UK Regulatory Radar

January 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.

UK regulators continue to focus on the impacts of the pandemic, but 2021 will also see regulatory change in the UK, not only in the substance of the rules, but in the way they are formed and supervised. 

At the end of 2020, the FCA found itself having to react to the long-awaited independent reviews of its action in relation to the failure of the Connaught Income Fund and London Capital & Finance. Its responses are likely to change some of the ways that the FCA interacts with firms.

The end of the Brexit Transition period passed relatively quietly in financial services, with the FCA introducing some changes to smooth the transition. Discussions on equivalence continue, but the UK is already showing signs of divergence from certain EU rules. The PRA plans to consult on moving away from the latest EU capital treatment of software assets. The MiFIR open access regime is intended to stop the practice of trading venues requiring exchange-traded derivatives to be cleared at a CCP under common ownership. The application of the regime continues to be delayed in the EU, but HM Treasury confirmed at end-2020 that the regime would continue to apply in the UK from 1 January 2021, but it will be reviewed this year. 

The way in which the future process and responsibilities for forming UK regulation will work in practice has been indicated by the structure of HM Treasury's consultation on crypto-assets. The Government has set policy objectives and principles and a regulatory perimeter, but it proposes that rules and requirements should be designed and implemented by the relevant regulators.

• Tables turned as FCA receives public censure
• Post-Transition: ongoing uncertainty
• COVID-19: regulatory implementation
• Latest banking prudential issues
• Insurers switch to SONIA
• Managing the risks of crypto-assets
• Accountability and remuneration

The outcomes of two independent reviews on the FCA were published in December and the FCA came in for some heavy criticism. The independent reviews investigated whether the FCA reacted, and then responded, appropriately in relation to the failure of the Connaught Income Fund and London Capital & Finance.

The two reports make a total of 14 recommendations, most of which are unlikely to be viewed by readers as unique to the specific subject matter of these reviews, innovative or developmental. Many of the recommendations simply articulate the basic and presumed elements of an effective regulator and thereby indicate the size of the challenge for the FCA. 

In response, the FCA has accepted all recommendations and has outlined the key actions it will undertake in the next six months, including:

• Restructuring the FCA to join up its policy, supervision and competition functions under two new Executive Directors, so it can better translate insights into risks and warnings, and act upon them
• Becoming a more data-enabled regulator to transform the way it handles and prioritises information and intelligence
• Enhancing training for all frontline Supervisory, Authorisation and Enforcement staff to give them greater confidence in knowing when and how to intervene using relevant intelligence held across the FCA
• Taking forward a range of new measures and initiatives to tackle scams
• Recruiting additional prudential specialists to act as quality assurance and assess firms with complex business models, including where they combine regulated and unregulated activity
• Managing down firms' unused regulatory permissions by conducting a “use it or lose it” exercise, to reduce the risk of firms having a permission to carry out regulated activity purely to add credibility to their unregulated activities

The FCA Board and its Audit and Risk Committees will oversee implementation of the recommendations and will provide an update in the FCA's next annual report.

The Transition Period for the UK's withdrawal from the EU has ended, with the future EU-UK Trade and Co-operation Agreement (TCA) agreed at the eleventh hour. Financial services are covered only in a limited manner in the main body of the agreement. The likelihood of their broader inclusion (especially for retail markets) was always very low, and most firms had planned on this basis. However, critical issues remain unresolved or uncertain, including:

• EU decisions on the equivalence of the UK's current financial services regulation and supervision. Non-binding political declarations (PDF 711 KB) released alongside the trade agreement commit the EU and the UK to agree a way forward by end-March 2021
• The availability of run-off regimes for contracts entered into prior to the end of 2020 
• The transfer of personal data, which is covered by temporary arrangements for up to six months
• The need (or not) for work permits

UK firms and funds can no longer use the EU passports. The critical questions, therefore, are if and how quickly any equivalence decisions will be confirmed (both by the EU and by the UK) and what national arrangements are or might be put in place to smooth the impact of the end of the Transition Period. The UK has already issued several equivalence judgements on the EU, but the EU has issued only two, time-limited equivalence decisions on the UK.

Just before the end of the Transition Period, the FCA and PRA published final onshoring instruments, related guidance and Temporary Transitional Power (TTP) directions to ensure a functioning regulatory and legal framework for financial services continues to be in place. 

Specifically, the FCA announced it would use its TTP to allow firms subject to the UK Derivatives Trading Obligation (DTO) to trade with, or on behalf of, EU clients subject to the EU DTO and to transact or execute those trades on an EU venue, if the venue is a UK-Recognised Overseas Investment Exchange, has applied under the Temporary Permissions Regime or its activities meet all the conditions required to benefit from the Overseas Person Exclusion.

The FCA also published a useful supervisory statement (PDF 339 KB) that brings together in one document how it will operate the pre-and post-trade transparency regime under UK MiFID II/MiFIR.

The UK government is looking at ways in which financial services can help support recovery, including plugging the large hole in the Exchequer's finances. On 9 January, it announced that the dormant assets regime will be widened to cover the insurance, pensions, investment and wealth management, and securities sectors. This is the result of a four-year review that started before the pandemic, so is not a surprise and has broad industry support, but it will require participating firms to amend documentation and develop specific processes.

The priority will continue to be locating and reuniting people with their financial assets. Where that is not possible, firms may voluntarily transfer dormant assets into the scheme. People are able to reclaim their assets in full at any time. Since 2011, 30 banks and building societies have enabled the release of over £745 million from dormant accounts that have been inactive for at least 15 years, £150 million of which was unlocked in May 2020 to support the charity and voluntary sectors. 

The ongoing issue relating to whether policyholders have valid claims under their Business Interruption insurance has now reached a conclusion. The Supreme Court has substantially allowed the FCA's appeal on behalf of policyholders. This completes the legal process for impacted policies and means that many thousands of policyholders will now have their claims for coronavirus-related business interruption losses paid.

During the initial onset of the pandemic, the FCA and the PRA allowed some flexibility in the application of the SMCR rules. On 18 December 2020, they published statements for dual-regulated and solo-regulated firms outlining their expectations that firms' application of the rules should return to normal. The FCA published a similar statement on the Approved Persons Regime. 

The FCA's Market Watch 66 emphasises its expectation that firms should have adapted policies, controls and oversight around telephone recording and electronic communication to take account of risks arising from alternative working arrangements, including increased homeworking.

Finally, the FCA has been consulting on new guidance for consumer credit firms and mortgage lenders in relation to repossessions. They are now possible for consumer credit contracts from 31 January, but the ban on repossessions relating to mortgages is to be extended until 1 April 2021.

The Band of England (BoE) has announced details of the severe economic scenario to be used in its 2021 ACS stress test. End-2020 balance sheets of the eight largest banks (this year including Virgin Money for the first time) will be tested to update and refine the FPC’s December 2020 assessment of the resilience of the UK banking system, leveraging the reverse stress test carried out in August 2020. In recognition of ongoing operational challenges, the timeline will be staggered, banks will not be asked to submit baseline projections and the ring-fenced subgroups of stress-test participants will not be included. Aggregate outcomes are expected in summer 2021 and bank-specific results in Q4 2021.

The PRA has updated the position set out in its 30 June statement on the EU's revised capital treatment of software assets, which currently applies to PRA-regulated firms. As this treatment does not derive from the Basel Standards (global) and is specific to the EU CRR, the UK could now choose to diverge from it. The PRA has found no credible evidence that software assets can absorb losses effectively in stress and is concerned that exempting software assets from the CET1 capital deduction requirements could undermine the safety and soundness of UK firms. It therefore intends to consult on returning to the previous position with all software assets continuing to be fully deducted from CET1 capital. 

The PRA does not normally give advance warning of its intended approach for future consultations but has made an exception in this case. Pending the outcome of the consultation, the PRA has recommended that firms do not base their distribution or lending decisions on any capital increase from applying this requirement. They should also take into account any significant software assets included in their regulatory capital in making capital management decisions. The update is a strong indication that the PRA would reverse the EU position should the results of the consultation support this course of action. The timeframe is yet to be confirmed.

The PRA is also consulting on its approach to branch and subsidiary supervision for international banks (banks headquartered outside the UK or part of a group based outside the UK), including firms operating in the UK through a branch. The consultation aims to provide clarity to international banks on the implications of the different ways they may choose to structure their operations. The proposals also seek to explain how the PRA would assess such firms against its threshold conditions, particularly the condition relating to the effective supervision of firms, when a firm belongs to a group based outside the UK. There are unlikely to be many surprises in the proposals for firms that have operated in the UK for some time, and the clarity around meeting threshold conditions may be welcome for those firms that have had or are considering changes in operating structures. The consultation closes on 11 April 2021, with likely implementation date for the final policy in Q2 2021.

The BoE has published a Discussion Paper as the first part of its review of minimum requirements for own funds and eligible liabilities (MREL). The review will consider resolution strategy thresholds, the calibration of MREL, instrument eligibility and the application of MRELs within banking groups. It also considers a potential alteration to the MREL requirements for mid-tier banks with end-state MREL and resolvability deadlines extended to 1 January 2023, except where they are already subject to a later deadline. Comments are invited by 18 March 2021. The BoE intends to consult in summer 2021 on any proposed changes to its MREL framework with these changes to be effective by end-2021, if agreed.

The PRA is consulting until end-March 2021 on the transition away from LIBOR as regards the rates and spreads used by insurers in calculating the matching adjustment and volatility adjustment. Since end-2020 (post-Transition), the PRA has been required to publish technical information (TI) that includes the risk-free rates for each currency. Those rates must be based on financial instruments that are traded on a deep, liquid and transparent market.

The PRA proposes to transition to SONIA swap rates for the GBP TI references, from end-July 2021, and to transition the JPY and USD TI references to an Overnight Indexed Swap rate (OIS), on dates yet to be determined. Given that GBP LIBORs are currently higher than the equivalent SONIA rates, the transition could lead to increased technical provisions for insurers. The PRA therefore proposes some mitigating measures, including in relation to transitional relief and the calculation of long-term average spread.

HM Treasury perceives that the small but rapidly growing crypto-asset and stablecoins market is now at a stage of development where it is necessary to consult on the regulatory framework. The government wishes to support innovation but to ensure that the technology is reliable and safe for consumers and markets. The consultation sets policy objectives and principles and a regulatory perimeter but proposes that requirements for firms are designed and implemented by the relevant regulators - the BoE, the FCA and the Payment Systems Regulator. It proposes an approach in which the use of currently unregulated tokens and associated activities primarily used for speculative investment purposes, such as Bitcoin, would initially remain outside the perimeter for conduct and prudential purposes but would be subject to the financial promotions regime (if proposals are adopted) and AML/CTF regulation. 

The use of stablecoins is rising, which could play an important role in retail and cross-border payments but also pose risks to financial stability, market integrity and consumers. The government proposes to introduce a regulatory regime for stable tokens used as a means of payments. Stable tokens are tokens that stabilise their value by referencing one or more assets, such as fiat currency or a commodity (i.e. those commonly known as stablecoins). The category could include tokenised forms of central bank money. This classification is agnostic on the technology underpinning the tokens, i.e. it is not necessarily distributed ledger technology (DLT). 

The consultation also includes a call for evidence on the use of crypto-assets in investment and wholesale markets; specifically, if any areas of existing regulation require amendment to support the use of security tokens, and how DLT could be used to support financial market infrastructure.

The PRA's first evaluation of the Senior Managers and Certification Regime (SMCR) confirms that the introduction of the SMCR has helped ensure that senior individuals in PRA-regulated firms take greater responsibility for their actions, with a large majority (around 95%) of the firms surveyed saying the SMCR was having a positive effect on individual behaviour. The report's nine proposed follow-up actions and recommendations do not propose any radical changes but clarifications around items such misconduct reporting in regulatory references, further articulation of the link between SMCR and remuneration adjustments, and whether board responsibilities and individual accountability are mutually reinforcing. 

The EU's fifth Capital Requirements Directive (CRD V) amends certain remuneration provisions, which the UK was required to transpose into UK law by 28 December 2020. The PRA amended Supervisory Statement 2/17, and the FCA published Policy Statement 20/16 and updated guidance via FAQs for dual-regulated and IFPRU (PDF 183 KB) investment firms' remuneration codes. The amendments aim to ensure there is greater proportionality in the application of the codes. Other items include adding categories of staff who must be included as material risk takers, amending the minimum deferral and clawback periods, and introducing a new requirement for firms to have gender neutral remuneration policies and practices.