UK fintech – what are new regulations trying to achieve… and why?

The UK government’s Financial Services and Markets Bill (FSMB) arrives at a critical time for the UK economy. Inflation is soaring, a prolonged recession seems likely and bankers’ bonuses are in the spotlight as many consumers are forced to choose between “heat or eat”.

Meanwhile, Whitehall has lit a bonfire of EU regulations, Paris, Amsterdam and Frankfurt are vying with London for financial market supremacy – with some success – and fears of loosening the shackles of financial regulation are, reasonably, rooted in 2008-09. noise. Are there not security measures for good reason, to ensure customer safety, market safety and financial stability? Should struggling British consumers be stuck in a national sandbox with MPs and regulators, throwing things around to see what works?

But what does all this have to do with technology? Well, the FSMB seeks to define the post-Brexit regulatory framework so that – like the automotive industry before it – Financial Services increasingly becomes a technology sector with data at its core. This is one area where the UK has done better than most: it is considered the world’s number two in fintech, behind the US.

Among the changes the bill seeks to bring in is increased coordination between regulators over new technology, data and changes to the economy itself as the sector is affected by cryptocurrencies, stablecoins, NFTs, tokenization and blockchain/distributed ledger technology (DLT). Controversially, it also provides greater opportunities for the government to intervene.

But it’s fair to say that the edifice of decentralized finance itself looks shakier than it did a year ago, as many coins have fallen (including stablecoins) and the FTX collapse is increasingly looking like complex fraud. The brave, new, safer world we’ve heard about in recent years looks remarkably like the old in important ways: fraud, money laundering, and the enabling (and obfuscation) of financial crime.

Indeed, some commentators see parts of the crypto market as little more than Ponzi schemes, centered around coins that have no intrinsic value except for speculators operating on the age-old principle of the greater fool. Good luck, you might think, to regulators who want to enter such a space.

So, if nothing else, FSMB is bold – at least in its timing. Britain wants growth and a loosening of shackles which, the government says, limit financial innovation. But the economy is failing to deliver that growth except in fits and starts, not helped by Westminster’s brief bout with ‘Trussonomics’. And when it comes to innovation, does the success of UK fintech this century suggest that it has flourished without significant regulatory changes, on the back of initiatives such as Open Banking?

But politics and economics aside, what is the legal perspective on all this? That was the question techUK put to financial regulation specialist Matthew Rutter, partner at international law firm DAC Beachcroft, this week. The tech industry organization hosted a one-on-one hybrid event with him.

Rutter said:

[The FSMB] has been described as a “once-in-a-generation opportunity to transform the regulation of financial services”. At least those were the words of Sheldon Mills [Executive Director, Consumers and Competition, at the Financial Conduct Authority] in the House of Commons committee, and reviewed the bill.

But I’m not sure it’s literally a once-in-a-generation opportunity. We’ve had several changes to the Financial Services and Markets Act over the years: if you look through it, you’ll see this alphabet soup of sections, which is a giveaway that they’ve been added after the original draft. But it is very important in what it is trying to achieve. As much a cultural change in terms of the focus of the regulators, taking advantage of the fact that the UK is no longer bound to follow European regulation.

But if the UK deviates too far from EU rules, critical data adequacy could be at risk. In Rutter’s view, however, the core message of the bill is the new way of thinking it implies – for better or for worse. He said:

Firstly, it tries to drive forward a change of attitude among the regulators and partly the politicians. One of the challenges that many of our clients have faced since the 2008 financial crisis has been caution on the part of regulators, who were understandably criticized as a result of the failures that occurred.

Many of the requirements [of previous regulation], which we still see play out in terms of measures like excise duty, are very protectionist, to prevent things from going wrong. None of these are bad things in themselves, obviously, but if that’s your only focus – preventing things from going wrong – then you’ve missed out on many of the other expectations that a good regulator should achieve.

A changing focus

This is a very ‘on message’ view of the thrust of recent UK policy, with even regulators such as the ICO encouraged to support innovation and growth rather than focus on protecting consumers. But aren’t consumers suffering at the moment, rather than Financial Services professionals? In some cases because of politicians meddling with economic orthodoxy at the behest of opaque think tanks?

In the eyes of some critics, this is evidence that the UK wants to tear up citizen protections to enable a free-for-all market, at a time when the global direction of travel is arguably towards European-style consumer safety when it comes to data and new technology.

To his credit, Rutter acknowledged that there are real risks with this shift in emphasis. He said:

It is an element [in the Bill] to try to shift that focus without discarding the good elements of the regulation. Because it is clear that without adequate consumer protection, consumers will be less willing to engage in the market for financial services. But by the same token, you need to try to make it much easier than it currently is for new businesses, especially those that may be more technology-focused, to get involved.

[Fintech companies might ask] What are the rules that apply to me? That should be a very simple question to answer. But it is not at the moment. […] And it is not only about the extent of regulation, but also about availability, and having it proportional to the development of risk. […] European legislation was very nonsensical and didn’t really connect the different parts of the regulatory jigsaw, so we have an opportunity to remove some of these anomalies.

A wide spectrum for crypto

But what about decentralized finance? In this specific regard, the bill, as originally drafted, sought to regulate stablecoins – digital tokens backed by, or tied to, assets or fiat currencies. But there has been a recent change to bring cryptocurrencies into the scope of regulation. Rutter downplayed the significance of this, saying:

I’m careful not to read too much into it. As with the original Financial Services and Markets Act 2000, it is essentially a framework, and it sets out at a fairly high level what the scope of regulation can be. I think it makes sense to draw the potential boundaries quite wide.

I don’t think it necessarily implies that all types of crypto-assets should be regulated at once, but it makes it easier for the Treasury to act quickly if they feel there is a need to expand the regulatory space in the future. As we know, technology can develop quickly, while devolved legislation needs parliamentary time and can be hard to come by. So it makes sense to have a broad spectrum.

And what about the so-called “Henry the Eighth” powers included in the bill, which authorize the government to override the previously independent regulators: a controversial approach for an administration allegedly opposed to direct market intervention? Rutter added:

It is certainly unusual that the Bank of England, PRA [Prudential Regulation Authority], and the FCA have been publicly critical. These arguments are usually kept private, indicating that their private lobbying has not been successful in this regard.

I’m nervous about that, in terms of good regulation. I think the government is now trying to reassure the markets and the regulators that they only intend to use that power in very limited circumstances. But of course it’s what the powers actually say that matters, rather than the intention behind it!

Part of the problem, going back to the 2008 financial crisis, was that we had a few years before the government trying to argue for lighter regulation, saying the relationship was too onerous and so on. And of course, all that was quickly forgotten when things went up.

So there is a danger in politicians pushing, perhaps on a short-term basis, and trying to intervene in regulation. One would hope a good financial regulator would remember the lessons learned from a number of years ago and be more cautious and cautious.

That said, of course the danger is that they become too cautious and too cautious, so I can see the desire for the politicians to try more levers. But I think the better way to do it is to have better accountability and set performance goals that reflect what you wanted to achieve. Instead of, so to speak, directly intervening and saying, ‘You have to do this or stop doing that’. Because I think it creates a blurring of the lines of responsibility.

A regulator must be able to regulate at will, and then be responsible for it. I think that is the better way to operate.

My opinion

Unusually strong words from a lawyer and regulatory expert. In addition to the concerns of the regulators themselves, it is difficult to avoid the impression that finance is being openly politicized by the authorities – as a Trojan horse against other sectors’ rules being relaxed to kick-start high-risk growth. And Liz Truss’ short tenure in Downing Street has already shown the damage it can do to consumers.