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July 2020

This UK regulatory round-up provides insights on where the agenda is heading and implications for firms. As we move beyond the pandemic and as the post-Brexit landscape takes shape, we track the direction of UK regulation and highlight key developments.

Post-transition approach takes shape

As firms emerge from the immediate response to the pandemic and review their future business priorities and operations, regulators are doing the same. The volume of non-COVID-19 publications from regulators has picked up and they cover a wide range of topics. Whilst some concessions remain in place, regulators are reverting to their pre-pandemic 'to-do' lists. Regulatory agendas have not changed, but priorities and targets are being adjusted. Sustainable finance and technology are now higher up the agenda. 

At the top of the UK regulators' lists is preparing for the end of the transition period, with several indicators over the past month of the future direction of UK regulation and supervision. This includes the continued onshoring of EU regulation but also signs of divergence. The use of guidance and speeches is marked, including in new areas of regulatory focus, such as the payment services sector.

The regulators are also looking further afield and to the longer-term. For example, the Bank for International Settlements (BIS) selected the Bank of England to host a centre of its Innovation Hub, with Governor Andrew Bailey noting the importance of international cooperation in leveraging technology and innovation “to build a more effective, resilient and inclusive financial system” and the role central bankers and prudential regulators have in ensuring that innovation is consistent with financial stability.


Post-transition regime takes shape

The UK Government has indicated plans for divergence from EU regulation in its post-transition approach to UK financial services regulation, stating that “there will be some defined areas where it is appropriate for the UK  - as a large and complex financial services jurisdiction - to take an approach which better suits our market”. In particular:

  • The UK will not implement the settlement discipline requirements of the Central Securities Depositories Regulation (CSDR), due to apply in the EU from February 2021, which are unpopular with market participants. However, given the extra-territoriality requirements of the regime, UK firms settling trades on EU CSDs will still need to comply.
  • The UK will not implement the reporting obligations for non-financial counterparts (NFCs) under the Securities Financing Transactions Regulation (SFTR), applicable in the EU from January 2021.
  • There may be divergence in the UK implementation of the Bank Recovery & Resolution Directive II (BRRD II). HM Treasury is consulting on the aspects that do not need to be complied with until after the end of the transition period, in particular MREL requirements.
  • A review of Solvency II will cover risk margin, matching adjustment, operation of internal models and reporting requirements, and will start with a Call for Evidence in Autumn 2020.
  • Smaller amendments are planned to the Benchmarks Regulation and Market Abuse Regulation.
  • There will be improvements to the functioning of the PRIIP KID regime and to address potential risks of consumer harm.

However, implementation of the European Market Infrastructure Regulation (REFIT) will be completed. Further policy statements will be published in July 2020. 

Divergence may ease requirements in some areas but will add to the complexity of regulatory change programmes and future operating models of firms planning to operate in both the UK and the EU.

In the meantime, the FCA confirmed that regulators and firms need to continue to prepare for a range of scenarios at the end of the transition period. To support this, the notification window for the Temporary Permissions Regime will re-open on 30 September, allowing EEA firms to continue providing services and EEA funds to continue to be marketed in the UK once passporting ends at the end of the year. The FCA will consult later this year on how these EEA firms will apply for permanent authorisation.

Looking longer term, a speech by FCA Chair, Charles Randell indicated that the FCA plans to operate in a fundamentally different manner in the future. His speech described a conduct regulator which is more outcomes-focused, acknowledges the limitations of regulatory disclosure and is trying to steer firms away from tick-box compliance. He identified five shortcomings with the current rules-based approach:

  • it does not automatically follow that rules will result in good outcomes for consumers and markets
  • it assumes that the regulator is always able to judge whether firms are following the rules and to intervene in a timely way
  • rules tend to assume a consumer journey that is no longer typical - if it ever was
  • retail consumers are sometimes offered a bewildering array of products unsuited to their needs
  • the polluter does not pay: the cost of bad behaviour by firms which then fail is met by others, via the FSCS

This speech is a clear trail for the future of conduct regulation review that is planned for this year and gives a strong indication of the FCA's ambition for change.

Sustainable Finance: time to move beyond rhetoric

It is not yet certain that the FCA will introduce rules on sustainable finance and, if so, whether they will be aligned with EU regulations, which start to take effect from March 2021, after the end of the transition. The current approach of the UK regulators appears to be the articulation of supervisory expectations and reference to industry guidance, rather than rules (potentially as an early adoption of Charles Randall's vision described above). Also, although there are references in speeches to social issues, such as diversity, the balance of regulatory comments remains tilted towards environmental issues, specifically climate change risks. However, the overriding message is strong and clear: sustainable finance ought to be a strategic priority for firms and the time to act is now.

A letter from Sam Woods underlines the PRA's expectations of banks and insurers and confirms that it will continue to embed climate-related financial risk into its supervisory approach. The letter provides thematic feedback from the PRA's review of firms' responses to SS3/19, highlighting gaps between firms' intentions and supervisory expectations in the areas of governance, risk management, scenario analysis and disclosures. It also confirms that firms will be expected to have fully embedded their approaches to managing climate-related risks by the end of 2021, taking a proportionate response that reflects their exposure to those risks and the complexity of their operations.

Similar messages have been reiterated by a statement confirming the Bank of England's commitment to the goals of combatting the adverse effects of climate change and the UK's net zero target. Also in June, the Bank published, for the first time, its own climate-related financial disclosure, sending clear signals on the level of expectations on firms and that the regulator intends to lead from the front.

In a speech, Sarah Breeden of the PRA alluded to the enormous size of the task and drew parallels between the COVID-19 crisis and climate change: “both with far-reaching, system-wide risks that affects the whole economy, from which the financial system is not immune.” She also said, “we have now entered the far more difficult second phase, where we must answer the question of how to turn aspiration into action.” 

In response to the considerable practical challenge facing firms, the Climate Financial Risk Forum (CFRF)  - set up by the PRA and the FCA, and comprising banks, insurers, asset managers and others  - has issued a detailed guide for firms on how to integrate these risks into their strategy and decision-making processes. The guide does not constitute formal regulatory guidance but complements existing regulatory initiatives and is intended to provide practical tools, experience, knowledge and case studies, which firms can use as they develop their strategies, processes and approaches, especially with regard to risk management (PDF 1.4 MB), scenario analysis and disclosures (PDF 734 KB). There is much work to be done by firms on data identification and collection, building of tools and frameworks, and their application to business decisions.

PRA refines prudential measures

In addition to forward-looking work on climate risk and innovation, the Bank and the PRA are still responding and adjusting prudential requirements to the impact of COVID-19. Also, although broadly supporting EU initiatives, there are indications of pushback in some areas.

In some cases, measures are being stood down, for example the permitted delays to certain regulatory reporting submissions from April to end May. The PRA will be flexible in its expectations of banks' publication timeline for Pillar 3 disclosures but expects that, in most cases, this should not be affected by the pandemic. Banks are asked to refrain from actions that reduce the quantity and quality of own funds, to ensure the resilience of the financial system and to continue to support lending.

In other cases, pre-pandemic proposals require adjustment. The PRA has confirmed that the reduction proposed in December 2019 in variable Pillar 2A (P2A) requirements for some banks will still be applied on or before 16 December 2020, although the UK Countercyclical Buffer now stands at 0%. To counteract uncertainty around the extent of the stress, the PRA buffer for all banks receiving a P2A reduction will be temporarily increased, until at least March 2022, by 56% of the bank's total P2A reduction. Where banks have already applied the P2A reduction, they may see an increase in their capital planning cost. The PRA also updated its supervisory statement for the Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process (SREP).

For insurers, the PRA provided feedback on recent stress tests: the 2019 exercise and engagement on COVID-19 stresses. The climate change scenarios included as part of the 2019 exercise highlighted gaps in firms' capabilities, data and tools to evaluate climate-related scenarios. The regulator also issued a statement on the application of the matching adjustment (MA) during the pandemic, recognising that firms with MA benefit might seek to adapt their investment strategies. 

The PRA clarified its proposed approach to publication of Solvency II technical information for use by UK insurers following the end of the transition period. It is not yet clear, however, whether the PRA will follow EIOPA's stress testing principles or consider the outcome of the current consultation on methodologies. 

For banks, whilst noting the benefits of public information on the effects of measures taken by UK firms in response to COVID-19, the PRA is taking a pragmatic approach to the EBA's June reporting and disclosure Guidelines. UK banks are not expected to follow the supervisory reporting elements at this time, and a proportionate implementation of the disclosures is proposed, with PRA modifications, for larger, systemically important firms.

There is no full-scale acceptance either for the Capital Requirements Regulation (CRR) “Quick Fix” package announced on 27 June. The PRA supports the amended transitional arrangements for IFRS 9. However, it is less clear about the acceleration of the application date for the revised SME support and infrastructure support factors under CRR2, and discretion for firms to remove a proportion of unrealised gains and losses on exposures to certain public sector authorities until December 2022.The PRA will carry out further analysis to understand better the impact of these measures on firms' capital positions and any implications for safety and soundness.

FCA indicates prudential approach

In contrast to areas where the regulators are already indicating non-implementation of EU rules, the FCA's discussion paper (PDF 2.7 MB) on prudential rules for investment firms that better reflect their business models closely follows the Investment Firms Directive and Regulation, due to come into effect after the end of transition. The FCA does not generally propose fundamental differences to EU rules, but asks questions about interpretation, points of detail and use of member state discretions. However, it is unlikely that the FCA will weaken its current perspective, demanding a SREP and ICAAP (to be become ICARA) process for relevant firms.

The FCA also published its final guidance (PDF 621 KB) on how firms should assess whether they have adequate financial resources and how they should be able to evidence this to the FCA. The document is aimed at those firms not subject to detailed prudential standards (FCA solo-regulated firms subject to threshold conditions and/or the Principles for Business (PRIN)). However, the FCA states that other firms should consider this document alongside existing requirements. The guidance will be a key document for firms seeking FCA authorisation.

More on pensions and retirement income

Following FCA announcements on Defined Benefits (DB) pensions covered in the last edition, there has been a range of announcements from different regulators on pensions and retirement income, with the same overarching intention: to make the retirement planning sector operate more efficiently and effectively for the benefit of consumers.

Pension freedoms have resulted in consumers taking a more holistic view of their retirement provision, thinking outside the traditional pension mindset. This has led to a significant increase in the equity release advice sector, as customers seek additional retirement income source. The FCA's review of the sector found equity release to be working well for many, but:

  • Advice did not always sufficiently consider consumers' personal circumstances
  • Consumers' reasons for considering equity release were not always challenged by firms
  • Firms were not always able to evidence that their advice was suitable

These are consistent with FCA findings in the investment (and DB transfer) advice sector. The FCA plans to revisit this topic, so firms have a limited window to address any failings, ensuring that their propositions, fact-finding and record keeping arrangements are appropriately aligned to regulatory expectations and to deliver good customer outcomes.  

In its thematic review of the effectiveness of Independent Governance Committees (IGC) and Governance Advisory Arrangements (GAA) of workplace pensions in delivering value for money, the FCA identified issues in relation to the level of independence and challenge provided by some IGCs, making it more likely that members would receive a poor outcome. Further, GAAs operated by third-party firms (on behalf of pension providers) were less effective at delivering meaningful improvements in value for money. In fact, although the FCA found a small reduction in charges across all pension savings, it could not be directly linked to the work of IGCs and GAAs. A consultation paper maintains the FCA's focus in this area. Firms should be objectively assessing how well IGCs and GAAs are generating the outcomes the FCA is seeking.

Ahead of Government legislation, The Pension Regulator (TPR) has unveiled the standards it will require the new DB Superfunds to meet. Industry will want to better understand how this TPR guidance will operate in practice and whether it will deliver comparable consumer protection and prudential capital requirements to FCA regulated pension contracts. 

The TPR has also updated its Corporate Plan to address COVID-19 challenges. Like the FCA and PRA Business Plans, there have been no fundamental changes. The TPR will continue to seek to protect pension savers by carrying out targeted regulatory interventions, improving standards of trusteeship and ensuring automatic enrolment continues to provide safe workplace pensions for savers.

Finally, the Pensions Dashboards Programme (which is progressing the initiative to improve visibility for consumers of their legacy pension contracts) has published a call for input on data scope and data definitions. These will determine the breadth of coverage of dashboards and the depth of information displayed, respectively. They will be fundamental in shaping the data standards for the initial dashboard which, in turn, will be pivotal to the success of overall initiative.

Payment services firms in the spotlight

The continuing rapid development of the payment services sector led to the safety and accessibility of payments being one of the five key priorities in the FCA's 2020/21 Business Plan (PDF 1.2 MB). There have since been changes to consumers' payment methods during lockdown and the collapse of a high-profile firm, which has led to increased scrutiny of the sector. 

Confirming its concern that lockdown measures have impacted payment firms' financial strength and consumers' ability to access cash and payment services, the FCA quickly published additional temporary guidance (PDF 237 KB) on safeguarding customer funds, building upon the guidance already available in its Payment Services Approach document (PDF 218 KB). The new guidance details further requirements on: safeguarding, including documentation of account reconciliation process, safeguarding accounts and audit requirements; managing prudential risk, including stress testing; and wind-down plans. Published at the same time, a 'Dear CEO' letter (PDF 2.7 MB) to payment service firms highlighted six key areas of supervisory focus, some of which are covered by the guidance. The FCA plans a full consultation later in 2020/21 on changes to the approach document.