Financial Services Regulation Changes and Trends
We address the issue of prioritisation, the practical implications for organisations, and what to look out for on the horizon. There is a great deal of uncertainty in the UK market at present; to cut through that uncertainty we’ve focussed on changes that should be a focus for 2023, and then outlined the wider changes expected in the market.
The impact of these changes will be widespread and require targeted, focussed solutions.
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Foundations laid in 2022, including Future Regulatory Framework Review, post-Brexit legislation, a sustainability focus, and a handful of implementation deadlines will hit in 2023, driving change agendas for financial services organisations. The year will also bring continued regulatory divergence between the UK and EU, although we expect the direct impact of this to be felt later, potentially beginning in 2024. Several consultations also being established for longer- term focus indicate firms will need to keep a close eye on regulatory progression, how they may be impacted, and what it means for them in practice.
We have chosen to use this ‘wide-angle-lens’ because we know investment decisions made now will impact organisations’ ability to respond to changes in regulation when they do come in. We also know that failing to invest whilst waiting for the rules to become clear is a sure way to tie yourself up in inflexible operating models and find yourself unwinding legacy technologies or bolting on expensive manual processes to achieve compliance.
With that, we’ll turn our eye to the horizon and attempt to discern which way the wind is blowing.
Regulatory Priorities in 2023
Consumer Duty
The Financial Conduct Authority (FCA) has introduced a new Consumer Principle which mandates that firms provide 'good outcomes' for their retail customers. This principle will apply to all current products from 31 July 2023, and all previously sold products from 31 July 2024.
Manufacturers are required to review their products to meet the outcome rules and share the results with their distributors by 30 April 2023. Companies that fall under this regulation must provide regulators with specific examples and details demonstrating how consumer outcomes are being improved across four key areas, namely consumer communication, appropriateness of products and services, fair price and value, and support provided. The main challenge for firms will be defining what constitutes ‘good consumer outcomes’ and determining what steps required in order to achieve them.
A recent consultation on Implementation Plans relating to the Duty called-out specific deficits in firms’ preparedness to meet the requirements of the regulation. The FCA have advised that firms focus on “effective prioritization, embedding the substantive requirements, and working with other firms” whilst also pointing to issues around Governance, Culture and People and Deliverability. The changes required to meet the Consumer Duty are widespread and diverse and will require effective, expansive change management to realise.
2. SFDR and SDR
The Sustainable Finance Disclosure Regulation (SFDR) has been enforced by the EU since 2021, with Level 2 rules implemented in January 2023. SFDR requires financial services firms in the EU, as well as non-EU investment managers and advisors who market to EU clients, to disclose when sustainability risks are integrated into investment decision-making processes and the likely impacts of such risks. Reports with these new requirements are due by 30 June 2023.
The proposed Sustainability Disclosure Requirements (SDR), with Green Taxonomy, is the intended UK version of SFDR. While not interchangeable, the two regulations are complementary and contain many of the same requirements. Therefore, it is advisable for UK firms to implement SFDR as, if they are prepared for the EU regulations, they will be in a good position to comply with SDR, if and when it is implemented.
3. Digital Finance - MiCA, DORA, CBDC
In 2023, the European Union will focus on the Markets in Crypto-Assets (MiCA), with legislation anticipated to be approved in the first half of the year and become effective in 2024. Becoming compliant with MiCA will require significant organisation-wide efforts. Firms seeking MiCA authorisation should act early and make sufficient time to ensure compliance and to capitalise on strategic opportunities.
The implementation period for the Digital Operational Resilience Act (DORA) commenced on 16 January 2023, and companies must be fully compliant by January 17, 2025. DORA's objective is to reinforce the IT security requirements of financial institutions, including crypto providers and third-party ICT providers, but it does not apply in the UK. Nevertheless, UK companies conducting business in Europe should begin planning for an enhanced operational resilience framework to meet the requirements.
The European Commission will present a proposal for a Central Bank Digital Currency (CBDC), the Digital Euro, in Q2 2023, while the UK has pledged to collaborate with the Bank of England on a UK Retail CBDC in 2023. Regardless of the decisions made around CBDCs, financial services organisations should begin assessing their readiness to handle transactions denominated in digital currencies. A sensible first step would be a Digital Money Readiness Review to weed out those systems which will present barriers to integration of CBDCs and begin upgrading them.
4. AML & Financial Crime
AML and Financial Crime have been in focus for some time now, with regulators taking a harder line against operational practices that provide opportunities for Financial Crime. However, we are beginning to see divergence in approaches between the UK and the EU. In June 2022, the UK diverged from the EU on their AML and terrorist financing, declining to make wholesale changes and suggesting that UK AML was working effectively and could be tightened by means of progressive, incremental changes. Meanwhile the EU established the Anti-Money Laundering Authority (AMLA) to standardize AML/CFT rules and provide EU-wide supervision. Differences between UK and EU regimes will create challenges for organisations wishing to serve customers on both sides of the channel and strong strategic direction will be needed on whether a single-rule set can be implemented or whether operational divergence is needed. This is unlikely to be a simple decision and should be taken with an eye to the future.
The Economic Crime and Corporate Transparency Bill, set to pass in Spring 2023, will require directors and persons with significant control to be identity-verified, potentially simplifying KYC and AML processes. Furthermore, starting 1 September 2023, the FATF's 'Travel Rule' will extend information sharing requirements for wire transfers to crypto-asset transfers exceeding $1000, requiring Virtual Asset Service Providers and financial institutions to be prepared for this new reporting obligation. This challenge may fall to service providers to implement although customers should be aware of their liabilities with regards to effective and timely reporting.
5. Basel IV (Development of Basel III)
From 1 January 2023, EU and UK firms must comply with this twice-delayed regulation that is set to improve the banking sector's stability by revising capital requirements methodologies. The regulatory framework, Basel IV, will be implemented through CRR3 in the EU and through a new standard implementation being consulted on by the PRA and Treasury in the UK, with the consultation closing on 31 March 2023.
In addition, H1 of 2023 will bring the PRA's proposed changes to the liquidity coverage and net stable funding ratio frameworks, as well as a stricter CET1 capital structure. These revisions will increase reporting and breach disclosure requirements, making them administratively significant across the sector. Capital efficiency will be critical for organisations in dealing with ratio changes.
On the Horizon
6. Edinburgh Reforms
Wide ranging across the financial services landscape, the Edinburgh Reforms are set to have a major impact from 2023 onwards. The reforms build upon the work of the Financial Services & Market Bill and Solvency II in implementing the UK’s approach to reforming Financial Services Regulation post-Brexit.
The Senior Managers and Certification Regime (SMCR) regulatory framework is being reviewed by the PRA and FCA through Q1 2023 which coincides with a government ‘Call for Evidence’, assessing the regime’s current application and effectiveness and seeking improvements. If changes arise from these reviews, firms will need to allocate time and resources to updating practices and meeting new requirements.
The UK Government will consult in 2023 on removing banks without major investment banking activities from the Ringfencing regime and review the deposit threshold for being in scope. Geographical restrictions where ringfenced banks operate could also be removed. An assessment of the practicalities of aligning Ringfencing and Resolution regimes is planned and the results from these reviews will have implications on firms, as they will need to assess if the updates change the scope of the services they are allowed to supply.
The government is also focussed on enhancing the UK as a global Wholesale Markets Hub. To achieve this, there is due to be review and reform around short selling, securitisation regulation and removal of certain MiFID reporting requirements, demonstrating the continued divergence of UK from EU regulation. UK Government has also committed to introduce a UK consolidated tape regime by 2024 and an Accelerated Settlement Taskforce exploring how trades can be settled faster, who are due to publish initial findings by December 2023. The implications for firms could be widespread, as UK firms operating in EU will need to ensure they are compliant with both EU, and updated UK regulation. The government’s vision for the UK also provides firms with an opportunity to contribute to creating an innovative, sustainable and technology-driven marketplace.
There is an ongoing consultation on Consumer Credit Act reform, which closes on 17 March 2023. This asks for input on how consumer credit regulation could be improved to optimise customer communications, protection, and sanctions for non-compliant firms. It will also seek to identify ways in which to simplify information requirements whilst maintaining crucial protections. This consultation, again, indicates prioritisation on protecting consumers, meaning organisations will need to invest in meeting new requirements, as responsibility on firms increases.
The Edinburgh Reforms provide firms across the industry with opportunity to collaborate and shape this newly diverged landscape, but also brings with it increased complexity in regulation, and a level of uncertainty that will require firms to act quickly, flexibly, and pre- emptively, where possible, in order to take advantage of change, and stay compliant.
7. Financial Services & Markets Bill
The Financial Services and Markets Bill is expected pass in Q2 2023. The Bill legislates for reforms which arose from the Future Regulatory Framework Review and Brexit. Key proposals include allowing Treasury to revoke or repeal all retained EU Law and Regulatory Requirements relating to Financial Services; and enhancing and aligning FCA and PRA powers with a new regulatory framework, partly to fill any regulation gaps caused by removal of EU requirements. These new powers put crypto-assets and BNPL products and providers in scope of financial services regulation.
Many of the proposals will take several years to implement in full; however significant progress on implementation of reviews into Wholesale Markets, Securitisation and Solvency II is expected by close of 2023. Firms impacted by changes in these proposals should be prepared to illustrate plans and progress to supervisors, and acting early will reduce the burden on firms to make extensive, disruptive operational and reporting changes on a tight deadline.
8. MiFID II
European Securities and Markets Authority (ESMA) has been reviewing MiFID II, with focus on amendments to Regulatory Technical Standards (RTS) on cross-border services and passporting in the EU. The primary aim is to improve market data access and trade transparency provisions across cross-border activities including marketing in host member states; organisational structure; and language arrangements for international offerings. We don’t anticipate operational change during 2023, MIFID-regulated firms would be wise to stay abreast of requirement developments.
The UK currently recognises a 'MiFID Override', meaning this EU change will apply to UK firms for now. The introduction of the Edinburgh Reforms and UK divergence from EU legislation means firms should stay alert on changes to the ‘MiFID Override’ as it is likely that there will soon be a UK specific regulation in place of MiFID II. This means that the many firms in Europe and UK that operate within, as well as outside of, the EU will need to adapt to stay up to date with diverging regulatory requirements.
How Valentia Partners can help
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Valentia Partners has been supporting Financial Services organisations with large-scale transformation and regulatory compliance projects since 2006. We’ve seen it all, from Ringfencing to Consumer Duty and we’ve established a straight forward, no-nonsense approach to evaluating, understanding and delivering against the requirements of regulations across multiple jurisdictions.
We’re a firm of thinkers, fixers and do-ers and we live and die by the mantra “Always Do Right”. Our expertise across Financial Services from the Front Office to the Back gives us a unique perspective on transformation challenges and our commitment to our values means we give straight answers that make complex deliveries simple.
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