The Edinburgh Reforms: A Love Rekindled

It’s a modern love story: a strong, mutually beneficial partnership where each party grew and nurtured the other over the years; then one party went through a difficult period and had to be supported by the other; their love cooled; and the relationship descended into acrimony.  But the UK Government has fallen in love with the financial services industry again.  It has realised that the UK’s strength and future prosperity depends on the growth and development of the sector, and it may just help show that the biggest decision of the last decade (leaving the EU) can generate the benefits promised to voters.  

Jeremy Hunt’s ‘Edinburgh reforms’ are an expression of the Government’s rekindled enthusiasm for the industry and its aspirations for its future.  The speech outlines the Government’s planned regulatory reforms which, according to HM Treasury, will “unlock investment and turbocharge growth in towns and cities across the UK”.  

These are the reforms which the Chancellor expects to deliver this ambitious claim.

A competitive marketplace promoting effective use of capital

Building a smarter regulatory framework

The Future Regulatory Framework Review and the Financial Services and Markets Bill (the FS&M Bill) already set out the Government’s aspirations to build a “comprehensive FSMA regime” (which might be sub-titled a “UK regime free from EU regulation”). The Chancellor’s speech and the accompanying policy statement “Building a smarter financial services framework for the UK” seek to show what this means in practice with reforms to the prospectus and securitisation regimes.  The reforms to the prospectus regime in particular have been much trailed and are expected to implement proposals in Lord Hill’s Listing Review to boost UK capital markets.

The Chancellor also announced a review of the short selling rules, and a consultation on PRIIPs and retail disclosure in the UK.  These are retained EU regimes which the Government is keen to review and reform to tailor for the UK market.

Updating banking regulation and the ring-fencing regime

The ring-fencing regime (a domestic, not an EU regime) was one of the key reforms introduced following the 2008 financial crisis with the intention of making large UK retail banks safer and sounder, thereby strengthening the resilience of the UK banking sector.  The key feature of ring-fencing is to separate core retail banking services from investment banking activities, and the regime contains significant restrictions on links between a ring-fenced bank and the remainder of the financial system.  Following the independent review on Ring-Fencing and Proprietary Trading, the Chancellor announced that the Government will bring forward secondary legislation in 2023 which will improve the functionality of the ring-fencing regime.  While significant reform seems unlikely, any reductions in frictions and costs that might flow from a relaxation of parts of the regime will be welcomed.  The Government will also issue a call for evidence to review the practicalities of aligning the ring-fencing and resolution regimes, potentially rewarding ring-fenced banks with credible resolution strategies.

The PRA will consult on relaxing the rules for certain non-performing exposures held by banks.

The Government will also legislate to amend the Building Societies Act 1986 to relax restrictions on wholesale funding which will enable building societies to compete on a more level playing field with retail banks. As part of this, the Government will modernise corporate governance requirements for building societies, in line with the Companies Act 2006.

Ensuring a regulatory focus on growth and competitiveness

The FS&M Bill already includes new secondary objectives for the FCA and PRA to focus on growth and international competitiveness.  As an additional spur to the regulators the Chancellor also laid before Parliament new remit letters setting recommendations for how the regulators should have regard to the Government’s economic policy to bolster the UK’s competitiveness as a global financial centre.  The new secondary objective in the FS&M Bill has already attracted criticism from those who are concerned that this will muddy the regulators’ objectives and risk undermining their core focus on the safety and soundness of firms, integrity of markets and protection of consumers.  The Government clearly considers that the UK’s competitiveness is a proper objective for its regulators.

The Government is also proposing to review the UK senior managers and certification regime (SMCR).  Introduced in the wake of the financial crisis, this regime (which was always a UK regime not imposed on the UK by Brussels) was intended to strengthen the regulation of firms by enhancing the responsibility and accountability of senior managers.  The regime has been implemented across the UK financial services sector over the last six years, often at significant expense.  While the industry was concerned at the outset about the implications of the regime, it’s not clear if SMCR is really such a constraint on the UK’s international competitiveness.

Wholesale markets reform

The Chancellor announced a mix of wholesale market reforms.  Some are technical, such as changing certain MiFID reporting rules (although a reduction in unnecessary reporting will be welcome for firms).  Some proposals are potentially more significant; for example, creating a taskforce to look at reducing settlement times for securities transactions and reviewing the provision of research and its contribution to UK capital markets, the latter responding to a long-running complaint about the MiFID rules which restrict the provision of free research.

Unlocking investment to drive growth across the whole economy

The reforms to Solvency II have been touted by the Government as a Brexit dividend which will unleash a wave of investment from UK insurance companies.  In his speech the Chancellor also outlined plans to enhance the investment freedoms of other long-term capital; for example, there will be a consultation on new investment guidance for the local government pension scheme (LGPS) to ensure LGPS funds are considering investment opportunities in illiquid assets. 

The Government will also encourage further consolidation in pension schemes, and promote a Value for Money framework with the FCA and Pensions Regulator setting metrics for performance, costs and charges and quality of service for pension schemes.  Consolidation of smaller schemes may permit more diversified investment strategies to be pursued.

World leader in sustainable finance

The Government wants to make the UK the world’s premier financial centre for sustainable finance  To this end it will update its Green Finance Strategy in early 2023 and consult on bringing ESG ratings providers within the regulatory perimeter, subjecting them to regulatory oversight and control with the aim of improving the transparency of ratings for the benefit of investors. 

A sector at the forefront of technology and innovation

In addition to rekindling its interest in financial services, the Government is continuing its love affair with the tech sector.  The FS&M Bill already contains provisions to create a regulatory sandbox for market infrastructure (for more detail, see this blog post).  The Chancellor’s speech also outlined plans to create a new category of trading venue, which would allow trading of financial instruments on an intermittent basis.  This is a potentially exciting and important innovation allowing multilateral trading of shares in private companies without triggering all of the obligations which currently accompany admission to trading on a trading venue.  This would be a bridge between private and publicly traded company.

The Chancellor also plans to consult on the case for a central bank digital currency in the UK – a sovereign digital pound.  This consultation has been foreshadowed for some time already, so its inclusion in the Edinburgh reforms is perhaps more of a reaffirmation of the Government’s interest in technology than a new declaration of love.

Delivering for consumers and businesses

Consumer credit is one financial product which touches most consumers.  The consumer credit regime in the UK is old, fragmented and complex.  The Chancellor announced a consultation on reforming the UK Consumer Credit Act 1974, which is intended to modernise the regulation of consumer lending, update consumer protections and ensure they work in a digital world.  It is also intended to increase access to credit through more innovative credit products.  The Government will also work with the FCA to look at the boundary between financial advice and financial guidance, presumably with a view to permitting ‘guidance’ to plug the gap left by past reforms which reduced the availability of financial advice.  As in many areas of its reform proposals the Government will need to balance twin objectives here: reforming the regulatory regime to benefit the economy without risking consumer protection.

Oui, je t’aime

The Chancellor’s speech promises many changes for the financial services industry.  Some are not new.  Some are technical changes.  And some are more radical.  The industry will welcome many of the changes but question the rationale for others.   The real test will be whether these reforms deliver the increased efficiency, innovation and growth promised – and whether that offsets the loss of market access resulting from Brexit.  The answer to this will not be known for some time.  But one thing is clear now – the Government is in love with financial services again.