UK: Financial Services And Markets Act 2023: Building A Smarter Regulatory Framework In The UK?

1. Introduction

The Act contains a large number of substantial – but in many ways quite disparate - measures that will – in time – effect a major overhaul of the UK's regulatory framework for financial services, payment services and financial market infrastructure. Some of these operate as amendments to the Financial Services and Markets Act 2000 and other enactments, others operate on a standalone basis in the 2023 Act.

The Act stands as a part of a host of policy changes that the government wants to see or is considering. These were set out in the Edinburgh Reforms last December and expanded on in the "Mansion House reforms" announced in the Chancellor's speech to Mansion House on 10 July 2023. In an update published on 11 July 2023, Building a Smarter Financial Services Regulatory Framework for the UK: HM Treasury's Plan for Delivery, the government says it expects "significant progress by the end of the year".

There is no doubt that the Act provides the foundations for a significant overhaul and restructuring of the UK financial services and markets regime. The changes in the Act include the implementation of the UK's post-Brexit framework (which will involve the repeal of retained EU legislation relating to financial services and markets, as well as the migration of much of that law from the statute book into the regulators' rulebooks), new powers and objectives for the UK financial services and markets regulators, as well as a number of measures relevant to financial market infrastructure operators, and payments, e-money and fintech firms.

Other measures include a new regime for the approval of financial promotions, a wholly new regime to regulate a category of "designated activities", additional powers for the regulators of UK financial services and markets in respect of critical third-party service providers and various provisions to bring payment systems and other actors connected with digital settlement assets into the relevant regulatory and legislative frameworks.

There are several provisions which generally relate to the regulation of the regulators, giving them new powers but making them subject to additional obligations and oversight. For instance, the FCA and PRA will have a new "secondary" objective that will require them to act in a manner which facilitates the international competitiveness of the UK economy and its growth. The existing sustainable growth principle to which they are both subject will be recast as a requirement to contribute towards achieving compliance with the net zero emissions target. Given that the FCA, the PRA and the Bank of England (in its supervision of CCPs and CSDs) will benefit from a significant extension of their powers under the new rules-based regime, various provisions will make the regulators accountable to HM Treasury and subject to its oversight.

Commencement dates for various provisions in the Act, where known, are given in square brackets, though in many cases the effect will be to bring into effect an empowerment (e.g. for the Treasury to make regulations and/or for the regulators to make rules) and therefore nothing material will necessarily happen on the relevant date. However, those commencement dates that have been published, and their relative immediacy, may be indicative of the level of priority that the Treasury has attributed to the relevant provision(s) in the context of the overall changes provided for in the Act.

2. Revocation – a bonfire of EU financial services and markets laws?

It is clear that the process of creating a comprehensive domestic model for financial services and market regulation – which will involve removing an intricate body of EU-derived financial services and markets laws from the UK statute book and, subject to the retention of some statutory framework provisions, replacing it with a UK Financial Services and Markets Act-based, rule-driven model – is not going to be completed overnight, even if there will shortly be a flurry of repeals of pieces of retained EU law relating to financial services and markets deemed to be unnecessary.

The Act establishes a framework that will enable the eventual revocation of retained EU law relating to financial services and markets. In this regard, "retained EU law" is wide ranging. (In this context, it should be noted that, by virtue of section 5 of the Retained EU Law (Revocation and Reform) Act 2023, which also received Royal Assent on the 29 June 2023, after the end of 2023 the term "retained EU law" will be known as "assimilated law", "retained direct EU legislation" will be known as "assimilated direct legislation" and "retained direct principal EU legislation" will be known as "assimilated direct principal legislation". However, because the Act as published uses the unamended "retained" terminology, this briefing does likewise.)

Schedule 1 to the Act lists a significant number of provisions to be revoked by name. This schedule is in five parts and includes:

• all retained direct principal EU legislation - i.e., the EU regulations that had been previously directly applicable and which were "onshored" into UK law at the end of the Brexit transitional period, including, among many others:
  • UK EMIR;
  • UK CRR;
  • UK MAR;
  • UK MiFIR;
  • UK SSR;
  • UK SFTR;
  • UK CSDR; and
  • UK PRIIPs.
• UK subordinate legislation that implemented or transposed EU obligations (such as the Financial Services and Markets Act 2000 (Markets in Financial Instruments) Regulations 2017, the Alternative Investment Fund Managers Regulations 2013, the Undertakings for Collective Investment in Transferable Securities Regulations 2011, a number of amendment regulations that made changes to elements of the Regulated Activities Order, the Financial Markets and Insolvency (Settlement Finality) Regulations 1999, the Financial Collateral Arrangements (No. 2) Regulations 2003, the Payment Services Regulations 2017 and, while not technically retained EU law, various Brexit "deficiency-correcting" instruments that made changes to such law);
• EU "tertiary" legislation, being any provision made under a number of named EU directives (including EU AIFMD, EU UCITS Directive, EU MiFID and EU CRD);
• A "catch-all" category of all other "EU-derived legislation" not falling within the above lists so far as "relating to financial services or markets"; and
• Certain specified provisions of FSMA.

On the face of it, that's a lot of combustible EU-derived financial services and markets material for a post-Brexit bonfire of regulation.

However, although section 1 of the Act stridently states that the legislation referred to in Schedule 1 "is revoked", such revocation will be controlled by the Treasury and it is already clear that the section 1 revocation will be effected on a piecemeal basis.

Broadly, the listed retained EU law provisions will be dealt with in one of three ways which will have an impact on the timing of their revocation:

• Where the relevant requirements are no longer needed, they will be repealed without replacement – i.e. there will be no need to wait for any regulatory rule changes. Repeal of these will be coming soon.
• Where the substance of the regulatory requirements is considered to be appropriate for the UK regime with no demonstrable need for policy changes, those requirements will be either restated in UK legislation or will be repealed to be replaced with regulatory rules.
• Where the government decides that the substance of the EU-derived regulatory requirements will benefit from a degree of policy change, HM Treasury will take the lead on making changes – but a combination of statutory and regulatory reform is likely.

To date, one commencement order has been made. The Financial Services and Markets Act 2023 (Commencement No.1) Regulations 2023 provide that only certain provisions listed in Schedule 1 are revoked on 11 July 2023, i.e.:

• specific provisions in the onshored UK Taxonomy Regulation that effectively release the Treasury from its obligations to make regulations (this is all pending the development of the UK Green Taxonomy); and
• The Money Market Funds Regulations 2018.

A raft of other provisions in Part 2 of Schedule 1 – nearly 100 of them - will be revoked on 29 August 2023. These are all pieces of UK subordinate legislation that the Treasury has decided can be repealed without replacement and whose repeal will not impact upon the operation of the UK financial services and markets regime.

Further provisions will be revoked on 1 January 2024, including the onshored version of the ELTIF regulation, parts of the Payment Accounts Regulations 2015 and some specified sections of FSMA 2000 (broadly to remove the current restrictions on the regulators' rules modifying, amending or revoking any retained direct EU legislation).

Beyond these more or less immediate revocations, however, the process will almost certainly be much slower. HM Treasury has been clear that it expects that it will take a number of years to complete the process of revoking retained EU law. It is likely therefore that, with the exception of those items which are no longer needed and which will be repealed without replacement, individual pieces of retained EU law will only be revoked once the structure of the regulators' "destination" rules and/or the appropriate UK financial markets policy are firmly established, and that the whole process will take place on a phased, piecemeal basis.

As a practical matter, given that the overall aim of the Smarter Regulatory Framework is (where appropriate) to replace provisions that are currently in retained EU law with UK rules, the revocation of individual parts will not in such cases happen unless and until the regulators have drafted and consulted on such rules and they are ready to be enforced. This will necessarily be a significant programme of work for the regulators, requiring a substantial commitment of resources and spanning a number of years. The FCA, in its 2023/24 Business Plan, acknowledged this.

As mentioned, to a significant extent, that process is already underway with the initiatives launched under the Edinburgh Reforms package last December. At that time, the government identified two tranches of retained EU law: tranche 1 included the outcome of the Wholesale Markets Review (much of which was incorporated into the Act), the Securitisation Review and the Solvency II review. Tranche 2 includes further reforms to the MiFID framework, PRIIPs, the Short Selling Regulation, the Payment Services Directive and the E-Money Directive, as well as the Capital Requirements Regulation and Directive.

In the paper published on 11 July 2023, Building a Smarter Financial Services Regulatory Framework for the UK: HM Treasury's Plan for Delivery, the government provides an update on its progress so far and sets out its indicative delivery dates for the making of the statutory instruments (during the rest of this year and into next). The government has already issued several draft SIs for comment. The regulators will separately have to make relevant rules to replace the repealed legislation.

How different in substance the replacement UK regimes will eventually be compared to the retained EU law that they will replace will depend on the extent to which policy change is required (and this in turn will have a bearing on how soon revocation will happen)(see above). At one end of the spectrum (and leaving aside the more immediate revocation of "unnecessary" EU-derived legislation), the exercise for some retained EU law will involve a relatively straightforward "lift and shift" approach where policy change is not considered appropriate (so, on the face of it, little more than a cosmetic relabelling exercise, figuratively replacing the EU flag with the Union flag). At the other end of the spectrum, to give effect to UK policy changes, a good deal more work by the Treasury and the regulators will be required to give effect to the transition.

What is certain is that, eventually, the FCA, the PRA and the Bank of England should be able to make and change rules considerably more quickly than the EU – or indeed the UK parliament – can make and change legislation, and without some of the checks and balances that parliamentary scrutiny currently provides (subject to the oversight provisions mentioned in Section 6 below). This will likely mean that there will be an increase in the volume and frequency of highly significant consultations, on which firms, FMIs and industry will have to focus often against tight deadlines.

So, if there is to be a bonfire of EU regulation, it is unlikely to be a fast and furious conflagration – rather, it is far more likely to be a rather slower-burning affair, with a series of controlled incinerations along the way towards a rebuilt framework. The first small fires have already been lit.

Pending their eventual revocation there will actually be some quite significant changes to some pieces of legislation. These are to give effect to the outcome of the 2021 Wholesale Markets Review and, broadly speaking, involve reforms to the UK's financial services regulatory framework for the capital markets.

These changes are described, somewhat confusingly, as "transitional amendments" – this is because they will take place during a time that the Act defines as the "transitional period". This, in relation to any EU-derived legislation, simply means the period ending with the eventual revocation of that legislation – in other words, the "transition" from the current regime founded on retained EU law to the final "destination" – i.e. the new, domestic rules-based regime. As the Treasury puts it, "each piece of [retained EU law] related to financial services is now within a "transitional period", lasting until the repeal of each piece is commenced by HM Treasury in a phased and sequenced manner". HM Treasury will retain the power to bring the transitional amendments into force at a time of its choosing, although there appears to be little reason why it would want to delay for long now the Act is law. As mentioned above, the first commencement regulations, The Financial Services and Markets Act 2023 (Commencement No.1) Regulations 2023 were made on 10 July 2023.

Schedule 2 to the Act sets out some specific amendments to particular pieces of legislation from Schedule 1 (though the Treasury retains to power to make further, unspecified transitional amendments subject to conditions (see below)).

The "transitional" changes that will be made to UK MiFIR, pending its eventual revocation and replacement by a FSMA-based regulatory rule regime, include the following:

• Share Trading Obligation [29 August 2023]: The provisions in Article 23 of UK MiFIR relating to the Share Trading Obligation will be removed – so firms will be free to trade shares on any UK trading venue or overseas, with any counterparty, or on an OTC basis. What is left of the article will be retitled "Investment firms operating internal matching systems" and will require (as now) that such firms which execute client orders in shares, depositary receipts, ETFs, certificates and other similar financial instruments on a multilateral basis must have Part 4A permission to operate an MTF.
• Derivatives Trading Obligation [29 August 2023]: Although the Article 28 UK MiFIR derivatives trading obligation (DTO) will remain, there will be changes:
  • The DTO will be aligned with the UK EMIR clearing obligation in terms of the counterparties that are in scope.
  • Under new rules, the FCA will have the power to suspend or modify the DTO, with the Treasury's consent. It may only give such direction if it considers that the suspension or modification is necessary for the purpose of preventing or mitigating disruption to financial markets and advances one or more of the FCA's operational objectives (the "conditions"). If a direction has effect for a period of longer than 6 months, the FCA must, as soon as reasonably practicable after the end of each applicable 6-month period, issue a statement as to why the conditions continue to be met.
  • The FCA will also be able to make rules that will disapply the DTO (and also the MiFID best execution obligation and the requirement to operate an MTF or OTF where a firm operates a multilateral system) where the firm carries out its activities as part of a risk reduction service (i.e. a service provided to two or more derivatives counterparties for the purpose of reducing non-market risks in derivative portfolios, such as portfolio compression). A corresponding amendment will be made to UK EMIR to provide for a power for the Bank of England to make rules providing for an exemption from the clearing obligation for use of such risk reduction services.
• Equity pre-trade transparency waivers: The existing statutory regime governing the basis upon which waivers from pre-trade transparency for equity instruments may be granted will be scrapped, so the 'hard wired' reference price, negotiated trade and large in scale waivers will go. Instead, the FCA will have the power to make rules in this regard, provided it considers such rules necessary or expedient for the purpose of advancing one or more of its operational objectives. Such rules may include whatever conditions on the application of the waiver that it considers appropriate. The FCA will also have the power to withdraw already-granted waivers and to suspend the availability of such waivers for up to six months (extendable by a further six months).
• Fixed income pre-trade transparency waivers: As regards fixed income instruments and derivatives, again the FCA will have the flexibility as regards pre-trade waivers (and their withdrawal and suspension) and will be required by rules to impose post-trade transparency requirements (which may include provisions relating to deferrals and suspensions).
• Double volume cap [29 August 2023]: The double volume cap mechanism under Article 5, UK MiFIR (which limits the use of the equity waivers under the existing reference price and negotiated trade waivers) is to be scrapped.
• Systematic internalisers: The definition of systematic internaliser will be narrowed back to the qualitative-only definition (i.e. by reference to the "organised, frequent, systematic and substantial basis" criteria (determined in accordance with FCA rules)) and the existing quantitative criteria will be removed. It will still be possible for firms to opt into the regime.

Under the UK Securitisation Regulation, certain securitisations can be designated as Simple, Transparent and Standardised (STS). Currently, banks and insurers are able to benefit from a preferential capital treatment (relatively speaking), in terms of how much capital they must hold, when investing in an STS securitisation as compared with other types of securitisations, but only where the originator and sponsor of that STS are established in the UK. The UK Securitisation Regulation will be amended to allow the establishment of an equivalence regime for STS securitisations originated in non-UK jurisdictions. Under the changes introduced by the Act, HM Treasury will be able to designate a country or territory outside the UK as having an STS securitisation framework equivalent to that of the UK. This in turn would mean that the preferential capital treatment outlined above would be extended to investments in such "STS equivalent non-UK securitisations".

It should be noted that these transitional changes relate narrowly to the establishment of an STS equivalent non-UK securitisation framework. Other changes that HM Treasury is now considering to the UK securitisation framework as a result of its 2021 report and as part of the Edinburgh Reforms – reflected in a recently published Policy Note and draft SI, The Securitisation Regulations 2023 which the government intends to lay before the end of this year – are outside the immediate changes proposed in the Act for the purposes of the "transitional period". (It should also be noted that, by the government's own admission, the draft Securitisation Regulations (and those draft SIs currently in circulation dealing with Solvency II and the MiFID data reporting services requirements) do not currently conform to the reform structure established by the new Act. Those draft SIs will be restructured, before they are finalised, to align with the new framework approach.)

Aside from the above, HM Treasury will also have the power to make further transitional amendments to any of the legislation referred to in Schedule 1 where it considers it necessary or desirable to do so for one or more listed purposes, including protecting and enhancing the stability of the UK financial system, promoting the effectiveness and functioning of the financial markets, and protecting UK economic competitiveness and protecting consumers.

3. New regulatory regimes

The Act also includes three new regulatory regimes which include new powers in respect of both authorised firms and, in some cases, unauthorised persons.

The Designated Activities Regime (DAR) is a new regime for the regulation of certain financial services activities outside the existing regulated activities authorisation regime. Initially, most designated activities are expected to be those which are currently regulated through retained EU law.

Under the DAR, HM Treasury has a power to designate certain activities relating to UK financial markets or exchanges and financial instruments, products or investments (including cryptoassets) issued or sold to, or by, persons in the UK. Under the designation, the designated activity may be prohibited or subject to specific rules and requirements. Where relevant, the FCA will be able to make rules in relation to designated activities and may also have the power to give directions and other enforcement powers. These powers will come into effect as from 29 August 2023.

Activities which are likely to be designated include certain activities related to derivatives; short selling; acting as an originator, sponsor, original lender or securitisation special purpose entity in a securitisation; selling a securitisation position to a retail client in the UK; certain activities related to benchmarks; offering securities to the public; and arranging for the admission of securities to trading.

The DAR will apply to both authorised and non-authorised persons and, therefore, persons who are not currently authorised or regulated by the FCA will find themselves subject to some regulatory rules in the future. HM Treasury's Plan for Delivery states that the designated activities will be included in a single statutory instrument, which may be updated from time to time, in much the same way as for regulated activities.

Third parties providing critical services to authorised firms, payment and e-money institutions and financial market infrastructures (FMI) may be designated as "critical" by HM Treasury. If designated, the services provided by such third parties will be subject to direct oversight by the Bank of England, the PRA and/or the FCA. This may include making rules, giving directions, gathering information and taking enforcement action.

The new regime is intended to address concerns around a large number of regulated firms or FMIs being dependent on a small number of third party service providers and the associated risks to the financial system in the event of the failure of such third party. Therefore, a third party may be designated as "critical" only if a failure in, or disruption to, the provision of the relevant services could threaten the stability of, or confidence in, the UK financial system. This assessment will include the materiality of the services provided and the number and type of service recipients.

A Discussion Paper on the exercise of these powers, including through minimum resilience standards and resilience testing, was issued by the Bank of England, the PRA and the FCA in July 2022. A survey was also issued to third parties in April 2023 to assist in determining the costs and benefits of implementing the proposed regime. These powers will come into effect as from 29 August 2023 and a further consultation is expected in the second half of 2023.

The Act introduces a new regime for the approval by authorised firms of the financial promotions of unauthorised persons. This is to address concerns that authorised firms may have been approving promotions relating to matters for which they have no particular expertise or where they have not carried out due diligence on the unauthorised person or the contents of the promotion.

The new regime takes the form of a regulatory "gateway". Broadly, any authorised firm wishing to approve the financial promotions of an unauthorised firm will first need to obtain the permission of the FCA to carry on this activity (unless a specific exemption to this requirement applies). The FCA will also be able to place limitations on the types of promotions that a particular firm will be able to approve. For example, a firm could be restricted to approving financial promotions in its field of expertise.

This new regime will allow for greater oversight of financial promotions by the FCA and will form part of the FCA's increased focus on the approval of financial promotions. Further measures by the FCA in this area are set out in FCA Policy Statement 22/10 and include requirements for firms to include their name (or Firm Reference Number) in any retail promotions that they approve as well as to monitor the continuing compliance of approved promotions.

The next steps are not entirely clear. The FCA stated that it would publish final rules once the Act is finalised but there is no date yet announced for when the relevant provisions of the Act will come into force.

4. New rules for financial markets infrastructures

The Act includes a new general rulemaking power exercisable by the Bank of England in relation to central counterparties (CCPs) and central securities depositories (CSDs), as previously proposed by the government in its Consultation on the Future Regulatory Framework Review. The power is exercisable to the extent that it appears to the Bank to be necessary or expedient for the purpose of advancing its Financial Stability Objective (as set out in section 2A of the Bank of England Act 1998). This broad new power will allow the Bank to replace provisions in retained EU law relating to the regulation of CCPs and CSDs with its own rules over time and also enable rules applying to CCPs and CSDs to be updated more quickly in response to emerging risks and new forms of technology, and developments in international standards.

While the power is exercisable primarily in relation to UK CCPs and CSDs, the Bank will be able to extend the application of rules applying to UK CCPs and CSDs (in whole or in part) to their overseas equivalents. Subject to an exception for systemic non-UK CCPs, the Bank may only apply rules to non-UK CCPs and CSDs to the extent it is authorised to do so under secondary legislation made by HM Treasury.

In addition, the Act enables the Bank to impose requirements (i.e. obligations not in the nature of a rule) on recognised CCPs, recognised CSDs or systemic non-UK CCPs (relevant FMI entities) to advance its Financial Stability Objective or if it appears to the Bank that the relevant FMI entity has failed, or is likely to fail, to satisfy the applicable recognition requirements or has failed to comply with another obligation imposed on it by or under FSMA. The Bank may also impose or vary a requirement in response to an application made by a relevant FMI entity. These powers are similar to the existing powers that the FCA and PRA have in relation to authorised firms they regulate under FSMA.

The FCA is granted a general rulemaking power in respect of recognised investment exchanges and data reporting service providers to enable it to replace the provisions in retained EU law relating to the regulation of these entities.

The Act provides HM Treasury with a new power to introduce an "FMI sandbox" through secondary legislation, allowing participating FMIs to test and adopt new technologies and practices for delivering FMI services within a "safe space". Participants in an FMI sandbox (including trading venues, CSDs and potentially other types of FMI or, in principle, other "persons" where designated by HM Treasury – which might, going forward, include payment systems) would be able to carry out such testing in a modified legal and regulatory environment with HM Treasury having the ability to temporarily "switch off" or modify the application of UK legislation that would otherwise apply to the participant's activities.

The UK government's ambition is for the FMI sandbox to foster effective innovation and competition in the provision of FMI services using developing technologies or new or different practices, ultimately providing benefits for users of FMI services and their participants or clients. It will also allow HM Treasury, regulators and the industry to better understand what changes might be needed to the FMI legislative framework to support the effective and safe adoption of new technologies such as distributed ledger technology. FMI sandboxes will be particularly attractive to both new and incumbent FMIs looking to offer new services, or implement new technologies, which are not wholly compatible with existing legal and regulatory rules. On 11 July 2023, HM Treasury published a consultation paper setting out its proposals for its first (and quite clearly not the last) FMI sandbox, which it is proposed will extend to arrangements for the trading and settlement of digital securities such as equities, bonds and money market instruments (but not derivatives, unbacked cryptoassets or payments effected through systems that are not embedded in a "digital securities depository").

The Act also provides the necessary powers for arrangements tested and implemented as part of an FMI sandbox to be made permanent. If the performance of an FMI sandbox is determined to have been successful, HM Treasury would have the ability to make permanent changes to legislation to allow FMIs to continue to use the new technologies or practices outside of the sandbox. It will be important for FMIs that do not participate in the sandbox to monitor future consultations which could give rise to changes with broader impacts.

Following a consultation by HM Treasury in July 2021, the Act introduces a Senior Managers and Certification Regime (SMCR) for UK CCPs and CSDs, which closely mirrors the existing SMCR for banks, insurers and other authorised persons and includes a Senior Managers Regime, a Certification Regime and Conduct Rules. The Act also gives HM Treasury the power to apply the SMCR to credit rating agencies and recognised investment exchanges.

The Bank and the FCA will also have the power to make prohibition orders if it appears that an individual is not a fit and proper person to perform an in-scope function.

In terms of timing, as we said in our June 2022 briefing on HM Treasury's response to its July 2021 consultation on an SMCR for FMIs, it is unlikely that this new regime will be in place in the short term. Besides the fact that the Bank will need to consult on its own detailed implementing rules, the Edinburgh Reforms included a re-examination of the SMCR itself, and it seems rather unlikely that the Bank would pre-empt the outcome of that review.

The prospective implementation of the SMCR for systemically important payment systems and specified service providers is not governed by the Act. That legislative process is being taken forward separately to a different, longer timeframe to account for the government's review (see below) of the regulatory perimeter for systemic firms in payment chains: see paragraph 5.4 of HM Treasury's Consultation Response, "Senior Managers & Certification Regime for Financial Market Infrastructures" (June 2022).

The Act reflects the legislative outcome of HM Treasury's February 2021 consultation on an Expanded Resolution Regime for CCPs, introducing a new, bespoke resolution regime for CCPs, intended to mitigate the risk and impact of a CCP failure and the consequential risks to financial stability and public funds. As the consultation noted, the current regime (introduced by the Financial Services Act 2012) pre-dates guidance on international standards in this field produced by the Financial Stability Board (FSB) as well as developments in the EU.

The regime therefore contains new and broader powers that the Bank of England may exercise in relation to a CCP in resolution, including powers to "tear up" one or more contracts with clearing members to return the CCP to a matched book, to make cash calls on clearing members, to take control of the CCP and to reduce or cancel variation margin payments owed to clearing members. Schedule 11 contains the detailed provisions and, at nearly 100 pages in the parliamentary version of the Act, will require careful consideration by CCPs.

5. Fintech and payments

The Act contains a number of provisions focused on payments (including payment systems) and fintech. We outline a number of the key provisions below.

Before and alongside the passage of the Act, there have been a number of other legal and regulatory developments in the payments and fintech space – both in the UK and internationally – including:

• HM Treasury's consultation and call for evidence on Payments Regulation and the Systemic Perimeter – which, in summary, set out various proposals in relation to changes to the regulatory and systemic perimeters in relation to payments, and provides additional context as to how the government and HM Treasury might exercise some of the powers included in the Act;
• the Law Commission's highly anticipated Digital Assets Final Report – which, among other things, recommended placing the status of digital assets as a third category of personal property (in addition to things in action and things in possession) on a statutory footing and implementing statutory reforms to clarify and support the use of crypto-tokens and other third category things as collateral, as well as its conclusions as to how English common law might develop to support the transfer, custody and use as collateral of, as well as the prevention of the unlawful or wrongful interference with, crypto-tokens and other third category things; and
• CPMI and IOSCO's final guidance on stablecoin arrangements – which, in short, sets out guidance on the application of the Principles for Financial Market Infrastructures to systemically important stablecoin arrangements.

The provisions in the Act should be understood in the broader context of the ongoing domestic, EU and wider international focus on the payments and fintech sectors, and the government's ambitions to maintain and grow the UK's position as a global fintech hub and leader in digitised financial services.

The Act introduces the concept of "digital settlement assets" (DSA). The term "DSA" is used in a number of places in the Act, including in relation to amendments to the Banking Act 2009 and the Financial Services (Banking Reform) Act 2013 (FSBRA) and in relation to certain new powers conferred on HM Treasury (each outlined further below).

The Act defines a "digital settlement asset" as:

"a digital representation of value or rights, whether or not cryptographically secured, that— (a) can be used for the settlement of payment obligations, (b) can be transferred, stored or traded electronically, and (c) uses technology supporting the recording or storage of data (which may include distributed ledger technology)."

The same definition is tracked into the amendments to the Banking Act 2009 and FSBRA.

This definition is broad and, notably, not limited to cryptographically secured assets or assets using DLT. However, and notwithstanding the breadth of the definition, the Explanatory Notes show a clear focus on stablecoins, which plainly fall within the definition, and which are often used as a "ramp" between fiat currencies and more volatile unbacked cryptoassets, such as cryptocurrencies. This focus is unsurprising and consistent with the policy direction outlined in HM Treasury's consultation and call for evidence, and its subsequent response. We therefore anticipate further developments in this area imminently.

The Act also gives HM Treasury the power to amend the definition – the Explanatory Notes confirm the intention to enable HM Treasury to amend the definition "in the event that there are changes in the features, underlying technology or usage of these assets, so that the regulation can continue to have effect as intended." This seems to be an implicit recognition that technology and innovation in digitised financial services is now developing at a pace and in a way which may require definitional amendments in the future, notwithstanding the broad and technologically-neutral way in which the definition of "digital settlement assets" has been drafted.

The Act amends the scope of Part 5 of the Banking Act 2009 to enable HM Treasury to recognise payment systems which use or involve DSAs, and certain service providers in relation to those systems (called "DSA service providers"). In essence, the effect is to expand the scope of those systems (and operators), and service providers to or connected with those systems, that can become subject to Bank of England supervision.

The term "DSA service provider" is given a prescriptive definition in the amendments to the Banking Act 2009, and captures (among others) persons providing services to a payment system who create or issue DSAs involved in the payment system, persons who provide services to "safeguard" DSAs, and persons which qualify as "digital settlement asset exchange providers" (which is itself specifically defined in the amendments).

The amendments to the Banking Act 2009 also extend the "specified service provider" (SSP) concept to include service providers to DSA service providers and service providers to (or connected with) payment systems that include arrangements using DSAs.

In addition to the amendments outlined in the Act, the government is also considering the feedback to its proposals to widen the scope of Part 5 of the Banking Act 2009 further. The proposals, outlined in HM Treasury's consultation and call for evidence on Payments Regulation and the Systemic Perimeter (which closed in October 2022), would enable HM Treasury to recognise (and bring into the scope of Bank supervision) certain "payment providers" and their service providers. For these purposes, "payment providers" are, in summary, those entities and actors within the payments chain that pose "systemic risk in [their] own right to the financial system or the UK economy". In other words, the proposals have the effect of extending Bank of England supervision beyond payment systems. The consultation acknowledged that some of these "payment providers" might also be subject to FCA's remit under the Payment Services Regulations or Electronic Money Regulations. The consultation explained that the proposal reflects the 'same risk, same regulatory outcome' principle – if actors in the payments chain pose systemic risk, they should be subject to the same supervision and regulation as other actors (like payment systems and other FMIs).

The Act also amends FSBRA to enable HM Treasury to designate payment systems which use DSAs, with the effect that those payment systems are subject to regulation by the Payment Systems Regulator (PSR).

Finally, the Act enables HM Treasury to make regulations (and confers a number of other and related powers on the Treasury) in relation to:

• the regulation of payments that include DSAs;
• the regulation of recognised payment systems that include arrangements using DSAs, recognised DSA service providers, and service providers connected with such recognised payment systems or recognised DSA service providers; and
• insolvency arrangements in respect of such systems and service providers.

The powers are very broad, but the Explanatory Notes to the Act provide more context and indicate that (among other things) these powers could (and perhaps are likely to) be used to "[e]stablish an FCA authorisation and supervision regime, drawing broadly on existing electronic money and payments regulation, to mitigate conduct, prudential and market integrity risks for issuers of, and payment service providers using, stablecoins". As outlined above, the focus on stablecoins is not surprising.

There is clearly a significant volume of consultation and secondary legislation to follow, which will be of fundamental importance to this fast-evolving (and globally connected) sector.

The Act contains important provisions in the context of authorised push payment (APP) and other scams which are not currently protected under the Payment Services Regulations 2017 (the 2017 Regulations).

The Act obliges the PSR to prepare and publish a requirement for payment service providers to reimburse victims in cases of payment orders made as a result of fraud or dishonesty which are executed over the Faster Payments Service (which, according to the PSR, is the payment system through which the "vast majority" of payments resulting from APP scams are processed).

The PSR commenced actively working on this well before the Act completed its passage through Parliament, publishing its Policy Statement in anticipation of Royal Assent, and the draft legal instruments very shortly afterwards. The proposals contemplate a central role for Pay.UK (as the operator of the Faster Payments Service) and represent a very significant change; including as they do a model in which liability for the cost of reimbursement will be shared between both the sending and receiving PSPs. The closing date for feedback on the draft instruments is 25 August 2023.

To support this action, section 72 of the Act also amends regulation 90 of the 2017 Regulations to make clear that it does not affect the liability of any PSP to reimburse victims under the requirement to be implemented by the PSR. This amendment is intended to address any (actual or perceived) concerns that regulation 90 – which provides that payments executed in accordance with the unique identifiers provided by the payer are deemed to have been executed correctly – might be a barrier to the exercise of any relevant powers.

The Act includes measures to support financial inclusion by ensuring people across the UK can continue to access cash, an issue that continues to receive much attention recently, partly in the context of difficulties that some faced during the pandemic and, more recently, as a consequence of the discussions about the Bank of England issuing a 'digital pound' (which is seen by some politicians and commentators as increasing the risk to the continued use of, and access to, cash).

This includes a power for the FCA to make rules to ensure the continued reasonable provision of cash withdrawal and deposit facilities, for example, by requiring designated firms to refrain from the closure of a cash access service where there is no suitable alternative.

The Act also establishes (by insertion of a new Part 5A in the Banking Act 2009) a statutory oversight regime of wholesale cash distribution throughout the UK (or any part of the UK), with the Bank of England given formal oversight responsibility over certain "recognised persons" specified under order by HM Treasury. This regime includes powers for the Bank of England to require the provision of information, give directions to recognised persons and publish principles and codes of practice that the industry must follow. The regime appears to be closely based upon the corresponding provisions applicable to recognised payment systems under Part 5 of the Banking Act 2009.

6. Regulating the regulators

The Act leaves unchanged the FCA's and PRA's existing functions and objectives, but has added a new "secondary" objective. The new objective will require the regulators, when discharging their general functions, to – as far as reasonably practicable – act in a manner which facilitates, subject to aligning with relevant international standards, the international competitiveness of the economy of the UK and its growth in the medium to long term.

The rationale for the new objective is that, as the regulators are tasked with setting detailed rules in areas currently covered by (formerly EU) law, they should have both the power and the responsibility to do so in a manner which promotes medium to long term growth and international competitiveness. Each regulator will be required to report to the Treasury on how it has complied with its duty to advance the competitiveness and growth objective. This objective, while secondary to the "primary" functions and objectives, is being seen as an important addition by many industry groups.

The Bank of England will also, for the first time, need to have regard to new regulatory principles modelled on the FCA and PRA's existing principles when exercising its FMI functions (which includes making rules and determining supervisory policy in relation to CCPs and CSDs). In addition, although the Bank's Financial Stability Objective will remain its primary statutory objective, a new secondary objective to facilitate innovation in the FMI services provided by CCPs and CSDs, with the aim of improving the quality, efficiency and economy of clearing and settlement services will be introduced. The Bank will also need to consider the effect that its regulation would or could have on the financial stability of other jurisdictions in which CCPs or CSDs may be established or provide services, and the desire to regulate these entities in a manner that ensures non-discrimination on the basis of nationality or location.

The FCA and PRA's existing sustainable growth principle is the desirability of sustainable growth in the economy of the United Kingdom in the medium to long term. That is to be replaced with a new, more granular and calibrated principle – the need to contribute towards achieving compliance with the UK's net zero emissions target as set out in section 1 of the Climate Change Act 2008 (where each regulator considers the exercise of its functions to be relevant to the making of such a contribution). The reason for the change is to embed the government's commitment to net zero specifically (as opposed to a more general commitment to sustainable growth) into the matters to which the regulators must have regard when discharging their functions. It had originally been proposed to retain the sustainable growth principle and supplement it with the new net zero principle, but this was considered unnecessary duplication. A version of this principle will also apply to the Bank of England (in respect of its FMI functions) and to the Payment Systems Regulator.

The Treasury will be required to prepare and publish an SDR policy statement, setting out the government's policies concerning sustainability disclosure requirements. The FCA and PRA will then be required, when making rules or issuing guidance on sustainability, to have regard to the Treasury's current SDR Policy Statement.

The Act contains a number of new provisions recognising the significant extension of powers that are being granted to the FCA, the PRA and the Bank of England (in respect of its supervision of CCPs and CSDs) and so seek to make them accountable to HM Treasury, but not under its control. The tenor of the new provisions (under the heading "FCA and PRA engagement") therefore tends to be "review, explain and consult", rather than "approval or veto".

• Reviews - The FCA, the PRA and the Bank will be required to keep under review rules made by them under statutory powers. Each regulator will be required to prepare and publish a statement of its policy with regards to how it conducts its reviews: this will have to provide information about how representations can be made and will be considered. HM Treasury will also have the power to direct the FCA, the PRA and the Bank to carry out a review of specified rules in certain circumstances – i.e. where the rules have been in force for at least 12 months, the Treasury considers that it is in the public interest that the rules are reviewed and it does not appear to the Treasury that the relevant regulator is carrying out or proposing such a review or, if it is, that such a review would be sufficiently effective. Where the Treasury has made a direction the relevant regulator must report as to whether the relevant rules under review are (broadly) compatible with the regulator's objectives and its new competitiveness and growth objective (see above).
• HMT power to direct the making of new rules [29 August 2023] – HM Treasury may make regulations to direct the FCA, the PRA or the Bank to make new rules in relation to a specific activity or a specific description of person. Such regulations may specify matters that the rules must cover and a timeframe within which the rules must be made. They may not, however, specify the form, content, or outcome of any rules made. There will also be a power for HM Treasury to make recommendations to the PSR and to the Bank; in the latter case, more specifically to an "FMI Committee" which the Act establishes and which will be the Bank's decision-making body for the purposes of its FMI functions.
• Matters to consider when making rules [29 August 2023] – Subject to the above power, while the Treasury's power will fall short of one of approval or veto, each regulator must nonetheless have regard to any general or particular matters that the Treasury has specified in regulations.
• Deference decisions and international trade obligations – The FCA, the PRA and the Bank of England (in respect of its regulation of CCPs and CSDs) are required to consult HM Treasury if they propose to make rules or take certain other steps where there is a material risk that to do so would be incompatible with a notified deference decision. Limited exceptions apply. (A deference decision is a decision by HM Treasury that the law or practice of another country is considered equivalent, either generally or in relation to a specific matter. In the UK, the process involves an assessment of whether the corresponding provisions provide an equivalent outcome (as opposed, for example, to being closely corresponding in their terms).) A similar obligation to notify, but in this case not to consult, HM Treasury is proposed where there is a material risk that the making of rules or taking certain other steps would be incompatible with an international trade obligation is proposed (although ultimately HM Treasury could use existing powers to block such rules or steps). [29 August 2023, in respect of deference decisions]
• Disapplication and waiver – The Act contains a provision which permits HM Treasury, in consultation with the relevant regulator(s), to make regulations which would broaden the existing framework allowing for the regulator to disapply or modify the application of certain rules to certain persons. This would not apply to rules of conduct, rules under the threshold condition code or trust scheme rules, scheme particulars rules, contractual scheme rules or contractual scheme particulars rules. There has been little commentary about this provision to date so it is difficult to gauge if or how it will be used in practice.
• Engagement with Parliamentary Committees [29 August 2023] – Where the FCA or the PRA issues a consultation containing proposals for new or changed rules, or proposals under one of its statutory duties or about the exercise of any of its general functions, then it must notify the chair of each Parliamentary Committee (the Treasury Committee of the House of Commons, the Committee of the House of Lords and the Joint Committee of both Houses).
• Engagement with statutory panels [29 August 2023] – The existing provisions in FSMA relating to the statutory panels – the FCA Practitioner Panel, the Smaller Business Practitioner Panel, the Markets Practitioner Panel and the Consumer Panel – are bolstered by additional provisions relating to the composition of the panels and the fact that the Treasury may by regulations require specified panels to produce an annual report and deliver it to the Treasury, which must then lay it before Parliament.
• Consultation on rules [29 August 2023] – The existing rules on consultation are subject to some relatively minor amendments. One of those amendments provides that, where representations have been made to the FCA by a Committee of the House of Commons or the House of Lords or a Joint Committee of both Houses, the account of the representations it has received in response to its consultation (which is already required) must also describe how the FCA has specifically considered the representations made by that Committee in making the rules.

Schedule 7 of the Act amends FSBRA to introduce very similar measures in respect of the PSR.

7. Other measures

The Act also includes some other miscellaneous amendments to the UK regulatory regime.

Under a provision which came into force on the day the Act was passed (29 June 2023), the Treasury is required to exercise the power conferred by section 49 of the Sanctions and Anti-Money Laundering Act 2018 (SAMLA) to make regulations amending Part 3 of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs).

These amendments are required to have the effect that, where a customer is a domestic politically-exposed person (PEP) (or a family member of a known close associate of a domestic PEP) the "starting point" is that the customer presents a lower level of risk than a non-domestic PEP. In the absence of enhanced risk factors, therefore, the extent of enhanced customer due diligence measures to be applied to that customer is less than the extent to be applied in the case of a non-domestic PEP.

Within 3 months of the Act being passed (i.e. by 29 September at the latest) the FCA is required to publish an update on its plan for reviewing its guidance on PEPs and within 12 months of the Act being passed (i.e. by 29 June 2024 at the latest) publish the conclusions of its review and (where it considers change is required) a revised draft for consultation.

Although this is not explicitly stated, this may go some way to addressing concerns around UK politicians' access to banking services as have been reported in the UK press.

HM Treasury will have the power to make regulations about unauthorised co-ownership alternative investment funds with the same or similar rights and liabilities for participants as for authorised co-ownership schemes including limited liability and segregated liability for umbrella schemes. This lays the ground for the introduction of new types of fund vehicles for professional investors, such as the proposed Reserved Investor Fund.

The Act expands some of the statutory disciplinary and enforcement powers that the FCA and the PRA have so that they may be exercised against formerly authorised firms for misconduct while they were authorised. These powers could only be exercised against firms which cease to be authorised on or after 20 July 2022 (so no retrospective effect) and could include public censure, financial penalties and/or requirement for restitution.

Also, the Act extends the circumstances in which the FCA and PRA may impose conditions on controllers to include where the FCA or PRA considers it desirable to do so in order to advance any of its objectives (but disregarding the economic needs of the market). The FCA's objectives include consumer protection, protecting the integrity of the UK financial system and promoting effective competition and the PRA's objectives include promoting the safety and soundness of PRA-authorised persons.

It does not seem likely that this will have a significant impact in practice and will only affect a small minority of cases.

New powers have been given to the Treasury to enable it to make regulations giving proper effect to mutual recognition agreements (MRAs) to which the UK is, or is expected, to become a party. MRAs are agreements between the UK and its international trading partners, in respect of which each of the parties recognises the law and practice of the other's jurisdiction as being equivalent to their own. Among other things, the Treasury now has the power to make changes to legislation to enable negotiated MRAs to be fully implemented, including granting additional powers to, or imposing duties on, the regulators to enable them to ensure full implementation. These powers came into force on the date on which the Act was passed.

8. Next steps

The Act received Royal Assent on 29 June 2023. The restructuring of the UK financial services and markets regime now proceeds in earnest: the next few months and years will be busy.

If you would like further information or assistance in understanding the Act and its implications, please speak to your usual Travers Smith contact or any of the individuals below.