Edinburgh Reforms View

If you missed our flash call on 13 December 2022 on the Edinburgh Reforms you can watch it here.

Yes, it’s Jeremy Hunt’s seasonal gift to the nation, exquisitely wrapped in red, white and blue paper and with a tartan gift label. In this inaugural edition of our Edinburgh Reforms View, we unwrap the parcel and look inside for you, finding that not all of it is having its first outing. There are old initiatives (ring-fencing and consumer credit review), new chapters (SMCR review, digital currency), borrowed items (prospectuses, securitisation, consolidated tape) and do we perhaps detect a touch of “blue” political fanfare as 2025 starts to loom on the horizon.

Will you welcome the Reforms? Or will you be looking for the gift receipt? Let’s find out…

1. The backdrop – the Financial Services and Markets Bill

This is all against the backdrop of the Future Regulatory Framework Review outcomes which are being implemented in the Financial Services and Markets Bill that, like the Polar Express, is currently steaming ahead through Parliament and will be passed at some point in the New Year. We all know a lot about the FSM Bill already but now we have a tiny bit more detail on the future trajectory of the process though. As a reminder:

• The FSM Bill will, amongst other things, create the tools and framework needed to repeal EU financial services law and move it into the regulators’ rulebooks
• This will take several years and will involve “significant policy, regulatory and legal resource” – so some policy changes might happen
• Significant progress on first 2 “tranches” of this are expected by the end of 2023
  • Tranche 1 will be implementing the Wholesale Markets Review, the Listing Review, the Securitisation Review and the Solvency II Review
  • Tranche 2 will be remaining reform of MiFID, PRIIPS, SSR, Taxonomy Reg, MMF Reg, PSD and EMD, CRR and CRD, LTIF Reg, IMD
• This will be a painstaking process as Parliament will need to pass SIs to repeal each piece of retained EU law (or “REUL”)
• Government will tell the regulators what they must “have regard” to from a government policy perspective in their rule-making
• The FSM Bill introduces “Designated Activities” – a new piece of jargon to mean activities that need rules around them (e.g. making a public offer) and that will be used at first for EMIR, MIFIR commodity derivatives rules, SSR, Securitisation Regulation, PR, BMR – i.e. to allow the government to preserve elements of EU regimes

The FSM Bill proposes a new secondary FCA objective of growth and competitiveness. And, as part of the Edinburgh Reforms, we now also have new letters from Jeremy Hunt to the FCA and PRA specifying that they must have regard to supporting government’s objectives of medium to long term economic growth and promoting the international competitiveness of the UK.

We are also promised less EU terminology in future and more UK terminology, thus potentially depriving the industry of further stimulating discussions about how “RTO is like arranging (bringing about)”.

To discuss further, please contact Charlotte Stalin, Penny Miller, Rosali Pretorius or Alex Ainley.

2. SMCR review (new)

Whilst not insignificant, it’s clear that an “overhaul” of the SMCR is not guaranteed. There’s actually very little detail from Jeremy Hunt’s statement except that there will be a Call for Evidence in Q1 2023 where information will be gathered on the effectiveness of the regime, the legislative framework, its scope and proportionality, and also to seek views on potential improvements and reforms. Key initial takeaways for firms are:

1. There is a general sense in the market that this is likely going to be more about reviewing and tweaking the SMCR rather than scrapping it all together or looking to weaken standards.

2. It may potentially slow down other FCA initiatives relating to the SMCR – for example, the FCA’s long awaited guidance on non-financial misconduct as part of their 2023 D&I consultation paper - until there is clarity over what revisions to the regime might look like.

3. It’s status quo for now with any potential legislative changes unlikely to be quick given there will be a review/consultation phase after the Call for Evidence – but, clearly it is something to watch next year and something we will be following closely in SMCR+ View too (please go to the link to sign up).

To discuss this further please contact Penny Miller or Amy Sumaria.

3. ESG (something blue green)

The UK government published its previous Green Finance Strategy in July 2019. Since then, we’ve seen the UK government, PRA and FCA work to implement that strategy. Their work to-date has included the mandatory TCFD-aligned climate disclosure rules across the UK economy (including financial services firms, pensions, and larger listed corporates), and the proposed new Sustainability Disclosure Rules (SDRs).

The Edinburgh Reforms announced that an updated Green Finance Strategy will be published in early 2023.

This could cover further work to support the UK Government’s 2050 net zero commitments, including mandatory transition plans across the UK economy (including for financial services). We also anticipate further work on the UK’s version of the EU’s environmental taxonomy, and potentially also a social taxonomy. As a first tangible step, the Edinburgh Reforms included a specific proposal on bringing ESG ratings providers into the scope of the UK regulatory perimeter.

For further details, please contact Nick Colston.

4. Consumer Credit Act review (old) – some long overdue reforms

Coming in at 48 pages plus annexes, this is currently the biggest of the consultation papers. Building on the FCA’s 2019 Retained Provisions Report and the June 2022 announcement of CCA reform, this long overdue modernisation of the decidedly middle-aged and somewhat unwieldy CCA is expected to take several years. Two of the key principles of the reforms will be proportionality and simplification, with an eye also to the territory that is going to be covered by the FCA Consumer Duty.

Some of the points under consultation include:

• Changing or possibly abolishing the £25k minimum for the business lending exemption
• Reviewing and modernising information requirements
• Looking at how reform can encourage financial inclusion and remove barriers to financing electric cars and “green” energy for homes

Where possible, rules will be moved into the FCA Handbook and there may need to be some extension of FCA powers. The idea is that this will allow the rules to be flexible and to adapt rapidly to an evolving market. But the regime is likely to end up split between FCA rules and some residual legislation because some things need to be in legislation (e.g. rights to sue, powers that courts have, liability provisions where lenders can be jointly liable with brokers, circumstances in which credit agreements are unenforceable).

To discuss this further, please contact Alex Ainley, Sarah Boswall or Penny Miller.

5. Ring-fencing (old) – some expected reforms

This follows on from the Skeoch report recommendations in March 2022, which concluded that the UK’s ring-fencing regime is worth keeping for now but may gradually be superseded by the recovery and resolution regime. The Government intends to call for evidence in Q1 2023 on better aligning the ring-fencing and resolution regimes, and will consult in mid-2023 on reforms including some of the Skeoch recommendations such as:

• Descoping banking groups who do not have major investment banking operations (er…. come to think of it, weren’t the ones that collapsed in 2008 in this category, whereas the ones with IB operations didn’t collapse? Just saying…..)
• Amending the definition of Relevant Financial Institutions
• Removing geographical restrictions on where ring-fenced banks can operate
• Reviewing activities which ring-fenced banks can carry out and potentially expanding them
• Increasing the deposit threshold from £25bn to £35bn

For further details, please contact Alex Ainley.

6. PRIIPS (new, but not a surprise)

Honey I shrunk the KIDs!…. Literally, because the PRIIPs KID’s days are now numbered and will soon cease to be a feature of the disclosure regime to UK retail investors. But watch this space; HMT is asking for views on a new framework for retail disclosure via a consultation which closes 3 March 2023. The new disclosure regime will be crafted by the FCA, whose in-tray must now be creaking under the weight of the Government’s festive generosity.

HMT has been critical of the prescriptive, standardised document approach favoured by the EU and wants to move towards something which is more flexible and can be tailored to retail client needs. They have criticised comparability, saying that it is not feasible to provide for a single format across such a wide range of varied products. The FCA will determine the format and presentation requirements for disclosure – more high risk or complex investments may have more prescriptive requirements, for example – but for other investments they would like to introduce flexible requirements that can be incorporated into firms’ existing information documents. The FCA might define product classes or groupings within which there would be some standardisation so that similar products can be compared, but HMT acknowledges the challenges with this approach, such as not permitting firms the flexibility to tailor their disclosure to different clients.

Two important points to note:

• Whilst the revocation process will commence “as a matter of priority” following Royal Assent - the upcoming changes to UK PRIIPs regime which take effect on 1 Jan 2023 are still coming into force.
• This revocation will be effective in relation to UK retail investors only; firms will still need to continue to provide EU-compliant PRIIPs KIDs for EU retail investors.

You may be asking how this will this impact the other PRIIPs reforms on the regulatory horizon. Helpfully, HMT have ruled out different disclosure regimes to govern UCITS and PRIIPs long-term. Therefore, the FCA shall integrate UCITS and PRIIPs disclosure into a coherent UK retail disclosure framework before the end (in 2026) of the exemption for UK UCITS from producing PRIIPs KIDs.

The consultation also expresses a key ambition to improve the choice of investment products available to UK retail investors, and specifically mentions US ETFs in this regard. This indicates a longer-term move away from the current situation, where most of the non-UK funds that are made available to retail are EU funds.

There is not much detail at the moment, but there are a number of obvious questions:

• What is the purpose of the new disclosure regime over and above what Consumer Duty requires under the Customer Understanding outcome? Will it make certain disclosures mandatory? The Government says it wants a “less prescriptive approach”
• How will the new regime interact with the Consumer Duty given that FCA will have power over both?
• Will the new regime apply to incoming offers from non-UK firms? Presumably yes, hence the FCA’s consultation question about what additional powers the FCA may need. But how will this help achieve the Government’s desire to open up UK retail access to non-UK products?

To discuss this further, please contact Penny Miller, Charlotte Rendle or Rosie Davies.

7. Short Selling Regulation (new)

This is in the nature of a policy review. At this stage, the Call for Evidence covers shares only, government bonds and CDS to be consulted upon separately. The government wants to understand what does and doesn’t work under the regime for shares.

We have a (lengthy) laundry list of things that could be improved, including:

1. raising, to sensible levels, the initial reporting thresholds for both private and public disclosure,

2. requiring the FCA to create and maintain a definitive public list of the shares that are in scope (on which everyone would be permitted to rely definitively),

3. requiring in-scope issuers to publish a denominator, again, on which everyone is permitted to rely as a “golden source” (with no reporting requirement unless and until the relevant issuer has published),

4. exempting firms from having to report net short positions to the extent that the position is matched by a delta equivalent long position in a convertible or warrant,

5. changing the timeframe for reporting to something a lot less aggressive than 3:30pm on T+1 (why does the market need to know about the position within such a short timeframe when the long regime allows 2-4 trading days?); and

6. allowing allocations in a capital raising to count as acceptable cover for sales (even if there are technical conditions (such as admission by the exchange) which still need to be satisfied before the issuance takes place).

For further details, please contact Darren Fox.

8. Independent Research Review (new but not clear what its impact will be)

We are told this is yet another review of investment research and its contribution to UK capital markets competitiveness. We suspect this will be about unbundling (if you do not know what that is, we have a MiFID 2 survivors group that can explain) and perhaps also another look at the golden age of unconnected research* ushered in by the FCA’s 2017 IPO reforms.

(* not really……)

To discuss further please contact Alex Ainley or Nick Colston.

9. Investment Manager Exemption (new)

HMRC has published the responses to its earlier consultation on expanding the investment transactions list for the purposes of the investment manager exemption (IME). The response confirms that the expansion will take place, with regulations to be introduced before the end of 2022. The IME provides a safe harbour for non-UK funds using UK-based investment managers to conduct investment transactions on behalf of the fund without creating a risk of UK taxation for the foreign fund.

The government has decided to push ahead with the expansion of the investment transactions list to include cryptoassets. Overall this seems a very positive outcome, especially as the government has recognised the need to introduce the changes without further delay. For further details, see our article IME to expand to include cryptoassets.

To discuss further, please contact Martin Shah.

10. VAT Treatment of Fund Management Consultation (old / borrowed)

This is something old or maybe borrowed for most fund managers.

The government has published a consultation document setting out its plans to codify the existing UK VAT exemption for the management of special investment funds.

In essence, the government intends to replace the existing definition with a clean and simplified rule allowing investment managers to determine whether they fall within the VAT exemption with greater certainty.

For the industry, a top priority was the review of the VAT treatment of fund management, to ensure that the treatment of fund management in the UK is competitive and that the case for zero-rating is considered.

However, disappointingly, the consultation will not consider the possible introduction of a VAT zero-rate for fund management fees due to cost. The consultation also avoids commenting on model portfolio services, which may leave many in the industry feeling that the most complex and divisive issues are not being properly addressed by HMRC. Further details can be found in our article, Codifying the VAT exemption for fund management.

For more details, please contact Jo Crookshank.

11. Payments (new – ish)

There are two main initiatives linked to payments, neither of which are completely out of the blue – a consultation on changes to the information requirements in the Payment Account Regulations (PARs) and a wider overhaul of the regulatory framework for payment services and e-money that will start with the FCA’s powers to make rules in relation to APIs and EMIs.

The consultation on PARs runs until 17 February 2023 and affected firms – mostly banks - are encouraged to feed back on the current information requirements. The PARs contained a lot of mandatory requirements on the form and content of fee information that must be provided to customers. Building on the post-implementation review conducted in 2021, HMT have come to the conclusion that most of these requirements are too prescriptive or ‘less necessary in a UK context’. This won’t be news to anyone but the prevalence of free-when-in-credit-banking in the UK makes a lot of the requirements not only unnecessary but also irrelevant so there is a good opportunity to respond constructively to the consultation with a view to moving away from the current EU centric approach. One note of caution, however. In the context of the Consumer Duty, firms will need to consider how any changes or a perceived move away from being transparent with customers will be viewed by the FCA.

On the overhaul of the rules affecting payments and e-money, this was signposted as part of the Future Regulatory Framework Review. The focus here is on giving the FCA powers (and HMT influence) to make rules for APIs and EMIs in the same way they do for authorised firms under FSMA. Of particular interest here is the power with regard to client money that has been called out in the draft Statutory Instrument changing the EMRs and PSRs. Having lost the argument around the creation of statutory trust in a safeguarding context at the Court of Appeal (the Ipagoo case from earlier this year) the FCA now appears to have found a way to make the necessary changes to the regulation to impose this requirement directly – the Policy Note is available here.

There is an interesting focus on the ability to make changes that encourage economic growth and respond quickly to the innovation in the payments space. This is obviously a welcome development but it remains to be seen how effective the FCA will be when asked to take on a more commercial role. It does, however, open up the possibility that regulators will engage more with industry which was one of the main recommendations of the Kalifa Review.

Overall, it’s far from clear at this stage whether the divergence we’ve seen to date in fairly limited areas like TPP access and the application of SCA will turn into wholesale differences in payment regulation when between the UK and the EU.

For more details, please contact Oli Irons or Elizabeth Blair.

12. Markets (old-ish)

Much of the package announced was already known to the market.

The key detail is in the government’s response to the Wholesale Markets Review. Although openness and competition – to enhance the UK’s position as a global hub for wholesale markets – is a key objective, this is not to be at the cost of maintaining high regulatory standards. That said, many of the proposed reforms will be welcomed by many in the markets, in particular, the simplification of the SI regime and dropping the double volume cap for equity markets. Also to be welcomed is the allocation of responsibility for certain matters to the rights market actors: so for example the position limit regime is going back to the exchanges – like in the US.

What is also good to see so far is that the government is picking up on responses to the Wholesale Markets Review: for example on access to capital for small companies, a respondent suggested that a new type of trading venue which works with trading windows rather than continuous trading might be a solution. The government has announced that it will work with the regulators and market participants to trial such a new class of wholesale market venue.

Other new things are also be trailed by others, so for example, the ideas for improving post trade by shortening the settlement cycle and working out which laws need to be changed to see if blockchain technologies can be used by CSDs are already being looked at in the US, India and the EU. The key question will be how flexible and forgiving the detailed provisions to hang onto the scaffolding in the FSM Bill will be.

To discuss further, please contact Rosali Pretorius or Emily Ballisat.

13. UK LTIF / LTAF (new, but not a surprise)

The EU’s European Long-Term Investment Fund (ELTIF) structure was introduced in 2015 to encourage investment in long-term assets, and the UK retained the ELTIF in the immediate aftermath of Brexit, snappily re-naming it the UK Long-Term Asset Fund (“UK LTIF”) for rather obvious reasons. However, no ELTIF or UK LTIF has even been authorised in the UK and, since Brexit, the UK has introduced the Long-Term Assets Fund (“LTAF”) - an authorised fund which is considered more appropriate for UK investors. Further, the EU itself is currently looking to amend the ELTIF regime to make it a more attractive regime for EU managers.

The lack of any existing UK LTIFs, the introduction of the LTAF, and the incoming changes to the EU’s ELTIF regime have left the UK LTIF as a bit of a lame duck. Therefore, probably one of the least surprising announcements last week was that the UK LTIF will soon disappear from the menu of UK authorised funds.

To discuss further, please contact John Dooley.

So, there you have it. A veritable festive feast of reforms. It’s not immediately apparent that these will constitute a massively radical departure from the status quo, but we can already tell that a lot of work lies ahead for everybody. And the inevitable D-word must be uttered here – Divergence. For some international financial services groups, the increasingly complex compliance task ahead may not be much desired. Whether the Government can get this all through in the allotted time it has left remains to be seen, but the trajectory for the short to medium term has been clearly set.

How much of this is laying the groundwork to claim a Brexit benefit? A fair question and, as we said above, the forthcoming 2025 election may be in mind too. Groucho once said: “These are my principles and if you don’t like them…. well I have others”. The industry will give its collective judgement in due course.

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