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As we enter the second half of 2021, it is possible to detect a subtle change in the way that regulators in the UK and EU are approaching rule-making.
One set of rules is arguably more prescriptive, setting detailed requirements and expectations of firms, while the other is increasingly principles and outcomes based. While this could represent an example of how the two regimes are diverging post-Brexit, for many firms, especially those with activities in both jurisdictions, it also means there is a need for increased monitoring, to ensure alignment with both sets of rules.
The picture from Europe
EU regulators continue to progress with regulatory reforms which set out detailed reporting expectations. The Sustainable Finance Disclosures Regulation (SFDR) is a key example; the Level 1 requirements were implemented on 10 March 2021. SFDR requires firms to describe the extent to which management of portfolios takes account of climate related risks, and to mitigate the risk of practices such as ‘greenwashing’.
The requirements under SFDR so far have been comprehensive, with detailed mandatory disclosures. Taken with the EU Taxonomy regulation, the EU has arguably taken a prescriptive approach to regulation, and the regulators have been quite specific and direct in terms of what is expected in terms of compliance. The view appears to be that detailed requirements enhance investor protection by requiring firms to be as specific and transparent as possible in their reporting.
How the UK is evolving
For some time now, UK regulators have indicated a move towards a more outcome-focused, principles-based regulatory regime, which looks rather different to the more prescriptive rules coming from Europe, but remains just as concerned with strong governance and investor protection. This is an example of how the UK regulatory regime is evolving to support the competitiveness of the UK market, post-Brexit.
In July 2020, for example, former interim chief executive of the FCA, Chris Woolard, set out the position view as follows:
“What we need is outcome-based regulation... The Covid crisis and Brexit have only reinforced this need. We now have an opportunity to look again at our rulebook, focusing less on tick box compliance and more on promoting outcomes that serve the public interest.”
This statement has been echoed by his successor in the role, Nikhil Rathi, who in a speech on 22 June 2021 noted that “we have to be agile… to build and operate an effective regulatory regime for the firms and consumers of the future”, to support competitive markets. In order to achieve this, the focus is on making the UK’s rules “more efficient and targeted”, and focussing on “high, internationally consistent and outcome-driven standards.”
The message from the top is therefore that a shift in approach is underway.
Principles in practice
There are increasing examples of this more principles- and outcomes-based strategy taking shape. Arguably the Financial Reporting Council’s UK 2020 Stewardship Code gave an early indication, with its twelve voluntary reporting principles for asset managers and asset owners, and the explicitly increased focus on outcomes.
Similarly, the FCA is working on a set of regulatory principles for ESG, building on a speech given by Richard Monks, FCA director of strategy on 22 November 2020, in which five “guiding principles” were set out – consistency in messaging; reflecting ESG focus in a product’s objectives; setting out how a product’s sustainability objectives will be met; ongoing reporting against sustainability objectives; and assurance of ESG data quality. Further work by the FCA is underway to develop these principles, with additional details expected later this year.
Aside from ESG, we saw another example of the UK moving away from EU regulatory requirements in the 2021 Financial Services Act. In a key amendment, the introduction of the “Key Information Document” (KID) for UK UCITS funds, which was with the onshored Packaged Retail and Insurance-based Investment Products regulation (PRIIPS) was delayed until the end of 2026 at the earliest. The proposed PRIIPS KID had received negative feedback from the UK funds industry for being too onerously prescriptive, and so its delay was a welcomed example of the UK move away from some of the more contentious aspects of EU regulation.
The challenges of the new reality
There are of course challenges in terms of navigating the new regime, particularly with ongoing uncertainty in terms of the final state of UK-EU regulatory relations. While the UK government has said that it wants to promote “globally consistent standards”, the Memorandum of Understanding did not contain a commitment to equivalence.
This is something that Nikhil Rathi also acknowledged in his speech on 22 June:
“the lack of mutual equivalence creates obvious market inefficiencies and results in increased costs for consumers both here and in the EU.”4
This observation will be acknowledged by firms that are now required to monitor and align with different requirements for UK and EU markets, as a result of the lack of equivalence.
Increased efficiencies in terms of UK regulation may be balanced by the increased demands of staying on top of the two diverging regimes.
The NatWest Trustee and Depositary Services view
As noted in our response to the HMT call for input on the review of the UK funds regime, we welcome moves to enhance the competitiveness of the UK funds regime.
Regardless of whether regulation is principles based or more prescriptive, there is an increasing need for firms to utilise data analytics in order to conduct credible reporting and be transparent with regulators and end investors. It is a key objective of our transformation programme to enable investor transparency with close to real-time reporting.
For some firms, there is a need for increased monitoring of regulation and policy in order to ensure that developments in both the UK and the EU are fully captured and understood.