The Government's Phase 2 Consultation on the Financial Services Future Regulatory Framework Review, which highlights the significant drawbacks of retaining the onshored regime over the long term and sets out a blueprint for future financial services regulation in the UK, closes for responses this week.

The blueprint involves adapting the Financial Services and Markets Act 2000 (FSMA) model, based on delegation of standard setting to regulators, to address the challenges of managing the onshored regime and to establish a more rational and democratically accountable framework for the development and application of future UK financial services regulation.

What are the challenges of the existing regulatory framework?

Operation of the FSMA model was complicated by the UK's membership of the EU as the EU approach to financial services regulation involves setting out detailed regulatory standards in legislation. Through onshoring, most directly applicable EU legislation now resides (with amendments to make it workable for the UK outside the EU) on the UK statute book, preserving and compounding the patchwork quality of the UK financial services regime. There are four main drawbacks to this model:

  • Primary responsibility for setting and maintaining regulatory standards is removed from UK regulators which hold the expertise.
  • Legislation has neither the agility nor the responsiveness to changing conditions of a regulator's rulebook.
  • The allocation of responsibilities across Parliament, HM Treasury and the regulators is unclear.
  • Firms have to navigate a fragmented regulatory framework, with regulatory requirements spread across different forms of legislation as well as regulator rules.

While the onshoring provided a smooth transition to the UK's position outside the EU, the fragmented structure of regulatory requirements scattered across a range of sources, a medley of domestic and retained EU legislation, regulator rules made under the FSMA and onshored prescriptive EU technical standards is far from the Government's vision for future financial services regulation in the UK.

What is the Government's blueprint?

The Government proposes a future approach to financial services regulation adapted from the current FSMA model in three main ways:

  • Legislative framework set by government and Parliament coupled with regulators' rules: this would involve transferring most retained EU provisions to regulator rulebooks according to the current scope of the regulators' respective FSMA rule-making powers. Scope of the regulated activities and issues relating to the UK’s regulatory and trading relationship with other countries, such as equivalence arrangements or mutual recognition agreements, would remain on the statute book as matters for government and Parliament to decide.
  • High level, purpose-driven policy framework legislation: government and Parliament would set the policy approach for specific areas of financial services regulation.
  • Additional transparency requirements for regulators: in addition to explaining how proposals will meet their overarching statutory objectives and how they have had regard to the general FSMA regulatory principles (as they currently have to do), regulators would have to explain how their proposals meet the statutory purpose set for a particular regulatory regime and how they have taken into consideration activity-specific regulatory principles.

Can the FSMA model be adapted to the UK's position outside the EU?

Yes. The FSMA model has a good and solid track record. Owing at least in part to its flexibility and the agility of the UK regulator, the FSMA model of regulation has robustly withstood the test of time across periods of fairly dramatic change, including the 2007/8 financial crisis, with minimal disruption for market participants. The FSMA model, relieved of the requirement to follow the EU approach to financial services regulation, provides a tried and tested foundation for the UK’s future regulatory approach outside the EU.

Is rationalisation of the UK regulatory regime the way forward?

Yes. Under the Government's framework rationalisation proposals the intended output would be a single source of requirements for firms – the regulators’ rulebooks.

Historically, the rationalisation of the patchwork of statutes and voluntary codes to form the single, legislative FSMA centrepiece, dovetailing effectively with the Regulated Activities Order and consolidated rulebooks was welcomed across the industry many years ago. Now, similarly, a rationalisation of rulebooks and departure from the present complicated and fragmented regulatory rulebook would likely be well-received by market participants and end-users.

Will the adapted FSMA model affect an EU equivalency determination?

The answer is at best uncertain.

The post-Brexit equivalence process between the UK and EU has, in the words of Andrew Bailey, Governor of The Bank of England in his Mansion House speech last week, "not been straightforward". The EU has not thus far made a determination of equivalence (other than a temporary determination in relation to UK central counterparties/clearinghouses) in favour of the UK notwithstanding that the UK rulebooks have already largely been updated to incorporate specific detailed rules from EU financial services legislation, and EU financial services legislation itself has now been onshored.

As pointed out by Mr Bailey, less was enough when Canada, the US, Australia, Hong Kong and Brazil were all deemed equivalent. Likewise, the EU recently made the US SEC equivalent for central counterparties, subject to certain conditions. These conditions are already met by UK central counterparties as they are a legal requirement in the onshored legislation, but equivalence beyond the temporary determination remains uncertain.

So, while the UK and the EU have committed to entering into a Memorandum of Understanding (MoU) constituting a framework of co-operation in financial services by next month, just how far the MoU will go to address the issue of the EU's equivalency determination is uncertain at this point.

Equivalency regimes, even for the EU Directives in respect of which they are available, are no substitute for the passporting regime which for UK firms seeking to operate in the EU ended with the implementation period on 31 December 2020. Equivalency determinations, highly politicised creatures by nature which can be removed on 30 days' notice, are arguably a fragile regulatory foundation for UK firms operating in the EU going forward. Furthermore, many larger UK firms, not holding their breath for the equivalency regime, have already obtained local authorisations in the EU states they operate in.

Concerns that a shakeup of the structure of the UK's regulatory regime might reduce chances of an EU equivalence determination are, therefore, understandable. Will the equivalence issue steer the UK's way forward on financial services regulation reform? On balance, the UK financial services industry is likely to prefer the adoption of a single rulebook approach for new UK rules and EU onshored financial services regulation.

Next steps

The Consultation closes on 19 February 2021 and is intended to generate a full debate among stakeholders and in Parliament. A final package of proposals will be presented in a further consultation later this year.

It is clear from the Consultation that the Government intends to create a regulatory framework that capitalises on the opportunities provided by the UK’s withdrawal from the EU and which will underpin a stable, innovative and globally competitive UK financial services sector long into the future.


Lindsay Lee

Senior Associate