This blog was published on 21 February 2022.
At a glance:
- At the end of 2021, HM Treasury (HMT) published its long-awaited response to the Payment Landscape Review. HMT announced two new major policy initiatives to future-proof the UK regulatory framework for digital payments, amongst growing concerns that current rules are ineffective in the face of fast-paced technological and business innovation in the sector.
- First, the Government plans to give Financial Services (FS) regulators more responsibility for regulatory requirements in areas of retained ('onshored') EU payment services law, as part of its broader Future Regulatory Framework (FRF) reforms. This will enable regulators to use their expertise to update regulatory requirements to respond relatively quickly to emerging dynamics and innovation in the payments market, without waiting for Parliament to amend primary legislation.
- Second, HMT will consult on expanding the Bank of England (BoE)’s regulatory perimeter to bring new types of systemically important payments firms under its direct regulation and supervision in the first half of 2022. Details around which type of firms the new perimeter may capture are yet to emerge, but the bar to be deemed “systemic” will remain high. Large payments processors, acquirers, facilitators and future stablecoin arrangements are all possible candidates in our view.
- While we expect the payment industry to welcome these initiatives overall, firms will still need to prepare for a more dynamic and, for systemic firms, much stricter regulatory environment. They will need to put in place the capabilities to monitor and respond to quickly changing and, if they operate across both the UK and EU, possibly diverging regulatory requirements.
Digital payments play a strategic and fundamental role in the economy and in society. However, UK authorities - like their EU counterparts - are concerned by the (in)ability of the current payments regulatory framework to keep pace with the rate of technological and business innovation in the sector. The growing complexity of the digital payments chain and the importance of non-banks and unregulated providers are two areas of particular concern.
Against this background, at the end of last year, HMT issued its response to the Payments Landscape Review (the Review). It confirmed that future-proofing the UK legislative and regulatory framework for payments would be one of the Government's key priorities.
What is the Payments Landscape Review, and what did it say?
HMT launched the Review in July 2020 to seek views on the opportunities, gaps and risks that the UK needs to address to remain at the forefront of payments technology and innovation. Last October, HMT issued its response to the Review and its plans to create a future-proof, proportionate and competitive regulatory framework for payments to support future innovation whilst ensuring resilience and consumer protection.
HMT announced two new major policy initiatives, discussed in this article. The first involves giving UK FS regulators more responsibilities in line with its broader FRF Review. The second consists in expanding the regulatory perimeter to capture new types of systemic payment firms.
Giving more responsibilities for payments regulation to UK regulators to deliver a more responsive regulatory framework
As part of its FRF Review, the Government plans to transfer more responsibility for regulatory requirements from Parliament to regulators in areas of retained ('onshored') EU payment services law. This would include the direct regulatory requirements set out in legislation such as the Payment Services Regulation 2017 and the Electronic Money Regulation 2011, which implemented EU law – such as the second Payment Services Directive (PSD2) - in the UK before Brexit. The FRF Review also proposes giving the PRA and FCA a secondary competitiveness and growth statutory objective.
The Government intends to transfer specific regulations from statute into the regulators' rule books to deliver two main benefits. First, to ensure that appropriate experts (i.e., designated regulators) have primary responsibility for reviewing and maintaining regulatory standards, albeit under an enhanced accountability framework and scrutiny by Parliament and HMT. Second, to allow regulators to update rules more quickly to respond to the changing payments and global competitive landscape without relying on Parliament to find time in its legislative schedule. [You can read a more detailed analysis of the FRF Review here.]
However, the FRF Review's recommendations require primary legislation to be implemented. Therefore, it will take some time for firms to feel their actual impact. Assuming the 2022 Queen's Speech will include plans for FRF legislation, it is still unlikely that the Government would be able to introduce the relevant Bill in Parliament before late 2022 or early 2023. Therefore, the full details about regulators' new powers and how they will exercise them in practice are unlikely to emerge for at least another year.
We see the same challenges in the EU, where a review of PSD2 is just starting. But any legislative proposals (or PSD3) will not be published until late 2022/early 2023. And depending on how substantive they are, they may take at least a couple of years to negotiate.
However, we believe FRF reforms will give UK regulators the tools and the powers to shape an effective and globally competitive UK regulatory framework for digital payments. Once fully implemented, they will enable regulators to update or make timely tweaks to emerging dynamics and innovation in the payments market. Recent experience also suggests that UK regulators will not shy away from leveraging their expanded remit to pursue their statutory objectives, including any new focus on competitiveness and growth. For instance, just a month after the end of the Brexit transition period, the Financial Conduct Authority (FCA) did not hesitate to use its newfound autonomy to propose amendments to onshored PSD2 regulatory technical standards to remove well-known hurdles to Open Banking adoption.
Bringing new systemic payment firms into BoE regulation and supervision
Innovation and the growth in digital payments have led to firms other than banks and payment systems providers increasingly conducting payments activities. However, while these firms could become (or already are) systemically important in payment chains, they are not currently supervised from a financial stability perspective. In response, the UK Government is expected to consult on bringing new systemically important firms in payments chains under the BoE's direct regulation and supervision in the first half of 2022.
Details around which type of firms may be captured are still to be revealed, but we know that the bar to be deemed systemically important would remain high. We believe it is plausible that some of the criteria may be similar to those used by HMT to designate important payment systems. For example, they may consider the nature, number and value of transactions processed, the relationship with other payments providers, and how easy it would be for another firm to handle the transactions in the event of an operational or financial failure. An expanded BoE's regulatory perimeter may capture firms conducting either unregulated activities or activities currently regulated solely by the Financial Conduct Authority. This could include large payments processors, acquirers, facilitators and future stablecoin arrangements.
If we are right, these firms will experience a steep increase in regulatory scrutiny. As we said before, this is likely to result in significantly greater compliance costs and, in some cases, affect the economics of their business models. This will have a knock-on effect on the other players who use their services.
However, focusing only on new types of systemic payments could be just the first step in managing broader financial stability and resilience risks in the payments ecosystem.
As respondents to the Payment Landscape Review highlighted, the current regulations for e-money and payments institutions are no longer adequate to deal with the increasing size and complexity of the firms – often part of larger corporate groups - operating under these licenses. In addition, other firms providing critical technical payments solutions, such as payments gateways or processors, are currently unregulated. Even if not systemic, these firms play a crucial role in the payment value chain and could cause significant harm to consumers and the resilience of digital payments unless they are effectively regulated. For example, many of these firms can facilitate indirect access to payment systems – e.g., the UK Faster Payments Services – for other regulated or unregulated firms.
Any changes to the regulatory perimeter will still require Government' intervention. However, once implemented, we believe regulators will have the tools under the FRF reforms to perform a broader review of the regulatory framework for digital payments and ensure that risks are appropriately managed.
What else did the Government's response to the Payment Landscape Review say?
HMT also reiterated several other known initiatives and commitments the Government is taking forward to deliver its vision for the UK payments sector. These include the Government's consultations on the regulatory approach to cryptoassets and stablecoins and its legislative proposals to protect access to cash. While it didn't announce any new initiatives, the Government reiterated its continued commitment to work closely with regulators, industry, and the global community on the following areas:
- support the delivery of the UK's New Payments Architecture;
- enhance cross-border payments in line with the G20 roadmap; and
- strengthen consumer protection measures, including widespread adoption of Confirmation of Payee, against scams and fraud.
The Government's focus on unlocking the full potential of Open Banking-enabled payments to give consumers a choice to pay directly from their bank accounts for goods and services, rather than having to use debit or credit cards, is also set to continue. However, how this will affect the cards business will depend on multiple factors, including consumer trust and the economics associated with account-to-account payments.
Over the last decade, the dramatic growth of digital payments has transformed the payments sector. Yet, applying old rules to innovative solutions remains a challenge for regulators and firms. The proposal to transfer rule-making responsibilities to regulators and expand the perimeter for financial stability will go a long way towards empowering regulators to respond quickly and effectively to the fast-moving payments landscape.
We expect the industry to welcome FRF reforms overall. Nevertheless, firms will need to prepare for a more dynamic regulatory environment, especially if they operate in both the EU and the UK. While FRF reforms will not drive post-Brexit divergence per se, they will reduce the time it will take UK regulators to amend onshored EU payment services and e-money regimes if they choose to do so. Therefore, firms will need to establish the capabilities to monitor changing and diverging (in timing, if not in detail) regulatory developments in the EU and UK and understand the impact on their business, operating and compliance models.
The Payments Landscape Review offers a view into the medium-term regulatory changes we can expect in the payments landscape. In the meantime, as our 2022 Regulatory Outlook sets out, we expect UK supervisors to continue to stretch the limits of existing rules and step up either scrutiny of payments firms' complex business or operating models. We believe they will focus particularly on fast-growing firms, spill-over risks from unregulated activities, and operational resilience risks arising from extensive use of unregulated third-party providers.