At a glance

  • HM Treasury (HMT) recently published the final consultation in its Future Regulatory Framework Review, setting out a series of proposed reforms to the UK’s financial services regulatory framework.
  • The review proposes introducing a secondary competitiveness and growth objective for the PRA and FCA, which balances the need for the regulators to consider competitiveness whilst not having this undermine their existing, primary, statutory objectives.
  • The UK’s financial services regulators will be given responsibility for setting many of the direct regulatory requirements which are currently set out in retained EU law. However, there will also be increased Parliamentary scrutiny of the regulators.
  • The review proposes giving HMT a new power to be able to require the regulators to review their rules if it thinks this is in the public interest. This is potentially more controversial, as to some, this could be seen to be undermining the regulators’ independence.
  • There will be a new statutory requirement for the regulators to publish their cost‑benefit analysis (CBA) frameworks. The government also proposes the creation of a new statutory panel designed to review, and make recommendations on, the regulators’ production of CBA, in order to improve the process.
  • The review proposes giving HMT the ability to establish “have regards” provisions and obligations for specific activities or pieces of regulation. These provisions will enable HMT to provide strategic direction on specific regulations, without involving itself in the details of rulemaking.
  • While firms are likely to welcome the proposals, including the regulators’ new competitiveness objective, it will be how these changes are put into practice which will determine whether they succeed in making the UK’s regulation more “coherent, agile, and internationally-respected”.

Introduction

HMT recently published the final consultation in its Future Regulatory Framework Review, setting out a series of potential reforms to the UK’s financial services regulatory framework. The consultation will remain open for three months, closing on 9 February 2022.

The consultation builds on the previous one issued in October 2020 and is intended to play a critical role in delivering the vision for the financial services sector set out by the Chancellor in his speech at Mansion House and HMT’s accompanying “new chapter in financial services”, in July 2021. The proposals include changes to the regulators’ statutory objectives and enhanced mechanisms for accountability, scrutiny, and oversight of the regulators by Parliament, HMT, and stakeholders.

This blog provides an overview of the consultation’s proposals and our analysis of their implications for firms and the regulation of the UK’s financial services sector more generally.

Background

HMT established this review to determine how the UK’s financial services regulatory framework should adapt to the UK’s new post-Brexit position and the need to ensure the UK’s FSMA model of regulation remains fit for purpose going into the future.

The review aims to ensure the UK has a “a coherent, agile, and internationally-respected approach to financial services regulation that delivers appropriate protections and promotes financial stability”.

Overview

Central to the review’s proposals is the introduction of a secondary competitiveness and growth objective for the PRA and FCA. This would mean the regulators have to consider the effect of their actions, both regulatory and supervisory, on the UK’s international competitiveness and economic growth. However, the regulators’ existing primary objectives would take precedence over this. HMT says it received a wide range of views from stakeholders on this subject, with some arguing competitiveness should be a primary objective, whilst others, including consumer groups, suggesting that it would detract from consumer protection and so should not be an objective at all. HMT has chosen a middle way between these two views. As this is one of the most prominent changes HMT is proposing to introduce, we expect it to continue to be a matter of debate as these proposals are developed.

Given the UK government’s commitment to a zero carbon economy, the review proposes amending the existing FSMA regulatory principles (NB, these are different to the FCA’s principles for businesses) to ensure that the “sustainable growth principle” is consistent with the government’s commitment to achieve net-zero by 2050.

In light of Brexit, the review also seeks to address the question of which institutions will take on responsibility for much of the financial services regulation previously devised at the EU level. The review proposes that the UK’s financial services regulators (as opposed to Parliament) be given responsibility for setting many of the direct regulatory requirements which are currently set out in retained EU law. This means that increasing amounts of regulation will, in time, be transferred away from statute and into the regulators’ rule books. This should ensure the UK has a more agile system of regulation, where regulators can more easily update rules and regulations, without the need for Parliament to find time to make the necessary changes.

To accompany this increased responsibility for UK regulators, the review proposes to enhance the accountability of the regulators to Parliament. It proposes formalising a number of the existing arrangements for Parliamentary scrutiny, by introducing  a new statutory requirement for the PRA and the FCA to notify the relevant Parliamentary committee when they publish a consultation on any matter, and for the regulators to respond in writing to formal responses to statutory consultations from Parliamentary committees.

HMT will also gain new powers to direct the regulators. In the first instance, the PRA and the FCA will be given a new duty to respond to the recommendations letters issued by HMT, and set out how they plan to take into account HMT’s recommendations. These recommendation letters are sent from HMT to the regulators, advising them on matters of government policy HMT wants the regulators to consider. The most recent one was sent in March 2021.

The review also proposes giving HMT a new power to be able to require regulators to review their rules if it thinks this is in the public interest. This is potentially more controversial, as to some, this could be seen to be undermining the regulators’ independence. Whilst HMT says that “the government expects the proposed power would only be used in exceptional circumstances”, writing  limitations on the use of this power into the new legislation would ensure that both the perception and substance of regulatory independence are beyond dispute.

Regulators will also have to consider the potential impact their rules and supervisory policy may have on deference arrangements (such as equivalence decisions) and how these comply with relevant trade agreements.

The review recognises the important role the FCA’s and PRA’s various panels play in holding the regulators to account. It proposes putting the FCA’s Listing Authority Advisory Panel and the PRA Practitioner Panel’s insurance sub-committee on a statutory footing, in line with the PRA’s and FCA’s other panels, as well as a new duty for the regulators to publish information on their engagement with all their panels. The regulators will also have to publish a statement on their approach to the recruitment of regulatory panel members, to ensure that their membership represents a truly diverse range of stakeholder views, with sufficient diversity of thought.

How regulators conduct their CBA is also in frame. There will be a new statutory requirement for regulators to publish their CBA frameworks. The government also proposes the creation of a new statutory panel designed to review, and make recommendations on, the regulators’ production of CBA, in order to improve the process. However, the consultation does not set out who would sit on the new CBA statutory panel. Its membership, and the important question of who would Chair the panel, remain unanswered.

HMT is open to a number of different ways in which the panel could operate, and asks: “whether it would be most effective for the panel to provide its input “pre-publication” as part of the development of CBA for individual consultations, or for the panel to provide its input “post-publication” and scrutinise the approach post-implementation, at a more aggregate level, to consider more systematically the regulators’ approach and methodology in approaching CBAs”. In our view, adopting post-implementation reviews of the costs and benefits of given regulations would be the more rigorous approach. Post-implementation reviews analyse the real world (rather than hypothetical) impact of regulation, and as a result they often prove more relevant, provided that the evidence base they generate is used to inform future regulation.

The review also proposes introducing a new statutory requirement for the PRA and the FCA to publish and maintain a framework for how they review their rules. This is again designed to ensure the regulators take account of how their rules are working in practice, whether the rules are having the desired effect, and if they continue to remain appropriate or need to be amended to address any issues that may have come to light.

A new “Designated Activities Regime” will also be introduced. This will allow the regulators to write rules for certain activities without requiring the firm which carries out those activities to become a fully authorised FSMA regulated entity. This regime is being introduced to ensure continuity in way certain onshored EU regulations, such as those related to short selling, work in practice. However, this regime could also be used more broadly; it would provide regulators with an attractive way of regulating new technologies which become increasingly important to financial services (e.g. AI and cloud computing), without becoming having to subject the technology companies which provide them to full FSMA regulation.

Finally, the review also proposes giving HMT the ability to establish “have regards” provisions and obligations for specific activities or pieces of regulation. The Financial Services Act 2021 introduced a number of these “have regards” provisions with respect to how the PRA implements Basel standards and the FCA makes rules concerning the Investment Firms Prudential Regime. One of these provisions is for the PRA to “have regard” to the “the likely effect of the rules on the ability of CRR firms to continue to provide finance to businesses and consumers in the United Kingdom on a sustainable basis in the medium and long term”, showing HMT’s desire that any new rules should not adversely affect the supply of credit to the UK economy. This example points to how these provisions will allow HMT greater ability to provide strategic direction on specific regulations, without involving itself in the details of rulemaking.

Conclusion

Firms are likely to welcome many of these proposed changes. The regulators’ new focus on competitiveness and growth will be seen as a positive development, as will the regulators’ ability to update rules flexibly in what had previously been EU legislative competencies.

What will a secondary objective focusing on competitiveness mean in practice? Looking at the PRA’s existing secondary competition objective may provide us with a guide for what to expect. In recent years a large number of new challenger banks have been authorised by the PRA, and the regulator is also looking at introducing a new “strong and simple” prudential framework for smaller banks. Both of these are intended to increase competition and point to the PRA’s secondary objective having a notable effect on how the regulator operates. This suggests that the proposed secondary competitiveness objective might lead to similar changes.

HMT’s power to require the regulators to review particular rules could be substantive and significantly rebalance the relationship between HMT and the regulators. However, HMT has said it intends to use this power only rarely, suggesting a widespread rebalancing of power is off the cards. How HMT uses these powers in practice will determine whether this amounts to a wholesale shake‑up or a tweak to the existing framework.

The review is also likely to increase the operational burden faced by the regulators. It introduces a suite of new requirements for the regulators to notify various parties, prepare and publish responses, and undertake reviews of its regulations and actions. Whilst some of these merely codify existing practices, others - such as the duty to respond to HMT’s recommendations letter - are new.

The review also adds additional complexity to the long list of considerations the regulators must take into account when devising new rules and regulations. This includes both their primary and secondary statutory objectives (with a new secondary competitiveness objective adding to these), FSMA’s regulatory principles, HMT’s recommendations letters, and the various new “have regards” provisions that legislation may now introduce. Whilst the regulators have a clear instruction on how to weigh some of these considerations against one another, in other cases they will have to make tricky judgements over what they prioritise when regulating in future.

Overall, it is how the package of changes that emerges from this review is put into practice that will determine whether it succeeds in making the UK’s regulation more “coherent, agile, and internationally-respected”.