Prudential regulatory aspects of the Edinburgh Reforms
On 9 December 2022, the UK government released a package of reforms to financial services regulation. Dubbed the "Edinburgh Reforms", the measures build on the government’s vision for an open, sustainable, and technologically-advanced financial services sector and for using legislative flexibility after the end of the transitional period for Brexit.
There are 30 announcements which relate to various reforms at different stages of development. This publication focuses on reforms to prudential regulation, including proposed amendments to the UK ring-fencing regime, the deductions regime applying to non-performing exposures and the securitisation regulation.
A smarter financial services framework for the UK: HM Treasury (“HMT”) proposes to create a comprehensive Financial Services and Markets Act model of financial services regulation in the UK (the “FSMA model”). This will involve: (i) the repeal of retained EU law pursuant to the Financial Services and Markets Bill (the “FSM Bill”) currently in Parliament; (ii) the use of new tools in the FSM Bill, including the designated activities regime, to regulate financial services, restate, amend or repeal retained EU law; (iii) the use of secondary legislation and statutory instruments to bring retained EU law into the FSMA model; and (iv) rulemaking powers for regulators to make rules on specific matters, such as the rulemaking powers of the Prudential Regulation Authority (the “PRA”) in relation to prudential regulation and retained EU law and new requirements on the Financial Conduct Authority (the “FCA”) and the PRA to consult on and monitor risks in relation to securitisations. Accountability for prudential regulatory measures taken by the PRA and the FCA will follow the FSMA model where ultimate oversight rests with HMT.
General: HMT proposes to use the flexibility provided to UK legislators after Brexit to relax certain EU-derived provisions of prudential regulation as well as certain other UK/EU-specific legislative initiatives in an attempt to modernise UK financial services legislation and ensure the UK remains competitive through the comprehensive FSMA model for financial services regulation. That said, we note that the UK continues to strive for super-equivalence with Basel standards as demonstrated in its recent proposals for the implementation of Basel 3.1.
Ring-fencing: HMT is proposing secondary legislation “to quickly improve the functionality of the existing regime”. It intends to consult on the proposed reforms in mid-2023 with a view to bring forward secondary legislation later in the year. In general we expect the proposals to be welcomed by the market. The key proposals are:
- Scope of the regime: a proposal to take banking groups without major investment banking operations out of the regime. Whilst this will no doubt be welcomed by the UK challenger bank market, it will be important to see the detail on how this exclusion will apply.
- Scope of the regime: separately, the Government intends to consult on increasing the £25bn core deposit threshold above which the regime applies to £35bn. We expect this would be welcomed by UK challenger banks but also by certain international investment banking groups with retail banking businesses that sit beneath the current ring-fencing threshold.
- Location of the ring-fence: HMT is proposing to allow ring-fenced banks to do more activities, including hedging additional risks (including, for specified products, mortality risk and inflation risk), having greater flexibility to restructure loans through debt to equity swaps and, in very specific cases, taking equity stakes in partnered technology companies. It is also proposing to remove the blanket restriction on ring-fenced banks operating subsidiaries outside the EEA.
Amendments to EMRs/PSRs: The proposals seek to amend the Electronic Money Regulations 2011 (the “2011 Regulations”) and the Payment Services Regulations 2017 (the “2017 Regulations”) to remove a limitation on the FCA’s power to make rules in relation to authorised electronic money institutions, small electronic money institutions, authorised payment institutions, small payment institutions, and registered account information service providers. They will also extend the FCA’s existing powers to make rules for authorised persons in relation to client money, the control of information, and the appointment of auditors so that such rules may also be made in relation to these institutions, apply HMT’s power to make recommendations to the FCA in connection with its general duties to the FCA’s duties in relation to electronic money institutions and payment services, and require the FCA to have regard to the net zero emissions target as one of the regulatory principles applying to the exercise of its functions under the 2011 Regulations and the 2017 Regulations.
Deductions and non-performing loans: The PRA will consult on removing rules for capital deductions of certain non-performing exposures (NPEs) held by banks. This will allow the PRA to apply a judgement-led approach to address the adequacy of firms’ provisioning for NPEs as opposed to the formulaic approach that applies in the EU.
The Securitisation Regulation: HMT published an illustrative example of a statutory instrument (“SI”) in relation to securitisation designed to demonstrate how the comprehensive FSMA model would be applied to different aspects of financial services in the UK. The proposed Securitisation Regulation requires the FCA and PRA to monitor risks, including concerns over the stability of a financial institution, arising from securitisation transactions in relation to their respective regulated entities, keeping in mind capital buffers, liquidity buffers and liquidity risks from maturity mismatches. The PRA and the FCA are tasked with introducing appropriate policies and procedures of originators, sponsors, special purposes entities (“SPEs”) and lenders to mitigate such risks. A requirement to consult on re-securitisations is introduced, while a number of revoked provisions are reinstated, including restrictions on establishing SPEs in high risk jurisdictions and due diligence requirements for occupational pension schemes, among others.
Building Societies: The government will also legislate to amend the Building Societies Act 1986 to give building societies in the UK greater flexibility to raise wholesale funds, enabling them to grow and compete on a more level playing field with retail banks, while retaining their mutual model. As part of this, HMT will also modernise relevant corporate governance requirements in line with the Companies Act 2006.