Former Prime Minister Harold Wilson once said: ‘A week is a long time in politics’. Financial services regulation, despite often being one part politics, is not usually associated with such rapid change. But looking back over the almost five months since the Brexit transitional ended, what really strikes me is the breadth and the scale of change in train or planned. HMT is taking forward reforms to the UK’s regulatory framework. The prudential regimes for banks, insurers and investment firms are all being changed to various degrees. We’ve seen the recommendations of the Hill and Kalifa reviews. The focus on issues like digitalisation, operational resilience, customer outcomes and diversity and inclusion (D&I) has strengthened even further. Consultations are planned over the summer on the UK wholesale markets framework. The BoE has published ambitious plans to transform data collection across the financial sector, and the FCA has launched ambitious plans to transform itself. I could go on, but the regulators have helpfully captured all the planned changes in the latest version of the regulatory grid, which runs to 40 pages, with 46 new items added since the last grid was published in September 2020. The global financial crisis led to an overhaul of the regulatory framework across the globe. Thirteen years on we are entering a new phase of reform with many different drivers. So what does this all mean for the financial sector and how is the UK’s post-Brexit regulatory framework starting to shape up?
The Government and the regulators have been clear that Brexit means doing things differently, not for the sake of divergence from the EU, but in order to tailor the UK’s regulatory framework in a way which suits the UK market. So far the changes announced to the rules the UK inherited from the EU have been relatively targeted. This reflects an awareness of the costs of unnecessary change and an ongoing commitment to internationally agreed standards. The Government is, however, looking to be more proactive in identifying areas to change regulation to make the UK a more attractive place for business, including for financial services. So over time we are likely to see greater changes in approach, particularly if the EU remains non-committal on equivalence. The wholesale market review, which will be launched in the summer, is an area to watch to gauge how radical HMT and the FCA are prepared to be in reforming aspects of onshored capital markets regulation. The PRA’s commitment to a more proportionate prudential framework for non-systemic banks, a process which kicked off with a recent discussion paper on the topic, is another. Amendments to the regulatory framework which reduce unnecessary costs are welcome of course, but different approaches between the UK and EU are already bringing challenges for firms, which are used to monitoring and implementing regulation at the European or EMEA level. And of course the UK regulators are at least as, if not more, likely to use their new found regulatory flexibility to strengthen their approach, particularly when it comes to implementing Basel Committee rules and on consumer protection issues, as evidenced in the recent UK CRR2 and consumer duty proposals. It may well be that the UK regulators use the new found flexibility to build greater protections for retail consumers while also seeking to reduce burdens on wholesale markets activity. The institutional set up for developing regulation in the UK outside of the EU is also starting to shape up. The clear direction of travel, as set out in HMT’s future regulatory framework review, is for the regulators to become (in the PRA’s words) ‘rule makers not takers’, with policy development powers which previously resided at the EU level being delegated down to them. In recent weeks senior PRA and FCA officials have also spoken about moving towards a more outcomes-based approach to regulation, moving (in some areas) from a framework based on granular rules to one where the regulators set out the outcomes they wish to see delivered, with much greater flexibility for firms in how they achieve them. Readers with long memories will recall this isn’t a new idea, the FSA also explored the concept prior to the global financial crisis. More recently the regulators’ approach to operational resilience and vulnerable customers could also be characterised as outcomes based. The benefits of this approach are that it allows firms the flexibility to embrace and deliver change in a way which suits their business. In my experience the challenge comes when firms struggle with the lack of certainty rules provide, a recent example being what constitutes an important business service under the operational resilience framework. If the regulators follow through with a commitment to a more outcomes-based approach, firms are going to have to get used to dealing with, and indeed embracing, a greater degree of ambiguity in the regulatory framework. Doing so will require a fundamental rethink in approach towards compliance for some firms.
Of course Brexit is just one force driving the regulatory agenda. COVID-19 has had a profound impact on the financial services sector, its customers and the wider economy. Many of the trends that were transforming the sector prior to the pandemic have been expedited. It's understandable then that the regulators are responding. We are seeing an increased focus on the implications from the digital transformation of financial services. Customers are far more likely to access financial services digitally and firms are seeking to embrace technologies such as AI and the Cloud to reduce costs and drive efficiencies. This raises a number of regulatory questions. How can the regulatory environment encourage innovation in a safe way? How are consumers that are unable to access services through digital channels to be protected? What are the risks to consumers accessing financial advice and markets online? Are firms managing the risks from tools such as AI and the dependencies on third parties, particularly for Cloud services? All of these are questions the regulators will continue to grapple with in the coming years, seeking to strike a careful balance between encouraging innovation and mitigating risks to consumers and financial stability. The effects of the pandemic, Black Lives Matter and a growing recognition of the vital role the financial sector needs to play in the transition to net zero means that the regulatory agenda is being increasingly shaped by these societal priorities. COVID-19 has clearly had a damaging effect on the economy, small businesses and consumers - and firms need to be prepared for a strengthened focus on consumer outcomes and fairness. The FCA’s business interruption insurance High Court case and recent consumer duty proposals being two recent examples of a more assertive regulatory approach in this area. Nikhil Rathi, the CEO of the FCA, has also been clear that if firms do not make progress in improving levels of diversity, particularly at senior levels, the regulators will take action. The FCA and PRA are publishing a discussion paper on diversity and inclusion in June and I would expect them to make this agenda a more central part of their supervisory approach in the future. Understandably, environmental issues will also remain a key regulatory theme, particularly as the UK is hosting COP26 this year, with policymakers seeking to ensure the financial sector is both managing the risks from the transition and supporting the wider economy in doing so.
Regulatory change is of course not new to the financial sector. Firms have always had to manage and adapt to changing requirements and expectations. For a number of years though the breadth of regulatory focus has expanded. When I started my career in financial regulation, just after the global financial crisis, the priorities of the FSA were (understandably in the context) narrower than the current focus of the PRA and FCA and of course large swathes of the regulatory framework derived from the EU. Now we are entering a period where the amount of regulatory issues firms have to deal with has grown considerably and the scope for different approaches between the UK and EU has increased. In many ways this is welcome. The steps the regulators are taking to drive change on issues like D&I and climate change can only be applauded, and few would deny that the regulatory framework needs to evolve to keep pace with a rapidly changing sector. But firms need to ensure they are keeping pace with the busy regulatory agenda and understand the implications of the changes for their business and operating models, product mix and interactions with customers and clients. More than ever in the post-Brexit world, understanding and embracing the outcomes regulators wish to see and factoring them into operating and business models will be key to navigating a changing regulatory landscape.