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Regulatory Update June 2023

In this issue we cover:

Model risk management for banks 

FCA’s speech on changing global markets

FCA on support during challenging times 

UK-EU on financial services regulatory cooperation

FRC on UK Corporate Governance Code

Cryptoasset firms marketing in UK

UK: An alternative way to deal with unclaimed client money?

Consulting on USD LIBOR (FS23/2)

Changes to MIFIDPRU Consultation No.40

Cultural evolution

 

Model risk management for banks 

The PRA recently issued a policy statement in response to its consultation on model risk management principles for banks. This will be of interest to all UK incorporated banks, building societies and PRA designated investment firms. The expectation is that these firms will adopt five principles within their model risk management framework for it to be effective. These include proportional implementation, allocation of a Senior Management Function, reporting to the audit committee and benefits and risks of using artificial intelligence within the models.

 

FCA’s speech on changing global markets

In a recent address, Sarah Pritchard, the FCA’s Executive Director, underscored the organisation’s intent to further enhance the status of UK’s wholesale markets. She made this statement even amidst a substantial decline in the UK’s listed companies since 2008.

Pritchard emphasised that despite this drop, the UK needs to confidently promote its vast expertise and comprehensive services in the global wholesale market.

She also brought attention to forthcoming considerations regarding potential modifications to prospectus rules, following recent proposals for listing requirement reforms. These considerations include how to deal with forward-looking information in prospectuses, the way to devise requirements for issuers who aim to introduce securities to junior markets, and the guidelines to be set for companies opting to manage a public offer platform for raising investor capital without needing to join a public market.

 

FCA on support during challenging times 

During Mental Health Awareness Week, Laura Dawes, the Director of Authorisations at the FCA, penned a blog discussing the organization’s response to anxiety. The recent Financial Lives cost of living survey revealed that the ongoing cost-of-living crisis has resulted in about half of adults feeling anxious or stressed during the last six months leading up to 2023.

The principal message for firms from these findings is the likelihood of an increased number of people displaying signs of vulnerability during these times. Therefore, it is crucial for these companies to ensure they are offering the necessary care and support to their clients and implementing this understanding into their marketing strategies.

 

UK-EU on financial services regulatory cooperation

In a move seemingly aimed at offering clarity in the aftermath of Brexit, the UK government and EU Commission have unveiled a draft Memorandum of Understanding (MoU) concerning financial services cooperation.

The proposed MoU outlines mutual goals of maintaining financial stability, upholding market integrity, and ensuring the safety of investors and consumers. It also proposes the creation of a Joint EU-UK Financial Regulatory Forum intended to foster collaboration through:

  • Mutual exchanges of opinions and analyses on regulatory changes,
  • Discussions during the process of granting and revoking equivalence decisions,
  • Bilateral exchanges of perspectives and analyses regarding market trends and financial stability issues,
  • Strengthened cooperation and coordination, including within international organizations where applicable.

The MoU is currently undergoing the EU’s internal process but is anticipated to be officially signed shortly after its completion.

 

FRC on UK Corporate Governance Code

The Financial Reporting Council (FRC) is consulting on updates to the UK Corporate Governance Code. This comes in response to UK Government’s legislative and governance reforms intended to bolster UK’s audit, corporate reporting, and corporate governance systems, as detailed in the May 2022 white paper, “Restoring trust in audit and corporate governance.”

The proposed updates mainly target Section 4 (Audit, Risk and Internal Control) of the Code and focus on creating a robust framework for prudent risk management and effective internal controls. They aim to strengthen reporting on the effectiveness of these frameworks. Other changes encompass responsibilities of the board and audit committee in broadened environmental, social, and governance (ESG) reporting, and areas identified by the FRC for reporting improvements, including “overboarding.”

Key alterations include a new principle that encourages companies to demonstrate the impact of governance practices when reporting their governance activities. The proposal also highlights the need for increased focus on environmental and social issues, including climate ambitions and transition planning.

To address “overboarding” concerns, FRC suggests expanded provisions that require annual reports to contain detailed information on director appointments. Amendments in Section 3 seek to enhance the Code in terms of diversity and inclusion, encouraging companies to consider diversity beyond gender and ethnicity.

Major changes are proposed for Section 4, in line with the UK Government’s May 2022 white paper. These include a proposal for all companies reporting against the Code to have an Audit and Assurance Policy, with the audit committee responsible for developing, implementing, and maintaining this policy. The proposal also seeks to strengthen the provisions on risk and internal controls and maintain the going concern and viability statement provisions.

Changes to Section 5 underscore the need to align remuneration outcomes with company performance, purpose, values, and ESG objectives. The proposal includes the addition of ‘malus’ and ‘clawback’ provisions in director contracts and remuneration agreements. References to pay ratios and pay gaps would be removed from the Code to avoid duplication of disclosure.

 

Cryptoasset firms marketing in UK

The FCA aims to safeguard UK consumers from potential losses in cryptoasset investments by ensuring they fully understand the associated risks. The FCA is concerned about misleading cryptoasset advertisements targeting retail investors. Thus, from 8 October 2023, all firms marketing cryptoassets to UK consumers, irrespective of their location or promotional technology, will be governed by the UK financial promotion regime.

The new rules will classify any communication promoting the purchase or sale of “qualifying cryptoassets” to UK residents under this regime. The regulations mandate fairness, clarity, and transparency in promotions, including clear risk warnings and restrictions on investment incentives. Additional requirements apply to Direct Offer Financial Promotions (DOFP), such as cooling-off periods for first-time investors and consumer categorisation.

Non-compliance can result in penalties such as website takedown, warnings, or enforcement action, with unauthorized firms risking criminal charges, unlimited fines, and/or imprisonment. As a result, firms must choose one of the four legal communication paths and inform the FCA if they intend to approve cryptoasset communications, potentially increasing their marketing costs. The FCA’s goal is not to inhibit cryptoasset transactions but to ensure consumer awareness of the risks.

 

UK: An alternative way to deal with unclaimed client money?

The FCA published a consultation paper (CP23/12) on 22 May 2023, marking the second phase of expansion for the Dormant Assets Scheme. Initially, this scheme allowed banks and building societies to shift idle funds to an authorised fund for charity purposes. This scheme, under the FCA, HM Government, and Reclaim Fund Limited, is expanding to incorporate more asset classes, focusing on dormant investment assets and client money.

The Dormant Assets Scheme, initially formed under the 2008 Act, allowed institutions to transfer funds from inactive accounts to the scheme, which were then used for good causes. The second expansion phase, guided by the Dormant Assets Act 2022, will enable firms holding client money to transfer unclaimed funds to the scheme instead of a charity, impacting investment assets, client money, insurance, pensions, and securities.

To enable this, the FCA plans to amend its rules and guidance, reflected in the 2023 Dormant Assets Instrument. Also under consideration is the role of the Financial Ombudsman Service in managing complaints about dormant asset fund operators.

 

Consulting on USD LIBOR (FS23/2)

On May 31, 2023, the FCA released its Feedback Statement (FS23/2) discussing the prior consultation on decisions related to USD LIBOR. The FCA underscores some crucial transformations that market players should anticipate:

  • The overnight and 12-month USD LIBOR settings will discontinue after their final issuance on June 30, 2023.
  • The 1-month, 3-month, and 6-month USD LIBOR settings will be presented in synthetic form from July 3, 2023, until the end of September 2024. This will only apply to existing contracts, excluding cleared derivatives.
  • All novel applications of remaining USD LIBOR settings will be banned, superseding the exemptions granted by the FCA to the restriction on new use, implemented from January 1, 2022.

The FCA urges market participants to take necessary measures to comprehend how their contract terms relate to the USD LIBOR phase-out and prepare for the ongoing transition away from LIBOR.

 

Changes to MIFIDPRU Consultation No.40

On June 2, 2023, the FCA suggested the following changes to MIFIDPRU as part of its Quarterly Consultation:

  • Clarifying guidance will be issued stipulating that if a MIFIDPRU investment firm is subject to other FCA prudential norms, the Own Funds Threshold Requirement under the Investment Firm Prudential Regime (IFPR) cannot fall below the total resources requirement under any other prudential regulation applicable to that firm.
  • The “Assessment B” portion of the Liquid Assets Threshold Requirement diagram in MIFIDPRU 7.7.5 only necessitates the supplementary amount of liquid assets required for orderly wind-down (in excess of the basic liquid assets requirement).
  • Comprehensive guidance will be introduced on when an investment firm group should conduct an Internal Capital and Risk Assessment (ICARA) process on a consolidated basis.
  • Additional guidance will be provided on the individual compliance requirements to satisfy the group ICARA conditions outlined in MIFIDPRU 7.9.5.
  • The MIF007 form in the FCA Handbook will be harmonized with RegData to resolve discrepancies.

 

Cultural evolution

In a speech by Emily Shepperd, Chief Operating Officer and Executive Director of Authorisations shed light on significant cultural changes.

Highlights of the speech-

  • Regulation reform to Consumer Duty and ESG proposals are being designed and refined to meet the evolving demands of consumers and the markets themselves.
  • Firms must ask tough questions whilst assessing the fitness and propriety of staff embedded within financial services.
  • Culture is critical to confidence and can hugely impact bottom lines.

Culture across modern organisations today can be found deficient in the eyes of Millennials and Gen Z, as every generation which comes believes itself to be the more intelligent that their predecessors. Purpose underpins modern culture, and it is a valuable indicator the FCA uses to understand how firms are adapting to a changing world with consumers that come with a variety of needs. Culture drives conduct and consequently business performance and confidence, we can see why senior levels of financial services firms are required to pass and continually meet fitness and propriety assessments.

Consumer Duty is a demonstration of continued effort, as investors demand for their money to be put to use for good (for both people and the planet). As the FCA develop their sustainability disclosure requirements and investment labelling we can see that change is on the horizon at almost every turn in the financial services sector. We are experiencing an age of evolutionary culture, with data-driven processes and user experience informing future changes.