The UK’s Regulatory Regime After Brexit: The Financial Services Bill

The Financial Services Bill 2019-21 (the Bill) is the first large piece of primary legislation in the UK, addressing issues relating to financial services and financial regulation arising from Brexit.  The Bill concerns the future of UK regulation and starts to look at how the UK will regulate financial services outside of the EU.  It covers numerous areas which we summarise below including: (i) prudential regulation of credit institutions and investment firms, (ii) benchmarks, (iii) access to financial services markets, (iv) amendments to the Proceeds of Crime Act 2000 and (v) amendments to the PRIIPs regulation.

1. Prudential regulation of credit institutions and investment firms

1.1 The EU is in the process of implementing a new prudential regime for investment firms, the Investment Firm Regulation (IFR) and Investment Firm Directive (IFD). The UK was heavily involved in formulating this regime, recognising that the EU’s capital requirements derived from the Basel capital standards were not suited to all investment firms. Indeed, in the explanatory memorandum accompanying the Bill, the UK Government notes that the current prudential framework for investment firms can be disproportionate, inappropriate and may impose unnecessary administrative and compliance burdens on investment firms.

1.2 The Bill proposes that the UK’s on-shored version of the EU’s Regulation (EU) No 575/2013 on prudential requirements for credit institutions (CRR) will only apply to credit institutions and PRA-designated investment firms. As a result, firms not regulated by the PRA will move off the CRR and on to the FCA’s new proposed Investment Firm Prudential Regime (IPFR).

1.3 The Bill also provides the FCA and the PRA with the power to make certain prudential rules. In particular, the PRA will be able to introduce new rules to implement in the UK, the Basel standards covered by CRR II Regulation ((EU) 2019/876) (CRR II) and the final Basel III standards.  This is necessary since aspects of CRR II did not form part of retained EU law in the UK (taking effect from 28 June 2021 and so forming “in-flight” legislation that was not onshored). 

1.4 The Bill inserts a new Part 9D in the Financial Services and Markets Act 2000 (FSMA) conferring power on the PRA to make rules for the prudential regulation of credit institutions and PRA-designated investment firms. In making such rules, the PRA must have regard to:

• the relevant standards recommended by the Basel Committee on Banking Supervision from time to time;
• the likely effect rules would have on the standing of the UK as a place for internationally active credit institutions and investment firms to be based or carry on activities;
• the likely effect of the rules on the ability of firms to continue to provide finance to businesses and consumers in the UK on a sustainable basis; and
• any other matter specified by Treasury regulations.

1.5 Additionally, when making rules for prudential regulation, the PRA must:

• consider the UK’s standing in relation to other countries and territories which internationally active credit and investment firms are most likely to choose to be based or carry on activities; and
• consider and consult with Treasury about the likely effect future rules will have on any relevant equivalence decisions.

1.6 Similarly, with respect to the IFPR (the UK’s proposed regime in response to the EU’s IFD / IFR), the Bill introduces a new Part 9C to FSMA which gives the FCA power to make prudential rules applying to investment firms.  In exercising this power, the FCA must have regard to: 

• any relevant standards set by an international standard setting body;
• the likely effect of the rules on the standing of the UK as a place for internationally active investment firms to be based or carry on activities; and
• any other matter specified by Treasury by Regulations.

1.7 Additionally, when making rules for prudential regulation, the FCA must:

• consider the UK’s standing in relation to the other countries and territories in which internationally active investment firms are most likely to choose to be based or carry on activities; and
• consider and consult with Treasury about the likely effect of the rules on relevant equivalence decisions.

2. Benchmarks

2.1 The Bill will revise the UK’s regulatory regime for benchmarks to address issues relating to the transition from LIBOR. The government’s aim is that by the end of 2021, the FCA will have the appropriate regulatory powers necessary to manage the orderly wind-down of a critical benchmark such as LIBOR before its cessation. 

2.2 With respect to tough legacy contracts, it is proposed that the FCA will have the power to exempt legacy use of a benchmark from the prohibition on the use of that benchmark and shall have discretion to specify the scope of any permitted legacy use and the length of the permission period.

3. Access to financial services markets

3.1 Overseas Funds Regime

3.1.1 Currently, an overseas scheme must be “recognised” before it is able to be promoted in the UK. This process is set out in section 272 of FSMA and to become recognised, the FCA must be satisfied that each scheme, its operator and its trustee and depository, if there is one, meets several tests in legislation and that adequate protection is afforded to investors in the scheme.

3.1.2 As noted in our Brexit article here, the UK introduced the temporary permissions regime (TPR) to ease the Brexit transition. However, for schemes that have been notified under the TPR their access to the UK market is temporary and when the TPR ends, to continue to access the UK market they will need to be recognised.  The TPR is currently scheduled to end at the end of 2023 (and may be extended by one year at a time). The Bill will extend this to the end of 2025 to allow time for the overseas fund regime to take effect. 

3.1.3 The UK Government recognises that the process of recognition under section 272 is not suitable for recognising a potentially large number of overseas schemes. This is because the process is resource intensive for scheme operators and the FCA. It also operates on a scheme-by-scheme basis which is not well suited to dealing with potential changes in regulation or requirements that impact large numbers of schemes.

3.1.4 Given the deficiencies under the section 272 recognition process, the Bill introduces a new overseas funds regime (OFR) to allow overseas collective investment schemes to be marketed to all investors, including retail investors, in the UK market on appropriate terms. Under the OFR there would be two new mechanisms: one for retail collective schemes and another for money market funds (MMFs).  Section 272 of FSMA will not be repealed.  It will continue to be available for individual retail schemes that are not eligible to be recognised through the OFR because they are not covered by an equivalence determination for retail schemes.

3.1.5 Under the OFR, HM Treasury will have the power to grant equivalence to a specified category of schemes from an overseas country. OFR equivalence will be based on outcomes.  This means that other countries need not have identical laws to those in the UK, but the overall effect of their rules should achieve the same outcomes.  For retail collective investment schemes, an overseas country must offer at least equivalent investor protection and for MMFs, law and practice in a particular country or territory must offer equivalent effect to Regulation (EU) 2017/1131 of the European Parliament and of the Council of 14 June 2017 on money market funds.

3.1.6 As well as the overseas country needing to be equivalent, the OFR may also impose additional requirements in certain circumstances, for example, where an overseas country meets the standard of equivalent investor protection but it is still desirable to specify additional requirements as a pre-requisite of marketing in the UK.  Any such additional requirements would be set out in the statutory instrument giving effect to the equivalence determination.

3.1.7 In relation to overseas retail collective investment schemes, once an equivalence determination has been granted (alongside any additional requirements), individual retail collective investment schemes wishing to market in the UK will need to be recognised by the FCA under the OFR. Retail collective investment schemes will need to apply to the FCA for recognition and the FCA will have the power to require scheme operators to provide it with such information as is reasonably considered necessary for determining the application (for example, information which confirms the scheme is eligible for recognition and meets any additional requirements to the extent any apply).   The Bill proposes to disapply notification requirements under the national private placement regime for schemes that are recognised under the retail equivalence regime of the OFR.

3.1.8 In relation to overseas MMFs, the process of gaining market access will depend on whether they intend to market to retail or professional clients:

• to market solely to professional clients in the UK, MMFs must provide MMF equivalence and notify under the NPPR;
• to market both retail and professional clients, the MMF must either be located in a country or territory with equivalence determinations for both MMFs and retail schemes and apply for recognition under the OFR, or be located in a country or territory with an equivalence determination for MMFs and be recognised as suitable for marketing to retail investors under section 272 of FSMA.

3.1.9 The Bill proposes that both the OFR and section 272 of FSMA apply to collective investment schemes. It will therefore be clear that each of the regimes will be able to recognise overseas schemes structured as umbrella funds and sub-funds.

3.2 Gibraltar and the UK:

3.2.1 The Bill will establish a new permanent market access regime concerning Gibraltar (the GAR). Under the GAR, Gibraltarian financial services firms will have access to the UK’s wholesale and retail markets as “authorised persons” under FSMA (without actually needing to be authorised by the FCA) where they provide certain approved activities.  Firms will not be able to carry on regulated activities in the UK for which they do not have authorisation in Gibraltar.  Access to the UK market will be dependent on certain conditions including sufficient alignment of the law and practice of the UK and Gibraltar and adequate cooperation between the Gibraltarian and UK authorities.  

3.2.2 As market access is a sovereign matter, the government of Gibraltar will need to legislate for reciprocal market access for UK firms. The Bill does, however, make provision for the procedure UK firms should follow as a pre-condition for accessing the Gibraltarian market. UK firms will need domestic authorisation to carry on the relevant regulated activities and notify UK regulators of their intention if market access is available. 

4. Amendments to MiFIR – the Title 8 Regime

4.1 Pursuant to the UK’s on-shored MiFIR, third country investment firms can provide cross-border investment services and activities into the UK to eligible counterparties and per se professional clients where certain conditions are satisfied, including that there is an equivalence decision in place with respect to that third country (referred to as the Title 8 Regime). Under this regime, HM Treasury has the necessary powers to assess whether a third country is equivalent for the purposes of the Title 8 Regime.

4.2 The Bill proposes updating the Title 8 Regime to broadly reflect the changes introduced by the EU to their own regime under MiFIR. The Bill proposes giving the FCA the power to specify reporting requirements for firms that register under the Title 8 Regime.  It will also enable HM Treasury to impose specific requirements on firms registered under the Title 8 Regime.

4.3 Finally, the Bill includes an amendment to clarify the scope of the reverse solicitation exception (where firms service UK clients at the client’s own initiative, without relying on the Title 8 Regime). The Bill inserts a new paragraph 5A which provides that where a third-country firm or a person acting on their behalf solicits a person, the provision of an investment service or activity by the third-country firm to the person is not initiated at the person’s own exclusive initiative.

5. Amendments to the Market Abuse Regulation

5.1 The Bill makes two amendments to the UK’s on-shored Market Abuse Regulation (MAR) which closely reflect changes recently made to the EU MAR:

5.2 MAR requires issuers or any person acting on their behalf or on their account to maintain an insider list. The Bill will amend MAR so that it is clear insider lists must be maintained by issuers and any person acting on their behalf or on their account.

5.3 The Bill amends MAR to adjust the timetable within which issuers are required to disclose transactions by their senior managers to the public. This will be within two working days of those transactions being notified to them by senior managers or persons closely associated with them.

6. Extending the maximum criminal sentence for market abuse

The Bill will increase the maximum sentence for criminal market abuse from seven to ten years.

7. Amendments to the Proceeds of Crime Act 2000

7.1 Currently, sections 327, 328, 329 and 339A of the Proceeds of Crime Act 2000 (POCA) allow deposit-taking bodies only, in certain circumstances, to process transactions where there is suspicion of money laundering if the transaction is below a threshold amount (£250), without needing to submit a defence against money laundering suspicious activity report (DAML) to the National Crime Agency (NCA) and without committing a principal money laundering offence. Currently, as this only applies to deposit-taking bodies and not to payment institutions and e-money institutions registered under the Payment Services Regulation 2017 or Electronic Money Regulations 2011, such payment institutions and e-money institutions are required to submit DAMLs, even for minimal sums. The Bill proposes to amend POCA to bring payment and e-money institutions within the scope of the threshold provisions.  

7.2 Additionally, it is proposed that both POCA and the Anti-Terrorism, Crime and Security Act 2001 (ATCSA) will be amended so that powers concerning account freezing orders and forfeiture provisions in POCA and ATCSA will extend to accounts held at payment and e-money institutions.

8. Amendments to the PRIIPS Regulations

The Bill proposes amendments to the PRIIPs Regulations in line with the suggestions in HM Treasury’s policy statement published in July 2020. The FCA would be given the power to make rules specifying whether a product or category of product falls within the definition of a PRIIP.  The Bill would require KIDs to contain a brief description of performance scenarios and assumptions made to produce these.  Finally, as regards PRIIPs, the Bill gives HM Treasury the power to specify a later date for the exemption of UCITS (so long as this is no later than 31 December 2026).

9. Conclusion

The Bill is interesting as it is a first glimpse at the UK’s future regulatory framework outside of the EU.  At a glance, the UK remains cautious of its position outside of the EU as is seen with respect to the prudential regime provisions of the Bill – the FCA and the PRA will not have carte blanche to make rules relating to the prudential regime, they will each need to consider the likely effect their future rules will have on any relevant equivalence decisions. This is likely to be a theme we will see running through future rules and regulations, especially if the EU adopts equivalence decisions as regards UK financial services in the near future. 

The Bill is very extensive, covering a number of areas that will directly impact on firms so ensuring timely compliance with the new rules will be important.  In terms of the Bill’s progress, it has completed its progress in the House of Commons and is currently at the committee stage in the House of Lords.  The Bill is on track to receive Royal Asset during the Spring of 2021 to enable some of the reforms to take effect in the Summer.

If you require further information about anything covered in this briefing, please contact Grania Baird, Kya Fear, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, March 2021