Financial Services & Markets Bill: Innovate Finance Briefing
About Innovate Finance
Innovate Finance is the independent industry body that represents and advances the global FinTech community in the UK. Innovate Finance’s mission is to accelerate the UK's leading role in the ﬁnancial services sector by directly supporting the next generation of technology-led innovators.
The UK FinTech sector encompasses businesses from seed-stage start-ups to global ﬁnancial institutions, illustrating the change that is occurring across the ﬁnancial services industry. Since its inception in the era following the Global Financial Crisis of 2008, FinTech has been synonymous with delivering transparency, innovation and inclusivity to ﬁnancial services. As well as creating new businesses and new jobs, it has fundamentally changed the way in which consumers and businesses access ﬁnance.
What is the Financial Services & Markets Bill?
The Financial Services & Markets (FSM) Bill has its Second Reading in the House of Commons on 7 September 2022. The Bill makes provisions to create a new, post-Brexit regulatory framework for UK ﬁnancial services. As well as transferring new powers to the UK regulators, which were previously exercised by EU institutions, the Bill is an opportunity to update the regulatory system and future proof it for new technology, products and services.
Why is it relevant to FinTechs?
The UK has consistently attracted the most global investment in FinTech after the US. Last year we reported a record-breaking $11.6 billion USD invested into FinTech in the UK, more than the next 6 European countries combined. Our recent 2022 half year report showed that whilst this is levelling oﬀ, investment in the UK in H1 this year still exceeded H1 2021. This is a testament to the strength of our ecosystem, including our innovative entrepreneurs and founders, strong and diverse talent pool, and a supportive policy and regulatory framework.
But we can not rest on our laurels, as the pace of change accelerates and we are seeing a new wave of digital transformation take place in ﬁnancial services. Maintaining our global standing in FinTech innovation is critical to maintaining the UK's global standing in ﬁnancial services as a whole. We need a regulatory framework which creates the right powers and principles to enable the UK’s regulatory system to adapt and support innovation and international competitiveness. Below are the critical areas of the Bill that are relevant to (current and potential) UK FinTechs.
Source: Innovate Finance 2022 Summer Investment Report
Cryptocurrencies regulation - stablecoins
The FSM Bill provides the enabling powers for a much needed regulatory framework for stablecoins. It will:
- Enable the FCA to establish an authorisation and supervision regime to mitigate conduct, prudential and market integrity risks for issuers of, and payment service providers using, stablecoins.
- Enable HM Treasury to designate ‘systemic’ stablecoin providers and operators and for the Bank of England to regulate these to mitigate ﬁnancial stability risk, deﬁned as services threatening the stability of, or conﬁdence in, the UK ﬁnancial system, or have serious consequences for business or other interests in the UK.
- Enable the PSR to regulate payment systems using stablecoins (digital settlement assets), to address issues relating to competition, innovation, user interests and access.
- Enable HM Treasury to apply the Financial Markets Infrastructure Special Administration Regime, a bespoke administration regime to mitigate the risks to ﬁnancial stability associated with a systemic stablecoin ﬁrm’s failure.
- Finally, it will allow HM Treasury to amend or disapply existing FCA or PRA rules in areas relating to ﬁnancial stability to avoid relevant systemic stablecoin ﬁrms being subject to conﬂicting requirements.
The adjustments taking place in crypto asset markets make Government plans for regulation of stablecoins more important and more urgent. Arguably much of the recent volatility has arisen from a lack of clarity, consistency and transparency, which good regulation should provide. UK Government plans for the regulation of systemic stablecoins would provide veriﬁed, standardised approaches to capital assets underpinning stablecoins. This would provide the assurance that the market has realised (belatedly) it currently lacks. Some of the wider volatility in markets has also been triggered by questions being asked about custodial activities and the guarantee of customer funds in the event of a service provider bankruptcy. Custodial activities relating to stablecoins are one of the issues that industry players have been working on and where industry standards by the Government are greatly anticipated.
The UK has been at the forefront of payment innovation and pressing on with the Government vision creates the opportunity to maintain this new wave of transformation. The success of the FSM Bill in regulating cryptocurrencies will be determined by the speed and detail of implementation as well as collaboration with industry. We support the provisions in the Bill. It is important to give regulators the powers set out in the bill as quickly as possible and for these powers to then be exercised to develop a proportionate, competitive approach that protects consumers and supports innovation.
Financial Services Infrastructure Sandbox: Regulator-as-a-Platform
The Bill enables HM Treasury to set up one or more Financial Market Infrastructure (FMI) sandboxes, which will enable participating ﬁrms to test and adopt new technologies and practices. An FMI sandbox will do this by enabling participating ﬁrms to be subject to temporary modiﬁcations to legislation, where that legislation does not currently accommodate such activities or is ambiguous as to whether or not it can be accommodated. HM Treasury will also be able to make permanent changes to legislation via secondary legislation, on the basis of what is learned in each FMI sandbox. HM Treasury will be able to temporarily display or modify relevant legislation relating to the regulation of FMIs and to allow FMI entities to innovate, within the scope of the activities they have been authorised to carry out, in an FMI sandbox.
This is a radical reform to support innovation and allows for a very ﬂexible ‘beta testing’ approach to regulation for participating entities. This is the concept of ‘regulator as a platform’ – applying the tech model to regulatory activities. This goes beyond current sandbox models – which are a form of ‘hand holding’ whilst new businesses develop and adopt existing regulatory rules. They particularly have in mind DLT-enabled and digital asset-enabled market infrastructure such as the development of blockchain (and other technology based) capital markets infrastructure. The regulatory approach FMI sandboxes represent will be important in enabling the UK to remain at the forefront of the next wave of digital innovation around payments and ﬁnancial market infrastructure.
The ﬁrst wave of FinTech innovation over the last decade transformed the customer experience and the ‘front end’ of ﬁnancial services (user interfaces and consumer friendly apps and platforms). The next wave of crypto-related innovation will transform the ‘backend’ of ﬁnance, including the infrastructure or ‘plumbing’ of capital markets. Trading venues (such as stock exchanges and multilateral trading facilities) and post-trade infrastructures (clearing houses and settlement systems) provide for the transfer of legal ownership of assets and are therefore underpinned by the record or documentation of that ownership and trade. Moving to a system of digital record - or digital assets (in some cases using distributed ledger technology, but not necessarily) can enhance the functionality and eﬃciency of the ﬁnancial system. Digital tokens hold the promise of representing existing ﬁnancial assets, such as bonds or shareholdings, in a way that may be more eﬃcient if proven at scale. Digitalisation can also enable the exchanges themselves to be programmed with prudential controls to spot signs of ﬁnancial instability or unusual trading patterns. Potentially blockchain or DLT can also allow regulators to be able to digitally monitor the market in real time.
The UK Government’s proposals for a PRA/FCA ‘sandbox’ for Financial Markets Infrastructure are a welcome approach to supporting innovation in ﬁnancial services. This should provide a blueprint for all future ﬁnancial services regulation – and it would be helpful to have a commitment from the Government to evolve this across the regulatory system.
- Regulators: objectives and consistency
The Bill introduces a new ‘secondary’ objective for the Financial Conduct Authority (FCA) and the Prudential Regulatory Authority (PRA) to have regard to the competitiveness of the UK and for economic growth . Regulators will have to report annually on how they are applying this. We are supportive of the Financial Services and Markets Bill, including a competitiveness objective for regulators. This is critical to supporting proportionate rules that promote innovation and ensure better outcomes for consumers. The Bill could, however, be bolder in putting in place a system that ensures that regulators do support international competitiveness.
We would propose strengthening the Bill in the following areas:
- Promoting competitiveness
The Bill introduces a secondary objective for the ﬁnancial regulators which charges them with ‘facilitating the international competitiveness of the economy of the UK’. This falls some way short of encouraging the type of action taken by our competitors such as Singapore, where the regulators actively promote their market alongside the government and industry. An amendment to replace (or append) ‘facilitating’ with ‘promoting’ competitiveness would make a big diﬀerence.
This is not about reducing consumer protection or ﬁnancial stability measures. In a global ﬁnancial system, where technology enables people to make transactions and investments anywhere around the world, protecting UK consumers in part depends upon increasing their access to products and services that fall within the UK regulators' rules, which in turn means creating a stable and proportionate regime that attracts providers to the UK.
There is a case for extending the existing competition objectives of the PRA and FCA to the Bank of England - especially as areas like central bank Digital Currency and the capital requirements rules for challenger banks very much need to take account of competition in the market and avoid favouring incumbents or a few large market players.
- Payment Systems Regulator (PSR)
The proposed new regulatory framework in the Bill only applies to the PRA and FCA. The PSR could be more aligned to the framework for FCA and PRA - including the competitiveness objective - as the PSR will be dealing with more and more critical areas including open banking in payments and stablecoin.
- Regulatory cooperation and Financial Ombudsman Service (FOS)
The Bill contains sensible provisions on cooperation between FCA, FSCS and FOS - again, PSR might be included too (FOS will pick up complaints against handling of APP scam reimbursement cases, regulated by PSR). Inconsistent interpretation of rules by FOS and FCA is a major concern amongst our members. Firms reach an understanding with the FCA only to ﬁnd that the FOS takes a diﬀerent view in its case rulings. This creates uncertainty and unpredictability. We would welcome a provision to establish a principle whereby FOS should refer issues to the FCA and 'take regard" of an FCA opinion.