The UK Financial Services Regulatory Framework post Brexit - back to the future?

The year ended with the news that a Brexit deal had been agreed at the eleventh hour, setting the scene for the future relationship between the UK and the EU, albeit without including details on what this would mean for cooperation on financial services.

Now that UK standard setters and regulators have regained their policy-making discretion, what will the new Financial Services Regulatory Framework look like? How will the new regime impact the relationship that firms have built with their regulators? How can they participate in the policy-making process that results in rules that firms need to comply with?

In October 2020, HM Treasury issued Phase II of its consultation: Financial Services Future Regulatory Framework Review. This review starts to address some of these questions and sets out further detail on UK Government proposals, including how financial services rules will be made post-Brexit, who will be responsible for making them, how stakeholders will be consulted and how standard-setters will be scrutinised and held accountable. The consultation will close on 19 February.

What needs to change and why?

Currently, the EU approach to regulation is preserved in the onshoring of EU legislation. EU directly applicable legislation for financial services will now sit on the UK statute book, with amendments made to ensure this legislation works effectively in the UK. Although onshoring provided a relatively smooth transition for firms, it has also resulted in an unclear allocation of responsibilities across Parliament, HM Treasury and the regulators. The onshored regime is not intended to provide the long-term approach for regulation of financial services in the UK.

What is HM Treasury’s approach?

The regulatory model introduced by the Financial Services and Markets Act 2000 (FSMA) will remain as it is. The government believes that delegating the setting of regulatory standards to expert, independent regulators that work within an overall policy framework set by government and Parliament, continues to be the most effective model.

In addition, HM Treasury would like the regulatory regime to remain agile and flexible in order to respond quickly to emerging challenges and help UK firms seize new business opportunities.

So, at a high level, HM Treasury’s proposals aim to:

• Achieve a clear cut and coherent allocation of regulatory responsibility: The government and Parliament will set the policy framework for financial services and the strategic direction of financial services policy. Within this framework, the regulators will be able to use their rulemaking powers to ensure regulation is well-designed and keeps pace with market developments.
• Deliver enhanced scrutiny and consultation arrangements to ensure that the regulators are accountable and that stakeholders are fully engaged in the policy-making process. 

What are the key features of the proposed framework?

In addition to a clearer allocation of responsibilities between Parliament, HM Treasury and the financial services regulators:

• The Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) will design and implement regulatory standards using their existing rule-making powers in FSMA. This will transfer regulatory requirements in onshored legislation to the regulators, will rationalise some areas of non-EU derived financial services legislation and should result in one coherent source of regulatory requirements for firms – the regulators’ rulebooks.
• There will be enhanced transparency requirements for the PRA and FCA, with an obligation to “have regard” to the public policy issues set out by Parliament in activity-specific policy framework legislation.
• There will be more systematic consultation between HM Treasury and the regulators at an early stage in the policymaking process.

Where does this leave UK firms?

The approach proposed by HM Treasury deliberately represents continuity of the regulatory model embedded in FSMA 2000 - albeit with some tweaking at the edges to build on its existing strengths- rather than a full re-think of the regulatory approach. So, firms should not see too many changes in their day to day dealings with UK regulators.

The consultation tends to focus on the potential benefits of the post-EU framework, such as fully leveraging regulators’ expertise while ensuring that they take full account of broader policy issues and are made more democratically accountable. The revised framework would enable policymakers to be agile, designing rules in ways best suited to UK circumstances and promoting innovation and the competitive position of the UK, having done away with the legacy of a fragmented rulebook that resulted from the UK being subject to the EU legislative process.

However, an approach focusing solely on the benefits of the current regulatory model could result in a missed opportunity to review aspects that could be seen by the regulated community as in need of reform:

• Better coordination between multiple standard setters. Financial sector firms, especially smaller ones, have limited in-house resources to analyse and implement regulatory changes while managing BAU and the resilience of their business, especially in the current economic environment. There is an opportunity to better consider the cumulative impact of regulatory change emanating from different sources and tweak the framework to better address this.
• “Voluntary”  industry initiatives, codes and standards have grown in importance in recent years, with an expectation by regulators that they should be applied on a “comply or explain basis”. These too would benefit from better co-ordination and coherence with regulatory standards;
• Cost/benefit analyses (CBAs) have often been difficult for firms to understand resulting at times in a lack of clarity on the rationale for adopting a policy option. It could be that adjusting the framework so that it allows consideration by an external, independent body with appropriate expertise could address some of these concerns.

In conclusion…

It remains to be seen in practice how the framework will evolve post consultation and in particular how UK regulators will balance their rule making discretion with the need to maintain a certain level of equivalence with EU rules. The consultation already recognises that it would not be appropriate for some elements of legislation to become the responsibility of regulators, in particular equivalence arrangements or mutual recognition agreements.

Andrew Bailey, Governor of the Bank of England has recently reiterated that the UK will not be a “rule-taker”. He even saw as “problematic” the fact that the EU had asked HM Treasury about its intentions regarding future FS regulation. It will be important for firms to monitor the outcome of future discussions between City Minister John Glen and the EU on a Memorandum of Understanding on cooperation for financial services regulation and any consequential impact of reaching any such agreement on policymaking and the regulatory framework in the UK.