Overview of the Financial Services and Markets Act (2024)

Why the Financial Services and Markets Act 2023 matters to us all

The Financial Services and Markets Act 2023 (the Act) is a landmark piece of legislation. It introduces significant and far-reaching reforms to the UK’s financial services landscape that will affect almost all financial services firms and those that use financial services and markets. The Act’s provisions will, directly or indirectly, affect us all.

This is the first of a number of Insight pieces that will consider the effect of some of the Act’s key provisions. Over the next few weeks, we will consider different aspects of the Act and explore in detail some of the themes identified in this overview. The issues are important to all of us because, whether they are evolutionary or revolutionary in nature, this Act will materially change the shape of the UK’s financial services regulatory environment and we all need to be prepared for the changes.

The Act and the Edinburgh Reform package

The Act provides tools through which many of the Edinburgh Reforms, announced by the Chancellor on 9 December 2022, will be delivered. However, perhaps more significantly, the Act also establishes the regulatory architecture pursuant to which the Financial Conduct Authority (FCA), Prudential Regulation Authority (PRA) and Bank of England (BoE) (together the Regulators) will regulate the UK’s financial services firms and those that use the UK’s financial services markets over the medium and longer terms.

Many of the features of this new regulatory architecture will be familiar to the financial services sector and the Act expressly builds on the established model of regulation set out in the Financial Services and Markets Act 2000 (FSMA) as applied in relation to the regulated activities regime.¹The reforms introduced through the Act are also designed to support the government’s wider ambitions to maintain the UK’s financial services sector as a hub for global financing and a place that encourages innovation without sacrificing financial stability. In particular, the Act seeks to

• bolster the competitiveness of UK markets;
• harness the opportunities of innovative technologies in financial services;
• promote the effective use of capital; and
• support the UK’s position as an independent trading nation.

There are also a number of measures which support the government’s wider policy objectives – for example:

• supporting the levelling up agenda;
• promoting financial inclusion; and
• increasing consumer protection.

Whilst near impossible to summarise the Act's 349 pages into a few sides of A4, we provide a whistle-stop tour of the Act’s central themes and key highlights.

Extending the FSMA model to fully regulate the financial services ecosystem

It is central to the Act’s measures that the expert and independent UK regulators will set, in their rules, firm-facing requirements, many of which are currently set out in retained EU law. This approach will allow the regulators to provide a more flexible and responsive approach that is tailored to the idiosyncrasies of the UK’s financial services markets.

However, the pre-existing regulated activities regime framework,² with its requirement for authorisation of a firm, is not appropriate to capture all activities that were regulated under the EU regimes (for example, the European Market Infrastructure Regulation (EMIR), the Alternative Investment Fund Managers Directive (AIFMD) or the Market Abuse Regulation (MAR)). Accordingly, the Act extends the FSMA model through the creation of two new regulatory frameworks:

• the Designated Activities Regime (DAR); and
• the new BoE CCP/CSD regulatory framework.

In addition, in measures that reflect the changing way in which financial services firms source key services, in particular IT services, the Act creates a new regime designed to regulate these third party providers that are deemed to be systemically important (the critical third party regime).

The DAR

Through section 8, the Act will introduce a new designated activities regime to provide a mechanism for the regulation of financial markets activities where HM Treasury considers it would be disproportionate or inappropriate to bring those activities within the scope of the regulated activities regime. The Act confers new rule-making powers on the FCA but, in accordance with the FSMA model, confers perimeter-setting powers on HM Treasury. The DAR borrows significantly on existing FSMA arrangements relating to supervision and enforcement, but allows for these existing arrangements to be modified to properly accommodate new designated activities.

The DAR will initially cover activities relating to financial markets exchanges, instruments, products and investments currently provided for in retained EU law, but may be used more broadly in the future. For example, in its consultation paper on the future financial services regulatory regime for cryptoassets, the government confirmed that, for public offers of cryptoassets which do not meet the definition of a security token offering, it is considering an alternative route to regulate the activity. The DAR may be used to prohibit these offers unless they were conducted via a regulated platform.

The BoE CCP/CSD regime

Through section 48, the Act inserts a number of provisions into the Bank of England Act 1998 which create a new formal committee of the BoE, the Financial Markets Infrastructure Committee ("FMI Committee"). The Act confers on the BoE, acting through the FMI Committee, a new general rule-making power over, and ability to impose requirements on, recognised central counterparties (CCPs), central securities depositaries (CSDs, together with CCPs, Financial Markets Infrastructure (FMI) firms) and systemic third country CCPs (the latter being a novel concept in UK law). This brings FMI firm rule-making into a similar model to that exercised by the PRA.³ Not to be left out, the FCA will also be empowered through section 11 of the Act to make rules for Data Reporting Services Providers (DRSPs) and Recognised Investment Exchanges (RIEs).

These reforms to the structure of the BoE are predominantly evolutionary in that they take the existing FSMA model and extend it to fill the gap that Brexit has created in terms of regulatory responsibilities. These changes have been well trailed and firms should be familiar with the foundations of the new regimes, even if some of the detailed powers are novel. However, how the new FMI Committee will exercise its new general rule-making power and develop the UK-specific versions of EMIR, for example, is not yet clear. FMI firms that are subject to the new UK-specific regimes will need to consider how these new regimes interact with other new regimes (for example, UK MiFID), and consider whether and how the changes will affect their regulatory obligations.

The critical third party regime

In light of financial services firms’ increasing dependence on third party service providers, the Act creates (through sections 18 and 19) a new statutory framework to manage systemic risk posed by these (currently unregulated) entities, such as cloud service providers. The new regime will extend only to those firms that are designated as “critical” by HM Treasury, which again means that HM Treasury sets the regulatory perimeter. Once an entity has been designated, then the regulators will have powers to require the designated entities to comply with certain requirements and powers to supervise and enforce compliance with the new rules. In July 2022, the FCA and PRA published a joint discussion paper on this subject, followed by a third party survey in April 2023 and are expected to consult on proposals relating to the oversight of critical third parties during the second half of 2023.

New HM Treasury powers regarding rules

The extension of the regulators’ responsibilities has led many to ask what the appropriate level of oversight of these regulators should be and how they can be held to account. Among other things, this has led to questions about the regulators’ relationship with HM Treasury and their wider relationship with Parliament and other stakeholders.

Whilst the power for HM Treasury to make firm-facing rules was not included in the Act, the Act does introduce four new developments of interest in terms of regulators’ rules generally. It:

• grants HM Treasury a power to prescribe matters to which the regulators must have regard when making specific sets of rules⁴;
• grants HM Treasury a power to require regulators to make rules in relation to a specific activity or a specific category of persons⁵;
• imposes on regulators a requirement to keep their rules under review (the rule-review obligation);⁶and
• grants HM Treasury a power to require regulators to review their rules.⁷

Again, before we can assess how these provisions will affect behaviours, we will have to watch to see how and when HM Treasury will exercise its new powers and what impact the rule-review obligation might have.

These arrangements are new but are not necessarily revolutionary. The EU had many similar powers, in particular the EU:

• could require members to make particular rules, or require rules in particular areas; and
• had reserve powers to require authorities to review whether their rules properly delivered the EU’s policy objectives in the domestic jurisdiction.

We do not expect to see HM Treasury utilise these new powers regularly and, importantly, the powers are carefully crafted to ensure that they do not intrude on the regulators’ independence, so they do not materially move away from the established principles underpinning the FSMA model.

An increasingly competitive financial centre

In recognition of the importance of financial services to economic growth generally, the Act imposes a new secondary objective on the PRA and FCA to act in a way that advances the international competitiveness of the UK economy and its growth in the medium to long term.

Cheerleaders for this measure hope that it will provide the regulators with an incentive to consider growth and competitiveness when pursuing their primary objectives. UK Finance, trade association for the UK banking and financial services sector, has strongly endorsed the PRA’s and FCA’s additional secondary objectives for growth and international competitiveness. Similarly, ISDA and AFME have welcomed the introduction of the new competitive objective: “this approach will ensure high regulatory standards are maintained while also putting an appropriate level of focus on competition”. ISDA and AFME further observed that “the culture and approach of regulators to implementing regulation and supervising compliance has a significant impact on UK competitiveness” and expressed their support of the PRA adopting a proactive approach to the new secondary objective.

However, sceptics warn that excessive concern for competitiveness could lead to a "recipe for excessive risk-taking".⁸ It is our view that the balance between financial stability and competitiveness/growth has been appropriately calibrated to facilitate the evolution of a more competitive post-Brexit financial services sector, without compromising the need for high regulatory standards tailored to the UK’s needs. It is also worth noting that the regulatory environment has changed dramatically from that which prevailed before the financial crisis – for example, the more developed rules on capital requirements, leverage ratios and corporate governance (such as the Senior Managers and Certification Regime). Accordingly, in our view, it is unlikely that the introduction of a new secondary objective is going to herald a return to “light touch” regulation.

There is also a development in the arrangements around HM Treasury’s powers to issue recommendations to the regulators. First, this power is now extended to include the Payment Systems Regulator⁹ and will also apply to the FMI Committee.¹⁰ Second, the regulators will now be statutorily required to respond to these recommendations.¹¹ These recommendations will allow HM Treasury to provide some guidance to the regulators on the government’s economic priorities and how the regulators might support that programme which links to the growth and competitiveness objective. We see these developments as an important reinforcement of the relationship between policymaker and rulemaker.

Supporting the UK as an independent trading nation

HM Treasury has indicated that, as part of Brexit, the UK is “retaking full control over its framework and approach for facilitating international financial services business and supporting [its] strengths as a global financial centre.”¹² The UK has developed a new approach to regulatory deference, including equivalence decisions, mutual recognition agreements and free trade agreements, and the Act contains provisions to facilitate this domestic trade agenda.

Section 32 introduces new section 409A into the FSMA and requires the regulators to consider how their actions might affect notified deference decisions and to assess whether there is a material risk that the relevant action will be incompatible with a notified deference decision.¹³ If the regulator concludes that there is material risk that the action will be incompatible with a notified deference decision, then the regulator must consult with HM Treasury. Deference decisions are defined as decisions by HM Treasury that the law and practice of another jurisdiction is equivalent to that of the UK.

Section 33 introduces new section 409B into the FSMA which has a similar effect as section 32, but it applies to a situation where a regulator proposes to take an action where there is a material risk that the action will be incompatible with an international trade obligation. In this section, international trade obligation means free trade agreement as defined by section 5(1) of the Trade Act 2021 or in the Marrakesh Agreement establishing the World Trade Organisation.¹⁴

These provisions will be increasingly important as the UK forges its new international partnerships and develops new models of mutual recognition and regulatory deference.

Harnessing tech

Pursuant to sections 13 to 17 of the Act, HM Treasury will be empowered to introduce FMI sandboxes to facilitate the testing of the adoption of new technologies by disapplying or modifying certain legislation and regulations. These proposals go further than the EU DLT pilot regime¹⁵ as they permit a broader range of participants, disapplication or modification of a broader range of legislation, and the focus is on “developing technology” not just Distributed Ledger Technology (DLT). HM Treasury has started working with the financial services regulators, with the first FMI sandbox expected to be up and running in 2023, which will explore the use of DLT securities settlement systems integrated with trading platforms.¹⁶

In the cryptoasset space, the Act had originally envisaged a new regulatory framework limited to “digital settlement assets” (stablecoins). However, amendments were subsequently introduced to expressly extend existing regulatory frameworks (regulated activities and financial promotions) and proposed regulatory frameworks (the DAR) to include cryptoassets and services relating to cryptoassets.

UK purpose-built regulation

Finally, and certainly not to be forgotten, the Act opens with a bang by revoking retained EU law relating to financial services. Section 1revokes all retained EU Law listed in schedule 1, but provides for HM Treasury to commence these revocations over time. This will allow a carefully choreographed process of repeal and replacement with custom-made measures enacted under the UK’s new regulatory architecture. The government’s policy paper, setting out its approach to repealing and replacing retained EU law on financial services to deliver a comprehensive FSMA model or regulation tailored to the UK, confirms that we can expect a phased approach. This will prioritise areas of legislation “where there is the greatest opportunity for beneficial reform”. The coveted first tranche includes the Wholesale Markets Review, Lord Hill’s Listing Review, the Securitisation Review and the review into the Solvency II Directive. We anticipate that this process will involve a simplification of existing rules – for example, the removal of complexities in EU legislation created by accommodating multiple legal jurisdictions and measures designed to achieve a single marketplace, where appropriate.

The process of revoking and replacing retained EU law is expected to take several years. Consequently, retained EU law will, typically, continue to apply for a transitional period until replacement rules are in place. This means that we should (in most cases) first expect regulators to draft and consult on their proposal for new rules to be implemented, before an instrument is replaced. However, the regulators are excused the consultation requirements in the FSMA where the new rules will change existing rules and, in its opinion, the changes are “not material” – see section 31(3)(b). It will be interesting to see to what extent the regulators rely on this process exemption and whether or not it will noticeably impact changes that financial services firms are hoping to see to requirements stemming from retained EU law already entrenched in the regulators’ rulebooks.

One challenge facing regulators, and industry, is that the process of reforming EU rules will necessarily involve different regulators to simultaneously work on rules which might have implications for the work of other regulators. We anticipate that there will be a significant degree of regulatory coordination over this process and that we will see linked reforms coming out at similar times, regardless of which regulator has ultimate responsibility for the new UK regime or where the instruments within which the provisions sit (for example, certain provisions in MiFID and EMIR).

The Act will also empower HM Treasury to make targeted modifications to retained EU law during the transitional period in order to prevent existing rules and regulations becoming out of date or ineffective. A number of transitional measures are already laid out in schedule 2 to the Act and will take effect until the relevant retained EU regulations are replaced with UK purpose-made alternatives. In particular, changes proposed to the UK’s retained MiFIR and EMIR include the removal of the share trading obligation, replacing the pre-trade transparency waiver regime and removing the double volume cap, as well as changes to the position limits regime and the transparency regime for fixed income and derivatives. We expect that many of these changes will be warmly greeted by financial services firms.

However, one of the most significant developments in UK financial services regulation might be the consolidation of the firm-facing requirements into a single sourcebook. Simplification of the rulebooks is one objective of the Future Regulation Framework Review,¹⁷ and the benefits to industry might prove to be extremely valuable in terms of ease of access.

It is important to note that much of the Retained EU Law (Revocation and Reform) Bill will apply to retained EU law included in schedule 1 to the Act. As a consequence, the supremacy of EU law in relation to retained financial services EU law (where not yet repealed under the Act) will be abolished. This might result in some interesting questions of interpretation of retained financial services EU law pending its revocation, and may result in HM Treasury and the regulators trying to draft legislation or rules to introduce some interpretative glosses that are currently housed in EU case law.

So, is it evolutionary or revolutionary?

In terms of whether this is evolutionary or revolutionary, there are elements of both in this Act. The scale of reform is certainly unprecedented over the past two decades, and maybe even longer, which might suggest that it is revolutionary. However, at its heart, the reform package extends an existing model of regulation and applies it to a much wider body of regulation, albeit that the timing of the changes will be relatively short and might appear dramatic. The package relies on the existing high-level regulatory structures and responsible entities, and is necessary in light of the removal of the EU’s rule-making function. There is, inevitably, still some uncertainty about how the powers will be used and what changes we might see in the long term. It is almost certainly the case that there will be many further opportunities for firms (and trade associations) to influence the development of policy – most obviously through consultation processes and the soon to be created CBA panel.

Overall, this is an exciting time for financial services regulation and there is a huge amount of opportunity for firms operating in or on the UK’s financial markets to achieve greater efficiencies and deliver innovative financial services targeted at UK market users.

1. Responses to the Future Regulatory Framework Review (FRF): Phase II Consultation, indicated that industry stakeholders agree the UK’s FSMA model is “world-leading” and that “no alternative model provided a preferable approach to financial services regulation”.
2. Implemented through Part II of FSMA and the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO)
3. The PRA’s functions are exercised by the Prudential Regulation Committee of the BoE pursuant to Part 3A of the Bank of England Act 1998 (as introduced by the Bank of England and Financial Services Act 2016).
4. See section 31, which introduces new section 138EA into FSMA.
5. See section 30, which introduces new section 3RE into FSMA.
6. See section 29, which introduces new sections 3RA and 3RB into the FSMA.
7. See section 29, which introduces new section 3RC into the FSMA.
8. See Letter regarding the dangers of a competitiveness objective for financial regulators, 16 May 2022.
9. See new section 102A to the Financial Services (Banking Reform) Act 2013, through section 51 and paragraph 4 of schedule 7 to, the Act.
10. See new section 30I of the Bank of England Act 1998, introduced by section 48of the Act.
11. See: new section 1JA(2A) of the FSMA, introduced by section 35 of the Act, relating to the FCA; new section 30B(2A) of the Bank of England Act 1998, introduced by section 35; and new section 102A(3) to the Financial Services (Banking Reform) Act 2013, introduced by section 51 and paragraph 4 of schedule 7 to the Act.
12. See paragraph 1.1 of Guidance Document for the UK’s equivalence Framework for Financial Services, November 2020.
13. A notified deference decision is a deference decision made by HM Treasury that is notified in writing to the regulators by HM Treasury pursuant to new section 409A(5)(b)introduced by section 32 of the Act.
14. See new section 409B(12)introduced by section 33 of the Act.
15. Established under Regulation (EU) 2022/858.
16. See the “Innovation in post trade services – opportunities, risks and the role of the public sector” speech by Sir John Cunliffe on 28 September 2022.
17. See paragraph 2.40 in the Financial Services Future Regulatory Framework Review: Phase II Consultation, October 2020.