UK Regulatory Radar

March 2021

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.

Over the past month there have been various announcements that start to set out the future UK regulatory framework. Two important government reviews have published their findings on the UK Fintech environment and the UK Listing Regime. HM Treasury and the FCA have started to give indications of the direction of wholesale markets regulation, where there could be some continuing equivalence with EU regulation but also some divergence. And Sam Woods, CEO of the PRA, in a speech focused on plans for the review of UK Solvency II, put forward the case for rules being in regulatory rulebooks rather than on the statute book.

In his speech, Sam Woods emphasised that none of the changes to UK Solvency II under consideration will mean lower levels of protection for policyholders or less resilient insurance firms. Consumer protection remains high on the FCA's agenda, including its findings from a product governance review of fund managers, which have wider implications, and a further raft of COVID-related announcements. The FCA has also warned that younger investors are taking on bigger financial risks. The regulators have jointly issued their final policy approach on operational resilience for financial services.

Diversity continues to be a regulatory focus. The fourth Annual Review (PDF 1.32 MB) of HM Treasury Women in Finance Charter showed that the most common reasons given by the 30% of 209 Charter signatories that have missed deadlines for female representation in senior management were due to COVID-19 freezes on recruitment or promotion. FCA CEO, Nikhil Rathi emphasised that improving diversity and inclusion is both a matter of fairness and a crucial way to strengthen consumer outcomes. The FCA is considering whether diversity of management teams should be reviewed in senior manager applications and whether diversity requirements should be included in premium listing rules.

The FCA also announced the appointment of four women to its executive committee including the appointment of it first Chief Data, Information and Intelligence Officer (CDIIO) to help transform the FCA into a “data-led regulator”. Discussions continue in the Artificial Intelligence Private-Public Forum, with the latest minutes including reference to the Bank of England making the PRA Rulebook machine readable and using machine learning tools to enhance supervisory capabilities.

• Proposals for future frameworks start to land
• Equivalence and divergence in capital markets regulation
  
• The UK Solvency II review
• Product governance review findings
• Continued focus on COVID-19 impacts on consumers
• Stop Press: final operational resilience policy
  

With the departure of the UK from the EU, the UK government commissioned a number of independent reviews to recommend measures to keep the UK as a global financial centre, including changes to the regulatory framework.

The Kalifa Review's objectives were to recommend measures to support the growth and widespread adoption of UK fintech, and to maintain the UK's global fintech reputation. The review recommends several measures across skills enhancement, investment, international collaboration and national connectivity. On policy and regulation, the review calls for “dynamic leadership that protects consumers yet nurtures FinTech activity and encourages competition”.

Recommendations include:

• Deliver a digital finance package that creates a new regulatory framework for emerging technology
• Implement a “Scalebox” that supports firms focusing on scaling innovative technology
• Establish a Digital Economy Taskforce (DET) to ensure alignment across government
• Ensure that FinTech forms an integral part of trade policy

The UK Listing Review (PDF 746 KB) examined how companies raise equity capital on UK public markets and makes recommendations on improving the process, while aiming to maintain the high standards of corporate governance, shareholder rights and transparency. Key recommendations include:

• Modernising listing rules to allow dual class share structures in the London Stock Exchange's (LSE) premium listing segment, giving directors (in particular, founders) enhanced voting rights on certain decisions, with safeguards to maintain high corporate governance standards
• Reducing free float requirements - the amount of a company's shares that are in public hands - from 25% to 15% and allowing companies to use other measures to demonstrate liquidity
• An annual report on the state of the City, and its competitive position, delivered to Parliament by the Chancellor
• Rebranding and repositioning the LSE's standard listing segment to increase its appeal to companies of all sizes and types
• A fundamental review of the prospectus regime, so that in future, admission to a regulated market and offers to the public are treated separately - this will ensure it reflects the breadth and maturity of UK capital markets and the evolution in the types of business coming to market
• Liberalising the rules regarding special purpose acquisition companies (SPACs), with appropriate safeguards for investors

The FCA will review these recommendations and will consult in summer 2021, with a view to reaching final rules by late 2021. The FCA also supports proposal for a fundamental review of the legislative framework for the prospectus regime, with a view to better alingning documentation requirements with the type of transaction being undertaken.

The FCA has started to set out its plans for wholesale markets regulation in a speech by Edwin Schooling Later.

The FCA gave its first indications that it will match MiFID II changes made by the EU as part of the Capital Markets Recovery Package, with an FCA consultation shortly to be released proposing “a similar set of changes - not absolutely identical” to the EU changes. These include removal of the requirement to provide prescribed costs and charges information to professional clients and eligible counterparties, and a two-year suspension on the need to provide eligible counterparties with best execution reports (RTS 27 reports), with professional clients being able to opt out. The FCA has announced that it will not act against firms that do not produce RTS 27 reports for the rest of 2021. The FCA expects that by end-2021, it will have concluded its policy consideration of the future of these reports.

The EU will allow the “re-bundling” of equity research on firms with a market capitalisation below EUR 1 billion or and for that research to be offered free of charge to a firm's trading clients. It will be interesting to see whether the FCA adopts these changes, given they were key proponents of MiFID II's original unbundling measures.

On the MiFID II transparency regime, the FCA has already made it clear that it will not apply the double volume cap to dark trading of all equities traded in the UK, expanding from its originally scope of just UK equities, unless it sees harms to price formation or execution outcomes for investors. The European Commission is expected to present its proposals to amend the MiFID II transparency regime in the summer and it is clear from the speech that the FCA will also be presenting proposals to refine the framework.

On the Securities Financing Transaction Regulation (SFTR), the FCA will allow the regime to mature before it proposes any further divergence from the regime (non-financial companies are not in scope of UK SFTR unlike the EU SFTR). But the FCA recognises that “divergence between two regimes could add additional complication of cost to groups who would then have to adhere to two different set of reporting requirements”.

However, the proposed expanded Central Counterparties (CCPs) resolution regime, being consulted upon by HM Treasury, is similar to the EU regime apart from in a few technical areas. The proposal is also in line with Financial Stability Board guidance. The new proposals would give the Bank of England addition powers to mitigate the risk and impact of CCP failure, and the proposals are designed to balance the incentives of clearing members and CCP shareholders to encourage appropriate risk management and behaviour ahead of, and during, a resolution.

The joint PRA/FCA consultation on margin requirements for non-centrally cleared derivatives aims to bring the on-shored UK rules in line with pending EU amendments and BSB and IOSCO standards. Specifically, the regulators are consulting on amending UK bilateral margining requirements by:

• Changing the implementation dates and thresholds for the phase-in of IM requirements
• Requiring the exchange of variation margin for physically-settled foreign exchange forwards and swaps, to specified counterparties only
• Extending the temporary exemption for single-stock equity options and index options until 4 January 2024

The UK is not currently implementing regulation equivalent to the EU's suite of sustainable finance regulation. However, the FCA published a Primary Market Technical Note (PDF 208 KB) that helps listed issuers consider what they should be disclosing on ESG matters given existing requirements under the UK Listing Rules, Prospectus Regulation, Disclosure Guidance and Transparency Rules (DTR), and the Market Abuse Regulation (MAR).

The UK Government is creating a UK emissions trading scheme (UK ETS) to replace the UK's participation in the EU scheme. The FCA is consulting (PDF 1.22 MB) on the UK ETS Instrument 2021, which contains amendments to a number of Handbook modules to reinstate provisions and definitions previously deleted as a consequence of the UK's departure from the EU ETS at the end of the transition period. The consultation is open only for a short period as the government would like auctions for the UK ETS to commence as soon as possible and no later than Q2 2021.

Sam Woods speech to the ABI, entitled “Brave New World”, noted that regulation of the insurance sector in the UK is about to change and that more of the rules insurers need to follow will be set out in the PRA's rule book rather than in statute, to allow for greater flexibility in adapting to innovation and the changing environment and to enable regulation to be tailored to fit the UK market better and be “more efficient and coherent”. The speech acknowledged that, if the role of UK financial regulators expands post-Brexit, there needs to be a corresponding enhancement of accountability to Parliament. International standards will also play an important role, and the PRA is committed to continuing to develop these.

The PRA does not aspire to a zero-failure regime and policyholders are best protected by firms that have the right amount of capital and can grow and respond to the changing environment. However, Changes will not mean lower levels of protection for policyholders or less resilient insurance firms, and the PRA does have a low appetite for disorderly failure. The UK does not yet have a resolution regime for insurers, but there was a strong implication that this is coming.

The speech emphasised that the review will stay true to the basic principles of Solvency II. Broadly, the regime has served the UK well as demonstrated through the pandemic, but the regime is over-specified and needs tailoring in places, particularly on the life side. Risk margin is not yet correctly calibrated. The highest prudential standards should be applied to the institutions that create the most risk in the financial system - insurance is vital to the economy. The matching adjustment (MA) makes a significant contribution to insurers' capital base, but caution should be exercised around calls to make the MA more generous. The role of internal models is important and whole balance sheet modelling is fundamental to understanding the risk profile of large insurers - more explicit sanity checks and conversations around resilience are required. Supervisory stress tests also have a role to play.

The FCA published findings of its multi-firm review into product governance arrangements. Although the focus of the review was on eight asset managers, the nature of the findings makes them relevant for all sectors.

In short, the FCA believes there is significant scope for asset managers to improve their product governance arrangements to align them to its requirements. There is a palpable sense of frustration from the FCA. More than three years after the PROD rules came into force and despite previous issues being identified, there continues to be “significant scope for asset managers to improve their product governance arrangements”.

The findings were grouped into the following key failings:

1. Product design — Firms were not appropriately considering the product's negative target market and are not assessing conflicts of interest at a sufficiently granular level of detail.
2. Product testing — Stress and scenario testing was either too backward-looking or too generic by not addressing product specific characteristics.
3. Distribution — Some firms were conducting insufficient due diligence on distributors at outset and procedures for monitoring MI were insufficient. (The FCA had previously highlighted the challenges relating to MI.)
4. Governance and Oversight — Ineffective oversight by second line, poor record keeping and inadequate training.

The FCA expects firms to ensure they prioritise good customer outcomes and that they comply with the relevant regulatory rules and requirements. Firms should assess whether their product governance arrangements are fit for purpose and operating effectively.

The FCA has published a further raft of measures in response to COVID-19. This includes:

• Guidance on its expectation that firms should not enforce mortgage repossessions, except in exceptional circumstances, before 1 April 2021
• The limit of single and cumulative limits on contactless payments raised (PDF 290 KB) to £100 and £300, respectively
• Extended suspension of the requirement for firms to issue 10% depreciation notifications to investors and plans to consult later in the Spring on more permanent changes
• New rules, which come into effect on 4 May 2021, to provide “breathing space” to people in problem debt the right to legal protections from creditor action for a defined period
• The FCA will gather information on all non-damage business interruption policies that are, in principle, capable of responding to pandemic impacts, following the Court judgments

The FCA is still considering it policy response to its recent consultation on GI pricing practices, but it has published an announcement relating to the implementation period for any rules arising from the paper. Following feedback, the FCA will split the implementation dates for the remedies. Systems and controls rules and the product governance changes will come in at end-September 2021. However, changes to pricing, auto-renewal and reporting requirements will not come into until end-2021 to give firms sufficient time to implement.

The FCA has also published a consultation detailing how it intends to regulate pre-paid funeral plans, which will come into effect from July 2022.

The Pensions Regulator (TPR) is consulting on streamlining its codes of practice. TPR's 15 existing codes of practice are set to be transformed into a new online code, providing one up-to-date and consistent source of information on scheme governance and management. TPR also confirmed that it plans to consult on a draft defined benefit (DB) funding code in the second half of 2021. And on the topic of DB pensions, the FCA has published an update to its Finalised Guidance for firms on how to calculate redress for unsuitable DB transfers, to reflect Government changes to the way that the Retail Prices Index (RPI) inflation measure is calculated from 2030.

The Bank of England and FCA have published a joint paper (PDF 873 KB) on their final policy approach to operational resilience, together with a supporting package of Policy and Supervisory Statements. The combined requirements and expectations embed the approach set out in the December 2019 consultations. Final policy is not overly prescriptive and the regulators have said they expect best practice to emerge over time. However, they encourage firms and FMIs to view the policy as a minimum standard and look to implement it in a manner that is proportionate to their size, scale, and complexity. The package includes policy relating to Impact Tolerances for Important Business Services (PDF 1.08 MB), Outsourcing and Third-Party Risk Management (PDF 0.98 MB) and Operational Resilience of FMIs. Policy will take effect from 31 March 2022, with the expectation that all important business services will have been identified and impact tolerances defined by that date and that firms will have set out how they will comply with supervisory requirements and expectations. By 31 March 2025, firms and FMIs must show that they are able to remain within the impact tolerances they have set.