Financial Services SpeedRead: 12 May 2021

1. Capital Requirements Regulation (Amendment) (EU Exit) Regulations 2021 made

On 10 May 2021, the Capital Requirements Regulation (Amendment) (EU Exit) Regulations 2021 (SI 2021/558) were published, together with an explanatory memorandum.

Under Articles 493 and 498 of the UK and the EU Capital Requirements Regulation (575/2013) (CRR), commodity dealers are exempted from specific prudential requirements. These exemptions were to expire after 26 June 2021 – the date on which the Investment Firms Regulation ((EU) 2019/2033) applies in the EU. SI 2021/558 extends this exemption to 1 January 2022 – the date on which the date on which the UK Investment Firms Prudential Regime (IFPR) will come into effect.

2. HM Treasury issues guidance on open access regime for exchange-traded derivatives

On 30 December 2020, HM Treasury issued guidance, announcing that it would conduct a review of the open access regime for exchange traded derivatives (ETDs) to assess its suitability for UK markets after the end of the Brexit transition period.

Following this review, HM Treasury has concluded that the open access regime for ETDs, which was originally designed to improve cross-border capital markets in the EU, is not suitable in a UK-only context. The UK Government therefore intends to permanently remove the open access regime for ETDs when parliamentary time allows.

This decision has no bearing on the UK's continued support for the open access regimes in equity and OTC derivatives markets, which will continue to operate as normal.

3. Financial Services Act 2021 makes changes to the UK financial regulatory framework in light of Brexit

On 29 April 2021, the Financial Services Bill 2019-21 received royal assent. The Financial Services Act 2021 makes changes to the UK financial regulatory framework in light of Brexit.

The key aspects include:

• Prudential requirements for investment firms: The Act amends the UK Capital Requirements Regulation (CRR) so that it no longer applies to investment firms, other than PRA-designated firms. Schedule 2 to the Act sets out a new Part 9C to the Financial Services and Market Act 2000 (FSMA) on the prudential regulation of FCA investment firms;
• Prudential requirements for credit institutions: The Act introduces a mechanism for HM Treasury and the PRA to implement the Basel standards covered by the EU CRR II and gives HM Treasury the power to make regulations to revoke existing prudential regulation contained in the UK CRR;
• Benchmarks: The Act amends the UK Benchmarks Regulation (BMR) to give the FCA additional powers to manage the orderly wind-down of critical benchmarks (such as LIBOR). It will also extend the transitional period for third country benchmarks under the UK BMR from 31 December 2022 to 31 December 2025;
• Overseas Funds Regime: The Act amends Part 17 of FSMA to introduce a new Overseas Funds Regime. This regime allow overseas collective investment schemes to be marketed to all UK investors, including retail investors;
• MiFIR: The Act amends UK MiFIR to give the FCA powers to impose temporary restrictions or prohibitions on third-country firms providing investment services in the UK. The Act also gives the FCA powers to specify reporting requirements;
• Duty of care: The Act requires the FCA to consult on whether it should introduce rules providing that authorised persons owe a duty of care to consumers. The Act requires the FCA to publish its analysis of the responses to the consultation before 1 January 2022
• Market abuse: The Act amends the Criminal Justice Act 1993 and the Financial Services Act 2012 to increase the maximum sentence for criminal market abuse from seven to ten years;
• Buy-now pay-later products: The Act gives HM Treasury the ability to bring interest-free buy-now pay-later products within the regulatory perimeter; and
• Cashback: The Act amends Part 2 of Schedule 1 to the Payment Services Regulations (SI 2017/752) to introduce an exemption for cashback without a purchase, so that it will no longer be a regulated payment.

4. ESMA publishes guidelines on outsourcing to cloud service providers

On 10 May 2021, ESMA published guidelines on outsourcing to cloud service providers (CSPs). These guidelines aim to help firms and competent authorities identify, address and monitor the risks and challenges arising from cloud outsourcing arrangements. The guidelines provide guidance for firms on:

• the risk assessment and due diligence they should undertake on their CSPs;
• the governance, organisational and control frameworks they should establish to monitor the performance of their CSPs and how to exit their cloud outsourcing arrangements without undue disruption to their business;
• the contractual elements that their cloud outsourcing agreement should include; and
• the information to be notified to competent authorities.

The guidelines apply from 31 July 2021 to all cloud outsourcing arrangements entered into, renewed or amended on or after that date. ESMA states that firms should review and amend accordingly existing cloud outsourcing arrangements with a view to ensuring that they take into account the guidelines by 31 December 2022. Where the review of cloud outsourcing arrangements of critical or important functions is not finalised by 31 December 2022, firms should inform their competent authority, including the measures they plan to take to complete the review or their possible exit strategy.

5. Financial Services Regulatory Initiatives Forum publishes third edition of the Regulatory Initiatives Grid

On 7 May 2021, the Financial Services Regulatory Initiatives Forum (Forum) published the third edition of the Regulatory Initiatives Grid (Grid). The Forum is comprised of various key stakeholders, including the FCA, the Bank of England and the Payment Systems Regulator, with HM Treasury attending as an observer member. The Grid summarises some of the key forthcoming initiatives across various areas including "multi-sector" initiatives (e.g. ESG, operational resilience, conduct), banking credit and lending, and investment management. The latest edition of the Grid contains 128 initiatives, an increase on the 111 initiatives included in the previous edition in September 2020. This, in part, reflects that a number of new initiatives have been added where regulators are pushing forward in areas which are a shared priority (e.g. eight new ESG initiatives).

The Grid publication marks the end of a one-year pilot exercise. The Forum plans to keep publishing the Grid twice a year.

6. EU Commission publishes draft Delegated Regulation which specifies the content and presentation of information to be disclosed under Article 8 of the Taxonomy Regulation by undertakings subject to the Non-Financial Reporting Directive

Under Article 8 of the Taxonomy Regulation ((EU) 2020/852), financial market participants covered by Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (SFDR) and companies covered by the Non-Financial Reporting Directive (2014/95/EU) (NFRD) are both required to disclose, amongst others, the extent to which their products or activities are environmentally sustainable (as defined under the Taxonomy Regulations).

On 7 May 2021, the EU Commission published a draft Delegated Regulation which specifies the content and presentation of information to be disclosed by undertakings subject to Articles 19a or 29a of the NFRD and the methodology to comply with that disclosure obligation.

7. "Regulation for a different world?" – speech by Nikhil Rathi, CEO of the FCA

On 6 May 2021, Nikhil Rathi, CEO of the FCA, gave a speech to the Association of Foreign Banks on the UK regulatory landscape post-Brexit. We summarise the main points of his speech below.

• The FCA will continue to be a regulator that supports open, competitive markets with responsible innovation. However, one of the consequences of a lack of mutual equivalence between the UK and the EU is that EU banks are, for the time being, not able to offer their clients full access to all pools of global liquidity for the trading of interest rate swaps and certain credit derivatives. UK trading venues have retained material market share in various products.
• The FCA recognises the increased flexibility that is available to the UK post-Brexit and will use this for the benefit of UK financial markets and consumers.
• Key focus areas in international regulation include Environmental, Social and Governance, the sustainability agenda and dealing with financial crime.
• The FCA's regulation of overseas firms is aimed at achieving the same high standards of conduct and behaviour as its regulation of domestic firms. The rules and threshold conditions will remain the same for all firms and the FCA will apply the same standards to international firms seeking authorisation. However, where the FCA thinks that international firms can pose different risks, regulation may be more stringent.
• Cooperation with international supervisors and global standard-setting bodies is ever more vital, and working towards the same outcomes allows regulators to defer to each other more and avoid duplication of regulatory requirements.

8. "Outcomes-focused regulation: a measure of success?" – speech by Charles Randell, Chair of the FCA

On 6 May 2021, Charles Randell, Chair of the FCA, gave a speech to the Building Societies Association on the future of outcome-focused regulation. We summarise the main points of his speech below.

• Outcome-focused regulation came into disrepute when it was seen as having failed to detect early warning signs of the Financial Crisis. There might also be a more general problem with the concept of outcome-focused regulation, as both the (former) Financial Services Authority (FSA) and now the FCA have resorted to considering the inputs when assessing whether the desired outcomes have been achieved. The regulators' assessment of the requirement to treat customers fairly is cited as a case in point.
• The COVID-19 pandemic has revealed further limitations of outcome-focused regulation. The pandemic has led to increased demand for unsecured credit by illegal providers, which raises the question of whether the FCA should measure the impact of its actions only with reference to authorised firms.
• Nevertheless, there have been positive examples, where focusing on outcomes and measuring them has enabled the FCA to deliver its objectives of consumer protection, competition in the interests of consumers and market integrity. For example, the FCA's equity market cleanliness statistic shows a generally improving trend over the last decade.
• Focusing on the best consumer outcomes continues to be the right thing to do, but it has not been fully embedded in everything the FCA and financial services firms do. However, by defining the right outcomes, measuring them more and acting on the results faster and with an enhanced data capacity, the FCA will be able to target its interventions more effectively.
• The FCA should be bold about stating and measuring the outcomes even when it cannot fully control them, for example in the areas of fraudulent high-risk investments and speculation.

9. FCA publishes consultation paper on investor protection measures for SPACs

On 30 April 2021, the FCA published a consultation paper (DP21/10) on proposed changes to its Listing Rules for certain special purpose acquisition companies (SPACs). The FCA proposes amending the rules to allow an alternative approach for listed SPACs that are able to demonstrate higher levels of investor protection which have developed in certain overseas jurisdictions.

Currently, a SPAC will have to suspend trading in its shares at the point it identifies announces an acquisition target. Suspension seeks to preserve market integrity during a period when limited information on a prospective deal could result in disorderly trading in a SPAC's shares. However, suspension results in existing investors being locked into a SPAC until completion, which could be many months and therefore undesirable for investors and issuers. The FCA is proposing that SPACs that comply with higher levels of investor protection should not be subject to this requirement.

10. Financial Action Task Force updates table on assessment ratings

On 29 April 2021, the Financial Action Task Force (FATF) updated its consolidated table of AML risk assessment ratings. The table includes the FATF categorisation of countries on the FATF high-risk list. The updated list shows some discrepancies between the UK anti-money laundering (AML) high-risk list and FATF list. The breakdown is as follows:

• countries on the FATF and UK AML high-risk list: Barbados, Botswana, Burkina Faso, Mauritius, Myanmar, Pakistan, Panama, Senegal, Uganda and Zimbabwe;
• countries only on the FATF high risk-list: Bahamas, Bhutan Cano Verde, Ethiopia, Haiti, Hungary, Iceland, Kyrgyzstan, Madagascar, Mali, Mauritania, Mongolia, Saint Lucia, Seychelle and Vanuatu; and
• countries only on the UK AML high-risk list: Albania, Cambodia, Cayman Islands, North Korea, Ghana, Iran, Jamaica, Morocco, Nicaragua, Syria and Yemen.

11. FCA publishes consultation paper on strengthening financial promotion rules for high-risk investments and firms approving financial promotions

On 29 April 2021, the FCA published a discussion paper (DP21/1) proposing a number changes to the FCA's approach to financial promotions and product governance for retail clients in response to increasing concerns about gamification trading among new and inexperienced traders.

In summary, the FCA classifies high-risk investments as any investment which is subject to marketing restrictions under the FCA rules, including non‑readily realisable securities (NRRSs), peer‑to‑peer (P2P) agreements, non‑mainstream pooled investments (NMPIs) and speculative illiquid securities (SISs).

The FCA is seeking feedback on a number of points, including the following:

• whether the current classification of high-risk investments should be expanded, in particular bringing some cryptoassets into the scope of the financial promotion rules and including ordinary equity shares as a type of security that can be a SIS, and therefore capture shares issued to raise capital for speculative purposes (such as shares in SPACs) would be subject to the mass marketing ban on SISs;
• how to enhance the responsibilities of firms in categorising clients as high net worth, sophisticated or (in the case of NRRSs or P2P agreements) restricted investors. For example, should firms be required to take "reasonable steps" in all cases to independently verify that a retail investor meets the relevant requirements to be characterised as a high net worth or sophisticated? The FCA does not believe that the current situation which relies largely on self‑certification is the right outcome;
• how to make better risks disclosures. The FCA considers that "capital at risk" disclosures do not adequately cut through to consumers and whether the rules introduced for SISs which requires a standardised risk warning which clearly states that investors could lose all their money and that these products are high risk should be extended to other high-risk investments. The FCA is also interested to explore whether visual‑based risk warnings could help influence consumer behaviour;
• introducing positive friction in consumer journeys to prevent consumers from simply 'clicking through' and accessing high-risk investments they do not understand and which do not match their risk appetite. Examples include requiring SMS confirmations before investments are made, requiring consumers to watch 'just in time' education video, requiring consumers to pass an online test; and
• whether the FCA should introduce prescribed ongoing monitoring requirements when an authorised firm approves the financial promotions of an unauthorised person.

DP21/1 follows the FCA's Call for Input on the Consumer Investment Market which closed on 15 December 2020. A key theme in responses the FCA received to the Call for Input was the need to further segment high‑risk investments from the mainstream market, and to help prevent consumers from investing in inappropriate investments that do not meet their needs.

12. FCA publishes consultation paper on changes to UK MiFID's conduct and organisational requirements

On 28 April 2021, the FCA published its consultation paper (CP21/19) on proposed changes to UK MiFID's conduct and organisational requirements. The FCA proposes:

• to create several exemptions from the inducements rule, and therefore reversing the unbundling requirement, including:

- for research on listed or unlisted SMEs companies who have a market capitalisation below £200m. The £200m threshold would be assessed for the 36 calendar months preceding the provision of the research, provided it is offered on a rebundled basis or for free;

- for research received in connection with investment strategies that relate primarily to fixed income, currencies and commodities instruments;

- for research provided by independent research providers where this does not involve execution;

- for openly available research; and

• to remove the requirements to produce RTS 27 and RTS 28 reports entirely in relation to best execution. The FCA stated that its policy work and discussions with market participants indicate that RTS 27 and RTS 28 reports have not achieved their policy goal of enhancing investor protection or improving information on execution quality and order routing. Further, they are costly and market participants, do not view the reports.

13. Letter from PRA to Chief Risk Officers of PRA-regulated UK deposit takers

On 30 April 2021, Melanie Beaman, Director of the PRA's Deposit Supervision, sent a letter to Chief Risk Officers of PRA-regulated UK deposit takers. The letter states that the PRA is assured from its internal audit findings of 42 non-systematic banks and building societies that the processes and controls in place for collection operations are largely adequate and effective across the majority of the firms.

However, the letter also highlights that some firms need to continue to enhance their collections operation, develop the right level of control and governance to ensure its effectiveness, review the adequacy of resources, efficiently manage the processes and ensure adequate oversight at Board level.

14. PRA publishes discussion paper on prudential framework for non-systemic banks and building societies post-Brexit

On 29 April 2021, the PRA published a discussion paper (DP 1/21) on the options for developing a simpler prudential framework for banks and building societies that are considered by the PRA to be neither systemically important nor internationally active. The paper outlines reasons as to why the prudential framework at present may be viewed as overly complex for smaller firms (and how this relates to the PRA's wider objectives). It seeks to outline a vision for potential reform to the prudential framework in the UK, which could be changed in order to reduce potential complexity for such firms, whilst maintaining overall resilience in the sector. In particular, Chapter 7 of the discussion paper sets out various conclusions, which can be summarised as follows:

• the argument for simplifying the PRA's prudential rules for smaller firms is that the cost of understanding, interpreting, and operationalising prudential regulation falls more heavily upon smaller firms. Those costs could also have negative effects on the PRA's objectives. The aim is to simplify regulation in ways that reduce those costs while still ensuring all PRA-regulated firms face prudential rules and expectations that maintain their safety and soundness;
• this is why the PRA wants to introduce a strong and simple prudential framework. This framework would support the stability of the banking sector in the UK, but in doing so enable a dynamic and diverse banking sector in which successful firms can grow as other less successful ones contract and exit the sector;
• the diversity of the UK's banking sector implies that a single set of rules and expectations for non-systemic firms is unlikely to achieve the objective of simplifying while also ensuring resilience. The framework is likely to involve a series of layers, where prudential requirements and expectations increase in line with a firm's size and complexity of activities;
• a graduated framework is likely to take a number of years to introduce. The PRA is considering starting with a materially simpler prudential regime for the smallest banks and building societies, which are the firms that are likely to experience the complexity problem most acutely; and
• the discussion paper sets out ideas as to what that simpler regime might look like, including the possible approaches to identifying firms in scope, the possible requirements under the regime, and ways in which firms might transition in and out of the regime. The paper also highlights the key design choices and trade-offs the PRA will need to consider when designing and implementing the simpler regime.

15. "Building strong and simple: the first step" – speech by Victoria Saporta, Bank of England Executive Director for Prudential Policy

On 29 April 2021, Victoria Saporta, Bank of England Executive Director for Prudential Policy gave a speech, following on from her previous 2020 speech, concerning the PRA's approach to regulating banking and insurance services post-Brexit.

We summarise the main points of her speech below:

• PRA's approach to policy making: The PRA will be a rule-maker now. In light of a new legislative framework, the PRA is now required to have regard to issues like international standards, equivalence and climate change;
• Strong and simple prudential framework for non-systemic banks and building societies: Ms Saporta discussed the PRA's discussion paper (DP 1/21 – see entry 14 of this week's FFS) and highlighted that the PRA was looking for engagement from the industry about the proposed features of this framework and to ensure that it is proportionate and works for firms; and
• PRA aims: The PRA envisages a simpler regime with the same level of resilience for small firms. The PRA is aware that costs of implementing its rules can fall heavier on small firms than larger ones. Research by the PRA shows that prudential requirements that are well-matched with the risks that cause large banks to fail are not so well-matched with those that cause small banks to fail. A simpler regime will need to be viewed in light of Basel requirements for supervision (these are not the same as the Basel requirements for internationally active banks).

16. FCA publishes consultation paper on a new long-term asset fund to support investment in long-term, illiquid assets

On 7 May 2021, the FCA published a consultation paper (CP 21/12) on proposals for a new long-term asset fund (LTAF) designed to invest in long-term, illiquid assets. The LTAF would be open-ended and able to invest in assets such as venture capital, private equity, private debt, real estate and infrastructure.

The FCA proposes that LTAF rules embed longer redemption periods, high levels of disclosure and specific liquidity management and governance features. These would take account of the types of risk to which LTAFs might be exposed, and give investors confidence that they are being managed appropriately and in their interests.

Relatedly, the Bank of England published a statement on the progress of its Working Group on Productive Finance. The Working Group met this week to discuss progress on:

• the work done to develop the LTAF as set out above;
• the analysis undertaken to understand and begin to address operational barriers to investing in long-term assets, for example barriers associated with investing in non-daily dealing funds; and
• possible initiatives to support pension schemes in keeping costs low, while at the same time securing overall long-term value for their members.

No updates for this fortnight's edition of the FSS.

17. FCA fines Sapien Capital Ltd for serious financial crime control failings in relation to cum/ex trading

On 6 May 2021, the FCA fined Sapien Capital Ltd (Sapien) £178,000 for failings which led to the risk of facilitating fraudulent trading and money laundering. This is the first FCA case in relation to cum/ex trading, dividend arbitrage and withholding tax reclaim schemes. There are currently a number of ongoing and overlapping investigations.

The FCA found that between 10 February 2015 and 10 November 2015, Sapien failed to have in place adequate systems and controls to identify and mitigate the risk of being used to facilitate fraudulent trading and money laundering in relation to business introduced by the Solo Group.

The way these trades were conducted by the Solo Group and their clients, in combination with their scale and volume, were, in the FCA's view, highly suggestive of financial crime and appear to have been undertaken to create an audit trail to support withholding tax reclaims in Denmark and Belgium. Sapien executed purported OTC equity trades to the value of approximately £2.5 billion in Danish equities and £3.8 billion in Belgian equities.

In addition, in the FCA's view, Sapien failed to exercise due skill, care and diligence in applying anti-money laundering policies and procedures and in failing properly to assess, monitor and mitigate the risk of financial crime in relation to clients introduced by the Solo Group and the purported trading.

No updates for this fortnight's edition of the FSS.

No updates for this fortnight's edition of the FSS.

18. FCA publishes evaluation report on the Digital Sandbox Pilot

On 27 April, the FCA published its evaluation report on the Digital Sandbox Pilot (Pilot). The Pilot stems from a recent collaboration with The City of London Corporation to provide support to innovative firms tackling challenges caused by the COVID-19 pandemic and focused on three pressing areas: fraud and scams, vulnerability and SME lending.

The FCA found that access to a digital testing environment successfully accelerated development times for the vast majority of participants as well as providing other benefits, such as improving product design and refining early-stage business models.

The FCA announced that it was planning to launch a second phase of the Pilot focused on sustainable finance. The FCA noted that it would explore, with industry and other stakeholders, viable sustainable operating models for a future permanent version of the Pilot. The Pilot was also an opportunity to collect user feedback to inform and shape future iterations.

As set out in the report, the FCA have distilled a range of stakeholder feedback into actionable lessons learned and clarified that it will be incorporating these into the next phase of the Pilot.

19. EU Commission fines investment banks €28 million for participating in SSA bond trading cartel

On 28 April 2021, the EU Commission fined Bank of America Merrill Lynch, Crédit Agricole and Credit Suisse a total of €28,494,000 for breaching EU antitrust rules. Deutsche Bank was not fined, as it revealed the existence of the cartel to the Commission.

The four investment banks participated in a cartel in the secondary trading market of Supra-sovereign, Sovereign and Agency (SSA) bonds denominated in USDs through a core group of traders. The traders provided each other with recurring updates on their trading activities, exchanged commercially sensitive information, coordinated on prices shown to their customers or to the market in general, and aligned their trading activities. This conduct took place during a five-year period and affected the trading of USD denominated SSA bonds on the secondary market in the EEA.

In setting the level of fines, the Commission took into account the sales value in the EEA achieved by the cartel participants for the products in question, the serious nature of the infringement, its geographic scope and the respective duration of participation.