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FINANCIAL SERVICES: An Introduction

Contributors:
Nicole Wong
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Practice Area Overview: Financial Services  

Contributed by Nicole Wong of Fox Williams LLP 

Most of us had probably hoped that the COVID-19 pandemic would confine itself to 2020; however, the financial services industry (and the world more generally) continued to feel its effects well into 2021. As a result, consumer protection and operational resilience were high on the list of priorities for the regulators in their 2020/2021 business plans, and this continues to be the case in their 2021/2022 business plans.

As the industry begins to steady itself in what we hope is the tail end of the pandemic, space is being made for other key issues on the docket, in particular diversity and inclusion (D&I) and environmental sustainability.

Unsurprisingly, the impact of Brexit remains on the radar. We continue to watch this unfold as the government continues to take steps in shaping the new UK regulatory framework whilst balancing competing priorities of protecting the integrity of the UK financial system and remaining internationally competitive in a post-Brexit world.

Cross-market themes 

D&I will certainly be a focus for regulators throughout 2022, particularly in light of the Discussion Paper (DP) on D&I within the financial services sector, which was jointly published in July 2021 by the Financial Conduct Authority (FCA), the Prudential Regulatory Authority (PRA) and the Bank of England (BoE). In this Paper, the regulators set out policy options including, amongst others, the use of targets for representation, measures to make senior managers directly accountable for D&I in their firms, linking remuneration to D&I metrics and the regulators’ approach to considering D&I in non-financial misconduct. The DP is open until September 2021; the feedback and data received will be used to develop detailed proposals, with a joint consultation scheduled to take place in the first quarter of 2022. We expect the changes that flow from this to be significant and to impact all firms across the sector.

In support of the government’s plans for the UK to become the first country in the world to make the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) fully mandatory across the economy by 2025, environmental social and governance (ESG) matters are now at the forefront of regulators’ minds. The FCA are introducing an ESG Sourcebook within the existing FCA Handbook which will set out climate-related disclosure obligations for asset managers and owners, and it intends for this Sourcebook to be effective for the largest asset managers and owners from January 2022 (and for remaining asset managers and owners from January 2023). The PRA also set out detailed guidance in a Dear CEO letter published in June 2020 on how banks and insurers should embed their approaches to managing climate-related financial risks by the end of 2021. We expect the focus will not shift away from ESG during 2022, and will remain high on the regulators’ list of priorities for the next few years.

We expect to see the impact of Brexit continue to play out during 2022 (and beyond). For decades, most of the financial services policy and legislation within the UK have been directed by the European Union (EU). Brexit has provided the UK with the opportunity to set its own path moving forward. A wide-ranging programme of work to review the current regulatory framework is well underway, and the outcomes of this will undoubtedly shape the future of financial services within the UK.

Investment firms 

The Investment Firm Directive (IFD) and Regulation (IFR), the EU’s new prudential regime for investment firms, applied to most investment firms across the EU from June 2021 onwards. However, as this took place after the end of the Brexit transition period, it was not automatically onshored in the UK. Instead, the UK will be implementing its own Investment Firms Prudential Regime (IFPR), which is expected to come into force in January 2022. The UK had played a significant role in the policy discussions which led to the IFD and IFR, so it is unsurprising that the IFPR will have similar objectives and intended outcomes in mind, although we of course expect there will be some divergences from the EU regime as the regulators attempt to tailor the IFPR to reflect the number, size and nature of investment firms in the UK and the structure of the UK market.

Insurance  

In light of the opportunity Brexit has provided for regulatory divergence, it would be remiss not to mention Solvency II, the UK prudential regime for insurers and reinsurers. The government is currently undergoing a review to consider how the current regime, which was designed with the wider EU insurance sector in mind, can be better tailored to support the unique features of the UK insurance sector. In July 2021, HM Treasury (HMT) published its Response to the Call for Evidence; whilst the insurance industry was generally supportive of the Solvency II regime, there was agreement that many aspects were overly rigid. The Response seemed to indicate a move towards a simpler, less prescriptive regime with more allowance for the PRA to apply its supervisory judgement. A comprehensive package of reforms will be published for consultation in early 2022. It will be particularly interesting to see what the outcome of the UK review will be in contrast to the EU’s own review of Solvency II.

The FCA business interruption (BI) insurance test case drew to a close after the Supreme Court judgment was handed down in January 2021, which substantially allowed the FCA’s appeals and dismissed the insurers’ appeals. The judgment was binding on the eight insurers that agreed to be parties to the test case, and given that the outcome had not been in their favour, we question the willingness of insurers to engage with the regulators more than they absolutely have to moving forward. The FCA also commented on its expectations of insurance intermediaries in its March 2021 and May 2021 Regulation Round-up, making clear that it considers them to have a key role in ensuring policyholders’ valid claims. This may be an indication that the FCA will be taking more of an interest in insurance intermediaries in the near future.

Payments 

The Kalifa Review of UK Fintech, published in February 2021, sets out a series of recommendations to the government for how the UK can build on its existing strengths, create the right framework for continued innovation, and support UK firms to scale. One of the key recommendations was for tighter regulations and restriction of cryptocurrencies, as they continue to grow in popularity. With the FCA’s ban of Binance, one of the world’s largest cryptocurrency exchanges, in June 2021, we expect the crackdown on cryptocurrencies to continue into 2022 and any activity in this space to be subject to increased scrutiny.

Fintech 

2021 saw an explosion of open banking, with a noticeable increase of work relating to account information services and payment initiation services as companies look to capitalise on the commercial opportunities resulting from consumers seeking new and better ways to interact with their personal finances. We do not expect this to slow down during 2022.

With work-from-home mandates, lockdowns and the general shift to socially distanced working and living, the pandemic spurred an unprecedent increase in demand for online and digital services. Companies were forced to approach customer needs in innovative new ways, leading in particular to the popularity of embedded finance, also known as Banking-as-a-Service (BaaS). This integration of financial services into these companies’ business processes have allowed them to offer a more seamless and personalised customer experience. We expect the demand for BaaS will continue into 2022.

The change in consumer spending habits during the pandemic also gave rise to fintech players like Klarna, who dominated the fast-growing 'buy now pay later' (BNPL) market, subsequently drawing scrutiny towards the market’s currently unregulated status. The Woolard Review, commissioned by the FCA Board, made the case for bringing BNPL business into the scope of regulation. The Review was welcomed by both the FCA and HMT, and it is likely that many of its recommendations will be taken forward. We expect that there will be changes to the law surrounding consumer credit to come.

Enforcement 

The FCA appears to have stepped up its anti-money laundering (AML) enforcement approach and there are no signs that it intends to slow down in 2022, particularly in light of the criminal proceedings it brought against NatWest for breaches of the Money Laundering Regulations 2007 (MLRs) between 2011 and 2016 and following its Dear CEO letter to retail banks requiring actions in relation to “common” AML failings in the sector. Although failure to comply with the MLRs can be both a criminal and regulatory breach, with investigations often opening on a dual track with both types of breaches in scope, this is the first criminal prosecution under the MLRs by the FCA and the first prosecution under the MLRs against a bank.

March 2021 saw the Senior Managers and Certification Regime (SMCR) come into full force following a delay of certain SMCR implementation deadlines as a result of the pandemic. Personal accountability remains high on the FCA’s agenda, and recent FCA speeches have indicated that the SMCR will have a role to play in enhancing the diversity amongst senior management within firms. The FCA is also increasingly likely to pursue non-financial misconduct as demonstrated by the final notice it published in November 2020 against three individuals prohibiting them from working in the financial services industry on the grounds of lack of fitness and propriety. We expect the FCA’s scrutiny of senior managers will not relent in 2022 and may in fact give rise to an increase of regulatory investigations against individuals.