Fintech Digital Assets Payments Consumer Credit | UK Regulatory Outlook January 2024

Reforms to the financial promotions regime

The financial promotions regime has been amended by the Financial Services and Markets Act 2023 (FSMA 2023) to establish a regulatory gateway through which an authorised firm must pass before it is able to approve the financial promotions of unauthorised firms. It will launch on 7 February 2024. The UK Financial Conduct Authority (FCA) published a policy statement and near-final rules in September 2023.

All FCA-authorised firms that approve, or intend to approve, financial promotions for unauthorised firms will need to apply to the regulator for permission to do so, unless an exemption applies.

Firms have been able to apply for permission from 6 November 2023, and the initial application window will close on 6 February 2024. Only firms that have applied for permission to approve financial promotions during this window, or that have been approved by the FCA already, will be able to continue approving from 7 February 2024 onwards without breaching the new requirements. Firms that miss this window will have to cease all approving activities until they apply and obtain FCA permission.

Qualifying cryptoassets have been brought within the scope of the financial promotions regime from 8 October 2023, and the FCA has been taking a proactive approach to supervision. Firms that were granted a modification by consent to delay the implementation of certain direct offer financial promotion rules by three months must be prepared to comply with these rules from 8 January 2024.

Designation of critical third parties to the financial sector

HM Treasury intends to introduce a new regulatory regime applicable to certain third-party service providers, such as providers of cloud services, bringing material services they provide to the financial sector under the direct supervision of the Prudential Regulation Authority (PRA) and FCA.

This regime is being set up in response to growing concern that, with so many financial institutions relying on a very small group of major service providers, the collapse of only one service provider has the potential to trigger a crash in the financial markets.

HM Treasury will have the power to designate certain service providers as critical third parties (CTPs) if, in its opinion, a failure of or disruption to those services could threaten the stability of or confidence in the UK financial system. In practice, it is expected that the regulators may recommend third parties for designation (for example, based on factors such as aggregation risk, substitutability of services, and how firms could secure the continuity or prompt recovery of services).

The regulators will have rule-making, information-gathering and enforcement powers over CTPs, which will be subject to minimum resilience standards and resilience testing in respect of material services provided to the UK finance sector. Cloud providers will not be caught by the CTP regime if they are not designated.

On 7 December 2023, the Bank of England (BoE), PRA and FCA published a joint consultation paper on operational resilience and CTPs in the UK financial sector. It sets out the proposed requirements to be established in rules and accompanying expectations for CTPs. The consultation closes on 15 March 2024.

The PRA and the BoE intend to publish a further consultation paper relating to CTPs, containing a draft statement of policy on their approach to the use of disciplinary powers. This will be published in due course ahead of the final policy statement that will follow this consultation paper and contain the final rules and expectations for CTPs. To maintain a joint approach to the regime, the FCA plans to consult on its statement of policy on the use of disciplinary powers over CTPs around the same time.

Regulatory work on account closures

The possibility that payment service providers might be closing customers' accounts due to their political beliefs has attracted significant press attention during 2023.

In October 2023, HM Treasury published a statement on rule changes relating to payment service contract termination, following its July 2023 policy statement. The principal changes are that the minimum termination period will be extended from two months to 90 days, and firms will need set out "clear and tailored" reasons for termination.

These requirements will be subject to limited exceptions, for example if complying would be unlawful. In addition, the corporate opt-out will be available in respect to the new requirements, meaning that where the customer is not a consumer, a micro-enterprise or a charity with annual income of less than £1 million, the parties to a framework contract for payment services may agree that the new requirements do not apply.

The government plans to publish a draft statutory instrument by the end of 2023 and make the amendments, subject to parliamentary approval, as soon as parliamentary time allows.

The FCA published a report on payment account access and closures in September 2023 which indicated that the most common reported reasons for account applications being declined, suspended or terminated were financial crime suspicions, due diligence concerns, and inactive or dormant accounts. Information provided by firms surveyed suggests that no firm closed an account primarily due to a customer’s political views between July 2022 and June 2023.

The regulator expects payment firms to consider the findings of the report and whether they should take any actions. Among other things, firms should consider the management information they collect to monitor the nature, scale and impact of account declines, suspensions and terminations, and satisfy themselves they are able to define, monitor, evidence and stand behind the outcomes their customers are getting in line with their Consumer Duty obligations.

The FCA is planning further work on account closures, including:

• follow-up work to understand the accuracy of data reported, concentrating on outlier firms;
• additional supervisory work to be sure of the conclusions reached with regard to accounts closed for political reasons, and closer analysis of account closures for reasons of reputational risk;
• further review of account declines for basic bank accounts, as these appear relatively high;
• further research into the unbanked population;
• engagement with consumer groups and organisations to understand their experiences and the impact of account declines, terminations and suspensions; and
• a financial inclusion sprint in Q1 2024, focusing on improving consumer access to financial services.

UK regulation of stablecoins used as a means of payment

FSMA 2023 introduced a new broad definition of cryptoassets, and amended powers relating to regulated activities and financial promotions to clarify that they can be used to regulate cryptoassets and activities relating to cryptoassets.

The government intends to bring activities relating to fiat-backed stablecoins into the regulatory perimeter in Phase 1 of cryptoasset regulation, on the basis that they have the potential to become a widespread means of retail payment. Regulation of activities relating to other cryptoassets is expected to follow as Phase 2.

A package of publications issued by the FCA, BoE and PRA in November 2023 set out more detail on the forthcoming stablecoin regime. At a high level, responsibility for regulating UK-issued fiat-backed stablecoins will be divided as follows:

• the FCA will regulate issuers and non-bank custodians which are non-systemic, as well as regulating the use of stablecoins as a means of payment under the Payment Services Regulations 2017(PSRs);
• the BoE will prudentially regulate systemic stablecoin issuers and related service providers, while the FCA regulates conduct – the BoE will also regulate systemic payment systems using stablecoins;
• the PRA will prudentially regulate banks undertaking stablecoin custody activities and deposit-taking activity with respect to tokenised deposits, while the FCA will regulate conduct; and
• the Payment Systems Regulator will regulate designated payment systems and service providers for competition and innovation purposes.

The FCA discussion paper (DP23/4) sets out the regulator's thinking across areas such as custody and organisational requirements, conduct of business rules, consumer redress, prudential requirements (including a dedicated new prudential sourcebook, CRYPTOPRU), and managing firm failures.

HM Treasury is exploring how to regulate the use of overseas stablecoins in UK payment chains, including whether to give the FCA powers under the PSRs to authorise payment arrangers who would then assess overseas stablecoins against the regulator's standards.

Much detail remains to be confirmed as the proposals for the new regime progress. HM Treasury intends to bring forward secondary legislation by early 2024, subject to available parliamentary time. Regulators aim to finalise rules for consultation in H2 2024 (subject to secondary legislation being laid), with the new stablecoin regime being implemented in 2025.

UK regulation of cryptoassets

In February 2023, HM Treasury consulted on the second phase of the UK regulatory approach to cryptoassets, proposing a FSMA-style authorisation regime for cryptoasset firms. The response to the consultation in October 2023 confirmed the government largely intends to proceed with these proposals.

The list of specified investments in the Regulated Activities Order 2001 will be expanded, meaning that (subject to certain exceptions) a firm will generally need to be authorised by the FCA under Part 4A of FSMA if:

• they are undertaking one of the regulated cryptoasset activities, which cover the categories of issuance, exchange, investment and risk management, lending, borrowing and leverage, and custody activities;
• by way of business; and
• they are providing a service in or to the UK, with the overseas person exclusion not being extended to cryptoasset activities (the government’s position is that firms dealing directly with UK retail consumers should be required to be authorised wherever they are located).

As a general principle, the government’s intention is that cryptoassets not being used for one of the regulated activities in Table 4A of the consultation in financial services markets or used as a financial services instrument, product or investment should fall outside the future financial services regulatory regime.

The government’s aim is for secondary legislation to be laid in 2024, subject to parliamentary time; this will be accompanied by FCA publications.

Certain cryptoassets came within scope of the financial promotions regime from 8 October 2023, and the FCA has been taking a proactive approach to supervising firms promoting cryptoassets.

Regulation of buy-now-pay-later products

The government has confirmed its plans to expand the regulatory perimeter to include interest-free buy-now-pay-later products (BNPL) and other currently unregulated short-term interest-free credit products provided by third-party lenders.

Once the new rules come into force, BNPL providers and products will be subject to a range of new requirements, including pre-contractual disclosures, creditworthiness assessments, and in relation to the form and content of the credit agreement.

There will be exemptions for some agreements where there is limited risk of consumer detriment and where regulation would otherwise adversely affect day-to-day business activities.

HM Treasury published a second consultation seeking views on the draft legislation in February 2023. This consultation confirmed the government's view that the scope of regulation should be limited to agreements offered by third-party lenders, and should not extend to agreements provided by merchants (the providers of the goods or services being financed) online or at a distance.

The draft legislation narrows the exemption in Article 60F(2) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 by removing from its scope two types of borrower-lender-supplier agreement:

• firstly, agreements that would otherwise fall within the exemption but where the lender and the supplier are not the same person (that is, where the credit is provided by a person that is not the provider of the goods or services being financed) will now be regulated; and
• secondly, agreements where the lender purchases products from the supplier and resells them to the consumer on finance will become regulated.

Retailers introducing customers to newly in-scope products will continue to be exempt from credit broking regulation. However, this exemption will not apply to "domestic premises suppliers", in order to account for a perceived higher risk of pressure when selling to vulnerable consumers where sales routinely take place inside the home.

The rules as proposed are likely to have a significant impact on the BNPL market as it currently operates. The government will put in place a transition period from the point at which the legislation is made until the day on which regulation commences.

The government has not yet published a consultation response. In the meantime, there is some uncertainty in the industry as to whether the government may now intend to roll the regulation of BNPL into the wider project of Consumer Credit Act reform, which could potentially push out the timeframe significantly.

As part of its Financial Lives research, the FCA has published a research note exploring the use of BNPL by consumers in the UK. The note, which refers to BNPL as deferred payment credit, covers the increase in BNPL use, user demographics, how and why it is used, and the impact of its use, as well as its interaction with other credit products.