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-Transition landscape takes shape, we track the direction of UK regulation and highlight key developments.
Uncertainty, resilience and customers
2020 has been the first year of a new decade, a pandemic year and the end of the UK's transition out of the EU. As this momentous year draws to a close, three ongoing themes for both UK regulators and UK regulated firms are uncertainty, resilience and the treatment of customers.
The key message of the Financial Policy Committee's (FPC's) latest Financial Stability Report (PDF 2.9 MB) is that the UK financial system has so far been able to support households and businesses through the economic disruption due to COVID-19, but that downside risks remain, including ongoing pandemic impacts and uncertainty about the future trading arrangements with the EU. Similarly, the PRA's assessment of large UK banks' 2020 distribution plans concluded that, although some capital headwinds are to be expected in 2021, large UK banks remain well-capitalised and able to support the economy.
The PRA has written to international banks, UK deposit takers and insurers setting out its supervisory priorities for 2021. Unsurprisingly, financial resilience, operational resilience, the transition from LIBOR and the financial risks of climate change are on the radar for all and the PRA notes the importance of strong governance in meeting regulatory expectations. UK deposit takers also need to prioritise credit risk and competition and future regulatory frameworks. For insurers, the change in the PRA’s responsibilities after the EU transition will be key.
As the new UK regulatory framework evolves, regulators will continue to focus on both lessons to learn from 2020 events and finance in the new reality - digital and sustainable. For example, the Bank of England's (BoE's) Annual Report (PDF 1.16 MB) on the supervision of financial market infrastructures indicates that future priorities will be the procyclicality of margin calls and the resilience of non-bank liquidity, international work on lessons from 20as20's market volatility, innovation in payments, and the recognition and supervision of incoming CCPs. The focus on new finance is evidenced in a speech by Andy Haldane (BoE) on digital finance, a speech by Jonathan Davidson (FCA) on the business of social purpose, and various regulatory forums on climate financial risk, socio-economic diversity in financial services and productive finance.
The customer is not forgotten. The FCA has concluded its reviews of retail distribution and the financial advice market, and it continues to issue warnings and censures concerning firms' dealings with retail customers.
Highlights featured in this update:
The Transition Period draws to a close
With less than a month to go before the end of the Transition Period the FCA has reminded firms that they should be prepared for the end of passporting and the new regulatory landscape. There are key requirements that firms need to comply with from 1 January 2021, although the FCA will use its Temporary Transitional Power until 31 March 2022 to allow firms more time to meet the other requirements brought about by onshoring.
In a special edition of the Primary Market Bulletin, the FCA reminded issuers, investors and other market participants of the changes that will take effect when the onshored legislation enters into force - in particular, notification or reporting under the Short Selling, Market Abuse and Prospectus Regulations. The bulletin gives guidance to firms on the impact of proposed ESMA Guidelines and Q&As, and the delegated regulation under the EU Prospectus Regulation, which may or may not become effective or come into force before end-2020.
The FCA has published detailed notices on reporting of securities financing transactions (PDF 121 KB) under UK SFTR and the reporting of derivatives (PDF 127 KB) under UK EMIR. From 11 pm on 31 December 2020, the relevant reporting under the regulations will need to be submitted to FCA-registered or recognised trade repositories. Similarly, the FCA has published detailed plans for firms migrating their MiFID II transparency and reference data reporting from ESMA systems to the FCA's systems.
Finally, the FCA has amended (PDF 163 KB) the TPR notification procedures regarding the launching of new EU UCITS sub-funds in umbrella schemes already notified under the TPR.
The future UK regulatory framework
The Treasury Select Committee launched an inquiry into the “Future of Financial Services” with a call for evidence covering wide-ranging issues such as: the overall framework; trade and third-country relationships; the statutory objectives, funding and independence of regulators; and supporting actions such as skills and immigration policy and developing new areas of growth. Meanwhile, HM Treasury has issued its own call for evidence to understand how the current overseas framework supports the UK's position as a global financial centre and whether it is coherent, fair and easy to navigate for cross-border businesses.
The FCA continues to engage proactively with other regulators and announced that it will participate in GFIN cross-border testing of financial products and services. This initiative is open to firms looking to test innovative financial products, services, business models or regulatory technology across more than one country or jurisdiction.
Further to Discussion Paper DP20/2, the FCA has issued the first (PDF 3.8 MB) in a series of consultation papers on the rules to implement the new Investment Firms Prudential Regime (IFPR). The IFPR will be close but not identical to the EU Investment Firms Directive and Regulation, whose aims the FCA supports. The differences will reflect UK specifics in a few areas.
The FCA will regulate pre-paid funeral plans from summer 2022. It has announced that it will consult in spring 2021 on its proposed rules and approach to authorising firms.
Finally, recognising that not all firms will survive the current challenges, the FCA is consulting on providing additional support to assist insolvency practitioners. The proposed guidance aims to help them comply with FCA rules and guidance and relevant legislation and achieve better outcomes for consumers and market participants.
Conclusion of the Financial Advice Market Review
The FCA has finally published the outcome of the long-standing review of retail distribution (RDR) and the financial advice market (FAMR). Although it found evidence of some improvements relating to people accessing advice, adviser numbers and the rise in awareness and use of automated solutions, the report was otherwise downbeat and indicates that there is more work to be done in this sector. The findings include:
- Further innovation could help even more consumers make better use of their finances
- The level of new customers receiving ongoing advice (more than 90%) might lead to consumers paying for a service they do not need
- Lack of price competition around charges (both initial and ongoing), with most firms charging roughly the same - a broader distribution of charges would be expected in a well-functioning market
- Consumers would benefit from greater development of simpler and cheaper support services, such as streamlined advice and personalised guidance services
Whilst the FCA flags the above issues it is not, at this stage, proposing any action. Instead, it simply directs people to engage in its recent call for input (summarised here), which unhelpfully closed less than two weeks after the FCA published this paper. However, a core theme running through the findings relates to a lack of competition/value for money. This may provide an indication that this sector could be the next on the FCA's list to consider introducing remedies to ensure that it is delivering good customer outcomes.
Continued focus on retail conduct
Over the past few years, consumers have been moving away from cash and traditional bank accounts towards cards, mobile apps and electronic wallets. These services are often provided by a range of firms, from small money remittance firms to non-bank current account providers, which are classed as payment institutions (PI) and electronic money institutions (EMIs). The existing insolvency process for PIs and EMIs is sub-optimal, with consumers not being able to access their money for prolonged periods or being left with reduced sums of money at the end of the insolvency process. HM Treasury is therefore proposing a bespoke Special Administration Regime (SAR) with an explicit requirement for the special administrator to return customer funds as soon as reasonably practicable.
The FCA has confirmed final rules for the ban on marketing of speculative illiquid securities, such as “mini-bonds”, to retail investors. The ban will come into effect on 1 January 2021. It also published draft guidance to assist policyholders with the types of evidence and methodologies that policyholders can use to prove the presence of COIVD-19 when seeking to make a claim under their business interruption policies.
Consumer credit lenders, SIPP operators, and credit reference agencies and credit information service providers are the next three sub-sectors to receive portfolio (PDF 95.5 KB) letters. The portfolio-specific risks highlighted are:
- For the main consumer credit lenders (PDF 247 KB), the appropriate treatment of customers (considering affordability, handling of arears and persistent debt) and firms' approaches to transparency of pricing and features.
- For SIPP operators (PDF 190 KB), concerns about financial resilience, robustness of product governance (especially in relation to international SIPPs), complaint handling and protecting customer from scams.
- For credit reference agencies and credit information service providers (PDF 195 KB), the protection of personal data, product governance, financial resilience, technology resilience and complaint handling.
Complaints are clearly the topic du jour, with the TSC writing (PDF 170 KB) to the FOS seeking to better understand its approach to effective adjudication on complaints, its costs and levies, and how it deals with complaints about the FOS itself.
The current economic climate could cause firms to leave the market or merge with the other firms. The FCA has warned firms intending to transfer or receive personal client data that they must be able to demonstrate how they have considered the fair treatment of consumers and how their actions comply with data protection and privacy laws. The FCA has also directed firms to the ICO guidance on data protection.
Financial Stability Report
The key message of the FPC's latest Financial Stability Report (PDF 3 MB) is that the UK financial system has so far been able to support households and businesses through the economic disruption due to COVID-19, but that focus remains on downside risks, including:
- Risks arising from the evolution of the pandemic - including cash-flow deficits for UK companies, the need to access external financing, and likely increases in unemployment and insolvencies in 2021
- The transition to new trading arrangements between the EU and the UK
The UK banking system remains resilient to a wide range of economic outcomes and has the capacity to support businesses and households, even if these outcomes are significantly worse than currently expected. Major UK banks' and building societies' aggregate Common Equity Tier 1 (CET1) capital ratio increased to 15.87% as at end-September 2020, over three times higher than at the start of the 2008 financial crisis.
Banks have provisioned for £20 billion of credit losses although the effect on capital ratios is reduced by IFRS transitional relief. The FPC judges that they could absorb losses of up to £200 billion, but that such losses would occur only under much more severe UK and global macroeconomic scenarios than those currently forecast. The 2021 stress test will seek to confirm this view by testing banks' end-2020 balance sheets against a scenario similar to the FPC's August 2020 reverse stress test.
Banks should use all elements of their capital buffers to enable them to support the economy. The UK countercyclical buffer (CCyB) will now remain at zero until at least Q4 2021 and any subsequent increase will not take effect until Q4 2022 at the earliest. The speed of return to the standard 2% UK CCyB will depend on banks' ability to rebuild capital while continuing to provide support to the wider economy.
Most risks to UK financial stability that could arise from disruption to the provision of cross-border financial services at the end of the EU transition period have been mitigated, but some market volatility and disruption, particularly to EU-based clients, is possible. Financial institutions should continue taking measures to minimise disruption - this includes engaging with clients and customers.
The FPC remains committed to implementation of robust prudential standards in the UK - the level of resilience targeted will be at least as great as that currently planned, which already exceeds international baseline standards.
The UK mortgage market can be a key source of risk to UK financial stability due to the impact of high household indebtedness on either borrower or lender resilience. Existing FPC recommendations aim to guard against households becoming highly indebted by limiting the proportion of new mortgages with high loan-to-income (LTI) ratios. Mortgage credit conditions have tightened, particularly at high loan-to-value (LTV) ratios, reflecting concerns over the outlook for the UK economy, as well as operating constraints interacting with high demand for mortgages. High LTI mortgages have been less affected, suggesting that lenders' internal risk limits and operational constraints rather than the FPC's recommendations have driven the recent reduction in mortgage availability. The FPC is reviewing its mortgage market recommendations, including their calibration, and will report further in 2021.
The FPC is considering how the regulatory system should adapt to ensure confidence in the value of stablecoins at all times, while supporting innovation and efficiency. Stablecoins could be adopted widely if they are trusted and meet appropriate standards, but their growth could have implications for wider financial stability, including reinforcing existing risks of large flows of money. The BoE will issue a discussion paper in due course that will also consider issues relating to Central Bank Digital Currencies.
Capital distributions by large UK banks
The PRA's assessment of large UK banks' 2020 distribution plans concluded that, although some capital headwinds are to be expected in 2021, large UK banks remain well-capitalised and able to support the economy. Notwithstanding economic disruption due to COVID-19 and uncertainty around the UK's future relationship with the EU, the PRA considers distributions “an important and necessary part of the functioning of the banking system”. Large UK banks may therefore resume some shareholder distributions for 2020. Bank boards will determine the appropriate level of dividends but must do so prudently and within a framework of temporary guardrails:
- Distributions to ordinary shareholders should not exceed the higher of:
- 20 basis points of risk-weighted assets as at end-2020; or
- 25% of cumulative eight-quarter profits covering 2019 and 2020 after deducting prior shareholder distributions over that period
- The PRA must be satisfied that distributions would not leave the bank vulnerable to excess stress or prevent it from being able or willing to support households and businesses.
- Any firm wishing to pay a dividend in excess of the guardrails should engage with supervisors and expect a high bar for justifying exceptions
The PRA also expects firms to “exercise a high degree of caution and prudence” in the payment of cash bonuses to senior staff, including material risk-takers, and will scrutinise proposed pay-outs closely to ensure that the remuneration regime has been rigorously and appropriately applied.
The PRA intends to transition back to its standard approach to capital-setting and shareholder distributions through 2021. The Prudential Regulation Committee (PRC) and FPC plan to run a full system-wide stress test in mid-2021 and publish bank-by-bank results at end-2021. In the meantime, appropriately prudent 2021 dividends can be accrued but should not be paid out. Expect a further update ahead of the 2021 half-year results.
Other banking prudential matters
The BoE has confirmed that the UK approach to implementing the Capital Requirements Directive V (CRD V) will take place through EU Exit regulations and amendments to PRA rules and expectations. CRD V will come into effect on 28 December 2020, with most of its requirements, including those relating to Pillar 2A, applying from 29 December 2020. See also the PRA's final Policy Statement.
The PRA proposes (PDF 1 MB) to designate responsibility to entities within certain banking UK consolidation groups for ensuring that consolidated prudential requirements are met during a transitional period between 28 December 2020 and the date on which the UK parent holding company's application for approval or exemption is finally determined. Relevant holding companies will need to apply for approval or exemption in accordance with the EU Exit regulations. The consultation is relevant to banks and PRA-designated investment firms that are part of a UK consolidation group controlled by a UK parent financial holding company (FHC) or a UK parent mixed financial holding company (MFHC).
The PRA announced that it will maintain banks' Systemic Risk Buffer (SRB) rates at the rate set in December 2019 for a further year until December 2022, with no rate changes taking effect until January 2024. The CRD IV SRB will be replaced on 29 December 2020 by the Other Systemically Important Institutions (O-SII) Buffer, which will be set at the same rate as banks' current SRB Buffer. O-SII rates will next be reviewed in December 2022, based on balance sheet positions at end-2021.
The PRA published Leverage Voluntary Requirements (VREQ) applications for global systematically important institutions (G-SIIs) and institutions subject to an SRB. Firms to which the UK leverage ratio framework applies will be invited to apply for a VREQ, which will include an Additional Leverage Ratio Buffer (ALRB) based on either the G-SII buffer or SRB, and associated reporting and disclosure requirements. Firms that cannot meet the requirements will need to notify the PRA immediately and prepare and submit a capital plan.
A PRA statement recognised the global and interconnected nature of banks and the importance of supervisory coordination and committed to working closely with the European Central Bank and the Federal Reserve to ensure that supervisory approaches on operational resilience are well coordinated.
A speech (PDF 726 KB) by Andrew Hauser, BoE Deputy Governor for Markets addressed the role of the UK and the BoE in supporting Islamic Finance, why it has an important role to play in supporting the recovery from COVID-19 and how the BoE's new Alternative Liquidity Facility can help. It considered core principles of Islamic finance, such as prioritising equity-like risk over debt, factoring ethical and environmental considerations into investment decisions and embracing innovative financial solutions, and how these could be well-suited to addressing post-COVID challenges.
Stress testing by insurers
In a speech, “The fox and the hedgehog: preparing in a world of high risk and high uncertainty”, Charlotte Gerken, PRA Executive Director for Insurance Supervision set out initial details for the next two stress tests:
- The BoE 2021 biennial exploratory scenario (BES) will explore the financial risks posed by climate change. The exercise aims to test the resilience of the current business models of the largest banks and insurers, and the financial system, to climate-related risks, as well as the scale of adjustment that will need to be undertaken in coming decades for the system to remain resilient. Feedback from last year's discussion paper and engagement with financial firms, climate scientists, economists, other industry experts and informed stakeholder groups will ensure the test is effective and that the design is appropriate. The BoE will publish scenarios in June 2021, with initial submissions due by end-September. Firms are encouraged to start developing their capabilities sooner rather than later. Results are expected in the first quarter of 2022, following a second round of submissions, if necessary.
- A comprehensive insurance stress test in 2022 will include a dedicated scenario for general insurers underwriting cyber risk. Life insurers were included in the stress test for the first time in 2019. It was hard to produce robust results that were comparable across firms with diverse business models and capable of being sensibly aggregated. The BoE will engage with life insurers on lessons learned from the 2019 exercise to understand where further investment is needed by firms to improve capability and what the PRA can do to make the test more successful (including the way in which the BoE specifies stresses, and what can be achieved in time for the 2022 and subsequent exercises).
By 2022, the BoE aims to be able to use its stress testing exercises alongside other supervisory analysis to improve insights into the resilience of both the general and life insurance sectors.
Finally, the PRA has set out how it will fulfil its obligations to publish Solvency II technical information necessary for the valuation of insurance liabilities for each relevant currency.
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