The FCAs 2022 New Year resolutions

First published on Thomson Reuters Regulatory Intelligence on 4th January 2022

Well, what a year it has been. At best it could be described as like the hokey-cokey, we are in a pandemic, then we are out again, and then back in again (maybe, perhaps, possibly?). One thing is for sure we are out of the EU. The Brexit Transition Period came and went and the work continues to be undertaken in earnest. Some parts of the process remain in limbo: we have yet to see the official publication of the text of the Memorandum of Understanding agreed in a Joint Declaration on Financial Services Regulatory Cooperation announced in March 2021. But in terms of the post-Brexit reality for the financial services industry, we started to see the first indications of divergences between EU and UK financial services regimes, with the EU and UK issuing their own versions of MIFID Quick Fixes. Here at Ashurst, we are helping firms respond to these challenges by creating tools to map these divergences.

There have been changes in the leadership boards of the regulators. The FCA's new CEO, Nikhil Rathil started his new year along with a new team including Sheldon Mills, Director of Consumers and Competition. Verena Ross became the new chair of ESMA (replacing Steven Maijoor), while Klaas Knot became the new chair of the FSB, replacing Randal Quarles.

COP26 kicked off in earnest, ensuring that ESG was being put at the forefront of the regulatory radar.

In November 2021, the EU issued its Banking Package, signalling significant changes to banking operations. Almost two years since the onset of the COVID-19 pandemic, the financial services industry is still grappling with its impact. In response, regulators in the UK and elsewhere have continued to issue statements to firms on everything from vulnerability to cyber resilience.

So what next? We gaze into the regulatory crystal ball and offer our two cents.

2022 Predictions

Prediction 1: The UK's ESG initiatives don't quite take off

To coincide with COP26, the UK announced its approach to sustainable investments with proposals around a new product labelling system for sustainable investments. The response of those in the green space is overwhelmingly positive. Sustainable transitioning, sustainable aligned and sustainable impact are much clearer and much more understandable than 'article 8' or 'article 9'. But it remains to be seen whether the European Sustainable Finance Disclosure Regulation terminology is already so universally adopted that the UK's approach will fall flat. Despite being a much more practical and pragmatic approach, the industry looks as if it is already half way round the track as the UK regime is just getting started.

Prediction 2: Race to the "starting line" for new entrants in the cross-border payments space

Prolonged "digital confinement" experienced by retail and wholesale markets alike, due to numerous lockdowns in 2020 and 2021 respectively, will result in an explosion of new entrants in the cross-border payments space throughout 2022. Cross-border payments are currency transactions between people or businesses in different countries.

Victoria Cleland, Executive Director for Banking, Payments and Innovation at the Bank of England confirmed in a recent speech how the BoE's upgrade to its RTGS payments system will help spearhead the payments industry into the 21st century. Cross-border payments are expected to total $250 trillion by 2027, a phenomenal amount when compared with the total amount processed through the UK's high-value payment system (CHAPS) in 2019, which was around £34 trillion. A radical shake-up of the cross-border payments space is necessary because the industry still suffers from high costs, low speed, limited access and insufficient transparency.

Our prediction is that new entrants to the market will challenge not just the low value transactions in the following spaces: consumer to business, consumer to consumer and business to consumer transactions - incumbent banks will face stiff competition from new disruptors who want a bite of the cherry when it comes to business to business transactions which account for the majority of cross-border payment flows globally.

Prediction 3: We will hear more from the FCA regarding remuneration rules and overseas MRTs under the IFPR

The FCA has recently published its third and final Policy Statement (PS 21/17) in relation to the implementation of the IFPR, setting out final rules in relation to disclosure and remuneration and, in particular, material risk takers (MRTs). Under the regime, remuneration requirements apply to categories of staff whose professional activities have a material impact on the risk profile of the investment firm or of the assets that it manages (i.e. MRTs). The category includes senior management, risk takers and staff engaged in control functions.

Many UK firms that are part of international groups have senior overseas decision-makers on their boards or executive committees, in order to reflect group interests and strategy. It was traditionally understood that these people were out of scope of UK remuneration rules to the extent they were not paid by the UK firm, but rather received remuneration from the overseas parent (and their remuneration does not expose the UK firm to direct financial risk). In PS21/17, the FCA stunned many in the industry by indicating that it wants such board members/exco members to be included as MRTs and their whole global remuneration included in scope of the rules. It argued that the remuneration rules are not just about the financial risk that the payments create, but the incentives that bonuses create, which can encourage bad decision-making.

The FCA's position is likely to be unpalatable for many, so we can predict that either the rules stay the same and, in response, global groups will have their senior overseas people step down from UK boards and excos; or the FCA has a rethink and reviews its position/guidance. Either way, watch this space!

Prediction 4: More action from the FCA and the ASA to ban misleading advertising in relation to cryptoassets, high risk leveraged retail products, and the use of social media and "celebrities" to promote investments

You can't get on the tube these days without seeing numerous adverts trying to convince you to invest in various cryptoassets offerings. Unlike CFD products, the marketing of cryptoassets is not currently regulated, meaning that adverts usually only include the minimal disclosures. Cryptoassets, and the risks associated with them, have continued to be a concern for the FCA throughout 2021, and, with the end of home-working, we doubt that this advertising trend has gone unnoticed by FCA staff commuting into their Stratford offices. In September 2021, Charles Randell, current Chair of the FCA repeated FCA concerns in relation to the use of social media and celebrities to promote investments. He referred to a celebrity (Kim Kardashian) asking her 250 million Instagram followers to speculate on a digital token created a month before by unknown developers. Mr Randell warned of naïve consumers, who out of fear of missing out, rush into "cryptobubbles" often as a result of encouragement from their favourite influencers.

Although the FCA has not announced its intention to carry out full-scale regulation of cryptoassets (as the EU have done through MiCA) and an authorisation regime is likely not around the corner, we would not be surprised to see the FCA look to other ways, including new marketing restrictions, to discourage (or limit the encouragement of) cryptoasset trading.

Prediction 5: Flying close to the sun – greater FCA scrutiny of firms' ICARA process under the IFPR

As discussed earlier, investment firms and their groups will be subject to a new prudential regime from 1 January 2022 when the IFPR comes into force (though, more accurately, some transitional provisions have already kicked in before the new year).

While teething problems will be inevitable as the new rules are bedded in, firms will need to grapple with longer lasting impact of the internal capital adequacy and risk assessment process (the "ICARA process"). The ICARA process refers to a firm's internal systems and controls to identify and manage potential material harms that may arise from the operation of its business, and to ensure that its operations can be wound down in an orderly manner. This is also the process for firms to assess whether additional own funds and/or liquid assets need to be held (similar to "Pillar 2" under the old regime). The FCA sees the ICARA process as the "centrepiece" of a firm's risk management framework. Throughout 2022, we expect to see greater FCA scrutiny on firms' ICARA process and regulatory publications will highlight the following themes:

• It is not the same as the ICAAP – Although similar concepts and methodologies can be leveraged, the ICARA process is not a re-branding exercise of the old ICAAP. The ICARA process moves away from pre-defined risk categories to a more conceptual and holistic approach to harm identification and mitigation. Wind-down and recovery planning (both qualitatively and quantitatively) may also be a new undertaking for certain firms.

• The ICARA process is not static – Firms will be reminded not to conflate the annual review of the ICARA process with the ICARA process itself. The ICARA process is ongoing and dynamic to reflect the nature and extent of potential harm the firm may cause to clients, the markets, and itself. Firms should not only consider its risk framework once a year (or after a material change in business / operating model) when the ICARA document needs to be produced.

• Reporting may be sooner than you think – There is some time before firms need to submit their first ICARA questionnaire (MIF007 report). However, firms should realise that they need to report their own funds and liquid assets threshold requirements which are determined by their ICARA processes on a quarterly basis (i.e. via MIF001 and MIF002). The first set will be due in April 2022.

That is what we think readers should look out for in 2022. But how did we do on last year's predictions?

2020 Predictions

Prediction 1: Further action from the regulators on socio-economic diversity and ethnic minority diversity

We called this one correctly! As we noted, diversity and inclusion (albeit gender diversity) had been a recurrent theme. In March 2021, Nikhil Rathi, FCA CEO, gave a speech at the Women in Finance Charter Annual Review noting that diversity was a broad topic covering a range of characteristics – gender, ethnicity, sexual orientation, disability and, increasingly social background. Nikhil Rathi suggested that the famous 5 conduct questions firms ask themselves in relation to conduct risk could be expanded to include: is your management team diverse enough to provide adequate challenge and do you create the right environment in which people of all backgrounds can speak up? A link was drawn between how financial services providers produce products that fully serve diverse communities and the prevention of financial exclusion. This was followed with a speech by Sheldon Mills, Executive Director, Consumers and Competition at the FCA, on how firms could accelerate black inclusion at all levels as part of their diversity and inclusion agendas.

Similarly, the Bank of England launched its "meeting varied people" initiative. The aim of the initiative is to enable the Bank of England to hear from a more diverse range of people who work in financial markets and for this to inform the decisions it makes (e.g. on market operations). Perhaps the biggest indication of a sea change was the publication of the July 2021 discussion paper (DP21/2) by the FCA, the PRA and the Bank of England on why diversity and inclusion matters in financial services, both in terms of who is running financial services firms and how financial services firms need to better reflect the customers they are serving. The FCA followed this up with a consultation paper (CP21/24) on disclosure of adherence to board diversity targets.

Prediction 2: More regulatory cooperation and action in relation to non-bank financial intermediation

We called this one correctly. We noted the increasing importance of non-bank financial intermediation/market based finance as a key source of funding for firms and for the wider economy but that events such as the "dash for cash" market turmoil, witnessed in March 2020, highlighted the need for more regulatory action. 2021 was the year when UK, EU and global regulators arguably got serious in their response to this issue.

At the UK level, the Bank of England published a speech by Andrew Bailey on the need to improve the resilience of money market funds. In July 2021, the Bank published a detailed report on the resilience of market-based finance following the conclusion of a joint review by the FCA and the Bank of England on open-ended investment funds and the risks posed by their liquidity mismatch.

At the EU level, ESMA issued a March 2021 consultation on reforms to the EU Money Market Fund Regulation, while the ERSB issued a report on the systemic vulnerabilities of MMFs and preliminary policy options for their reform.

In October 2021, the FSB issued a report setting out a framework for individual FSB members to assess vulnerabilities in money market funds in their jurisdiction and a policy toolkit. In October 2021, the FSB published a speech confirming non-bank financial intermediation remained an FSB’s priority and in November 2021, the FSB published a report describing outlining progress and planned work under its NBFI work programme. This was followed by a December 2021 publication promoting a system-wide perspective to financial resilience.

Prediction 3: More action from regulators to tackle digital exclusion and financial exclusion

We called this one correctly. We noted how the UK government and the financial services sector had examined the varying levels of access to financial services and the specific challenges faced by certain groups in relation to this area. Access to cash, banking and bank accounts are some of the cornerstones of financial inclusion. We noted that regulators were observing that the pandemic had accelerated the long-term trend of consumers moving to "tech-enabled" business models but that technological innovation in financial services could also hinder financial inclusion. In 2021, we saw a number of initiatives and reports to indicate that regulators, the industry and the Government were thinking seriously about this issue. One of the recommendations contained in the February 2021 Kalifa FinTech Review Final Report was the use of FinTech to support financial inclusion and capability.

The House of Lords Select Committee followed up on its 2017 report on financial exclusion with a 2021 report noting that the COVID-19 pandemic had increased awareness of digital exclusion across the country and that digital skills had become increasingly important for accessing financial services as a result of the pandemic. Recommendations included a radical proposal for the Government to expand the remit of the FCA to include a statutory duty to promote financial inclusion as one of its key objectives. The Government's December 2021 report on financial inclusion noted the importance of maintaining access to cash for vulnerable people and set out several regulatory initiatives undertaken to respond to the effects of the pandemic, including a July 2021 Access to Cash consultation containing legislative proposals (as well as a proposal that the FCA becomes the lead regulator for oversight of the retail cash system). In December 2021, UK Finance announced an agreement by its Access to Cash Action Group on an initiative to ensure the long-term availability of cash across the UK. In response, the FCA and the Payment Systems Regulator published a statement welcoming efforts of firms to maintain access to cash.

At the EU level, several regulators, such as EU Commissioner Mairead McGuinness and Fabio Panetta at the ECB issued speeches on how COVID accelerated the adoption of digital technology and what this means for financial literacy and financial exclusion. Similar themes were echoed in the G20 Rome Leaders’ October 2021 Declaration.

Prediction 4: We will hear more from the FCA and other bodies in relation to "phoenixing"

We called this one correctly. "Phoenixing" refers to the practice of firms and individuals with a poor conduct history avoiding detection by re-emerging in a different legal entity. The FCA launched an initiative to address this issue in May 2019 in conjunction with the Financial Services Compensation Scheme (FSCS), the Financial Ombudsman Service (FOS) and the Insolvency Service, and Scotland's Accountant in Bankruptcy. A FCA June 2020 speech indicated that we might see an increase in the phenomenon during the COVID-19 crisis. In May 2021, the FCA published a consultation paper setting out its proposals to address so-called calls "claims management phoenixing" (CP21/14). In this case, an individual connected with a wound-up financial services firm reappears in connection with a claims management company and seeks to benefit from the former firm’s poor conduct by undertaking claims management activities against it. To prevent claims management phoenixing, the FCA proposed prohibiting CMCs from managing FSCS claims if a person connected to the CMC is or was linked to the FS activity that is the subject of the claim.

Overall score: 4/4

Not a bad result and one we will be sure to aim for next year! On that note, a Happy New Year to you all! May 2022 bring you a little more certainty, and a few less scuppered holiday plans!

Co-authors: Bisola Williams; Emma Tran; Anna Burn; Toni-Siobhan.Wilks-Pinnock; and Phillip Yung