Slaughter and May | David Shone | Jan Putnis | Nick Bonsall | Rufus Sachdev-Wood
Year in Review
i Financial Services and Markets Act 2023
In August 2023, the Financial Services and Markets Act 2023 (FSMA 2023) received royal assent. FSMA 2023 seeks to create a comprehensive FSMA model of regulation, whereby, in place of requirements made under assimilated law, the PRA and the FCA take responsibility for setting the direct regulatory requirements applicable to firms, operating within a framework established by the UK government and Parliament.
FSMA 2023 also made a number of immediate changes to the UK regulatory framework, including by:
- introducing new secondary objectives for the PRA and the FCA, requiring the regulators to facilitate the growth and international competitiveness of the UK economy; and
- establishing a new ‘access to cash’ regime, pursuant to which larger UK banks and building societies are expected to become subject to FCA oversight for the purpose of ensuring the reasonable provision of cash withdrawal and deposit services.
FSMA 2023 reflects the UK government’s desire to build an ‘agile, proportionate and homegrown’ rulebook and seize the opportunities afforded by the United Kingdom’s new position outside of the European Union. It also forms part of the wider ‘Edinburgh Reforms’, announced in December 2022 and intended to position the United Kingdom as an innovative and competitive global financial centre. Whether these reforms will, as some within government have hoped, lead to ‘Big Bang 2.0’ remains to be seen.
ii Regulatory change Implementation of final Basel III standards
The United Kingdom is in the process of implementing the remaining Basel III standards (Basel 3.1) as developed by the Basel Committee on Banking Supervision, which will require extensive reforms to existing UK prudential requirements. The PRA consulted on its approach to implementing the reforms in November 2022 and published its first policy statement containing near-final rules in December 2023 (a second policy statement is expected in the second quarter of 2024). The PRA originally set January 2025 as the date from which the new rules will take effect, but industry feedback has delayed this to July 2025 (with the output floor being phased in during a four-and-a-half-year transitional period ending in January 2030). This follows the PRA’s introduction of certain other Basel III standards into the UK CRR, which have applied since January 2022.
Resolvability Assessment Framework
The Resolvability Assessment Framework (RAF) was finalised in July 2019 with the intention of ensuring firms are sufficiently prepared for resolution and improve their accountability for such preparations. In June 2022, the Bank of England published findings from its first assessment of the resolvability of the eight major UK banks. It concluded each bank could fail safely while continuing to provide core banking services to the economy, with shareholders and investors rather than taxpayers bearing the cost, although a number of those banks were publicly rebuked by the Bank of England for perceived deficiencies in their assessments under the framework. The second RAF is ongoing, with results expected to be published at some point in 2024.
Ring-fencing regime
In September 2023, HM Treasury published a consultation paper on near-term reforms to the United Kingdom’s ring-fencing regime. These are intended to implement the conclusions of a 2022 independent review and a commitment made as part of the Edinburgh Reforms. The government is proposing to, inter alia:
- increase the ring-fencing threshold from £25 billion to £35 billion of core deposits;
- add a secondary threshold, exempting from ring-fencing banks with trading assets of less than 10 per cent of Tier 1 capital;
- permit ring-fenced banks to undertake a wider range of activities, including in relation to trade finance and hedging; and
- introduce transitional periods to comply with relevant requirements where an entity within a ring-fenced banking group acquires a non-ring-fenced bank.
Legislation implementing these reforms is expected in the first quarter of 2024. In the longer term, HM Treasury is considering reforms intended to align the ring-fencing and resolution regimes, and a policy statement to that effect is expected in the first half of 2024.
iii The consumer duty
In July 2023, the consumer duty (the Duty) came into force for open products and services. The Duty sets substantively higher standards of care and conduct than current requirements and heralds a meaningful shift in the FCA’s expectations around the protection of retail customers and the promotion of good outcomes for such customers. The Duty will come into force for closed products and services in July 2024.
The Duty introduces a new consumer principle that ‘a firm must act to deliver good outcomes for retail customers’, alongside four outcomes covering product and service quality, price and value, consumer understanding and consumer support. The FCA has highlighted the importance of governance and board oversight in relation to the implementation and operation of the Duty, including the appointment of a Consumer Duty champion.
Firms are expected to assess, test and be able to demonstrate effectively that customers are achieving good outcomes, and report on this annually.
The FCA is already using its powers under the Duty to compel higher standards of customer care, including by setting out an action plan to ensure that banks and building societies pass Bank of England base rate rises on to savers.
iv Operational resilience
Recent global geopolitical developments, including the aftermath of the covid-19 pandemic, events in Ukraine and ensuing instability in the energy market, and the crisis that followed the publication by the then UK government of its ‘mini-budget’ in September 2022, have emphasised the importance of robust operational resilience within UK firms. Under a new regime introduced jointly by the PRA, the FCA and the Bank of England, firms and financial market infrastructures (FMIs) are required to identify and set impact tolerances for each of their important business services. By the end of a three-year transitional period in March 2025, firms must demonstrate they are able to remain within each impact tolerance in the event of a severe but plausible disruption to their operations.
FSMA 2023 introduces a new regime to mitigate the systemic risks posed to financial stability and consumer protection by critical third parties (CTPs). This framework will enable the identification of CTPs (such as cloud service providers) for designation, subject CTPs to certain fundamental rules and operational risk and resilience requirements, and empower the regulators to direct, investigate and if necessary discipline CTPs. The FCA, PRA and Bank of England consulted on proposed new rules in December 2023, and it is expected that the regime will come into effect towards the end of 2024.
v Crypto
The enthusiasm of UK government and regulators to preserve the United Kingdom’s position as a global fintech leader and take advantage of post-Brexit regulatory freedom has generally been balanced by concerns about consumer protection and market integrity. The volatility of cryptoassets markets and the widespread fall-out from the collapse of crypto firms such as FTX has brought this into sharp focus.
Despite some calls for cryptoassets to be regulated as gambling, FSMA 2023 establishes the framework for cryptoassets to be subject to a comprehensive model of financial services regulation, which is intended to occur in two phases. The first will focus on the regulation of fiat-backed stablecoins, bringing these within the FSMA regulatory perimeter. The second will further extend the perimeter so as to include other cryptoassets, including exchange tokens such as bitcoin. Phase 1 legislation is expected to be introduced in early 2024, with phase 2 legislation to follow later in the year.
In the meantime, the existing regulatory framework has been expanded in a piecemeal manner to cover various corners of the crypto ecosystem. Most recently, in October 2023, the financial promotion regime, which regulates the marketing of financial products and services, was extended to cryptoassets.
In 2023, the Bank of England and HM Treasury consulted on the case for a central bank digital currency. Unlike cryptoassets and stablecoins, the digital pound would be issued by the Bank of England to be used by households and businesses for everyday payments. A response to the consultation paper was published in January 2024. A decision as to whether to proceed to a ‘build phase’, in which live pilot tests would be undertaken, is not expected to be taken until 2025 or later.
vi Artificial intelligence and Big Tech
The UK government has sought to capitalise on recent enthusiasm about artificial intelligence (AI), in particular with respect to large language models that power tools such as ChatGPT. To that effect, rather than establishing new economy-wide rules as is proposed in the European Union, the government is taking a sector-by-sector, principles-based approach to AI regulation, empowering the FCA and the PRA to oversee the use of AI by financial services firms.
In contrast to the UK government’s focus on AI, neither the FCA, the PRA nor the Bank of England have launched any new initiatives since they published a joint discussion paper on AI and machine learning in October 2022 (which itself predated the launch of ChatGPT). However, senior FCA figures have begun sketching the outlines of their supervisory approach, warning of the risks posed by AI, in particular in relation to fraud, cyberattacks and biased decision making, while also noting the potential benefits and encouraging the use of an ‘AI sandbox’ to test relevant innovations (expected to launch in 2024). It appears that the FCA intends to take a patient approach, applying the existing regulatory framework while AI’s development is incipient, rather than formulating prescriptive new rules which could rapidly be outpaced by technological change. More is expected from the regulators in early 2024: the government has asked the FCA and the Bank of England to publish an update on their strategic approach to AI by 30 April.
One area in which the regulators have taken a more active approach is the entry into financial services of ‘Big Tech’, with the FCA publishing a call for input on the topic in November 2023. This focused on the potential ‘data asymmetry’ that may arise as a result of Big Tech having access to open-source financial services data, for example via the United Kingdom’s Open Banking initiative, while their proprietary datasets remain unavailable to current incumbents. The FCA warned that this could give Big Tech a material advantage in formulating tailored products and services with highly granular consumer targeting and pricing, especially when the data is harnessed using AI, and over time could result in barriers to entry and excessive profits. It remains to be seen if and how the FCA will seek to mitigate the risks presented.
