Reform of the financial services regulators’ objectives – an amended framework to reflect a new world order

The proposed changes to the financial services regulators’ objectives are not only a matter of interest for regulated financial services, but are also significant for all those who use the financial markets. 

There has been a lot of focus on the new growth and international competitiveness objective for the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA), but there are many other changes which are similarly important innovations elsewhere in the regulatory ecosystem. These reforms, taken together, are going to require substantial shifts in regulator behaviour and, in combination with other reforms, will result in greater transparency about how regulators make decisions and weigh the different objectives.

Regulators’ objectives not only inform regulated businesses about how the regulators will approach that business’s activities, but also about the government’s regulatory policy and priorities for the sector, and for the provision of services to the wider economy. The regulators’ objectives are the government’s primary mechanism for ensuring that the regulators consider the appropriate public policy objectives when exercising their regulatory functions.¹

The Financial Services and Markets Act 2023 (the Act) has made some significant changes to the financial services regulators’ objectives – for example, it has introduced:

• a new secondary objective for the FCA and the PRA that they must, so far as reasonably possible, advance the growth (over the medium to long term) and international competitiveness of the UK’s economy (in particular, the financial services sector);²
• a new secondary objective for the Bank of England (the Bank), in relation to the regulation of central counterparties (CCPs) and central securities depositories (CSDs) to facilitate innovation in the provision of financial market infrastructure (FMI) services when it exercises its powers in relation to CCPs and CSDs;³
• a new net-zero regulatory principle;⁴
• extension of the ambit of the regulatory principles so they now apply to the Bank when it exercises certain functions relating to FMIs;⁵ and
• ·new arrangements in relation to recommendation letters, whereby HM Treasury may make recommendations to regulators about aspects of the government’s economic policy to which the regulators should have regard when exercising their functions.⁶

These changes have been strongly trailed and should not be a surprise to the financial services community. However, it is still worth careful consideration of the rationale for introducing them, what they might mean in practice and what changes they might herald in regulator behaviour.

Context for change

For the past 40 years, the EU has increasingly formulated financial services policy for the UK, and has delivered that policy through detailed legislative provisions in a typically civil code fashion. In discharging these functions, the EU has pursued its own political agenda of integration, harmonisation and ensuring that the EU remains competitive compared to other jurisdictions.

Following Brexit, the UK needed to find a new mechanism for formulating and delivering financial services policy. After considering various options, the UK has settled on extending the Financial Services and Markets Act 2000 (FSMA) model of regulation.⁷ Under the FSMA model:

• Parliament and HM Treasury will be responsible for setting the regulatory architecture within which the regulators operate; and
• the independent and expert financial services regulators (primarily the PRA and FCA, but also the Bank and the Payment Systems Regulator (PSR)) will be responsible for formulating detailed policy on firm-facing requirements which they will deliver through making rules.

Part of setting the regulatory architecture is ensuring that the regulators support the UK’s wider economic and political agenda. The principal mechanism for ensuring this outcome is to align the regulators’ objectives to the government’s policy position.

Accordingly, it was entirely appropriate for the government to review the financial services regulators’ objectives to ensure that the new firm-facing policy/rules are consistent with the government’s policy on financial services.⁸

The government has been clear about its ambitions for the financial services sector – it wants to create “an open, green and technologically advanced financial services sector that is globally competitive and acts in the best interest of communities and citizens, creating jobs, supporting businesses and powering growth across all of the UK.”⁹

In pursuit of this ambition, HM Treasury has consulted extensively on the possible status and nature of new objectives, and it is easy to chart the development of its thinking from the initial Call for Evidence in July 2019 to the final proposals set out in the proposals for reform document in July 2022.¹⁰

Growth and international competitiveness

Some of the most influential post-Brexit reviews on aspects of financial services and markets have recommended that at least some of the UK’s financial services regulators should have a growth and/or international competitiveness objective (G&IC objective).¹¹ Accordingly, it is no surprise that this reform is included in the Act.

There has been a significant degree of debate around terms of the form and status of such an objective, with some polarised views: for some, it heralds the return to light-touch regulation which contributed to the financial crash; for others, it does not go far enough and should rank alongside the regulators’ primary objectives.¹²

There are some minor differences between the PRA and FCA’s versions of the objectives, which reflect the differences in the structure of their existing objectives. However, we expect them to have the same legal effect. The text is spread over a couple of new provisions in FSMA and it is worth quick consideration because it contains a few interesting points (we use the FCA example here, but the same points apply to the PRA):

“When discharging its general functions in the way mentioned in subsection (1) the FCA must, so far as reasonably possible, act in a way which, as a secondary objective, advances the competitiveness and growth objective.”¹³

“The competitiveness and growth objective is: facilitating, subject to aligning with relevant international standards—

(a) the international competitiveness of the economy of the United Kingdom (including in particular the financial services sector), and

(b) its growth in the medium to long term.”¹⁴

Is this a return to light-touch regulation?

In terms of addressing concerns of those who see this as a return to light-touch regulation, there are a couple of points to note:

• the time-horizon for consideration of growth is medium to long term so the focus is not on immediate effect, which mitigates the risk of short-termism creeping into regulatory assessments; and
• as Lord Hill recognised, many jurisdictions accommodate some form of growth or competitiveness objectives.¹⁵

In fact, these factors have consistently played a part in the UK’s financial services regulation, even when we were a part of the EU: the EBA, ESMA and EIOPA are all required to consider the impact of their activities “on the Union’s global competitiveness”¹⁶ and the EU was always able to consider competitiveness when it formulated high-level legislation, alongside other political imperatives such as harmonisation; the geographical focus for the objective has merely changed. As Sam Woods noted: “It is not unreasonable to require that, if [the regulators] are to take on some functions that were conducted with political input when we were a member of the EU, then [they] should take more explicitly into [their] consideration some of the objectives that motivated that input.”¹⁷

It is also important to see the G&IC objective in the context of the whole regulatory ecosystem: as Sam Woods has noted, for a financial centre to be internationally competitive, financial stability is a prerequisite, but stability must be tempered by proportionality to avoid the “stability of the graveyard”.¹⁸ Another important factor is that the objective recognises the importance of internationally agreed standards and of the value of continued UK alignment with those standards. So, the objective is not designed to push the regulators to pursue UK competitiveness at the cost of alignment/compliance with international standards. 

The regulatory ecosystem is fundamentally different today than it was before the financial crisis and therefore it is unlikely that the introduction of the G&IC objective in its current form will unsettle the existing regime to the point that we see a return to the light-touch regulation of the pre-crisis system, but it should operate to temper any more extreme moves towards stability measures.

Operational impact on the FCA and PRA

In terms of how this objective will work in practice, it will arguably have a greater short-term operational impact on the FCA than the PRA: the PRA has operated since March 2014 with a secondary objective (to facilitate effective competition in relevant markets) and so is familiar with the structure of having primary and secondary objectives which need to be balanced; the new structure will be new for the FCA and so may require more adjustment to new processes. The FCA has indicated that it is considering how its processes will need to change to accommodate this new objective, including how to report on its application and how it moves the FCA’s output.¹⁹

In terms of the longer-term impact, this is difficult to assess. It is clear that the G&IC objective will not be capable of overriding the regulators’ primary objectives or be used as sole justification for developing a particular policy. However, all other things being equal, where there are a number of ways to deliver a policy, the regulators will now be informed by which of those options delivers the most pro-growth and international competitiveness outcomes. As Vicky Saporta noted in a recent speech, this is a “big thing” for the financial services regulators and therefore for the industry as a whole, and will change the way the regulators approach developing policy. This is significant in light of the transfer of policy-making responsibility that will flow from the extension of the FSMA model.²⁰

The new accountability measures require the regulators to report on how they are delivering against their new objective and this should ensure that their approach is sufficiently transparent that we can assess the effect of this new objective in reasonably short order. In particular, following a government amendment, the Act requires the FCA and PRA to produce two reports, the first to be produced within 12 months of the new G&IC objective coming into force and the second within 24 months of that date. The report must list how any rules and guidance it has issued advance the objectives and any action it has taken to ensure that the G&IC objectives are embedded in its operations, processes and decision-making.²¹

Bank of England’s new innovation secondary objective and other considerations relating to FMIs

One of the key regulatory changes that follows Brexit is that the Bank will now assume significantly more statutory responsibility for the regulation of CCPs and CSDs. The Act confers on the Bank a new general rule-making power in relation to CCPs and CSDs.²² The Act also creates a new statutory committee of the Bank, the Financial Market Infrastructure Committee (FMIC), through which the Bank will exercise the new general rule-making power.²³

FMIC will be subject to the Bank’s existing primary stability objective. However, HM Treasury has designed the objectives framework so that the Bank is expected to (a) consider the financial stability impact of UK CCPs and CSDs on other jurisdictions, and (b) ensure non-discrimination on the basis of nationality or location.²⁴ This adjustment to the standard stability objective reflects the interconnectedness of international financial services industries and the reasonably concentrated nature of the world’s markets in FMI.²⁵

The FMIC will be subject to a new secondary objective so that, as it advances its primary objective, it must, so far as is reasonably possible, facilitate innovation in the services provided by CCPs and CSDs they regulate, with a view to improving the quality, efficiency and economy of those services [paragraph 2.9 consultation response July 2022].²⁶ It is interesting that the requirement to facilitate innovation is focused on improving quality, efficiency and economy of those services, which recognises the importance of FMI services to the wider financial services ecosystem. The requirement is not for innovation for innovation’s sake, but, at least in part, to improve services to FMI users and thus the overall operation of the financial services ecosystem. Further, respondents to HM Treasury’s consultation hoped that this new objective could help facilitate getting new products out to market.²⁷

The Act also extends regulatory principles to the FMIC, albeit in modified form, shaped to reflect the unique characteristics of FMI. In particular, the principles introduce a requirement for FMIC to have regard to the desirability of facilitating fair and reasonable access to FMI services.²⁸ This requirement is designed to help protect financial services firms’ access to services which are critical to the wider financial services ecosystem and without which they could not properly offer services.

Finally, the Act extends HM Treasury’s ability to make recommendations about the government’s economic policy to which the Bank should have regard when considering both how to advance its objectives or the application of the regulatory principles.²⁹ This will allow HM Treasury to “fine tune” the objectives to reflect prevailing economic policies.

Impact on the Bank

Working with a primary and secondary objective will not require significant organisational changes for the Bank as it is already used to working with similar structures through the PRA. However, the Bank will need to develop a more formal and transparent decision-making structure to reflect the formalisation of the FMIC and it would seem logical to assume that the changed focus of the primary objective and the nature of the secondary objective combined with a new regulatory principle will require an amended approach to decision-making.

This new objective framework for FMI clearly demonstrates the government’s commitment to innovation in the financial services sector, and dovetails with other innovations in the FMI space – for example, the new powers to create FMI sandboxes.³⁰ It will be interesting to see how the reforms operate together in the future, and how the Bank interprets its objectives in relation to the operation of any sandbox created by HM Treasury. 

However, in a move that further reflects the unique nature of the FMI sector, the G&IC secondary objective will not be extended to cover FMIC. 

Payment Systems Regulator

Many people will be wondering why we have not focused on the PSR – after all, schedule 7 of the Act is all about amendments to the PSR’s accountability framework. However, although the government has extended the wider accountability framework to include the PSR, it has not amended the PSR’s objectives. The government explains that this is “… because the PSR is an economic and competition regulator with its own unique objectives. It already has an objective to promote the development of innovation in payments systems to improve the quality, efficiency and economy of payment systems. As such, a new growth and international competitiveness secondary objective for the PSR would, in effect, be duplicative.”³¹

Nudging the FS sector to be more competitive & innovative

In his 2019 Mansion House speech, Philip Hammond stated: “London’s position as the premier global financial services hub depends on our ability to capture a share of the booming [emerging] markets. And it depends, too, on our ability to integrate the technologies of the future into our mainstream financial services.”

In this statement we can see two broad ambitions:

• making London’s financial services sector as competitive as possible in order to attract business; and
• harnessing the powers of innovation and technology.

These ambitions have been a consistent theme through HM Treasury’s publications around the FRF Review and we can clearly see them come through in terms of the changes that the Act makes to the regulators’ objectives. 

The fact that the government has legislated to require the regulators to publish information about how they are delivering against these objectives means that there will be a significant level of transparency about how the regulators are interpreting the new objectives and how they are developing policy to meet the obligations. Accordingly, we should be able to monitor the impact of the amended objectives over the next few years. 

Until we have seen some concrete examples of how the new objectives have been met, we will not be able to truly assess the effectiveness of the changes. However, as the regulators have acknowledged, these reforms represent a “big thing” for the regulators. And, with one of the largest rule-rewriting exercises ever undertaken in a major financial centre taking place over the next couple of years, we should not have to wait long for the first measures of how the changes are affecting regulator behaviour. 

Whilst these changes appear likely to drive changes in the regulators’ behaviour, this is not really revolutionary. With a material change in the UK’s circumstances, it is inevitable (and in accordance with NAO guidance) that the regulators’ objectives would change. The nature of the changes is again predictable in terms of the government’s ambitions, and reflects the sort of considerations that exist in a number of other jurisdictions. So, whilst they are a big thing, they are really evolutionary to reflect the UK’s changed circumstances. 

1. Paragraph 3.18, The Regulatory Framework Review: Central Counterparties and Central Securities Depositories, January 2022.
2. See new sections 1B(4A) and 1EB (relating to the FCA) and sections 2H(1), 2H(1A) and 2H(1B) (relating to the PRA) of FSMA inserted by section 25 of the Act.
3. See new section 30D of the Bank of England Act 1998, inserted by section 48 of the Act.
4. See new section 3B(1)(c) of FSMA, inserted by section 27 of the Act.
5. See new section 30E of the Bank of England Act, inserted by section 48 of the Act.
6. The power to issue recommendations is now extended from PRA and FCA to include the Bank when exercising its functions over FMI (see new section 30 of the Bank of England Act 1998, inserted by section 48 of the Act) and the PSR (see new section 102A in the Financial Services Banking Reform Act 2013, inserted by section 51 of, and paragraph 4 of schedule 7 to, the Act) and all regulators are now statutorily required to respond to each recommendation letter outlining how it shall, or shall not, follow the recommendations and, where it will not, explaining why.
7. See paragraph 2.1 of Financial Services Future Regulatory Framework Review: Phase II Consultation, October 2020.
8. See paragraph 3.3 of Financial Services Future Regulatory Review: Proposals for Reform, November 2021. This approach was in line with the NAO Principles of Effective Regulation, page 12.
9. A new chapter for financial services, July 2021, at page 5.
10. Financial Services Future Regulatory Framework: Proposals for Reform, July 2022.
11. For example, Lord Hill’s UK Listing Review final report at page 6, and proposal 1.7 of final report of the Taskforce on Innovation, Growth and Regulatory Reform, at page 20.
12. See paragraph 2.4 Financial Services Future Regulatory Framework Review: Proposals for Reform – Response to the Consultation, July 2022.
13. New section 1B(4A) of FSMA, inserted by section 25 of the Act.
14. New section 1EB of FSMA, inserted by section 25 of the Act.
15. See UK Listing Review final report at page 6 and paragraph 1.2.
16. Recital 13 for each of the EU regulations establishing the EBA, ESMA and EIOPA.
17. Growth and Competitiveness, a speech by Sam Woods, published on 27 October 2022 – bis.org.
18. Growth and Competitiveness, a speech by Sam Woods.
19. Future Regulatory Framework (FRF) Review, December 2022 fca.org.uk, page 5.
20. The Regulatory Foundations of International Competitiveness and Growth, 27 February 2023 bankofengland.co.uk.
21. Section 26 of the Act.
22. See new sections 300F and 300G (in relation to overseas FMI entities) of FSMA, inserted by section 9 of the Act.
23. See new section 30F of the Bank of England Act, inserted by section 48 of the Act.
24. See paragraph 2.8 Future Regulatory Framework Review: Central Counterparties and Central Securities Depositories – Response to Consultation, July 2022.
25. Paragraph 4.10 of The Future Regulatory Framework: Central Counterparties and Central Securities Depositories.
26. See new section 30D(2) of the Bank of England Act 1998, inserted by section 48 of the Act.
27. See paragraph 2.9 of The Future Regulatory Framework: Central Counterparties and Central Securities Depositories.
28. See new section 30D(1)(a) and 30E(1)(i) of the Bank of England Act, inserted by section 48 of the Act.
29. See new section 30I of the Bank of England Act, inserted by section 48 of the Act.
30. See sections 13 to 17 of the Act.
31. See paragraph 2.8 of Financial Services Future Regulatory Review: Proposals for Reform – Response to the Consultation, July 2022.