By Martin Lovick, Director, and Bobby Johal, Managing Director, ACA Compliance Group.
A regime in transition
Investment managers are – quite rightly – focusing near-term on the cliff-edge nature of the UK/EU negotiations on future trade arrangements. Their contingency planning will have already considered the likely loss of passporting rights for UK firms exporting their services and/or funds products to the EU, replacing these where necessary with a local footprint.
They will have noted the FCA’s provision of a Temporary Permissions Regime (TPR) for firms and funds wishing to continue doing business in the UK. In addition, they’ll have considered guidance on their Temporary Transitional Power (TTP) which will affect the phased introduction of on-shored rules during a 15 month period ending March 31, 2022.
But what are the longer-term prospects for the UK regulatory regime? This challenge is not simply crystal ball gazing – it’s a future that must be factored into strategic planning two to five years out.
What we already know
The UK authorities’ approach to regulation has been signalled in recent speeches, albeit set against the backdrop of aggressive posturing seen in the UK/EU negotiations.
- The UK’s legal system is different. This was highlighted by Andrew Bailey (then CEO of the FCA) in a keynote speech to Bloomberg in April 2019. Historically, the greater use of legal codification and statute across the EU has been emphasised by the shift in approach from Directives, which create minimum and maximum standards, to harmonised and directly applicable regulations. Mr Bailey contrasted this with the UK’s common and case law foundations, which allow for evolution based on experience. His observation that “wholesale financial markets are more commonly found in countries with common law systems” is significant.
- Outcomes-based equivalence. Originally mooted as a successor to the “principles-based” regime that was tainted by the 2008 financial crisis, regulation which focuses on outcomes and the consequences of firms’ actions, was given new impetus by UK Chancellor Rishi Sunak in an important speech to Parliament in June 2020. As well as underlining the core principles of financial stability, market integrity and consumer protection, Sunak unveiled a determination to protect and promote the UK’s position as a world-leading financial centre. In the future, the UK will take care to consider whether EU proposals are sensible for the UK market (e.g. the Securities Financing Transactions Regulation (SFTR)). The FCA will also be more inclined to offer guidance and clarification in areas where previously it was bound by the specifics of EU regulations.
The contingencies – a period of highly-dynamic change
Of critical importance for both the short and medium-term outlook are:
- The outcome of the UK/EU negotiations: last minute reconciliation or a descent into recriminations? The tone of how these talks are concluded will be critical to any future relationship. Any agreement which maintains a degree of access for the UK to the Single Market, while offering more certainty, is likely to include an element of equivalence, therefore inhibiting the UK’s ambitions in other directions.
- UK political context – recapturing the centre-ground: with the lightening rod of the Brexit debate receding into history, will the UK revert to its more traditional battlegrounds? Notwithstanding the free market instincts of the current UK administration, a more electable, moderate opposition party seems likely to drag it back to the middle ground. Hopes of a Singapore-on-the-Thames, such as the development of a private funds regime in the UK, could be reigned back in this scenario.
What’s changing, what isn’t?
Any line-by-line analysis of the current regulatory regime, leading to predictions about the future of each set of rules, is of course highly speculative and must be hedged by the contingencies previously discussed. Putting this hesitation aside, the following framework may be helpful in considering if and how the UK’s rules will evolve:
- Little change – equivalence still the watchword
- Market Abuse Regulation. The EU’s harmonised regime is closely aligned to the longer standing UK version and current ESMA proposals to tweak certain aspects (e.g. on market soundings) appear sensible.
- MiFIR/EMIR transaction reporting. The importance of accurate transaction reporting to the FCA’s deterrence regime for market abuse has been consistently emphasised, as is EMIR reporting of derivative transactions to market stability. Proposals to level the MiFIR playing field across the investment management sector have been flagged for a while by both EU and UK.
Moderate change – wait and see
- ESG and sustainable finance. The EU’s Action Plan on Financing Sustainable Growth (2018) has positioned it as a world leader in encouraging capital flows towards sustainable activities and managing the financial risks of climate change. The Sustainable Finance Disclosures Regulation, coming into force in March 2021, is an important step towards integrating sustainability risks within investment strategy. The UK seems broadly sympathetic to its objectives but has deferred announcements on a detailed timetable for implementation.
- Investment Firm Directive/Regulation (IFD/IFR).The EU’s proposed reforms on prudential requirements for MiFID investment firms are due to come into force in 2021. The FCA has published a Discussion Paper on its own domestic set of changes to achieve similar objectives as the IFD/IFR, but a full Consultation still awaits. The FCA’s relatively lenient attitude in the past to the more controversial proposals on remuneration would appear to signal that proportionality will feature, particularly within wholesale firms in this specific and high-profile regard.
Considerable change – divergence and wholesale reform
- The FCA and UK Treasury have expressed their unease with key features of the PRIIPs regime for some time. The Treasury has already declared its intention to replace the “performance scenario” with the less prescriptive, but also less misleading, “appropriate information on performance”.
- Short Selling Regulation. The UK authorities have been traditionally uneasy about perceived intervention in the free operations of the capital markets, without any proven benefits to preventing economic harm. This was underlined again in March 2020 at the onset of the COVID-19 crisis when EU jurisdictions were much keener on imposing fresh restrictions on short selling. We would not be surprised if a pro-finance administration watered down or even eventually abolished this regime in the UK.
- AIFMD and a new UK private funds regime. AIFMD, first unveiled in 2011, can be seen as a political compromise between the hedge fund loving Anglo Saxon world and the more long-term, dirigiste instincts of much of the EU. The originally promised ‘third country’ passport for non-EU AIFs and AIFMs has not materialised, instead defaulting to the disparate, and increasingly limited, country-by-country National Private Placement Regime (NPPR).
As the trade negotiations reach their climax, and discussions begin in earnest on an AIFMD II (without FCA participation), the UK ? behind the scenes ? appears to be actively pursuing plans to create an on-shore regime for private (i.e. alternative) investment funds. This would mitigate the long-term risk to the traditional pattern of EU funds (notably in Ireland and Luxembourg) delegating portfolio management to UK managers, as well as promoting the growth of UK-based funds and fund services, including custody, administration and accounting. Such a regime will require parallel reforms in, inter alia, fund structures, tax, and depositary arrangements, but surely will find a receptive audience if the right combination of transparency and investor protections can be achieved.
While the TTP steers round the need for an immediate and rapid overhaul of the existing UK rulebook, the vagaries of the political and economic climate may steer us towards unforeseen (future) directions. However, it is noteworthy that the UK has been highly influential in shaping the regulatory landscape we traverse and the one we approach in the near horizon (the IFD/R being an obvious operative example).
Furthermore, the FCA has expressed an intention to remain highly active on the international stage – contributing to and shaping the agenda. Even with calls from some quarters to create a benign environment to preserve the UK’s pre-eminence in financial services, the likelihood of a regulatory big bang appears to be limited. Instead, a sophisticated, robust but responsive regulatory environment would appear to be the desired and likelier destination.
Watch this space!