Finance sector – what lies ahead in 2020?

March 2020 | SPOTLIGHT | BANKING & FINANCE

Financier Worldwide Magazine

March 2020 Issue

Financial institutions (FIs) are facing yet another busy year in 2020. In this article we touch on some of the key regulatory initiatives that will be demanding their attention, including, of course, Brexit.

Brexit

An important part of the Withdrawal Agreement is that there shall be an implementation period. This period began when the UK left the EU on 31 January 2020 and ends by default on 31 December 2020. During this period, UK FIs will still be able to passport their services into the EU27 (and vice versa for EU27 FIs) and EU financial services law will continue to apply in the UK. The implementation period can be extended on a one-off basis for up to two years where the EU and UK agree, but such agreement must, however, be made before 1 July 2020.

Given the length of time that trade negotiations can take with the EU, it was expected by many that in July there would be an agreement on an extension to the implementation period. However, following the general election the Conservative government made certain amendments to the legislation which ratifies the Withdrawal Agreement into UK law, the EU (Withdrawal Agreement) Act 2020, while it was undergoing the Parliamentary process. Such amendments included a prohibition on any UK minister from agreeing to an extension of the implementation period. In light of this, firms could possibly be facing another cliff edge scenario in December if the implementation period is not extended and the trade negotiations move slowly during the year.

From a financial services perspective, the political declaration does not give too much away, although both the UK and the EU are endeavouring to conclude their respective equivalence assessments by the end of June 2020. Many feel that this deadline is too ambitious, and it remains to be seen whether this can be achieved. Whether the EU’s equivalence regime will be tweaked in response to Brexit also remains to be seen.

Culture and accountability

The accountability agenda will be an important component of 2020. Financial Conduct Authority (FCA) solo-regulated firms entered the Senior Managers and Certification Regime (SMCR) on 9 December 2019. Firms spent much time and energy in preparing for the ‘day 1’ requirements of SMCR, but in 2020 they will need to stay on top of their obligations, including embedding the certification process – 9 December 2020 is the deadline for FCA solo-regulated firms to complete fitness and propriety assessments – and developing appropriate onboarding and induction processes so that new employees are aware of the new requirements, particularly the conduct rules.

Firms will also be mindful that, as their business develops over the course of the year, there may be a need to check at the six month and one year milestones of the SMCR whether their governance framework continues to be fit for purpose. Another area of focus for firms will be keeping an eye on any enforcement action that the FCA takes against firms for breaches of the SMCR. The SMCR also comes into force for benchmark administrators on 7 December 2020.

Sustainable finance

Regulators and policymakers are expected to intensify their focus on issues concerning sustainable finance. For example, in the UK, following its October 2019 feedback statement on climate change and green finance, the FCA is expected to publish in early 2020 a consultation paper that will clarify existing disclosure obligations relating to climate change risk and propose new disclosure rules for certain issuers. These will be aligned with the Task Force on Climate-Related Financial Disclosures’ recommendations, at least initially, on a ‘comply or explain’ basis. At the EU level, firms will be reviewing the draft level 2 measures that will be produced by the European supervisory authorities under three pieces of newly created legislation: (i) the Regulation on sustainability-related disclosures in the financial services sector; (ii) the Regulation on the establishment of a framework to facilitate sustainable investment (the Taxonomy regulation); and (iii) the Regulation on low carbon benchmarks.

In addition, the revised Capital Requirements Regulation (CRR II) and Capital Requirements Directive (CRD V) contain three mandates for the European Banking Authority (EBA) in the area of sustainable finance. The first, Article 98(8) CRR II, calls on the EBA to assess the potential inclusion of environmental, social and governance (ESG) risks in the supervisory review and evaluation process performed by Member State competent authorities. The second, Article 449a of CRR II, requires large institutions with publicly listed issuances to disclose information on ESG risks, physical risks and transition risks as defined in the report referred to in Article 98 of the CRD V. The third requires the EBA to assess whether a dedicated prudential treatment of exposures related to assets or activities associated substantially with environmental or social objectives would be justified (as a component of Pillar 1 capital requirements).

FinTech

Technology will continue to change the financial services landscape. Innovation offers huge opportunities for consumer good but can also be an enabler of new forms of harm. The question of what sits inside and outside the regulatory perimeter matters because it determines where consumers are protected and where they are not, and when a regulator can take action and when it cannot.

In the UK, HM Treasury will be consulting on potential changes to the regulatory perimeter to extend it to crypto-assets with comparable features to specified investments, and an exploration of whether and how exchange tokens (such as bitcoin) and related firms (such as exchanges and wallet providers) could be regulated.

In the EU the European Commission will follow up on its December 2019 public consultation on the future EU framework for markets in crypto-assets. Launched in parallel with a public consultation on a digital operational resilience framework for financial services, both consultations are initial steps towards the implementation of the Commission’s new president Ursula von der Leyen’s objective for Europe to grasp “all the potential of the digital age and strengthens its industry and innovation capacity, within safe and ethical boundaries”.

Internationally, the Basel Committee on Banking Supervision will be reviewing the responses to its December 2019 discussion paper on the possible prudential regulatory treatment of crypto-assets. Significantly, the Basel Committee has already stated that should it consult on minimum standards for internationally active banks, jurisdictions would be free to apply more conservative measures, including prohibiting such banks from having any exposures to crypto-assets.

Retail sector

The retail sector will see a number of developments in 2020, including the remaining new FCA rules relating to overdrafts coming into force in April. In terms of mortgages, regulation lenders will be gearing themselves up to deal with the changes to the FCA’s mortgage lender and administration return reporting requirements that come into force on 1 October 2020.

Interestingly, just before Christmas, the FCA launched a call for input exploring opportunities and risks arising from ‘open finance’, which is the extension of open banking-like data sharing and third-party access to a wider range of financial sectors and products. A feedback statement is expected from the FCA this year, following the closure of the call for input on 17 March 2020.

Prudential requirements for EU investment firms

The way in which EU investment firms are to be treated for the purposes of prudential regulation is changing. The introduction of the Investment Firms Regulation (IFR) and the Investment Firms Directive (IFD) will make significant alterations to the prudential framework governing investment firms. The regime deviates from the strict Markets in Financial Instruments Directive (MiFID) II services-based categorisation and uses instead quantitative indicators (so-called K-factors) that reflect the risk that the new prudential regime intends to address. The new regime will mean higher regulatory capital requirements for most investment firms, subject to transitional phasing-in. It will also mean new remuneration rules based on those that are currently applicable to banks, and internal governance and disclosure and reporting requirements.

The IFR becomes directly applicable in Member States 18 months following its entry into force (26 June 2021). Member States have 18 months following the entry into force of the IFD to adopt and publish measures that transpose the Directive. Most of these measures come into force after the 26 June date. The IFR also contains a number of transitional provisions. Systemically important EU investment firms have a deadline of 27 December 2020 in which to apply for authorisation as credit institutions.

The FCA stated in its ‘2019 Business Plan’ that it intended to publish a consultation paper in Q4 2019 on the implementation of the IFR and the IFD. The paper has not yet been published and is now expected in Q1 2020.

Payment services

Payment services and open banking will continue to be a topical area in 2020. An area where there may be increasing focus may be the rise of alternative providers, primarily technology companies. E-commerce firms will also be working on their implementation of the strong customer authentication (SCA) requirements under the revised Payment Services Directive. Following an FCA statement and ‘Dear CEO’ letter last August, these firms were given an extended period until 14 March 2021 in which to implement the SCA requirements.

LIBOR reform

Last November, the FCA published a useful speech by Edwin Schooling Latter, director of markets and wholesale policy, concerning the next steps in the transition from the London Inter-bank Offered Rate (LIBOR). In relation to the sterling swaps and loan markets, Mr Latter mentioned that the FCA will be encouraging market makers to make the Sterling Overnight Index Average (SONIA) the market convention from Q1 2020. Mr Latter also noted that LIBOR continues to be common among corporate lending, including syndicated loans. The Bank of England and FCA Working Group on Risk-Free Reference Rates have set a target of Q3 2020 to stop new lending using LIBOR. As a result of this, the FCA expects significant infrastructure and documentation preparation, customer communication and staff training exercises for some banks.

EU legislative reviews

2020 will also see some important EU legislative reviews. For example, in a keynote address in Frankfurt last year, the European Securities and Markets Authority (ESMA) chair, Steven Maijoor, stated that MiFID II had achieved some of its goals, such as increased transparency in markets and moving trading volumes onto regulated venues, but recognised there are areas where improvements may need to be considered. In particular, Mr Maijoor added that the industry could expect several key consultations and review reports, specifically on the MiFID II transparency regime, including the double volume cap, derivatives trading obligation and systematic internaliser regime. In the spring of 2020, ESMA is expected to submit its final report to the Commission following its consultation last October on the review of the Market Abuse Regulation. The Commission is also expected to publish in 2020 its report on the functioning of the Alternative Investment Fund Managers Directive.

In the market

The market itself appears to have remained relatively robust in the face of ongoing regulatory reform challenges and the enduring ‘lower for longer’ interest rate environment. Aside from the above developments, certain other focus areas highlighted in the Financial Stability Board’s (FSB) 2020 work programme present both challenges and opportunities for the domestic and global financial services community in the year ahead – in particular, non-bank financial intermediation, cross-border payments and correspondent banking, and cyber resilience and the finalisation of the FSB’s toolkit in this area.

Ultimately, with the relatively benign interest rate environment set to continue for the foreseeable future, the ongoing pressure on banks to increase top line revenue in an increasingly capital-efficient way will drive innovation, but the challenge for the banks will be to do this without increasing the underlying risk profile of the business in an unsustainable way.

Simon Lovegrove is the global head of financial services knowledge, innovation and products, and Alan Bainbridge is a partner at Norton Rose Fulbright. Mr Lovegrove can be contacted on +44 (0)20 7444 3110 or by email: simon.lovegrove@nortonrosefulbright.com. Mr Bainbridge can be contacted on +44 (0)20 7444 3279 or by email: alan.bainbridge@nortonrosefulbright.com.

Simon Lovegrove and Alan Bainbridge

Norton Rose Fulbright