an MTF.
That these changes are expected, of course, doesn’t make them unwelcome; wholesale banks and investment firms will welcome the liberalisation of the UK secondary markets – including the renewed focus on achieving the best outcomes for investors – even if their enthusiasm will be tempered by potential commercial and operational drag against conflicting EU provisions. The UK is now out of the EU Single Market, but their financial markets remain fundamentally connected, and the question of how to build the best regulatory environment for the UK without creating undue operational or commercial headaches in respect of cross-border activity remains an ongoing challenge.
To quote the Chancellor’s Mansion House speech, “[t]hat’s not all the Bill does.” A range of other familiar and less familiar proposals that have made their way into the Bill include:
- Financial markets infrastructure (FMI) sandboxes – Section 13 of the Bill would give HM Treasury a new power to introduce financial markets infrastructure (FMI) sandboxes under secondary legislation to allow “testing, for a limited period, the efficiency or effectiveness of the carrying on of FMI activities in a particular way.” Section 15 would in turn allow HM Treasury to make the sandbox arrangements permanent, either as tested or with such variations as HM Treasury consider appropriate. This new power will be particularly welcome to pioneers in digital and other alternative trading, clearing or settlement offerings whose operations do not fit neatly into existing regulatory criteria and/or legacy Single Market rules designed for a pre-digital era.
- Critical third parties – Technology services such as cloud computing and data analytics bring multiple benefits such as enabling digital transformation and catalysing innovation. However, increasing sector reliance on a small number of key third parties does create a degree of concentration risk across the market that needs to be managed. Section 18 of the Bill would introduce a new Chapter 3C to FSMA to help implement HM Treasury’s 8 June 2022 policy paper on Critical third parties to the finance sector, which is aimed at the leading cloud services providers and certain other key non-regulated financial sector intermediaries on which the regulated sector relies. This includes an express power to censure persons designated as critical third parties where they breach rules made by the FCA, PRA or Bank of England in connection with the services they provide to authorised persons, as well as the broad powers of direction, information gathering and investigation set out in HM Treasury’s paper. The proposals stop just short of formally bringing the main cloud services providers into the UK regulatory perimeter, but it certainly brings them closer.
- Changes to financial promotions rules – As expected, the Bill contains changes to the ability of authorised persons to approve financial promotions prepared by third parties that don’t hold a UK authorisation, e.g. affiliates based overseas who undertake business with UK customers on a pure-cross border basis in reliance on exemptions under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (the RAO). The Bill would introduce a new Section 55NA of FSMA which requires authorised persons to obtain a specific permission from the FCA in order to approve such communications. These changes are closely linked to HM Treasury’s review of the Overseas Framework and should assist in helping to prevent the UK’s financial promotions regime being misused by firms with a nominal footprint in the UK who may promote riskier products to UK customers without adequate levels of control or oversight.
- Net zero emissions target – Section 25 of the Bill will add the need to contribute towards achieving compliance with the UK net zero emissions target set out in the Climate Change Act 2008 (as amended) to the list of regulatory principles to be applied by both the PRA and the FCA, as set out in Section 3B of FSMA.
- Settlement of crypto assets – Section 22 of the Bill contains a new power for HM Treasury to introduce bespoke rules on the regulation of payments, payment systems and service providers in relation to the payments that include “digital settlement assets”, which includes any digital representation of value or rights, whether or not cryptographically secured, that “(a) can be used for the settlement of payment obligations; (b) can be transferred, stored or traded electronically, and (c) uses technology supporting the recording or storage of data (which may include distributed ledger technology).” This should allow the government to place payments technology that relies on distributed ledger technology or other forms of cryptography – as well as novel payment technology using other digital methodologies – to be put on a clearer regulatory footing, thereby helping to support the UK as a recognised centre for digital technology in the financial services space. These changes should allow certain types of stablecoin to be regulated as a form of payment in the UK, which in the view of the Treasury could facilitate stablecoins becoming a widespread means of payment, thereby driving customer choice and efficiency and cementing the role of the UK as a leading player in the crypto space.
- Access to cash – Against a background of the growth of digital payments, we should not lose sight of the fact that many in society prefer a more analogue lifestyle. With this in mind, the Bill would require the Treasury to publish a statement of policy concerning cash deposit and withdrawal services and designate certain firms – including current account providers meeting criteria set out in the Bill – as firms providing those services, with a view to ensuring the continuity of access to cash services through directions to firms so designated. These proposed new provisions in FSMA can be found in Schedule 8 of the Bill and align with recommendations made following the consultation on access to cash held by the Treasury during 2021.
- Protecting against authorised push-payment (APP) scams – Following the consultation by the UK Payment Systems Regulator (PSR) in November, 2021 on how to significantly reduce APP scam losses incurred by payment system users, the Chancellor confirmed in his Mansion House speech that the Bill contains powers that “enables regulators to require that victims of push payment scams are paid back.” In particular, Section 61(1) of the Bill requires that the PSR “must prepare and publish a draft of a relevant requirement for reimbursement in such qualifying cases of payment orders as the Regulator considers should be eligible for reimbursement.” In addition, in keeping with the overall theme of the Treasury taking the reigns of regulatory rulemaking, Schedule 7 of the Bill contains detailed new provisions on the accountability of the PSR, including a proposed new Section 102A of FSMA that would empower the Treasury to make recommendations to the PSR on (amongst other things) how to advance one or more of its payment systems objectives and exercise its regulatory functions. Notably, this is a power that must be used: Section 102A of the Bill provides that the Treasury must make recommendations in relation to the PSR’s payment systems objectives in particular “at least once in each Parliament.” It may be worth noting, in this context, that critics have contended that the powers should not be used against banks who can show they have identified scams before warning and informing customers.
The DLA Piper team will be looking at many of these key topics in further detail in more dedicated briefings in the near future.
Delays to the first reading of the Bill mean that it has been introduced into Parliament only a day before the summer recess; debate on the proposals will therefore have to wait until the September. With the identity of the country’s next Prime Minster due to be announced on 5 September, we should expect the next incumbent to champion the changes as part of their signature strategy and ensure that the Bill receives Royal Assent as soon as possible. In the meantime, other key elements of the reforms are being progressed on parallel tracks, including the FCA’s consultation on equity secondary markets reforms that was published on 5 July 2022.