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The latest regulatory update – July 2022

Regulatory Update July 2022

In this issue we cover:

FCA Consumer Duty rules

FCA fines for failures in AML and financial crime controls

Changes to FCA firm reference Numbers (FRNs) and product reference numbers (PRNs)

CryptoSprint outputs

LIBOR latest news

FCA regulated fees and levies 2022/23

Improving equity secondary markets

Compromises for regulated firms

FCA consults on improving equity secondary markets (CP 22/12)

High Court finds in favour of CMC – COBS and the Braganza duty

HM Treasury updates list of high risk third countries, removing Malta

Regulation for the future

Treasury Committee launches inquiry into crypto-assets

Bank of England proposes new rules for financial sector cyber resilience

 

FCA Consumer Duty rules

Last week the FCA published its final rules and guidance on the new Consumer Duty rules (PS22/9). The nature and scope of the rules remain largely unchanged but the final rules and guidance do contain some changes and clarifications relating to how they will apply, including changes to the implementation timetable.

The good news is that the timetable has been revised, giving firms more time than was expected to implement the new rules. Under the revised timetable, firms will be required to apply the Consumer Duty to:

  • new and existing products and services that are open to sale (or renewal) by 31 July 2023 (rather than the original date of 30 April 2023); and
  • products and services held in closed books by 31 July 2024.

For further information please see our separate note to be issued later this week

FCA fines for failures in AML and financial crime controls

The FCA has fined two firms £13.6 million in aggregate for failings in anti-money laundering and financial crime controls.

The controls which were found wanting in these cases include:

  • failure to demonstrate to the FCA that it had assessed money laundering controls after establishing relationships with oversees banks
  • not conducting an annual review
  • not training staff adequately
  • not establishing appropriate policies and procedures
  • specific instances of failure to prevent a bribe.

Changes to FCA firm reference Numbers (FRNs) and product reference numbers (PRNs)

The FCA will be changing the format of firm reference numbers (FRNs) and product reference numbers (PRNs) which uniquely identify firms and funds respectively. The reference numbers currently use a six-digit format, however, the limit of these numbers will soon be reached due to the volume of applications the FCA is receiving.

When this limit (999999) is reached, the FCA will move to a seven-digit format. There’ll be no change to the existing six-digit numbers or the firms using them.

CryptoSprint outputs

The FCA has now outlined the main themes that arose from its CryptoSprint hosted in May and June 2022.

The objective of the events was to increase the FCA’s understanding of emerging cryptoasset-market practices and to seek views from the industry on the design of an appropriate regulatory regime.

The updated webpage sets out key themes from the events including:

Cross-cutting themes

Including suggestion of taking a principle-based approach to help accommodate the pace of technology and market evolution and avoiding repetition of existing regulatory standards.

Issuance and disclosure

Information should be provided to buyers of cryptoassets and how cryptoassets should be vetted before being traded on an exchange.

Regulatory hooks

Identification of regulatory obligations on centralised and decentralised cryptoasset models.

Custody

Gaps needing to be addressed in the UK’s existing custody regulatory framework to help protect UK consumers and markets.

The FCA has set up workstreams to further understand what future crypto-standards and requirements may mean for other areas such as ESG and operational resilience. It aims to continue engaging with industry experts to further develop its policy.

LIBOR latest news

The FCA has issued a consultation paper on winding down the publication of the one, three and six-month sterling LIBOR settings, created using a ‘synthetic’ methodology. These were always intended as a temporary measure, which the FCA can extend by one year at a time for up to ten years after the end of 2021. This practice may no longer be required once existing contracts that rely on sterling LIBOR have transitioned to an alternative benchmark. The consultation aims to help the FCA assess when this might be.

US dollar LIBOR settings are due to end on 30 June 2023. The FCA is therefore seeking views on whether an orderly wind-down of existing contracts is possible prior to this date, or whether a ‘synthetic’ US dollar LIBOR may be required.

Firms have until 24 August 2022 to respond.

FCA regulated fees and levies 2022/23

The FCA has published its 2022/23 periodic regulatory fees and levies for itself, the Financial Ombudsman Service and the Money and Pensions Service. It includes feedback on the responses to the consultation on the draft fees and levies rules in CP22/07 ‘FCA regulated fees and levies: rates proposals 2022/23’.

Firms can also use the online fees calculator to understand the fees that will be due.

Improving equity secondary markets

As part of the wholesale markets review in collaboration with the Treasury, the FCA has recently released a consultation paper on proposed reforms to regulation in the secondary equity markets. They seek to help UK trading venues compete with other markets by scrapping redundant and burdensome regulation, particularly with respect to reporting and transparency.

Specific changes being consulted on include:

  • improving the content and consistency of post-trade transparency reports;
  • establishing a new designated reporter status for over-the-counter trades;
  • allowing UK trading venues to use reference prices from overseas markets where those prices are robust, reliable, and transparent; and
  • permitting the use of the tick size regime from overseas primary markets.

Compromises for regulated firms

Compromises are arrangements between a firm and its creditors and/or shareholders that can be used to reorganise a company or group structure, including restructuring debts.

Due to an increase in the number of firms proposing compromises to deal with significant liabilities to consumers, the FCA has consulted on guidance that sets out how the FCA considers compromises, the factors it considers when assessing them, and its role when a firm proposes a compromise.

The guidance focuses on schemes of arrangements, restructuring plans, and voluntary arrangements, with further explanatory notes including the FCA’s expectations and applicable considerations.

The FCA made a number of changes to the drafting of the finalised guidance in response to the feedback received in order to provide greater clarity. The summary of feedback received is included in Annex 2 of the guidance.

FCA consults on improving equity secondary markets (CP 22/12)

On 5 July 2022, the FCA issued a consultation paper on ‘Improving Equity Secondary Markets’ (CP 22/12). This follows on from the Wholesale Markets Review response published in March 2022 and the Queen’s speech in April 2022, which contained details of the Financial Services and Markets Bill.

The changes that the FCA is focusing on are:

  • improving the content and consistency of post-trade transparency reports;
  • establishing a new designated reporter status for OTC trades;
  • allowing UK trading venues to use reference prices from overseas markets where those prices are robust, reliable, and transparent; and
  • permitting the use of the tick size regime from overseas primary markets.

There are also general proposals in relation to outages.

The deadline for comments is 16 September 2022.

High Court finds in favour of CMC – COBS and the Braganza duty

On 1 July 2022, the High Court published its decision regarding CMC Spreadbet Plc v Tchenguiz [2022] EWHC 1640 (Comm).

The High Court had to consider whether the claimant, a spread betting firm (CMC), had complied with the FCA’s Conduct of Business sourcebook (COBS) and whether it had observed the Braganza duty in relation to a claim it pursued to recover £1.31 million as a debt, and alternatively as a sum due under contract, from the defendant. The debt was incurred as a result of losses made under a spread betting account in respect of which positions were taken.

The Braganza duty as outlined in Braganza v BP Shipping Ltd [2015] UKSC 17) implies a contractual obligation, in the absence of clear language to the contrary, to act rationally when exercising a contractual discretion in good faith and not arbitrarily or capriciously.

The defendant was an experienced spread betting client and had spread bet positions with a number of spread betting firms. These firms, including CMC, sought to classify him as an elective professional client. With respect to CMC, the defendant was initially classified as a retail client, and then reclassified. The CMC terms of business was provided to the defendant, together with a risk warning notice and an order execution policy.

The defendant argued that:

  • CMC breached COBS due to a failure to give due warnings in accordance with the COBS about the loss of protections concomitant with reclassifying him as an elective professional client, particularly negative balance protection;
  • The effect of the breach was that the debt did not arise since he should have still enjoyed negative balance protection, which would have meant that, whilst his investment might be lost, he could not be liable for losses over and above the amount invested, such as those claimed; and
  • If CMC was entitled to reclassify him as an elective professional client then CMC breached either COBS 2.1.1R or acted in a Braganza irrational manner in exercising its discretion, with the result that the defendant had a claim for damages under section 138D of the Financial Services and Markets Act 2000 (which gave a rise to an equitable set-off which extinguishes the claim).

The High Court found in favour of CMC and held that:

  • The defendant was lawfully categorised as a professional client and CMC did not fail to comply with the duty in COBS to give appropriate warnings;
  • The defendant’s contentions that in closing out his account CMC breached the Braganza duty or failed to comply with COBS 2.1.1R and the duty to act in the best interests of its client did not hold; and
  • The defendant was indebted to CMC in the sum of £1.31 million together with interest due.

HM Treasury updates list of high risk third countries, removing Malta

On 4 July 2022, HM Treasury issued an update to its guidance in relation to the notice of High Risk Countries as well as publishing the Money Laundering and Terrorist Financing (High-Risk Countries) (Amendment) (No. 2) Regulations 2022.

This follows the publication in June 2022 of two statements by FATF identifying jurisdictions with strategic deficiencies in their AML/CTF regimes.

The advisory notice sets out which jurisdictions will be included in forthcoming amendment to Schedule 3ZA of the Money Laundering Regulations and replicates those countries listed by the FATF as high risk, or under increased monitoring.

Regulation for the future

Nikhil Rathi has delivered a speech on how the UK will regulate for the future. The speech covered a range of topics.

A different type of regulator

The FCA has invested in data and tech platforms to improve how it uses analytics and insights to support decision-making. It will be able to take a more proactive stance and, crucially, spot harm and intervene more quickly and more broadly.

Crypto

The FCA is demonstrably supporting responsible use cases for the underlying technology while ensuring it’s not at the expense of appropriate consumer protection or market integrity.

ESG

The FCA supports the case for regulating ESG data and ratings as this is essential for enhancing transparency and promoting stronger governance. It’s working closely with HM Treasury, which is considering extending the FCA’s remit to cover these providers.

Consumer Duty

The FCA wants to break new ground with the proposed Consumer Duty, which will ensure all firms take account of the actual impact of their services and product suitability on the consumer.

Treasury Committee launches inquiry into crypto-assets

The Treasury Committee has launched a new inquiry into crypto-assets to explore their role in the UK.

This inquiry will look at the opportunities and risks that crypto-assets bring to consumers and businesses via written evidence submissions. Ultimately, MPs will use the outcome of the inquiry to explore whether regulation will help protect consumers without hindering innovation.

Bank of England proposes new rules for financial sector cyber resilience

In April the Bank of England shared a series of proposals focused on outsourcing and third-party risk management within financial market infrastructure firms (FMIs).

It follows publication of its operational resilience policy last year, ‘designed to improve the operational resilience of FMIs and protect the wider financial sector’. This noted that a major priority for the Bank, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) was to create a robust regulatory framework to ‘promote operational resilience’ amongst FMIs.

The Bank concludes in its guidelines that this reliance, in particular for cloud services, is enhancing the risk landscape and requires a clear regulatory response.

The proposals are therefore intended to:

  • facilitate greater resilience and adoption of new technologies, as set out in its Future of Finance report;
  • set expectations and requirements in relation to outsourcing and third-party risk management in FMIs; and
  • sit alongside the Bank’s Supervisory Statements (SS2/21) on FMI operational resilience

Under the proposed new rules, firms Central Counterparties (CCPs), Central Securities Depositaries (CSDs), Recognised Payment System Operators (RPSOs) and Specified Service Providers (SSPs) would be required to develop, maintain and test business continuity plans and exit strategies for critical business services provided or supported by third parties.

Of particular note within the guidelines is how the Bank highlights the importance of contractual and escrow arrangements between customer and third-party providers. Software escrow agreements are one of the most effective, proportionate and cost-efficient measures to managing third-party technology risks with cloud, software and technology providers. By offering a minimum level of resilience through legal and technical means, it ensures business continuity while a service is being restored or alternative options are being implemented.