i Prudential Regulation Authority
For many years, the United Kingdom's regulation of financial markets and of providers of financial services was in the hands of a statutory body known as the Financial Services Authority (FSA). However, in the wake of the financial crisis of 2008, the responsibility for prudential supervision of systemically important banks and other providers of financial services was transferred to the Bank of England in its capacity as the Prudential Regulation Authority (PRA). Currently, the PRA is responsible for the prudential regulation and supervision of around 1,500 UK banks, building societies, credit unions, insurers and major investment firms.
ii Financial Conduct Authority
UK banks and other providers of financial services that do not fall within the scope of the PRA for the purposes of prudential regulation and supervision are prudentially regulated and supervised by the successor to the FSA, the Financial Conduct Authority (FCA). The FCA is also responsible for regulating and policing the conduct of all firms carrying on regulated activities in the financial services sector in the United Kingdom (UK), whether those firms are prudentially regulated and supervised by the FCA or the PRA. Therefore, PRA-regulated firms are de facto dual-regulated firms: by the PRA for prudential regulation and by the FCA for conduct purposes.
Financial services legislation
There are two major pieces of primary legislation that govern much of the activity in financial services in the UK: the Financial Services and Markets Act 2000 (FSMA) and the Banking Act 2009 (Banking Act). Much of the detail of financial services regulation in the UK is found in the Rulebook of the PRA and the FCA Handbook, which contain legally binding rules made by the PRA and the FCA, respectively, under powers granted to them by the FSMA.
In addition, much of the legislation in this area originates at the EU level and either has direct effect in the UK (and other EU Member States) without the need for any domestic implementing legislation, such as the Prospectus Regulation,2 the Market Abuse Regulation3 and the Capital Requirements Regulation,4 or is given effect in the UK by provisions of the FSMA, the Banking Act, the PRA Rulebook or the FCA Handbook, such as the Transparency Directive,5 the Markets in Financial Instruments Directive6 (MiFID II) or the Bank Recovery and Resolution Directive.7
ii THE YEAR IN REVIEW
Casting its shadow over everything in the capital markets, and elsewhere, has been the UK's decision to leave the European Union (EU). While there have been many predictions of what might happen upon exit, there have been rather fewer concrete steps that enable predictions to be made with any accuracy.
On 29 March 2017, the UK gave notice under Article 50 of the Treaty on the European Union of its intention to exit the EU, setting the exit date as 29 March 2019 and starting a process of negotiations with the EU regarding the terms of the exit and the framework of the future trading relationship between the remaining EU Member States and the UK. This original exit date has subsequently been postponed three times and is currently scheduled for 31 January 2020. A withdrawal agreement and political declaration on the future relationship between the UK and the EU was endorsed by a decision of the European Council on 17 October 2019. Among other things, the agreement provides that, although the UK will formally exit the EU on exit day, it will continue to apply EU law in such a way that it produces in the UK the same legal effects as those it produces within the EU (subject as otherwise provided in the agreement). By the same token, EU Member States will continue to treat the UK as a Member State during the transition period (subject as otherwise provided in the agreement). This transition period is scheduled to last until 31 December 2020.
However, the UK parliament has so far failed to approve the withdrawal agreement and political declaration, leaving open the very real possibility that the UK will leave the EU on exit day without any withdrawal agreement and without any transition period coming into effect. To guard against this possibility, the UK has enacted legislation in the form of the EU (Withdrawal) Act 2018 (EUWA) and several hundred pieces of secondary legislation made under the EUWA which, among other things, is intended to convert the acquis – the body of European legislation – into UK law at the moment of the UK's exit from the EU so that, to the greatest practical extent, the same rules and laws will apply in the UK on the day after exit as on the day before.
In addition, this legislation provides, so far as the UK is concerned, for the responsibilities of EU bodies to be reassigned to UK authorities (the Bank of England (PRA) and the FCA) and for the creation of a temporary permissions regime (TPR), which will allow firms within the European Economic Area (EEA) that have lost their passporting rights on the UK's exit from the EU to continue operating in the UK for a time-limited period after the UK has left the EU; and provide those firms wishing to maintain their UK business permanently with sufficient time to apply for full authorisation from UK regulators.
It also provides that prospectuses approved by a competent authority in another Member State of the EU and passported into the UK before exit day will be grandfathered for use in the UK until their validity expires.
ii Benchmark reform and LIBOR transition
One unexpected consequence of the financial crisis of 2008 was the highlighting of both the critical importance and fragility of the major interest rate benchmarks, particularly the Interbank Offered Rates (IBORs). Following a major review, the Financial Stability Board recommended in 2014 developing alternative, nearly risk-free reference rates (RFRs).
In a speech on 27 July 2017, Andrew Bailey, the Chief Executive of the FCA, gave this process considerable momentum by questioning the future of the London Interbank Offered Rate (LIBOR) and announcing that the FCA had secured agreement from panel banks for sustaining LIBOR until the end of 2021 but that, beyond this date, the FCA would no longer use its powers to sustain LIBOR by persuading or obliging panel banks to continue to provide submissions.
Since this speech, there has been a dramatic increase in the efforts of authorities and market participants around the world to develop RFR-based benchmarks that suit market participants' requirements as well as or better than IBORs, to develop provisions for new contracts that are suitable for the new RFRs and to develop robust fallback provisions that deal more satisfactorily with a primary benchmark ceasing to be available for any reason either completely or for a prolonged period.
In the past year this has led to things such as the following:
- the almost complete cessation of new public issues of floating rate debt securities referencing sterling LIBOR maturing beyond the end of 2021;
- a significant volume, both in terms of number and value, of new public issues of floating rate debt securities referencing the Sterling Overnight Index Average benchmark (as the preferred alternative RFR for use instead of sterling LIBOR identified by the Working Group on Sterling Risk-Free Reference Rates sponsored by the Bank of England) or the Secured Overnight Financing Rate benchmark (as the preferred alternative RFR for use instead of US dollar LIBOR identified by the US Working Group, the Alternative Reference Rates Committee (ARRC), sponsored by the Federal Reserve Bank of New York);
- the working group on euro risk-free rates (sponsored by the European Central Bank) announcing that the Euro Overnight Index Average (EONIA) will, with effect from 2 October 2019, be recalibrated as the euro short-term rate (€STR) plus a fixed spread of 0.085 per cent (8.5 basis points) for a transition period covering the time from the first publication date of the €STR on 2 October 2019 until 3 January 2022, on which date EONIA will be discontinued;
- the European Money Markets Institute announcing that it has been granted authorisation under the Benchmarks Regulation8 for the administration of the Euro-zone Interbank Offered Rate (EURIBOR) by moving to a new hybrid calculation methodology, that it intends to transition panel banks from the current EURIBOR methodology to the new hybrid methodology by the end of 2019, and that as a result of the new methodology, it does not contemplate a cessation of EURIBOR comparable to LIBOR;
- the ARRC publishing recommended contractual fallback language for US dollar LIBOR-denominated floating rate debt securities; and
- the first consent solicitations starting to appear in the market whose purpose is to transition outstanding issues of floating rate debt securities referencing LIBOR to instead reference one of the alternative RFRs and to insert more robust fallback language in the issue documentation.
iii The new Prospectus Regulation
The new Prospectus Regulation9 has applied in full in all Member States since 21 July 2019. From that date it has repealed and replaced the Prospectus Directive regime (which was given effect in the UK by Part 6 of the Financial Services and Markets Act 2000 and the FCA's Prospectus Rules). As a result, much of Part 6 of the FSMA has been repealed, and the FCA has replaced its Prospectus Rules with new Prospectus Regulation Rules.
The new Prospectus Regulation regime represents an evolutionary rather than revolutionary change from the previous Prospectus Directive regime. Most of the landscape of the Prospectus Regulation regime is familiar territory to anyone used to working under the Prospectus Directive regime. The principal differences can be summarised as follows.
Wholesale versus retail
Under the Prospectus Directive regime debt securities with a minimum denomination of at least €100,000 or equivalent (wholesale securities) were subject to a somewhat less onerous regime than debt securities with a lower denomination (retail securities). Under the Prospectus Regulation, this less onerous regime has not only been maintained, but extended to non-equity securities that are to be traded only on a regulated market, or a specific segment of one, and to which only qualified investors have access for trading purposes. Both the Luxembourg and London stock exchanges have already established such market segments.
Summaries: exemptions extended
The Prospectus Regulation has abolished the requirement for a base prospectus to include a summary. However, the final terms for each individual issue under the programme described in the base prospectus must have a summary of the issue annexed to it, although there is an exemption for issues of wholesale securities or securities admitted to trading on a qualified investors only market segment. Under the Prospectus Directive regime, the only common situation where a summary was not required for a prospectus was where the prospectus related to wholesale securities. The Prospectus Regulation extends this exemption to any prospectus that relates to the admission to trading of non-equity securities on a qualified investors only market segment.
Summaries: prescriptive format
The Prospectus Regulation has abolished the highly prescriptive requirements of the Prospectus Directive regime for the format and content of prospectus summaries. However, it has replaced these requirements with new highly prescriptive requirements for format and content. The Prospectus Regulation regime requires that a summary must not exceed seven sides of A4 paper, subject to extension in certain limited circumstances, and that it must be made up of four sections, (a) to (d):
- Section (a) is largely made up of health warnings;
- Section (b) must describe the issuer, its principal activities, its major shareholders and its key managers, a selection of historical key financial information presented in a prescribed format for each financial year covered by the prospectus and any subsequent interim financial period (accompanied by comparative data), and the most material risk factors specific to the issuer;
- Section (c) must describe the main features of the securities and, if there is a guarantee, the nature and scope of the guarantee, as well as a description of the guarantor (including similar information to that required in relation to the issuer) and the most material risk factors specific to the securities (and, if there is a guarantee, the guarantor); and
- Section (d) must describe the general terms of the offer or the admission to trading, including the total expenses and the expenses charged to the investor, and the reasons for the offer.
The overall number of risk factors that can be included in the summary (risks relating to the issuer, the guarantor (if there is one) and the securities) is limited to 15.
Incorporation by reference
The Prospectus Regulation somewhat extends the range of information that can be incorporated by reference in a prospectus. However, it retains the requirement that such information must have been published prior to or simultaneously with the prospectus, although it is sufficient that the information is published electronically, and it is no longer necessary that it be approved by or filed with any competent authority. Most significantly, all regulated information, not just filings under the prospectus or transparency regimes, is now capable of being incorporated by reference. Furthermore, historic annual and interim financial information and audit reports, wherever published and for whatever reason, are now capable of incorporation by reference.
The Prospectus Regulation regime requires risk factors to be presented in a limited number of categories depending on their nature and, in each category, in order of priority according to the issuer's assessment of their magnitude and potential negative impact. There is also much new emphasis on risk factors being material and specific and corroborated either by other parts of the prospectus or by the surrounding circumstances. It remains to be seen whether this will have much effect in practice beyond intensifying the discussions between issuers and competent authorities over the drafting of risk factor sections.
The Prospectus Regulation has introduced a new feature into the prospectus regime: the universal registration document. This is a registration document drawn up by an issuer that already has securities admitted to trading on a regulated market or a multilateral trading facility in a Member State and that is designed to enable an issuer to fast track the approval of its prospectuses, and to avoid duplication of filings under the prospectus regime and the transparency regime. However, it is doubtful that in practice this innovation will have much impact. Nevertheless, it is worth noting that under the new regime it is possible to passport registration documents (including universal registration documents) in certain circumstances.
The Prospectus Regulation imposes new obligations on financial intermediaries through which securities are purchased or subscribed:
- to inform investors of the possibility of a supplement being published; where and when it would be published; and that the financial intermediary would assist them in exercising their rights to withdraw acceptances; and
- to contact investors on the day when any supplement is published.
This may require many financial intermediaries to introduce new compliance procedures and also to ensure that they are promptly notified by an issuer when it publishes any supplement.
When it comes to advertisements concerning prospectuses, little has changed except the definition (in the Prospectus Regulation) of what constitutes an advertisement. While under the Prospectus Directive regime an advertisement has to be an announcement, under the Prospectus Regulation regime a communication is sufficient. This suggests a wider category, including such things as bilateral conversations, to which it may not be straightforward to apply the Prospectus Regulation regime's advertisement requirements.
Profit estimates and forecasts
Under the Prospectus Regulation regime, if an issuer has published a profit forecast or a profit estimate (which is still outstanding and valid):
- in the case of non-equity securities, inclusion of that profit forecast or profit estimate in the prospectus is voluntary;
- in the case of equity securities, that profit forecast or profit estimate must be included in the prospectus; and
- in all cases, the Prospectus Directive's requirement to include an accompanying accountant's or auditor's report is removed.
This last point is particularly significant for a number of medium-term note issuers that publish preliminary annual results that fall within the definition of a profit estimate. Unless they are willing to pay for an accountant's or auditor's report (and the accountant or auditor is willing to provide one), such issuers have under the Prospectus Directive regime found themselves effectively unable to use their programmes from the date of publication of the preliminary results until the full annual results are published and incorporated in the programme base prospectus. This problem should no longer arise under the Prospectus Regulation regime.
Finally, while the Prospectus Regulation has repealed the Prospectus Directive and all regulations made under it, it provides that prospectuses approved in accordance with the national laws transposing the Prospectus Directive before 21 July 2019 shall continue to be governed by that national law until the end of their validity, or until 21 July 2020, whichever occurs first.
iv Sustainable finance
In December 2015, governments from around the world adopted the Paris Agreement on climate change, and in the same year the UN adopted its 2030 Agenda for Sustainable Development, which has at its core 17 sustainable development goals. Following on from this, in 2016 the European Commission appointed a High-Level Expert Group on sustainable finance, which on 31 January 2018 published its final report offering a comprehensive vision on how to build a sustainable finance strategy for the EU. Building upon the report of the Group, on 8 March 2018 the European Commission published its Action Plan on Financing Sustainable Growth, unveiling its strategy for a financial system that supports the EU's climate and sustainable development agenda. The Action Plan is part of broader efforts to connect finance with the specific needs of the European and global economy for the benefit of the planet and society.
Following the publication of the Action Plan, the Commission established the Technical Working Group on Sustainable Finance, and on 18 June 2019 it published reports and guidelines relating to its four key deliverables:
- EU Taxonomy for sustainable activities;
- EU Green Bond Standard;
- EU Climate Benchmarks and Benchmarks' ESG10 Disclosures; and
- guidelines on the disclosure of environmental and social information.
In parallel, in May 2018, the Commission adopted the following package of legislative proposals:
- the Taxonomy Regulation: Proposal11 for a regulation on the establishment of a framework to facilitate sustainable investment, which introduces an EU-wide taxonomy of environmentally sustainable activities. This envisages that the taxonomy will be rolled out progressively over time. It has been designed to identify a broader spectrum of sustainable activities than only assets, and it includes a roadmap for the taxonomy to be finalised, step by step, through a series of delegated acts scheduled for publication between 2019 and 31 December 2022;
- the Disclosure Regulation: a proposal12 for a regulation on disclosures relating to sustainable investments and sustainability risks, which imposes new transparency and disclosure requirements on firms that receive a mandate from their clients or beneficiaries to take investment decisions on their behalf;
- the Low Carbon Benchmark Regulation amending the Benchmarks Regulation to introduce two new categories of benchmarks – low carbon benchmarks and positive carbon impact benchmarks – has now been approved by the Council and is awaiting publication in the OJ; and
- the Delegated Regulation: a delegated regulation that amends delegated regulations made under the MiFID II Directive, and a delegated regulation that amends delegated regulations made under the Insurance Distribution Directive,13 which together will amend the product governance regime to require investment firms and insurance distributors to ask their clients about their preferences concerning ESG, and then to take them into account when advising their clients.
All of these Commission proposals are still going through the EU legislative process. In March and April 2019, the European Parliament announced it had reached agreed positions on all of these measures, and the Council is in the process of adopting positions on them.
In parallel with this action at an EU level, on 2 July 2019, the UK government published its Green Finance Strategy, which aims to align private sector financial flows with clean, environmentally sustainable and resilient growth, supported by government action, and strengthen the competitiveness of the UK financial sector.
Major elements of this Strategy include:
- setting out the government's expectation for all listed companies and large asset owners to disclose in line with the Financial Stability Board's taskforce on climate-related financial disclosure (TCFD) recommendations by 2022;
- consulting in 2019 on TCFD guidance for pension schemes with a view to putting it on a statutory footing during 2020;
- establishing a joint taskforce with UK regulators that will examine the most effective way to approach disclosure, including exploring the appropriateness of mandatory reporting; and
- clarifying the responsibilities of the PRA, the FCA and the Financial Policy Committee regarding the climate change commitments in the Paris Agreement when carrying out their duties.
The government says it will publish an interim report by the end of 2020, including progress on the implementation of the TCFD recommendations, and it will formally review progress against the objectives of the Strategy by 2022.
v The new Securitisation Regulation
The main development in the securitisation market has been the final agreed text from the European Parliament of the regulations dealing with capital treatment and permissible structures for securitisation transactions. What is referred to as the Securitisation Regulation was issued in two parts:
- Regulation (EU) 2017/2401, amending the regulations dealing with prudential requirements for credit institutions and investment firms, essentially amending the capital requirements regulations; and
- the much-awaited (and discussed) Regulation (EU) 2017/2402 of 12 December 2017 introducing (and laying down) a general framework for securitisation and creating a new category of securitisations to be known as simple, transparent and standardised (STS). Securitisations that satisfy the criteria for STS will attract favourable capital treatment for institutional investors.
The new regulations comprise a significant number of criteria to be complied with by those seeking to have their transactions accepted as STS, and applies to originators, sponsors, original lenders and securitisation special purpose entities. There are detailed requirements dealing with both asset-backed commercial paper (ABCP) programmes and transactions, and non-ABCP (i.e., term asset-backed securities). The due diligence requirements are extensive, as are the new reporting requirements to ensure that the transparency conditions are met. A number of the key provisions provide for the supplement to the basic text of the regulations of regulatory technical standards or implementing technical standards to be submitted by the European Securities and Markets Authority or the European Banking Authority, such as those relating to notification, risk retention and homogeneity (in relation to underlying securitisation exposures). New bodies will also participate in the STS process, such as the Securitisation Repositories (to store all the information to be required to be supplied as part of the STS accreditation) and third-party verification agencies, to assist parties with the substantial compliance process envisaged by the new regime. Notwithstanding the fact that the STS regime has applied since January 2019, there is still a great deal of detail to be fully understood. Accordingly, a number of transactions are already being structured in anticipation of the new compliance. Since the UK is still a party to these arrangements, at least until 31 October 2019, many UK deals are also being structured to take account of these new rules using the transitional arrangements set out in the regulations. How Brexit will affect these transactions is as yet uncertain.
HM Treasury and HMRC have been leading discussions with advisers around potential changes to the UK tax regime for securitisation vehicles to ensure that the UK regime for them remains competitive and appropriately focused. Any change is still some way off, however.
The Finance Act 2018 extended the exemption from withholding tax on payments of interest made on quoted Eurobonds to cover debt admitted to trading on a multilateral trading facility (MTF) operated by an EEA-regulated stock exchange. An MTF is defined as a multilateral system, operated by an investment firm or a market operator, that brings together multiple third-party buying and selling interests in financial instruments – in the system and in accordance with non-discretionary rules – in a way that results in a contract in accordance with Title II of MiFID II. This extension has notably brought within the ambit of the quoted Eurobond exemption the London Stock Exchange's International Securities Market and the Vienna Stock Exchange's Dritte Markt.
There is a further exemption from withholding tax on interest that applies to qualifying private placements (QPP). Some complex interplay between those QPP rules and the new double tax treaties with Jersey, Guernsey and the Isle of Man had meant that there was some uncertainty as to whether entities in those jurisdictions could benefit from the QPP exemption. It has now been clarified that they are not able to do so.
iii OUTLOOK AND CONCLUSIONS
Looming large over everything in the UK in the coming months will be the process of Brexit and its impact on all aspects of the UK economy. In the event that the UK exits the EU on 31 January 2020 on the basis of the withdrawal agreement and political declaration agreed on 17 October 2018, then a transition period will come into effect lasting from exit day until 31 December 2020 (or maybe later) during which the UK will continue to apply EU law in such a way that it produces in the UK the same legal effects as those it produces within the EU (subject as otherwise provided in the agreement). EU Member States will continue to treat the UK as a Member State (subject as otherwise provided in the agreement). For most practical purposes in the international capital market this will manifest itself as a preservation of the status quo until (at least) the end of the transition period.
On the other hand, if the UK and the EU fail to reach an agreement on the terms of the UK's withdrawal from the EU with the result that the transition period never comes into effect then it is likely that on 31 January 2020 the UK will exit the EU and simply become a third country as far as EU legislation is concerned. To prepare for this eventuality, HM Treasury plans to use powers in the EUWA to ensure that the UK continues to have a functioning financial services regulatory regime.
The functions of the EUWA that convert into UK domestic law the existing body of directly applicable EU law (this body of law is referred to as retained EU law) and give ministers powers to prevent, remedy or mitigate any failure of EU law to operate effectively, or any other deficiency in retained EU law are referred to by the UK government as 'onshoring'. These functions are largely given effect through secondary legislation (known as statutory instruments (SIs)) which is not intended to make policy changes other than to reflect the UK's new position outside the EU and to smooth the transition to this situation.
As part of the onshoring process, the government also plans to delegate powers to the UK's financial services regulators (the Bank of England, the PRA and the FCA) to address deficiencies in the regulators' rulebooks arising as a result of exit, and to the EU Binding Technical Standards that will become part of UK law.
To this end, HM Treasury has issued the Financial Regulators' Powers (Technical Standards etc.) (Amendment etc.) (EU Exit) Regulations 2018. Part 2 of the Regulations delegates the Treasury's powers under Section 8 of the EUWA to the FCA, the PRA, the Bank of England and the Payment Systems Regulator. Part 3 of the Regulations amends the Financial Services and Markets Act 2000 and the Financial Services (Banking Reform) Act 2013 to provide for the way in which the regulators are to exercise the legislative functions of EU bodies that may be transferred to them under the EUWA.
The government has also issued the EEA Passport Rights (Amendment, etc., and Transitional Provisions) (EU Exit) Regulations 2018. These Regulations will, in a no deal scenario, repeal the mechanism under which the UK participates in the EU passporting system and replace it with what HM Treasury calls the TPR (see Section ii.i), which will allow EEA firms that have lost their passporting rights on the UK's exit from the EU to continue operating in the UK for a time-limited period after the UK has left the EU; and provide those firms wishing to maintain their UK business on a permanent basis with sufficient time to apply for full authorisation from UK regulators.
Finally a number of SIs establish the financial services contracts regime (FSCR), which will operate alongside the TPR to ensure existing contractual obligations not covered by the TPR can continue to be met.
The FSCR will be relevant where EEA firms that carry on a regulated activity in the UK via the passporting regime fail to notify the FCA that they wish to enter the TPR, or are unsuccessful in securing authorisation at the end of it, but still have regulated business in the UK to run off. Its purpose is solely to allow EEA firms to run off existing UK contracts and conduct an orderly exit from the UK market. EEA firms within this regime will not be able to write new UK business.
1 Anna Delgado, Thomas Picton, Paul Miller and Jonathan Walsh are partners and Tim Morris is a consultant at Ashurst LLP. The authors would like to thank Vicky Brown for her assistance in the preparation of the section on tax.
2 Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market.
3 Regulation (EU) No. 596/2016 of the European Parliament and of the Council of 16 April 2014 on market abuse.
4 Regulation (EU) No. 575/2013 of the European Parliament of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms.
5 Directive 2004/109/EC of the European Parliament and of the Council of 15 December 2004 on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market.
6 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments.
7 Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms.
8 Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds.
9 Regulation (EU) 2017/1129.
10 Environmental, social and governance.
11 COM(2018) 353.
12 COM(2018) 354.
13 (EU) 2016/97.