The “Edinburgh Reforms” of UK financial services regulation were announced by the Chancellor with some fanfare on 9 December last year. We considered them here. This piece now considers these announcements in a wider context and takes a closer look at some of the more important ones.
A broadly deregulatory agenda
The overall context is the government’s desire to promote economic growth. It sees financial services both as a potential growth sector in itself and as a potential enabler of growth for the wider economy. Approaching the sector with this mindset, the main thrust of the announcements is deregulatory, though the preferred terminology is regulation that “smarter”, “agile and proportionate”.
Cryptoassets and the green agenda are really the only two issues seen as needing increased regulatory attention. Another candidate might have been the growing evidence of systemic risks posed by market-based finance – resiliency issues in money market funds and open-ended funds, margining practices, other liquidity risks in core funding markets, and leverage in non-bank financial institutions. The Bank of England has been increasingly vocal here, recently saying that “In 2023 international and domestic regulators urgently need to develop and implement appropriate policy responses to address [these] risks”.
But the deregulatory language and substance of the announcements are rather more measured than some of the talk in the lead-up of a “bonfire of regulation” and “Big Bang 2”. As it happened, the City didn’t especially relish the prospect of a bonfire. Allusions to the truly transformative “Big Bang” reforms of 1986 have also, with good reason, been dropped. Even so, “Edinburgh Reforms” is perhaps a rather grand title for a group of announcements which, though numerous, are in many cases simply next steps in initiatives begun some time ago, or consultations and reviews rather than “reforms” as such.
A disparate package
The Edinburgh Reforms are an extremely disparate package. They cover a very wide range of subjects, from retail advice and disclosure, to capital-raising and trading, cryptoassets, green finance, financial market infrastructure, bank structures, the regulation of senior managers, and many more. They also include policy-making at every possible stage of its life-cycle. As regards previously-announced initiatives, there are those largely completed (Solvency 2), consultations (Consumer Credit Act), announcements of consultation outcomes (Building Societies Act), and implementation updates where the general direction is already clear (prospectuses, securitisation, the process of dealing with retained EU law). And then, as regards potential genuinely new policies, there are calls for evidence (short selling), consultations (PRIIPS, Payment Accounts Regulation), promises of future consultations (the ring-fencing regime, SMCR); and establishing panels to consider potential reforms (accelerated settlement, investment research).
The financial crisis, Brexit and emerging issues
The initiatives can be divided into three main groups. There are those that are only possible now that the UK has left the EU. These are aimed at amending retained EU law so that it works better, or better suits the UK’s specific circumstances, or does not impose unnecessary burdens - “retained EU law changes”. Some of the language used here echoes the rhetoric of the Brexit campaign itself - “burdensome EU retained law”, “seize on our Brexit freedoms”.
Secondly, there are those that address developing technology and green issues, where new regulation is needed or existing regulation needs to be adapted - “new issues changes”. These also get their share of rhetoric, as the Chancellor acts “to ensure the UK retains global leadership” in sustainable finance, and to support a sector “at the forefront of technology and innovation”.
A third group is concerned with revisiting areas of existing regulation that have nothing to do with the EU legacy or emerging technology or green issues. These include, most significantly, potential relaxations of some of the UK’s post-financial crisis reforms. Understandably, for a government with a broadly deregulatory agenda, this is not the language used to describe this group and they are not attended by much rhetorical flourish.
Revisiting the UK’s post-crisis reforms
The two initiatives that have attracted the most attention concern the ring-fencing regime for banks and the regulation of senior managers (the senior managers and certification regime, SMCR). They are probably the most significant of the whole package - these regimes were major elements of the post-crisis reforms, two of the lines of defence against such a crisis happening again.
Neither has anything to do with EU regulation. Both regimes were introduced only by the UK (which the UK was free to do, even as an EU member). The EU seriously thought about doing something similar in the case of ring-fencing, but ultimately decided against it.
The SMCR was originally introduced only for banks. Its purpose was primarily prophylactic: to reduce the risk of bank failure by making it harder for unsuitable people to be appointed to senior roles, and by concentrating the minds of those in those roles by making it easier for regulators to hold them to account. But underlying this was a sense that, if a bank should nevertheless fail, regulatory action against responsible individuals may alleviate the perception that the rewards and risks of banking are split between banker and society as a whole on a “heads I win, tails you lose” basis. The introduction of the SMCR has undoubtedly resulted in a change in the regulatory dynamics. The Governor of the Bank of England, Andrew Bailey, recently commented, that it has “moved us from a world where the judgment was one of culpability to one of responsibility”; and from his perspective this has been helpful.
Over time the scope of the SMCR has been extended and now covers all regulated firms. The concerns leading to this blanket coverage, and the inclusion of more junior employees in some aspects of the regime, are not the macro-prudential crisis-prevention ones outlined above, and it is perhaps in these areas that reform efforts will focus (though there are few clues in what has been announced so far).
Ring-fencing is intended to insulate domestic retail banking from other activities such as investment banking and international banking. The purpose is to make banks easier to resolve if they get into problems, to protect domestic retail banking from risks arising from other activities, and to reduce implicit government guarantees and risks to the public purse. The Skeoch review, which reported in March 2022, concluded that the ring-fencing regime was “worth retaining at present” but that some recalibration was needed: in particular, in the short term there should be a new exemption for retail banks that do not carry on other activities beyond a certain level; and in the longer term, the authorities should have power to exempt banks from the regime if they are judged to be resolvable.
The latter would represent a significant shift. In the immediate aftermath of the financial crisis, defence against too-big-to-fail was seen as requiring “a belt and braces approach … with many belts and many braces”, in the words of the then Governor of the Bank of England, Mervyn King, advocating the multi-layered approach that the UK eventually adopted. The Skeoch review has effectively said that there is no need for the ring-fencing belt if the authorities judge that resolution braces will be effective.
But it should be borne in mind that the SMCR and (to a lesser extent) ring-fencing announcements are little more than headlines at the moment. For the SMCR, what has been announced is simply a review, to begin in Q1 2023 with a call for evidence on the effectiveness, scope and proportionality of the regime. In the case of ring-fencing, although an increase in the deposit threshold and some other changes are likely to be implemented by secondary legislation later this year, more substantial reform is only a possibility. A call for evidence in Q1 2023 will begin a consultation that will consider other options in addition to those recommended by Skeoch.
Retained EU law
While the Brexit rhetoric has raised some eyebrows, it is indeed the case that a number of the Edinburgh Reforms would not be possible if the UK was still an EU member. Some of the changes to the regulation of primary capital markets fall into this category, including the intended recalibration of the circumstances in which an issuer must publish a full prospectus. The government is also going to review the retained EU law requirements concerning investment research. It seems the focus here is the rules addressing potential conflicts of interest in the way research is supplied to the buy-side, rather than those dealing with the way it is produced. Concerns have been raised that the current restrictions are too prescriptive and unnecessarily hinder capital-raising, particularly by smaller companies.
The government is also consulting on changing the retained EU law governing short-selling of shares. The UK authorities have historically been rather less suspicious of short-selling than many in continental Europe. It is possible that some of the current restrictions and disclosure requirements may be seen as unnecessary.
On the retail side, disclosure requirements – specifically for packaged products such as mutual funds and insurance-based investments – will be reformed with the scrapping of the PRIIPS Regulation. (The EU is itself conducting its own wide-ranging review of it.) It is widely seen as having failed in its objective of ensuring retail investors get standardised, comparable and useful pre-purchase product information. The aims of standardisation and comparability may need to be sacrificed to some extent in the interests of having information that is truly useful and comprehensible. Few tears will be shed for the PRIIPS Regulation.
Many other changes can perhaps best be characterised as “tidying-up”. For example, the UK Long Term Investment Funds Regulation, designed to facilitate the development of these funds, will be scrapped – it has not been used. The Payment Account Regulation requirements for periodic standardised fee disclosures are also being revisited, on the basis that they are probably too prescriptive and less necessary in the UK market. Others include potential changes to the reporting obligations of investment managers, and easing some of the obligations of firms that trade in commodity derivatives as an ancillary activity.
Developing technology and green issues
How best to respond to the growth of cryptoassets is an increasingly pressing global issue. At the macro level, the government intends to publish a consultation paper shortly to explore the case for a UK central bank digital currency. It will also legislate (in the FSMB) to establish “a safe regulatory environment” for stablecoins, and to ensure that the government has power to bring a wider range of investment-related cryptoasset activities within the regulatory perimeter – a consultation paper on this was published last week (which we covered here). The government will also amend the tax rules relating to investment management to ensure they take account of cryptoassets.
The other main focus as regards developing technology is financial market infrastructure – trading venues, and clearing and settlement. As regards clearing and settlement, an industry-led Accelerated Settlement Taskforce is being established to consider whether the current UK standard T+2 settlement period can be shortened. (The US intends to move to T+1 by 2024.) And separately, a Financial Markets Infrastructure Sandbox is to be set up this year to enable firms to test out innovative approaches, including the use of distributed ledger technology. As regards trading, the government will work with others to bring forward a new type of wholesale trading venue, to operate on an intermittent trading basis. It is also committing to have a regulatory regime in place by 2024 to support a consolidated tape for trading data.
The green agenda is to be taken forward with the publication of a Green Finance Strategy early this year. And, at a specific granular level, the government is going to consult in Q1 on bringing providers of ESG ratings within the regulatory perimeter.
Conclusion
What to make of the Edinburgh Reforms? They are perhaps best seen as a staging post in a wider process of broadly deregulatory reform, facilitated to some extent by Brexit, that has been under way for some time and is set to continue for at least the remainder of this government’s term of office. What has been announced in concrete terms is actually quite modest, and relatively uncontroversial. These facts are somewhat hidden by the sheer number and diversity of initiatives included, by colourful rhetoric, and by the fact that in the more sensitive areas what has been announced are consultations and reviews rather than specific changes.
