The Financial Services and Markets Act – key objectives and measures
As a landmark piece of legislation, the Financial Services and Markets Act 2023 (the Act) contains significant reforms to the UK’s regulatory framework for financial services. The Act aims to maintain the UK’s position as a competitive marketplace with robust regulatory standards. It aims to establish an enhanced regulatory regime that is better tailored to UK markets, with updated objectives for the financial services regulators to ensure a greater focus on long-term growth and international competitiveness. We set out a summary of the key measures below.
Establish a framework for the revocation of retained EU law (REUL)
The Act establishes a framework for the revocation of retained EU law (REUL) relating to financial services. The UK Government is taking a phased approach to the revocation and transfer of REUL to the regulators’ rules or to legislation, with policy areas being ordered into tranches signalling when work has begun. Some of the revocation work is already underway for Tranche 1 following various Future Regulatory Framework Review (FRF Review) initiatives, for example the Wholesale Market Review, the Listing Review, the Securitisation Review, and the Solvency II review. The tranches and the order in which the files will be revoked are further detailed in the Annex to the HMT Policy Statement ‘Building a smarter financial services framework for the UK’ (9 December 2022) and the FCA’s ‘Future Regulatory Framework (FRF) Review’ (9 December 2022), the latter of which maps the FRF Review measures in the Act, the current approach for delivering the measures and prioritisation and next steps for implementation. Schedule 1 of the Act lists the legislation which will be revoked. These include all level 1 REUL, statutory instruments that reflect the implementation of REUL, provisions made under EU directives and specified provisions in the Financial Services and Markets Act 2000 (FSMA). The revocation of individual parts of Schedule 1 will not begin unless the regulators have drafted and consulted on the rules in the relevant areas that are ready to be enforced. HM Treasury expects that it will take a number of years to complete the process of revoking REUL.
Reform the legislative framework governing the UK’s wholesale markets
The Act removes unnecessary frictions on the UK’s wholesale markets by amending the UK Markets in Financial Instruments Regulation (MiFIR) to reflect the outcomes of HM Treasury’s Wholesale Markets Review including the following:
- Share Trading Obligation (STO) - The onshored STO requires firms to trade shares admitted to trading on a UK regulated market (RM), a UK multi-lateral trading facility (MTF), a UK systematic internaliser or an overseas venue assessed as equivalent. The STO was implemented by the EU with the aim of increasing transparency in share trading, however the explanatory notes to the Act explain that there is little evidence that it has achieved this. In fact, there are suggestions that it can prevent firms from accessing the most liquid markets and therefore achieving the best price for investors. The Act therefore removes the STO so that firms can trade shares (i) on any trading venue in the UK or overseas with any counterparty or (i) on an over-the-counter (OTC) basis.
- Derivatives Trading Obligation (DTO) – Counterparties (including financial, non-financial and analogous third country entities) in scope of the DTO will be formally aligned with those in scope of the EMIR Clearing Obligation.
- Systematic internalisers - the definition of “Systematic Internaliser” is revised to ensure that the regime is flexible and better able to account for market evolutions. The amendments seek to ensure that systematic internalisers achieve the aims of increasing transparency in price formation, while removing unnecessary burdens on firms. A harmonised tick size regime was introduced under the MiFID II framework to reduce the ever-decreasing increments in price seen on different trading venues. Prior to the introduction of the tick size regime, firms competed against each other with smaller and smaller price spreads to the detriment of the price formation process. The tick size regime sets minimum increments (“ticks”) by which prices for equity and equity like instruments can change and limits the ability of trading venues and systematic internalisers to cross at the midpoint (i.e., halfway between the buying and selling prices). In an effort to facilitate price improvements for investors and help systematic internalisers achieve the best outcomes for clients, the restriction on midpoint crossing for systematic internalisers for all trades are removed under the Act.
- Double Volume Cap – MiFIR introduced a mechanism to limit the amount of trading that happens under the reference price and negotiated trade waivers (the Double Volume Cap). The Act removes the Double Volume Cap in order to give firms greater choice over where they trade to get the best prices for investors.
- Position limits – The Act, removes the universal requirement for position limits to be imposed in respect of commodity derivatives and transfers the principal responsibility for the setting of position limits (and exemptions from those position limits) from the FCA to trading venue operators while empowering the FCA to develop a framework to support and constrain operators in both setting and applying position limits. The FCA will also retain an exceptional power to impose position limits, or restrict positions, itself as set out in the Financial Services and Markets Act 2000 (Markets in Financial Instruments) Regulations 2017 as amended by the Act. This approach is similar to the regime that was in place prior to the introduction of strict position limits in the MiFID II framework.
Framework for designation of critical third parties
Regulated financial services firms and financial market infrastructures are increasingly outsourcing important services to third parties that are outside the financial services regulatory perimeter. Accordingly, under the Act, HM Treasury has a new power to designate certain third parties as “critical” on the basis of defined criteria, including the materiality of the services which the third party provides to firms and the number and type of firms which use a third party. The Bank of England, PRA and FCA will have the ability to directly oversee critical services, including powers to make rules, gather information and take limited enforcement actions in respect of the services that critical third parties provide to regulated firms and FMIs. Following a joint discussion paper between the FCA, PRA and BoE which closed on 23 December 2022 and a third party survey that closed on 17 May 2023, there will be a further consultation on proposed requirements and expectations for critical third parties during H2 2023.
Reform the financial promotion regime
The Act establishes a regulatory financial promotion “gateway”, which authorised firms must pass through before being able to approve the financial promotions of unauthorised firms. Any authorised firm wishing to approve the financial promotions of unauthorised firms will first need to obtain the permission of the FCA in order to carry out this activity. The FCA will also be able to place limitations on the types of promotions firms will be able to approve. For example, it may restrict firms to approving financial promotions that are within their field of expertise. The regulatory gateway aims to improve the quality of financial promotions communicated by unauthorised firms, by allowing only those authorised firms that the FCA assesses as suitable and with sufficient expertise to approve the promotions of unauthorised firms. It will also give the FCA greater oversight of the approval of financial promotions and reduce the number of authorised firms that are able to undertake such approvals.
Digital settlement assets
The Act introduces a definition of “Digital Settlement Asset” and provides a power for HM Treasury to bring digital settlement assets into the UK regulatory perimeter when used as a means of payment. As part of the phased approach to regulating cryptoassets, stablecoins, a type of cryptoasset, are brought into the scope of regulation, paving their way for use in the UK as a recognised form of payment. Further detail on the government’s approach to regulating cryptoassets is set out in the following Engage articles summarising the proposed regulation of cryptoassets and the promotion of cryptoassets.
New objectives for the FCA and PRA
The Act amends FSMA to introduce new secondary objectives for the FCA and PRA to facilitate growth and international competitiveness of the UK economy. This will be backed up by changes to enhance the scrutiny and accountability of the regulators, including ensuring regular reporting and a greater focus on cost-benefit analysis, as further detailed in the accountability section below.
Access to cash and protections for APP fraud
The Act recognises that whilst digital payments are increasingly present in our society, cash continues to play a vital role in people’s everyday lives. The Act therefore puts in place a framework to protect the ability of people and businesses across the UK to access cash withdrawal and deposit facilities for the first time in law and ensuring free access to cash for individuals from free-to-use cash access points. This is a significant shift by the government during the passage of the Act in the Lords.
The Act requires the FCA to seek to ensure reasonable provision of free cash access services for current accounts of personal customers supporting the regulator’s wider duty of seeking to ensure reasonable access to cash. The Act also requires the government to publish a statement of its policies on access to cash including its policy on free cash access services for current accounts of personal customers which the regulator must have regard to when determining reasonable access. Reasonable access will be further determined in the policy statement. Currently on the whole, access remains extensive. According to FCA analysis, over 96% of the population are within 2 kilometres of a free-to-use cash access point.
The Act also introduces crucial protections for victims of Authorised Push Payment (APP) scams. Further information on the Payment Systems Regulator’s (PSR’s) plans to fight APP fraud are set out in this Engage article. The PSR’s proposals will now be able to move ahead as facilitated by the relevant provisions in the Act.
Amend FSMA to establish the Designated Activities Regime
In keeping with establishing a comprehensive FSMA model of regulation, the regulators need to have the appropriate powers to make rules when REUL is revoked. FSMA is amended by the Act to establish the Designated Activities Regime (DAR) to allow activities related to financial markets to be regulated within a framework which is compatible with a comprehensive FSMA model. This aims to address the fact that some activities, products or conduct are currently regulated by REUL but are not FSMA regulated activities.
Regulatory frameworks for FMIs (including SMCR) and FMI sandboxes
Central counterparties (CCPs), Central Securities Depositories (CSDs), Recognised Investment Exchanges (RIEs) and Data Reporting Services Providers (together financial market infrastructures (FMIs)) have previously sat outside of the core FSMA authorisation regime. However, in recognition of a number of FMIs being considered systemically important, the Act looks to establish robust regulatory frameworks to manage risks associated with FMIs. This includes a general rule-making power for the Bank of England to set regulatory requirements for two types of FMIs, CCPs and CSDs. The Act also gives the FCA general rule-making powers over another two types of FMI, DRSPs and RIEs to enable the FCA to replace the provisions in REUL relating to the regulation of DRSPs and RIEs to ensure the FCA has an effective way of upholding and enhancing standards in the future. The rule-making power will also help ensure that the FCA has the necessary tools to facilitate the development of a consolidated tape.
HM Treasury gains a new power to set up one or more temporary FMI sandboxes which will enable participating firms to test and adopt new technologies and practices. HM Treasury will be able to make permanent changes to legislation on the basis of what is learned in each FMI sandbox.
In recognition of CCPs and CSDs providing critically important functions underpinning the safe and effective functioning of global financial markets and the fact that the existing regime had limited provision for the oversight of individual conduct within these firms, the Act introduces a specific SMCR to be applied to CCPs and CSDs. The key features of the SMCR for CCPs and CSDs are similar to the SMCR for banks, insurers and authorised persons (set out in Part 5 of FSMA).
The Act also provides HM Treasury with a power to apply a specific SMCR regime to two other systemically important types of firms that promote market integrity, Credit Rating Agencies (CRAs) and RIEs should the government determine that this is appropriate following consultation with the industry. As CRAs and RIEs are regulated by the FCA, the FCA will make rules that will apply to those entities within the SMCR should this approach be taken forward.
Insolvency arrangements for insurers and the revocation of REUL in relation to insurance regulation
The Act makes targeted amendments to existing insolvency arrangements for insurers in Part 24 of FSMA expanding on the protections available to an insurer and its policyholders undergoing insolvency or write-down procedures. The Act’s measures on insolvency arrangements for insurers are set out at section 58 and schedules 12 and 13. Section 58 comes into force two months after Royal Assent (29 August 2023). Onshored Solvency II will be revoked over time pursuant to the Act and in accordance with HMT Policy Statement ‘Building a smarter financial services framework for the UK’.
Accountability of the regulators
The Act looks to reform the accountability, scrutiny and public engagement arrangements that apply to financial services regulators, particularly the FCA and PRA.
This topic attracted a great deal of interest given the increased responsibilities for the regulators in the Act and was the subject of numerous proposed House of Lords amendments. The general theme for the proposals has been that increased responsibilities must be balanced with clear accountability, appropriate democratic input and transparent oversight. Much of the debate centred on assuring as much as possible that the regulator’s objectives continue to be carefully balanced, particularly in relation to the new objective concerning international competitiveness.
As a result of further scrutiny during the legislative passage, further amendments have been introduced to place a statutory requirement on the regulators to provide a clear process for stakeholders, including the statutory panels such as the new FCA and PRA Cost Benefit Analysis Panels established by the Act, to make representations in relation to rules and a statutory requirement for the regulators to set out how they will respond.
Although the government did not pursue proposed amendments for an office for financial regulatory accountability (OFRA) the government has moved significantly in enabling an independent joint committee of both Houses of Parliament to hold the HM Treasury and the regulators to account.
Resolution regime for CCPs
The Act expands the resolution regime for CCPs in the UK, by providing the BoE with key powers to place CCPs into a resolution process, where all or part of the business has encountered financial difficulties.
The Act provides that HM Treasury can make necessary changes to domestic legislation to ensure that mutual recognition arrangements (MRAs) relating to financial services can be fully implemented using secondary legislation.
Background to the Financial Services and Markets Act 2022-2023
We thought it might be helpful to provide a summary of the background that led to the Act which is set out below.
The Future Regulatory Framework Review
The Act implements the outcomes of the FRF Review carried out in 2021-22 which considered how the UK financial services regulatory framework should adapt to the UK’s position outside of the EU. The outcomes of the FRF Review included the following proposals which are now reflected in the Act:
- Build on the UK’s domestic model of regulation to establish a comprehensive FSMA model approach to regulation in the UK. This means that the financial services regulators should take responsibility for setting the UK regulatory rules that will replace the many EU-derived regulatory requirements that are currently set out in REUL and which are due to be repealed;
- Enhance the statutory objectives and principles of the FCA/PRA to ensure greater focus on sustainable growth to encourage international competitiveness;
- Increase the accountability of the FCA/PRA to Parliament and to strengthen those regulators’ relationships with HM Treasury;
- Enhance engagement with stakeholders; and
- Create a DAR for certain activities performed by unauthorised persons.
Further detail on the FRF Review is set out in this Engage article.
The Edinburgh Reforms
The Act also interacts with the December 2022 Edinburgh Reforms. These are a wide package of financial services reforms which further elaborate on the aims of the FRF Review and the measures in the Act as further summarised below. You can find further detail about the Edinburgh Reforms in our Edinburgh Reforms quick guide:
- A review of the SMCR by HM Treasury and the regulators to encourage growth and competitiveness in the UK as announced on 30 March 2023 and summarised in this Engage article.
- A review of investment research which Hogan Lovells partner Rachel Kent is currently chairing, the outcomes of which are due to be published on 10 July 2023.
- A Call for Evidence to assess the current ringfencing regime for banks as further summarised in this Engage article.
- HM Treasury consultation on the Payment Accounts Regulations 2015, which implemented the EU Payment Accounts Directive as further summarised in this Engage article.
- A Consultation on a UK retail Central Bank Digital Currency was published on 7 February 2023 and closed on 30 June 2023. Further detail is set out in this Engage article.
- Providing a safe regulatory environment for stablecoins. Further detail is set out in this Engage article.
- Repealing the Packaged Retail Investment and Insurance Products regime and consulting on a new direction for retail disclosure in the UK.
- Repealing EU legislation on the ELTIF.
- Short Selling Regulation Call for Evidence.
- Bringing forward secondary legislation to implement the Wholesale Market Review reforms.
- Bringing forward a new class of wholesale market venue to operate on an intermittent trading basis, a consultation is expected imminently in relation to this.
- Setting up an FMI sandbox.
- Consumer Credit Act reform – a HM Treasury consultation was published on 9 December 2022 which closed on 17 March 2023 setting out the first steps towards ‘ambitious long-term reform’ as set out in this Engage article.
Rejected amendments during the Bill stages
During the Bill stages of the Act, the House of Commons rejected various amendments made by the House of Lords, some of which are set out below:
Requirements for the FCA and the PRA to have regard to the natural environment was rejected due to the proposed amendment being too broad and open to interpretation as drafted.
Requirements for the FCA to consider financial inclusion in respect of its consumer protection objective were rejected as “it would not be appropriate to change the regulators’ objectives, which are central to the way financial services operate in the UK, at short notice—this amendment came late in the stages of the Bill—and without the appropriate consultation”.
Restrictions on financial institutions' activities concerning forest risk commodities – this was rejected on the basis that further work was needed to ensure a practical regulatory due diligence framework for firms. Roundtables on this will be held in 2023 but are not enshrined in the Act.
Artificial intelligence (AI) in financial services – the Lords proposed that every business should have a designated AI officer responsible for the safe, ethical, unbiased and non-discriminatory use of AI. Although the government did not accept this amendment, it did say “The Government are firmly of the view that artificial intelligence has the opportunity to revolutionise every aspect of our lives, and we are committed to unlocking the enormous benefits that it can bring, in a way that is fair and allows everyone in society to benefit” and specifically in relation to financial services, “…the FCA, the PRA and the Bank of England recently published a discussion paper on how regulation can support the safe and responsible adoption of AI in financial services. Last week, the Government announced that the UK will host the first major global summit on AI safety this autumn.” Further detail on the FCA/PRA and BoE discussion paper is set out in this Engage article.
- It was originally proposed that the new powers for the regulators would be counterbalanced by “call in” intervention powers for HM Treasury to hold regulators to account. The government subsequently decided not to include the intervention power given concerns this could weaken the independence of the regulators.
Section 87 of the Act sets out the commencement provisions. Key sections came into effect on 29 June 2023 including conferring powers to make regulations in relation to the financial promotion gateway, the rules relating to critical third parties, and the MRAs. Other provisions come into effect two months after Royal Assent on 29 August 2023 including the rules in relation to digital settlement assets, access to cash, FSCS changes and the chair of the PSR becoming a member of the FCA Board.
Announcing the Financial Services and Markets Act 2023, the Economic Secretary to the Treasury, Andrew Griffith, said: “2023 is proving to be a banner year for reforming our financial services. This landmark piece of legislation gives us control of our financial services rulebook, so it supports UK businesses and consumers and drives growth. By repealing old EU laws set in Brussels it will unlock billions in investment – cash that can unlock innovation and grow the economy.” Sheldon Mills, Executive Director of consumers and competition at the FCA also referred to the new Act in a speech on 29 June 2023 discussing how the new international competitiveness and growth objective will help drive innovation and regulation in financial services in turn leading to economic growth.
Given the importance of this landmark Act to the future of financial services regulation in the UK we will be keeping a close eye on further regulatory developments and reporting on these going forward. Please get in touch if you would like to discuss any aspect of the Act.
Authored by Michael Thomas and Melanie Johnson.