UK Regulatory Radar

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.

COVID-19-related issues continue to be on regulators’ agendas. There is also a build-up of regulatory activity ahead of the end of the Transition Period (including important statements about market infrastructure and the need to focus on good customer outcomes) and an increasing focus on the UK’s future regulatory framework. The UK review of Solvency II may be the first big test case of divergence from EU rules as the UK goes it alone. The PRA is also proposing amendments to market and credit risk requirements for banks.

The PRA has provided early insight into industry responses to its operational resilience consultation - there are indications that firms who had already started to implement the policy proposals were best able to respond to the pandemic. Operational disruption in the event of zero or negative rates is now on regulators’ minds, with the Bank of England (BoE) and the PRA seeking to understand the potential technical challenges of such a decision.

The use and impact of artificial intelligence has also moved up the regulatory agenda, with the launch of the PRA/FCA Artificial Intelligence Public Private Forum (AIPPF), which will focus on data, model risk management and governance. The regulators are concerned about the fragmented nature of current regulation and the need for policy to evolve, striking the right balance between high-level principles and a more rules-based approach.

Meanwhile, there are further developments on payments systems and the availability of cash, and an increasing focus on the need to protect individuals’ savings in defined contribution arrangements.

• Continued focus on COVID-19 impacts 
• Towards the end of the transition period
• Future regulatory framework takes shape
• UK goes it alone on Solvency II
• Changing prudential requirements for banks
• Bank resolution framework
  
• Operational resilience - early responses
• Closing in on zero or negative rates
• More on payments and access to cash 
• 15-year plan to protect savers

Regulators continue to finesse and refine their focus to ensure that firms respond appropriately and reduce the risk of customer harm while the impact of the pandemic continues to be felt. In a noteworthy speech on market abuse, Julia Hoggett, FCA Director of Market Oversight commented that the regulator’s “expectation is that going forward, office and working-from-home arrangements should be equivalent." Helpfully, our latest report on remote governance and controls looks at how firms can best continue to encourage this outcome during this period of sustained hybrid working.

In terms of starting to remove concessions, the TPR has updated its guidance so that, from 1 January 2021, Defined Contribution pension schemes and providers will be asked to resume reporting late contribution payments.

To ensure that firms are continuing to focus on key customer harms, the FCA has issued a steady stream of publications articulating its evolving regulatory expectations. There has been new confirmed guidance for dealing with consumer credit (including overdrafts) customers and additional expectations for helping consumers with cancellations and refunds with credit and debit card providers as well as insurance providers. The FCA is also consulting on new proposed guidance to further prompt insurers and premium finance firms to help customers reduce the impact of financial distress and ensure that customers continue to have insurance that meets their needs.

Finally, the FCA has issued three Dear CEO letters to remind firms of their regulatory obligations in the light of COVID-19, two of them in relation to ensuring that firms maintain adequate client money arrangements [one generally (PDF 478 KB) and another just for insurance intermediaries (PDF 342 KB)]. The third letter relates to Business Interruption Insurance (PDF 281 KB) and ensuring that insurers are keeping policyholders suitability updated following the outcome of the High Court judgement detailed in our last update.

With the end of the transition period rapidly approaching, the regulators are putting in place arrangements to manage the risks of no trade deal, as well as sending reminders to firms of what they will need to have in place for 1 January 2021.

A major risk to financial stability has been mitigated until June 2022 by the European Commission’s decision that the UK legal and supervisory framework for central counterparties (CCPs) is ‘equivalent’. This allows UK CCPs to continue providing clearing services to their EU members. In welcoming the decision, the BoE noted that this would allow the European Authorities to finalise the remaining steps for recognition of UK CCPs.

Meanwhile, the BoE and US Commodity Futures Trading Commission (CFTC) have signed an updated Memorandum of Understanding (MOU) for the supervision of cross-border clearing organisations, to support “a system of enhanced equivalence and mutual deference supporting global management of risk”.

Firms were reminded in a joint letter from the PRA and FCA of the final actions required to prepare for the end of the transition period, including ensuring:

• Continuity of wholesale banking business and contracts (e.g. repapering and novating)
• Standard contractual clauses are included in relevant contracts given the absence of a decision by the EC on UK data protection adequacy
• Compliance with share and/or derivatives trading obligations under range of scenarios
• Additional debtor information on single European payment area (SEPA) payments
• Fair treatment in the provision of retail banking services to EU customers

A similar joint letter was sent to insurance firms, reminding them of:

• The need for contingency planning and continuity of cross-border business in respect of EU liabilities.
• The availability of the Part VII ‘saving provision’ to be able transfer insurance business.
• The need to review the impact of customers’ EEA bank account closures on the ability for UK insurers to make and receive payments from an overseas account.

Both letters also outline the requirements around the Temporary Permissions Regime (TPR) for EEA passporting firms.

On publishing an updated version of its handbook, the FCA confirmed that it will apply the Temporary Transitional Power on a broad basis from the end of the transition period until 31 March 2022, allowing firms more time to prepare to meet the changes to their UK regulatory obligations brought about by onshoring. However, the FCA did list some obligations that it will expect firms to comply with from 1 January 2021 such as transaction reporting and client asset obligations.

The FCA confirmed its position, first made in 2019, that it will not require UK investment firms that transact on trading venues outside the UK, in the EU or elsewhere, to publish details of those transactions through a UK Approved Publication Arrangement (APA). It also does not consider commodity derivative contracts traded on trading venues, whether in the EU or elsewhere, as economically equivalent OTC contracts and so they will not count towards the UK commodity derivatives position limits regime. This was prompted by ESMA stating it was considering whether EU investment firms trading in UK venues would need to publish transactions through EU APAs.

CP17/20 sets out proposed changes to the PRA’s rules, supervisory statements and statements of policy to implement elements of the Capital Requirements Directive V (CRD V) and updates to the UK framework as a result of amendments to the Capital Requirements Regulation (CRR, as amended in CRR II), which apply during the EU Exit Transition Period. The PRA proposes to implement certain CRD V requirements which apply to firms during the transition period but not requirements which come into force after the transition period. The consultation covers:

• New requirements for the approval and supervision of certain holding companies.
• Measures to enhance supervisory requirements to measure, monitor and control IRRBB.
• Revisions to the framework for applying capital buffers.
• Amendments to the definition of the maximum distributable amount (MDA) that constrains a firm’s distributions when it uses its capital buffers.
• Clarification of the quality of capital required to meet Pillar 2 requirements.
• The process for applying variable capital requirements to firms’ real estate exposures (and the public authority responsible for applying them).
• The methods that may be used for the purposes of prudential consolidation.

This consultation should be read in conjunction with CP12/20, which sets out the PRA’s approach to implementing other elements of CRD V.

HM Treasury has issued the second phase of the review of the UK’s post-Brexit regulatory framework, which focuses on the split of responsibilities between Parliament, the government and the regulators. The government and Parliament will set the policy framework for financial services, the strategic direction of financial services policy and, if they so decide, activity-specific policy. Working within this framework, the regulators will design and implement the regulatory requirements that apply to firms. Enhanced scrutiny and public engagement arrangements will help to ensure that the regulators are accountable for their actions and that stakeholders are fully engaged in the policy-making process. A fuller package of proposals will be issued next year.

Essentially, the regulators will be the rule-setters, but there will be more systematic consultation with HMT at an early stage in the policy-making process. EU legislation and regulations that have been “on-shored” to smooth the impact of the end of the transition period will, largely, be transferred to the PRA and FCA rulebooks. In the foreword, the Economic Secretary re-iterates that the UK remains committed to the highest standards of regulation and that it will continue to take its international responsibilities seriously. The government will continue to drive forward its policy agenda on innovation, stability, market integrity and customer protection, sound capital markets and openness.

Meanwhile, the FCA has been embedding its Data Strategy, by establishing a new, more empowered function to manage intelligence coming into the FCA.

HM Treasury has issued a Call for Evidence on the review of the on-shored Solvency II Directive. It is an important signal of the UK’s future approach to reviewing existing EU legislation. The intention is to tailor the Solvency II requirements to the UK insurance market. The paper seeks views on certain key themes:

• The impact of the design of the risk margin and what changes should be made to the methodology, noting that the current risk margin is excessively high and volatile, especially for long-term business with guarantee such as annuities. 
• For the matching adjustment (MA), changes needed to the eligibility of assets (currently, inflexible), to support the provision of long-term capital, to address climate change-related risks, to the MA approval process and to the PRA’s powers to manage risks to policyholders and insurers arising from the MA.
• Changes to the standard formula to calculate the solvency capital requirement (SCR), to address the risk profiles of UK insurers, to provide greater flexibility and to address climate-change related risks; and improvements to the requirements for internal models.
• Enabling the temporary calculation of the consolidated group SCR using multiple group internal models following an acquisition or merger.
• Changes to the process for recalculating deductions to the Transitional Measure on Technical Provisions for example, regarding the maintenance of legacy models.
• Refining the current multi-layered approach to reporting by UK insurers and branches of overseas insurers.
• Possible removal of the capital requirements for foreign branches.
• Adjusting the application thresholds in order to reduce the number of insurance firms that are regulated by the PRA under Solvency II.
• Improving the ‘mobilisation’ of new insurers by adjusting the period after authorisation (currently, five years), after which firms must meet or exceed the Solvency II requirements. 
• Factors to be considered as part of the proposed transition of insurance firm discount curves from LIBOR to Overnight Indexed Swap rates, including in relation to timing and the application of the Credit Risk Adjustment.

The PRA is consulting on calculation of risks not in VaR (RNIV), Internal Ratings Based (IRB) mortgage weights, overseas IRB models and further implementation of CRD V.

CP14/20 (PDF 801 KB) sets out proposals to introduce two new requirements for IRB UK mortgage risk weights: a risk weight of at least 7% for each individual UK residential mortgage exposure; and an exposure-weighted average risk weight of at least 10% for all UK residential mortgage exposures to which a firm applies the IRB approach. The PRA considers that models delivering risk weights materially below these levels are likely to be materially deficient in risk capture.

CP15/20 (PDF 760 KB) considers the calculation of own funds requirements for RNIVs and the meaning of ‘period of significant financial stress relevant to the institution’s portfolio’ for stressed VaR (sVaR) calculation. Recommendations are that:

• RNIV own funds requirements should be calculated at quarter-end as the average across the preceding twelve-week period of an RNIV measure calculated at least weekly 
• Firms should notify the PRA and be able to justify, on an ongoing basis, reasons for not calculating an RNIV measure at least weekly for any risk factor 
• Firms should consider an sVaR observation period that starts at least from 1 January 2007
• Firms may include the most recent 12 months where it leads to a more appropriately prudent outcome
• Where a firm believes that the sVaR observation period should exclude more than the most recent 12 months, it should notify the PRA of the rationale for this decision

The RNIV proposals aim to improve consistency in calculation across firms, reduce the potential for significant market volatility near quarter-ends and increase transparency over the RNIV framework. The observation period measures are expected to improve consistency of identification of the “period of significant financial stress” across firms, ensure that firms consider a sufficiently broad observation period and minimise overlaps between VaR and sVaR measures.

CP16/20 (PDF 758 KB) sets out the proposed approach to the use of overseas IRB models following the end of the transition period. The following criteria must all be met in order to use a model built to non-UK IRB requirements:

• Aggregate RWAs calculated using overseas models not to UK requirements to be no more that 5% of total group credit risk RWAs
• Aggregate overseas model exposure value to be no more than 5% of total group exposure
• Model scope limited to exposures within a subsidiary in an equivalent jurisdiction and to retail exposures, including retail SME exposures
• Model reviewed and approved by an overseas regulator and used to calculate local capital requirements in that jurisdiction
• Model outputs derived using both historical experience and empirical evidence (not purely judgement-based) and estimates plausible, intuitive and based on material risk drivers
• Use of relevant populations of exposures, lending standards and other characteristics
• Sufficient number of exposures in the sample and data period to provide confidence in the robustness and accuracy of estimates 
• Model provides a meaningful differentiation of risk and produces accurate and consistent quantitative estimates of risk
• Model subject to appropriate internal governance and validation of internal estimates processes
• Model used to inform credit decisions

The implementation date for overseas IRB models built to non-UK requirements that are not currently used for UK consolidated capital requirements will be 1 July 2021. Existing overseas IRB models built to non-UK requirements used for UK consolidated capital requirements that meet the proposed criteria can continue to be used for UK consolidated capital requirements. Where models will not meet the revised criteria by 1 July 2021, they must be remediated by 1 January 2023 in line with the planned implementation of Basel 4.

The PRA has published three consultations on bank resolution and resolution assessment:

CP18/20 (PDF 1.1 MB) relates to Contractual Recognition of Bail-in (CROB) and Stay in Resolution (Stays) Rules. The PRA proposes a “sunsetting” process for the CROB and Stays parts of the PRA rulebook to ensure faithful transposition of BRRD II by 28 December 2020. Most of the elements of the statutory instrument relating to CROB and Stays will come into force on Monday 28 December but will cease to have effect from 11pm on 31 December 2020 (implementation completion day). The relevant parts of the PRA rulebook will be suspended or amended then reintroduced immediately after implementation completion day.

To further alleviate operational burdens, CP 19/20 (PDF 891 KB) proposes to move back by one year the dates by which firms are required to submit their resolution reports and public disclosures:

• First report on preparation for resolution to be submitted by 1 October 2021.
• First summary of report to be published by 10 June 2022. 
• Subsequent reports and public disclosure will follow biennially from October 2021 and June 2022, respectively.

CP20/20 (PDF 1.1 MB) seeks to build on the work firms have already undertaken to implement the PRA’s existing Operational Continuity in Resolution (OCIR) requirements. Key updates relate to:

• Firms’ ability to remain operational throughout the resolution process.
• Requirements to hold financial resources to ensure resilience despite the failure or resolution of other group entities.
• Firms’ ability to ensure continuity while being restructured following resolution.
• Proposals for reduced requirements for arrangements that pose fewer risks.

In a speech in October, Nick Strange, Senior Technical Advisor on Operational Risk and Resilience noted that industry engagement with the PRA’s December 2019 consultation paper on operational resilience had been “impressive” and set out some early high-level feedback. Firms:

• Remain supportive of the proposed supervisory approach to operational resilience, particularly the focus on important business services.
• Support the shift to assuming that disruption will occur, as this encourages development of response and recovery capabilities, but note that this should not divert attention from improving preventative and detective measures.
• Welcome the proportionate approach set out in the CP. 
• Would like regulators to share good practice, encourage consistency of application of rules and guidance, and be consistent in both the principles and practical implementation of the new policy.
• Are calling for international and domestic consistency, i.e. between different regulatory jurisdictions and global standard setters and with other policies such as recovery and resolution.
• Are unsure how to assess the impact of disruption to their important business services on financial stability. (The BoE may be best placed to consider this and the FPC has indicated that it may also set impact tolerances. Following a delay due to COVID-19, the FPC will consider next steps for cyber stress testing later this year).

The financial sector’s response to the pandemic has been effective, according to Mr Strange, but the job is far from done. Future threats to resilience may not be “slow, prolonged and symmetric” as COVID-19 was. Much has changed, from the thinking around business continuity to adjustment of risk appetites, to increased cyber risk. Understanding the operational resilience of third parties has become more important than ever.

On harmonisation of international regulation, despite differences in terminology, the UK and BCBS are aligned on core principles. However, “different jurisdictions will probably have different views on what they consider critical or important. This is not fragmentation; this is just accepting reality.”

On harmonisation of domestic policy, there is differing terminology for OCIR and operational resilience, but firms will be expected to have a coherent narrative for what is critical under the former and important under the latter. Work done to understand the interconnectivity of functions, business lines and services should be leveraged for both.

There are early indications that firms who had made the most progress implementing the operational resilience policy proposals were best able to respond to the pandemic – the PRA will be looking at this in more detail.

On 12 October, the PRA issued an information request (PDF 354 KB) that aims to gauge specific firms’ operational readiness for a zero or negative Bank Rate. The BoE and PRA recognise that a negative policy rate could have far-reaching implications for firms’ business and customers and would also like to understand whether there are any technical operational challenges associated with the implementation of a zero or negative rate, in order to prepare for and prevent unintended operational disruption.

The request includes questions such as which important business services would be affected, what proportion of firms’ existing systems would be able to accommodate zero or negative rates, limitations of key systems and availability of tactical and strategic solutions to accommodate different rate environments. It also seeks information on potential costs and timeframes to implement the necessary changes and how preparations might differ between systems using a “flat” negative Bank rate and a “tiered” approach.

This is a pre-emptive exercise, and the information request is voluntary. The MPC has not indicated that it will move to a zero or negative rate – indeed, there appears to be divergence of opinion on the committee – but it has commenced structured engagement on operational considerations of a negative policy rate.

To inform the legislation it is developing to maintain access to cash, HM Treasury’s call for evidence seeks views on the key considerations, including deposit and withdrawal facilities, cash acceptance, and regulatory oversight of the cash system. New ideas proposed include facilitating cashback without purchase and giving the FCA overall statutory responsibility for maintaining a well-functioning retail cash distribution network.

Card-acquiring services enable merchants to accept card payments. The Payment Systems Regulator’s (PSR) interim report on these services, found that small and medium merchants are not getting a good deal as they are not shopping around or negotiating with their existing provider. The PSR is consulting on proposals such as contracts for these services having an end date and stopping auto-renewal of the contracts.

In an effort to stimulate debate around the PSR’s draft strategy, due to be published early next year, the PSR has published data on usage of payment methods in the UK and blogs on alternatives to card payments and choice around payment methods.

The Pension Regulator (TPR) has launched a discussion on its 15-year strategy for protecting savers, with an increasing focus towards defined contribution arrangements. Its five strategic priorities will be:

• Security: protecting the money that savers invest in pensions. 
• Value for money: savers’ money must be well-invested, costs and charges must be reasonable, and good-quality, efficient services are driven by robust data.
• Scrutiny of decision-making: monitoring those who make decisions that impact savers’ outcomes, closely scrutinising any decisions that pose a heightened risk to the quality of these outcomes.
• Embracing innovation: encouraging innovation and good practice, and collaborating with the market to enhance security, efficiency, transparency, simplicity and choice.
• Bold and innovative regulation: transforming the way TPR regulates to put the saver at the heart of its work; driving participation in pensions saving and enhancing and protecting savers’ outcomes; and anticipating and preventing issues before they materialise.

These themes chime closely with the FCA’s conduct agenda and its focus on customer outcomes. As seen in recent debates about costs and charges, TPR has used the inputs to and outcomes of FCA consultations to inform its own approach. The new Regulatory Initiatives Forum can be expected to strengthen this convergence.