Regulatory Update May 2023

In this issue we cover:

Whistleblowing update – Protection Bill

FCA to simplify rules to encourage listings in the UK

The Insider Dealing Order 2023

ECB report on climate-related disclosures practices

OPBAS report on legal and accountancy sector supervision

UK AI regulation white paper

FCA update on financial promotions

Price and value requirements under the Consumer Duty

 

Whistleblowing update – Protection Bill

The UK Government is working on the Protection for Whistleblowing Bill, currently under review by the House of Lords, which aims to enhance protections for whistleblowers. The proposed bill, set to replace the existing Public Interest Disclosure Act 1998, broadens the ‘protected disclosures’ categories and ‘whistleblower’ definition to include non-employees. It also proposes the establishment of an independent Office of the Whistleblower with enforcement powers like investigating disclosures and imposing penalties on violators. This bill is likely to increase compliance burdens for FCA-regulated firms, with potential risks of litigation and reputational damage. It aligns with a global trend of bolstering whistleblower protections and is anticipated to cause a rise in whistleblowing complaints once implemented.

 

FCA to simplify rules to encourage listings in the UK

The UK’s Financial Conduct Authority (FCA) aims to simplify and reform listing rules to boost the attractiveness of UK listings, enhance investor choice, and foster competition. This is in response to a 40% reduction in UK listings since 2008, with critics citing the current regulations as overly complex. Significant changes include merging ‘standard’ and ‘premium’ listing segments into a single category and emphasising transparency and sponsor oversight during listing. The FCA is proposing a framework centred on disclosure and engagement, aiming to rebalance the regulatory burden and attract more companies. Additional changes have been introduced to improve equity secondary markets operation, focusing on transparency, competition, and growth.

 

The Insider Dealing Order 2023

The draft of the Insider Dealing (Securities and Regulated Markets) Order 2023 was introduced on 17 April 2023. This proposed legislation aims to align the types of securities and markets covered under the Criminal Justice Act 1993 (CJA 1993) with the civil market abuse regulations of the UK Market Abuse Regulation (UK MAR).

Key modifications include:

1. It revokes the Insider Dealing (Securities and Regulated Markets) Order 1994.
2. It updates Schedule 2 of the Criminal Justice Act 1983, replacing the list of securities with the list of financial instruments mentioned in Part 1 of Schedule 2 of the Financial Services and Markets 2000 (Regulated Activities) Order 2001.
3. It substitutes the list of named trading venues with UK, EU, and Gibraltar regulated markets, organised trading facilities, and multilateral trading facilities, aligning with UK MAR. It maintains NASDAQ and the SIX Swiss Exchange within its scope and includes NYSE.

The updated legislation is scheduled to come into force 21 days after its official issuance.

 

ECB: Report on climate-related disclosures practices

On 21 April 2023, the European Central Bank (ECB) shared the results of its third assessment of climate and environmental (C&E) risk disclosures by major banks within the single supervisory mechanism, as well as select smaller institutions. This review, based on the ECB’s 2020 guide on C&E risks, examined 186 banks’ disclosures in critical areas like risk management, governance, and metrics. From 2023, these banks must also comply with the Commission Implementing Regulation (EU) 2022/2453 on environmental, social, and governance risk disclosures.

The ECB found that, although there was improvement in basic information disclosures, the quality was often lacking, with disclosures being generic and unsubstantiated. It noted that current disclosure standards suggest low readiness for binding Pillar 3 disclosure standards, something the ECB will closely monitor. Around 15% of banks consistently fell short in their disclosures, down from 45% in 2021. The ECB also found that while not entirely in line with supervisory expectations, the largest European banks had better disclosures than their global counterparts.

The ECB confirmed that it would assess compliance with the new standards, with non-compliance considered a breach of the Capital Requirements Regulation (CRR), which may lead to supervisory action.

OPBAS report on legal and accountancy sector supervision

OPBAS, an arm of the Financial Conduct Authority (FCA), responsible for overseeing 25 Professional Body Supervisors (PBSs) in the legal and accounting sectors, has published a report highlighting progress and areas of concern. Despite an increase in enforcement actions and fines, OPBAS noted numerous PBSs are not meeting required standards. Key issues include limited proactive information sharing with regulators and slow action against firms breaching rules.

Although OPBAS has used all regulatory tools within the anti-money laundering (AML) framework, it voiced the need for supervisory standards reform due to variable effectiveness across PBSs. OPBAS supports the UK Government’s upcoming consultation on AML supervisory reform proposals.

Emad Aladhal, Director of Specialists at the FCA, stressed the importance of intensifying efforts against money laundering, acknowledging improvements but calling for faster action. In the coming year, OPBAS plans to employ regulatory tools, including enforcement actions, to ensure continued improvement and compliance by PBSs. From May 2023, OPBAS will assess PBSs against an updated sourcebook, released in January 2023.

The FCA’s Business Plan for the year affirms its dedication to combating financial crime, with OPBAS playing a crucial role in monitoring the consistency and effectiveness of PBSs.

 

UK AI regulation white paper

The UK government released a white paper titled AI regulation: a pro-innovation approach on 29 March 2023, in response to the growing adoption of artificial intelligence (AI) across various sectors. The paper outlines five core principles for AI regulation – safety, security, robustness, transparency, explainability, fairness, accountability, governance, contestability, and redress – that existing regulators will enforce.

The government will not pass specific AI legislation but instead plans to establish a framework around these principles. The aim is to ensure AI systems are safe, secure, transparent, fair, and accountable, with mechanisms in place to challenge and rectify their outcomes. The government will centrally observe and evaluate the application of these principles.

Defining AI poses a regulatory challenge due to its continuous evolution and diversity. The white paper uses two main characteristics to define AI: “adaptivity” and “autonomy”. This flexible definition includes systems that learn, develop new inference abilities, and make decisions independently.

The white paper also addresses potential inconsistencies among different legislative frameworks regulating AI, emphasising regulatory coordination and a unified approach to encourage AI investment. Despite regulatory uncertainties, AI adoption continues to increase in the UK, with projections showing that by 2040, about 34.8% of UK businesses will have implemented AI systems.

There are also indications that AI may play a more direct role in corporate decision-making, as seen with the appointment of an AI-powered robot as CEO of a subsidiary of Chinese company NetDragon Websoft Holdings Limited in 2022. The paper asserts that AI regulation should foster innovation. The implementation and effectiveness of the proposed principles and framework remain to be seen.

 

FCA update on financial promotions

The Financial Conduct Authority (FCA) has published its quarterly figures on actions taken against firms violating financial promotion rules. One measure included removing all trade names of a credit brokerage firm from the Financial Services Register due to the excessive number of trade names used for advertising foreign exchange and cryptocurrency trading platforms. This was done to address the ‘halo effect’, wherein the main firm’s regulatory status was displayed despite only having limited credit broker permissions. The FCA also imposed voluntary requirements on a debt company for misleading customers by suggesting they could become debt-free without any charges.

Between 1 January and 31 March 2023, the FCA intervened to modify or withdraw 2,225 financial promotions. The authority also expressed significant concerns over poor compliance with rules for high-risk financial promotions, some of which were implemented on 1 February 2023. The FCA is conducting investigations to ensure that firms have updated their procedures to comply with these rules and rectified any deficiencies.

Price and value requirements under the Consumer Duty

The Financial Conduct Authority (FCA) has published the results of a review of 14 firms’ fair value assessment frameworks under the Consumer Duty, which mandates firms to ensure price and value fairness. Fair value assessments help determine if the cost of a product or service is justifiable against the benefits the consumer is likely to receive.

Though the review imposes no new obligations, the FCA identified areas where firms could improve and offered examples of good practices. The Consumer Duty comes into effect on 31 July 2023, and the review indicates that while firms have made progress, further work is needed to fully comply with the rules.

Key areas for firms to focus on include:

1. Gathering and reviewing evidence to validate that their products and services offer fair value.
2. Establishing clear supervision and accountability for remedial actions if they fail to provide fair value.
3. Conducting comprehensive analyses of outcome distribution among target market consumer groups, when applicable, to ensure all groups receive fair value.
4. Summarizing and presenting fair value assessments in a way that aids decision-makers in determining whether a product or service offers fair value.

The FCA will continue to monitor firms’ efforts to ensure fair value for customers, including future reviews of firms’ fair value evaluations for specific products and services.