The International Capital Markets Review: United Kingdom
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 all EU Member States) without the need for any domestic implementing legislation, such as the Prospectus Regulation, the Market Abuse Regulation and the Capital Requirements Regulation, 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, the Markets in Financial Instruments Directive (MiFID II) or the Bank Recovery and Resolution Directive.
The year in review
i Covid-19 pandemic
Overshadowing everything else in the international capital market and elsewhere has been the covid-19 pandemic and its devastating effects all around the world on people's lives and livelihoods. The international capital market has continued to function reasonably effectively in spite of the pandemic and its effects, with perhaps the most significant difference caused by the pandemic being the ability, which most market participants have discovered for the first time, to work effectively from home.
There have been many government programmes established in many countries, not least the UK, to try to mitigate the effects of the pandemic, but as far as UK law and regulation is concerned these have not required any significant changes. From a purely legal perspective, the most significant changes have been a number of announcements to grant forbearance over filing or registration deadlines and to delay planned legislative changes. However, in some instances, such as LIBOR transition, the pandemic has only served to emphasise to the authorities the need to press ahead with planned reform without delay.
One major new piece of UK legislation inspired by the pandemic is the Corporate Insolvency and Governance Act 2020, which became law in June 2020 and, among other things, introduces a new moratorium procedure for UK-incorporated companies needing protection from creditors while they pursue a rescue plan. Under the moratorium, during an initial 20-day period, which can be extended, the company enjoys a payment holiday from most of its non-finance pre-moratorium debts and is protected from legal or enforcement action and forfeiture proceedings by its landlords. The Act is unlikely to have much impact on international capital market transactions, however.
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 and, after three postponements, the UK finally ceased to be an EU Member State on 31 January 2020 (exit day). 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 and implemented in UK law by the European Union (Withdrawal Agreement) Act 2020 (WAA), which received royal assent on 23 January 2020. Among other things, the agreement provides that, although the UK formally left the EU on exit day, it then entered into a transition period during which 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 (known in the WAA as 'Implementation Period completion day' (IP completion day)).
To guard against the possibility of the UK leaving the EU without a withdrawal agreement, the UK 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, were designed to convert the acquis communautaire – 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 would apply in the UK on the day after exit as on the day before. The withdrawal agreement between the EU and the UK envisages that during the transition period the two sides will negotiate and implement a new agreement that will govern their future relationship after the end of the transition period. However, to guard against the possibility of no such agreement being reached and implemented before the end of the transition period, the WAA made amendments to the EUWA to effectively postpone the no-deal contingency arrangements from exit day to IP completion day. Not all the legislative changes necessary to make this postponement of the no-deal arrangements fully effective have yet been made, but this chapter proceeds on the assumption that they will be made before IP completion day. Consequently the EUWA will provide that, to the greatest practical extent, the same rules and laws will apply in the UK on the day after IP completion day as on the day before.
iii Benchmark reform and LIBOR transition
One unexpected consequence of the financial crisis of 2008 was the highlighting of both the critical importance and the 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, in terms of both number and value, of new public issues of floating rate debt securities referencing the Sterling Overnight Index Average (SONIA) 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 (SOFR) 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);
- from 2 October 2019, the Euro Overnight Index Average (EONIA) being 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 until 3 January 2022, on which date EONIA will be discontinued;
- the European Money Markets Institute transitioning the eurozone Interbank Offered Rate (EURIBOR) by moving to a new hybrid calculation methodology, as a result of which it does not contemplate a cessation of EURIBOR comparable to that of LIBOR;
- the New York Fed beginning publication of SOFR period averages as well as a SOFR Index, the Bank of England beginning publication of a SONIA Compounded Index and the ECB announcing a public consultation on the publication of compounded €STR rates and daily indices; and
- the ARRC publishing (in March 2020) a proposal for New York State legislation to provide a commercially realistic solution for 'tough legacy' contracts referencing USD LIBOR to remove risks associated with potential lack of contractual continuity and the FCA and the European Commission announcing proposals for similar (but different) legislative solutions to deal with tough legacy contracts referencing LIBOR.
iv The Prospectus Regulation
The Prospectus Regulation 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 been not only maintained, but also 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 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 the 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. So far, this does not seem to have had 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. In practice, so far, this innovation does not appear to have had much impact. Nevertheless, it is worth noting that under the new regime it is now 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.
These new requirements have led to uncertainty in the market as to the scope of a financial intermediary's obligations in terms of which investors it is obliged to inform and practical difficulties in relation to how to ensure compliance with the same-day supplement notification requirement. As a result, in July 2020 the European Commission published a proposal to amend the Prospectus Regulation to clarify which investors a financial intermediary must contact in relation to the publication of a prospectus supplement, to provide additional time for financial intermediaries to notify investors following the publication of a supplement and to extend the period during which investors may withdraw their acceptances after publication of a 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 had to be an announcement, under the Prospectus Regulation regime a communication is sufficient. This suggests a wider category, including such things as bilateral conversations and has led to significant compliance difficulties for financial intermediaries seeking to understand and 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, although 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 would continue to be governed by that national law until the end of their validity or until 21 July 2020, whichever occurs first. This grandfathering period has accordingly now come to an end.
v 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, 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' ESG Disclosures; and
- guidelines on the disclosure of environmental and social information.
This has resulted in the following:
- The Taxonomy Regulation, which came into force on 12 July 2020, provides for establishment of a framework to facilitate sustainable investment, introducing an EU-wide taxonomy of environmentally sustainable activities. The Regulation envisages that the taxonomy will be rolled out progressively over time through a series of delegated acts scheduled for publication before 31 December 2022; the parts of it that relate to climate mitigation and adaptation objectives will apply from 1 January 2022 with the remainder applying from 1 January 2023.
- The Low Carbon Benchmarks Regulation, which entered into force on 10 December 2019, among other things, introduces two new categories of benchmarks – low carbon benchmarks and positive carbon impact benchmarks.
- The Disclosure Regulation on disclosures relating to sustainable investments and sustainability risks imposes new transparency and disclosure requirements on firms that receive a mandate from their clients or beneficiaries to take investment decisions on their behalf. It entered into force in December 2019 and will apply from 10 March 2021.
- The European Green Deal Investment Plan of 14 January 2020, in which the Commission announced it will establish an EU Green Bond Standard.
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 Disclosures (TCFDs) recommendations by 2022;
- a consultation (which closed in July 2020) on non-statutory guidance for the trustees of occupational pension schemes on assessing, managing and reporting climate-related risks in line with the TCFDs;
- 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 TCFDs recommendations, and it will formally review progress against the objectives of the Strategy by 2022.
vi The Securitisation Regulation
The main development in the securitisation market has been compliance with, and the interpretation 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 regulations entail compliance with a significant number of criteria by those seeking to have their transactions accepted as STS and they apply 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. During the course of 2020, a number of regulatory technical standards or implementing technical standards were submitted by the European Securities and Markets Authority or the European Banking Authority, relating to notification, risk retention and homogeneity (in relation to underlying securitisation exposures). The much discussed reporting requirements and templates were finalised and brought into force in September 2020. New bodies have been authorised to 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. Notwithstanding the fact that the STS regime has applied since January 2019, there are still a number of issues with the interpretation of the regulations and various proposed amendments, including a number of key matters put forward by the High-Level Forum of the European Commission. All mainstream securitisations, as applicable, must now comply with the basic requirements of the Securitisation Regulation and a number of STS transactions have been successfully completed. Since the UK will cease to be treated as a member of the European Union in 2021, the relevant competent authorities have put forward UK regulations to incorporate the main aspects of the Securitisation Regulation into relevant domestic law. However, the overall impact of Brexit on UK securitisations (in particular, equivalence issues and recognition in Europe) will need to be assessed in due course.
One of the impacts of the covid-19 pandemic has been the dramatically increased UK public borrowing. That has led to various discussions and ideas around how and when to raise UK taxes. The eventual package of tax changes is, as yet, far from clear. While those changes could materially impact how much tax is payable by market participants, it is less clear whether the changes will drive systemic change in these markets.
The UK replaced its regulatory capital securities regime in 2019. Under the previous rules, it was generally only certain types of regulated entities (in practice mainly banks and insurance companies) that could issue instruments of this kind and still obtain UK corporation tax relief for interest payments. The changes have allowed a wider range of UK issuers of such instruments to benefit from that treatment, albeit at the cost of increased complexity in these rules.
Her Majesty's (HM) Treasury and HM Revenue and Customs continue to consider various changes to the UK tax regime for securitisation vehicles to ensure that the UK regime for them remains competitive and appropriately focused. There have been a number of useful clarifications, but it remains to be seen whether there is any appetite for more material change.
Outlook and conclusions
For the foreseeable future, the covid-19 pandemic and measures to mitigate its effects will overshadow all other considerations. However, from a UK (and EU) perspective, the impact of Brexit on all aspects of the UK economy is also going to be a hugely significant factor. In the event that the EU and the UK reach an agreement on their future relationship, much will depend upon the terms of that agreement and how and when it is implemented in EU and UK law.
On the other hand, if the UK and the EU fail to reach an agreement on the terms of their future relationship, it is likely that on 1 January 2021 the UK will 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 (as amended by the WAA) 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 are not intended to make policy changes other than to reflect the UK's new position as a third country as far as the EU is concerned 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 in 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 (and subsequently amended them several times). 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 (as also amended). 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.ii), 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 IP completion day; 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.