The turn of a new year has brought new UK regulatory developments that have the potential to significantly impact financial services and other financially regulated businesses. This update highlights the key changes in the UK market from consultations undertaken by the Financial Conduct Authority (“FCA“) and HM Treasury (“HMT“) that will need to be carefully considered and navigated by traditional financial services firms and those that are currently operating just outside the regulatory perimeter, e.g. appointed representatives, cryptoasset firms, buy-now-pay-later
- Potential reforms to the current regulatory regimes, covering appointed representatives and unregulated cryptoassets
- The introduction of a new consumer duty in retail financial markets
- Changes to consumer credit regulation for BNPL credit
- Updates to the regulation of stablecoins
Appointed Representative Reforms
The last date for comments on the FCA’s consultation paper on improving the appointed representatives regime (CP21/34) is 3 March 2022. By way of background, the FCA has been focusing on the appointed representative regime and hosting platforms, following the collapse of Greensill Capital.
The FCA stated that it had identified a trend of harmful behaviour by appointed representatives (“ARs”). For example, some ARs were providing misleading information to customers or difficult for consumers to understand, some ARs were acting outside the scope of their appointment; and some ARs were not identifying or acting on possible harm to customers.
Broadly, CP21/34 consults on two main changes:
- Requiring regulated firms that appoint ARs to provide further information on their ARs to the FCA and imposing additional notification requirements when appointing ARs.
- Clarifying the FCA’s expectations of principals and their responsibilities. For example, the FCA are considering requiring firms that appoint ARs to prepare a self-assessment document demonstrating their compliance with the FCA rules relating to ARs. If requested, firms would need to submit the self-assessment document to the FCA.
The FCA also noted potential harm caused by regulatory hosting platforms and outlined potential options that could reduce the risk, including:
- Prohibiting the engagement of ARs which operate businesses that are materially distinct from that of the principal.
- Limiting the maximum size of ARs before requiring the ARs to apply for authorisation.
- Requiring FCA consent to provide regulatory hosting services.
- Limiting the range or scope of regulated activities that regulatory hosts can oversee and the number of ARs that they can appoint.
Additionally, HMT has published a call for evidence on possible reforms to the AR regime. For example, it covers the following
- Changes to the scope of AR regime. HMT is considering whether to further limit the range of activities that can be performed by an AR and/or is considering introducing additional criteria (e.g., introducing a maximum size of an AR’s business and/or requiring the principal to be carrying on the same regulated activities as its appointed representatives).
- Principal permission gateway. The call for evidence talks about the possibility of introducing a so-called “principal permission gateway” where authorised firms would need to gain a specific permission from the FCA before appointing ARs. It also raises the possibility of increasing the FCA’s investigatory powers to directly cover ARs (e.g., so the FCA does not need to request information through principals).
- Increasing regulatory obligations on ARs. The call for evidence discusses placing more regulatory obligations directly on ARs, for example, by extending the scope of the SM&CR to cover ARs.
- Extending FOS remit to investigate complaints involving AR activity. HMT are considering the possibility of extending the power of the FOS to investigate regulated activities that are outside the scope of the AR’s agreement with its principal.
3 March 2022 – Deadline for responses to consultation and call for evidence.
H1 2022 – FCA to publish a policy statement and final rules
Financial Promotion Reforms
To bring the relevant activities into scope, the consultation proposed that the Financial Promotions Order (“FPO“) is amended to include certain unregulated cryptoassets in the list of controlled investments and amend several existing controlled activities. HMT’s proposed definition of “qualifying cryptoassets” (i.e., the cryptoassets that would be brought within the scope of the financial promotion restriction) excludes cryptoassets that are not fungible and not transferable.
On 18 January 2022, HMT published the response to its consultation on bringing certain cryptoassets into the scope of the financial promotions regime. The key points in the response include:
- The government intends to define the scope of ‘qualifying cryptoasset’ as any cryptographically secured digital representation of value or contractual rights which is fungible and transferable.
- Some respondents thought that the concepts of ‘fungibility’ and ‘transferability’ were too complex. HMT rejected this observation but noted that work continued on getting the final definition right. HMT also stated that the legislation will be accompanied with the appropriate guidance.
- HMT received some feedback that thought the concept of ‘fungibility’ was not appropriate on the basis that some non-fungible tokens can be used for speculative purposes and also it could be possible to circumvent the requirements by wrapping a fungible token inside a non-fungible token. However, the government has decided to retain the concept of ‘fungibility’ in the definition of qualifying cryptoassets.
- In order to future-proof the definition, the government proposes to remove the reference to DLT from the definition of qualifying cryptoassets. This change is intended to future-proof the definition.
- The government also intends to include a ‘transferability exclusion’ within the definition to ensure that tokens such as travel passes, lunch passes, and supermarket loyalty schemes that are cryptographically secure are excluded from the regime.
- The government concluded that no new controlled activities need to be added to the FPO.
- HMT stated that both cryptoasset lending and DeFi may be in scope depending on the exact activities being performed.
- There will not be a new exemption for promotions that simply state that a vendor is willing to accept or offer qualifying cryptoassets in exchange for goods and services. The paper states that it is the government’s view that such statements would not constitute an inducement to enter into investments.
- The FPO exemptions for high net worth and self-certified sophisticated investors will not be expanded to cover cryptoasset promotions.
- The government now proposes a six-month transition period for this measure (it originally said there would be no transition period).
New regulatory gateway
In 2022, we are expecting the FCA to publish a consultation on new changes to its rules to establish a new regulatory gateway for the approval of financial promotions of unauthorised persons and for HMT to publish the necessary changes to legislation to implement the new financial promotion gateway. It is expected that there will be a transitional period and that the gateway will launch by March 2023.
Last year, HMT confirmed that it intends to amend the financial promotion approval regime by establishing a regulatory gateway for the approval of financial promotions made by unauthorised persons. The current financial promotion regime will be amended so that financial promotions made by unauthorised persons can only be approved by certain regulated firms that have been given permission by the FCA to approve financial promotions of unauthorised firms. Any existing authorised person wishing to undertake approval of financial promotions will need to submit a variation of permission to the FCA to have this requirement varied. There are to be certain exemption including intragroup approvals and approvals for ARs.
High-risk investments and approval regime
We are expecting the FCA to publish a consultation paper on financial promotions in relation to high-risk investment products. This follows the FCA’s recent discussion paper DP21/1 on the promotion of high-risk investment products. Among other things, the FCA are considering whether:
- more types of investments should be subject to marketing restrictions and, if so, what marketing restrictions should apply to these investments;
- changes are needed to how certain types of investments are currently classified for the purposes of the financial promotion rules;
- there any other features of an investment that means they are generally inappropriate for retail investors and should be subject to a mass-marketing ban;
- the investor categorisation process can be strengthened and changes that can be made to risk warnings;
- more “positive friction” can be introduced into a consumer’s journey for high-risk investments;
- whether there should be additional requirements for approvals of financial promotions to monitor a financial promotion on an ongoing basis after approval; and
- how involved a financial promotion approver should be in the client categorisation, appropriateness and preliminary suitability assessment processes on an ongoing basis.
Changes to high net worth and sophisticated investor exemptions
The closing date for HMT consultation on updating FPO exemptions for high net worth (“HNW“) individuals, sophisticated investors and self-certified sophisticated investors is on 9 March 2022. The consultation seeks views on HMT’s proposals to update the financial promotion exemptions for these entities set out in articles 48, 50 and 50A of the FPO. Proposals include:
- Increasing the financial thresholds for HNW individuals in line with inflation between 2001 and 2021. This approach would result in the net income threshold to be considered HNW being changed to £150,000 and the net asset threshold to £385,000.
- Amending the criteria for self-certified sophisticated investors. HMT is of the view that one of the existing criteria to be classified as a self-certified sophisticated investor (to have made more than one investment in an unlisted company in the previous two years) is no longer an indicator of investor sophistication and this element should be removed from the self-certified sophisticated investor definition.
- One of the criteria for self-certified sophisticated investors currently assesses whether the individual has been in the last two years a director of a company with an annual turnover of at least £1 million. It is proposed that the threshold be increased to £1.4 million (in line with inflation between 2005 and 2021).
- Placing a greater degree of responsibility on firms to ensure individuals meet the criteria to be deemed HNW or self-certified sophisticated. HMT has proposed that firms communicating the financial promotion must have a reasonable belief that an individual meets the criteria.
9 March 2022 – Deadline for responses to the HMT consultation paper on the financial promotion exemptions for high net worth individuals and sophisticated investors.
Q1 2022 – FCA consultation on its proposals for implementing the regulatory gateway
Q1 2022 – FCA consultation on its proposals relating to high-risk investments and approval regime
Q2 2022 – FCA to publish a policy statement regarding the implementation of the regulatory gateway
H1 2022 – HMT to publish its response legislative proposal on the expansion of the financial promotions regime to certain cryptoassets
March 2023 – Anticipated start date for the new regulatory gateway for the approval of financial promotions
New Consumer Duty
The FCA have stated that they want to see a higher level of consumer protection in retail financial markets, where firms compete in the interests of consumers. The FCA also want to drive a healthy and successful financial services system in which firms can thrive and consumers can make informed choices about financial products and services. To drive these behaviours, the FCA are consulting on the introduction of a new consumer duty. The FCA published its second consultation on the new consumer duty (CP21/36) on 7 December 2021. Broadly, the new consumer duty will consist of three different elements:
- New consumer principle. The introduction of a new consumer principle: “A firm must act to deliver good outcomes for retail clients”. This will require firms to consider questions such as “Am I treating my customers as I would expect to be treated?” and “Are my customers getting the outcomes from my products and services that I would expect?”. As a result of the overlap between the new consumer duty and Principles 6 and 7 – the FCA proposes that where the consumer duty applies – Principles 6 and 7 will be disapplied.
Cross cutting rules and guidance. The FCA will introduce new rules and guidance to support the new Consumer Principle, including requiring firms to:
- Act in good faith. The FCA will expect firms to act with honesty, fair and open dealing, and consistency with the reasonable expectations of consumers.
- Take all reasonable steps to avoid foreseeable harm to consumers. Firms must not cause harm to customers through their conduct, products or services and must take steps to avoid it. For example, firms should not seek to exploit customers’ vulnerabilities, behavioural biases or lack of knowledge. The FCA will expect firms to act fairly when describing the benefits and risks of their products and services.
- Take all reasonable steps to enable consumers to pursue their financial objectives. The FCA expects firms to take responsibility for establishing an environment in which consumers can act in their own interests. Some actual or potential harms arise when firms do not sufficiently recognise and take account of consumers’ behavioural biases and the impact that characteristics of vulnerability can have on consumers’ needs. Firms will need to take reasonable steps to understand these factors and use their knowledge of how consumers behave to enable and support them to make good decisions.
Four outcomes. These represent the key elements of the firm-consumer relationship: how firms design, sell and service products and services, and the key contact points along the customer journey. The four outcomes are:
- Products and services are specifically designed to meet the needs of consumers and sold to those whose needs they meet. The FCA has stated that it wants all products and services that are sold to consumers to be fit for purpose. It wants them to be designed to meet consumers’ needs and targeted at the consumers whose needs they are designed to meet. The FCA will introduce new product governance rules for manufactures and distributors – these will be similar to the existing PROD rules but will now apply to most financial services products.
Price and value of products and services. The FCA stated that it wants to ensure that products and services represent fair value. To achieve this outcome, the FCA is consulting on rules requiring firms to offer fair value to consumers, for example, requiring manufacturers to access whether the price of a product or service provides fair value taking into account the following considerations:
- the nature of the product or service, including the benefits that will be provided or that consumers may reasonably expect, and their quality;
- any limitations that are part of the product or service;
- the expected total price customers will pay; and
- any characteristics of vulnerability in the target market for the product or service.
The FCA also proposes that distributors must not distribute products or services unless they are satisfied that their distribution arrangements are consistent with the product or service providing fair value. The FCA will expect firms to review their value assessments to satisfy themselves that the products and services they manufacture or distribute continue to provide fair value.
Communications equip consumers to make effective, timely and properly informed decisions about financial products and services. The FCA states that it wants firms’ communications to consistently support consumers by enabling them to make informed decisions. Firms will be required to ensure that they:
- make sure communications are understandable, enabling consumers to evaluate the options available to them, the costs, risks and benefits attached to those options, and how those options relate to their needs and financial objectives;
- consider the characteristics of the consumers that their communications are aimed at, and tailor their communications accordingly so that they are likely to be understood;
- consider the appropriate level of detail for each communication, and take into account the kind of decision to be taken by its recipients, what the consumer needs to know, and where confusion could arise;
- communicate with their customers in a timely manner, giving them an appropriate amount of time to take in the information and, where relevant assess their options; and
- communicate at appropriate touch points throughout the product/service lifecycle (e.g., before the end of an introductory offer period, as is already the case in the mortgage market) and do so in a way that supports their customers’ decision-making.
- Customer service meets the needs of consumers, enabling them to realise the benefits of products and services and act in their interests without undue hindrance. The FCA wants firms to provide a level of customer service that meets the needs of consumers throughout their relationship with the firm. Firms’ customer service should enable consumers to realise the benefits of the products and services that they buy, and ensure they are not hindered from acting in their own interests.
15 February 2022 – Deadline for responses to the FCA’s consultation paper on the new customer duty (CP21/36)
31 July 2022 – Deadline for the FCA to make any new rules relating to the customer duty.
30 April 2023 – Deadline for firms to fully implement the consumer duty.
Consumer Credit Reforms – BNPL
Following the Woodward Review into unregulated consumer credit, the government intends to alter the regulatory perimeter to capture certain types of buy-now-pay-later credit (“BNPL“) that currently fall within the exemption in article 60F(2) of the RAO.
In October 2021, HMT published a consultation paper on regulating such products. Whilst HMT did not set out in the consultation its specific legislative proposals, it did outline a couple of potential options that are being considered. The current options are:
- Excluding from the exemption interest-free credit agreements where there is a third-party lender involved in the transaction but keeping arrangements directly between a merchant and a consumer exempt from regulation. The consultation raises the concern that this may draw the scope of regulation too widely, drawing in a large proportion of short-term interest-free credit alongside BNPL.
- Defining a BNPL agreement as one where there is a pre-existing, overarching relationship between the lender and consumer, for example, where a consumer opens an account with a lender, under which the lender agrees to finance one or more transactions but where any repayments made are toward specific agreements made as part of that relationship. However, the government is concerned that this option would leave open the possibility that firms will make a relatively small change to their BNPL products, so that it bears more similarity to running-account credit, to avoid regulation.
HMT also set out their views on other aspects of the potential regulation of BNPL credit:
- Credit broking. As a general rule, HMT believe that merchants should be exempt from the need to be authorised to carrying out credit brokering in relation to BNPL credit.
- Financial promotions. HMT take the view that promotions of BNPL agreements should fall within the financial promotions regime. Accordingly, merchants may be required to obtain approval for promotions of BNPL products from an authorised person.
- Pre-contractual information. For pre-contractual information, it is proposed that regulation of BNPL could rely solely on FCA rules, while the detailed and inflexible requirements for information disclosure in section 55 of the CCA could be disapplied.
- Credit agreements. HMT believe that it may be necessary to develop bespoke legislation on the form and content requirements for BNPL, which better suit the features of the product and how it is used by consumers in practice.
- Improper execution. HMT are minded to apply the CCA rules regarding execution, as these mechanisms provide very strong incentives to lenders to provide the necessary information to a consumer, or risk the agreement becoming unenforceable.
- Creditworthiness/forbearance. The regulation of BNPL should include the application of the FCA’s rules on creditworthiness to BNPL agreements and some requirements around how firms treat customers in financial difficulty. The government also are minded to keep some of the CCA provision regarding arrears and defaults.
- Section 75. HMT state in the consultation paper that s75 of the CCA could be applied to BNPL agreements.
- Small agreements. Currently some parts of the CCA do not apply to “small agreements”. HMT state that they believe that this exemption should not be available in relation to BNPL credit.
- FOS and redress. HMT state that they believe that BNPL arrangements should be within the FOS jurisdiction.
7 January 2022 – Deadline for responses to the HMT consultation on regulating BNPL products.
2022 – We expect further consultations from HMT and the FCA on the regulation of BNPL products during the course of 2022.
Regulation of stablecoins
In January 2021, HMT published a consultation paper on the UK regulatory approach to stablecoins. The consultation paper sets out proposals to bring “stable tokens” with-in the FCA’s regulatory perimeter.
The consultation did not include a clear definition of a so-called “stable token”, however the consultation states that the “regulated category of stable tokens would refer to tokens which stabilise their value by referencing one or more assets, such as fiat currency or a commodity (i.e., those commonly known as stablecoins) and could for that reason more reliably be used as a means of exchange or store of value.” The consultation goes on to state that the intention is to regulate tokens that “could be reliably used for retail transactions or wholesale transactions”.
The regime would cover firms issuing stable tokens and firms providing services relating to them, either directly or indirectly, to consumers (e.g., cryptoasset exchanges and wallets.) New regulated activities will be added to the RAO to apply the authorisation regime to in-scope providers. The rules and requirements for the proposed new regime will be based on the UK’s current approach to e-money and payments regulation. Single-fiat tokens would be required to meet the requirements of e-money under the EMRs 2011 (as amended where deemed appropriate). The government has also stated that it is considering introducing a lighter-touch regime for smaller firms below a certain turnover.
In a related development in the EU, as part of its Digital Finance Strategy, the European Commission adopted, in September 2020, proposed legislative measures to create a framework for the regulation of cryptoassets in the EU. This includes a proposal for a regulation on markets in cryptoassets (“MiCA“). Broadly, MiCA would establish a new EU legal framework for cryptoassets that are not covered by existing EU financial services legislation and introduce specific rules for stablecoins. The scope of the MiCA proposal is limited to cryptoassets that do not qualify as MiFID financial instruments, deposits or structured deposits or traditional e-money under existing EU financial services legislation.
Among other things, MiCA would introduce a licensing regime for persons who perform activities (including issuing) in relation to ‘e-money tokens’ and ‘asset-referenced tokens’. The proposals define an ‘asset-referenced token’ as a “type of cryptoasset that purports to maintain a stable value by referring to the value of several fiat currencies that are legal tender, one or several commodities or one or several cryptoassets, or a combination of such assets.” This is primarily targeted to types of stablecoins which have been adopted by users to transfer value or as a means of payment.
The MiCA proposal also regulates the offerings and marketing to the public of cryptoassets (other than asset-referenced tokens and e-money tokens (which are subjected to a new licensing regime)) (“non-stablecoin cryptoassets“). It does not introduce an authorisation regime for issuers and providers of non-stablecoin cryptoassets, but instead requires that issuers comply with certain requirements before they offer the cryptoassets to the public (e.g., produce a white paper). There are certain exemptions to a number of the requirements – for example, where the cryptoassets are offered for free; they are created through mining; are unique and not fungible with other cryptoassets; or are offered to fewer than 150 natural or legal persons per member state where such persons are acting on their own account – there is no requirement to publish a white paper.
The Council of the EU has now commenced trialogue negotiations with the European Parliament on the MiCA proposal.
2022 – We expect feedback to be published on the HMT consultation and call for evidence on the regulatory approach to cryptoassets and stablecoins. Following the feedback being released, we expect further consultations and legislative proposals to be published. In the EU, we expect a political agreement to be reached this year on the MiCA and for the EU to formally adopt the Regulations.