Our panel of experts consider what lies ahead for financial services lawyers in 2017.
David Troman (DT)—head of financial services at PA Consulting
Jane Parry (JP)—managing partner at PM+M
Chris Finney (CF)—partner at Cooley
Emma Radmore (ER)—legal director at Bond Dickinson
Andrew Barber (AB)—partner at Bond Dickinson
A view from the market
The burden of regulatory change continues to grow. Banks are spending 60% to 70% of project expenditure on mandatory regulatory change, reducing their ability to spend on potentially revenue-increasing initiatives such as new product launches and customer service improvements. As the regulatory industry matures, it will come under greater scrutiny in terms of costs and the value it delivers, in much the same way as the IT industry did when it was maturing in the 1980s and 1990s. And quite rightly too—the incomes aren’t there to support these very expensive programmes, which have a huge impact on operational expenditure.
Regulatory requirements also add to operational expenditure—for example the Volcker Rule and Senior Managers Regime bring ongoing operational overheads such as annual testing requirements, CEO attestations, and referencing checks. This pushes up the operating costs of risk, compliance and business units.
Risk and regulatory costs are now coming under the spotlight as shareholders, become concerned about falling margins. They want to see all areas within the bank—including risk and compliance—play their part in delivering costs savings.
Impact of Brexit on regulation
I don’t see the rulebook changing much during 2017, as the UK had a large input into current European regulations. I think that good conduct, transparency of market activity and high prudential standards will continue to be key focus areas.
I can see the industry organising itself much more around its desire to stay active in the European market. This is due to the balance of trade that would be impacted. I expect we will see stronger lobbying for a single market or at least a middle way around a concept of equivalence—where we can maintain trading across Europe. Asset managers are currently facing a lot of uncertainty, and are likely to see more impact on their business as funds move away from the UK.
Banks will start to act on their plan B contingency plans. Those who have a European presence will become more vocal and begin advancing their plans to move European trading, settlement and payments businesses and functions into Europe. It would seem as though the money is very much on places like the Netherlands, Dublin and Frankfurt at the moment.
Disruption and simplicity —the threat from more innovative markets and players
Regulation is often seen as an inhibitor to innovation. Evidence suggests that some of the largest markets, particularly the UK, US and Western Europe, are falling behind in areas such as payments. Established players are becoming overshadowed by more innovative markets such as the Nordics and large non-bank players such as Apple. There is a real opportunity for innovative firms to win and a threat for firms if they fall behind.
Many major banks have established innovation units, but they are failing to get value from these. Very few ideas generated are actually seen through to investment and delivery. One key issue is that these innovation units need more of a balance between the business and the technology experts. Banks must be willing to accept that the innovations emerging from these units will challenge their current way of doing business. Successful innovations can’t just be integrated into the existing business and infrastructure—they need to become the future business. Financial services can learn from the pharma industry in this area.
Artificial or machine learning will also continue to gather pace as the industry looks to move more towards ‘robo-advice’. Lots of trials are underway in the industry and will start to be rolled out and become business as usual in due course.
I see far greater use of big data in the industry. This will be particularly prominent in the insurance industry. Data from devices including wearable fitness monitors or smart meters in homes will all start being looked at by risk assessors and will start to impact on premiums.
Impact of Brexit on innovation
Brexit will have a minimal impact on innovation, aside from the challenge of having the right talent in place. Any central policy decision that determines the rights of EU citizens to work in the UK will have direct implications for financial services and impact their ability to have the right talent in place to respond to the challenger banks.
Cyber and business resilience will be a dominant topic for 2017. Regulators, boards and, perhaps more significantly, customers will seek more certainty on security of existing and new systems. This will have a huge impact on reputation for those that get it wrong. The key change here is to manage customer expectations. Scrutiny from customers will intensify and they will start asking questions about how resilient their bank is.
As low interest rates continue to impact returns, the pressure and appetite from firms and individuals for risk-taking investment strategies is likely to increase in the medium to long-term. It will be interesting to see what products and ways of improving returns will start to emerge, and one wonders what will be the next big failure in the market as people start to take more risks.
What are your predictions for 2017?
JP: There’s no doubt that 2017 is going to be an interesting year for the financial services sector. The last few years have seen some big changes and that is set to continue. One of the key—and ongoing—trends is of clients wanting even more value for money. There has been a definite polarisation in the financial services and professional services sectors between those people wanting a commodity and seeking it at the lowest cost—and those needing advice and support and recognising that they have to pay for it, but still seeking value for money. In terms of regulation, the main changes are coming from the Financial Conduct Authority (FCA), which believes that professional indemnity (PI) cover should be the first line of defence rather than the Financial Services Compensation Scheme (FSCS). This will affect wealth management firms rather than general accountancy firms.
The FCA is undertaking a review of FSCS pooling, looking at how the burden of the pooled risk should be shared. It is considering two things:
- how to spread the cost widely enough to avoid damaging other firms, but without spreading it thickly so that firms end up paying for failure of businesses outside of their sector, and
- how to spread the cost between the creator of the product, and the advisers and intermediaries that sell it
Some think these suggestions are excessive, but my view is that they are necessary, as there is a danger that all advisers are being tarred with the same brush and are having to share the additional costs of regulating the less compliant. However, there is an obvious need to ensure that the right balance is achieved between consumer protection and unnecessary red tape.
The main competition-related development across the financial services sector is ongoing consolidation in the market. Firms are merging (or being taken over), and many are becoming commodity providers. The way we are tackling this is by distinguishing our personal service and developing the relationships that we are able to foster and build with our clients.
ER & AB: Financial institutions will need to make many changes to their policies and procedures during the course of 2017, to reflect the changes in UK laws resulting from implementation of EU measures such as:
- the recast Markets in Financial Instruments Directive 2014/65/EU and Regulation (EU) 600/2014 (MiFID II)
- the recast Payment Services Directive 2015/2366/EC (PSD2)
- the Fourth Money Laundering Directive (EU) 2015/849 (MLD4)
- Regulation on Transfer of Funds (EU) 2015/847, and
- Regulation (EU) 1286/2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs)
Some of these measures are complementary, but others are unrelated and some have the potential at least to cross-cut each other if not addressed properly. Also, many of the changes will require significant gap analysis at institutional level before firms can make the necessary changes, and the lead-in periods will often be tight.
For most EU measures, Member States should have finalised their implementing measures six months before the provisions take effect. The UK invariably meets its target, but given the nature of some of the MiFID 2 changes in particular, firms may need a longer lead-in time in order to be compliant by the beginning of 2018.
In relation to MLD4, this six-month period was not included in the recast Money Laundering Directive, and will clearly not be met, as firms must be compliant by the end of June 2017, and none of HM Treasury, the Joint Money Laundering Steering Group (JMLSG) or the FCA have yet published even consultative versions of the new rules and guidance that are necessary. Therefore, it will be a key challenge to build implementation plans which are sufficiently concrete when there are not yet any firm UK requirements, so as to allow the right time for all necessary changes to flow through. At the same time, the plans should not waste time and resource on changes that may yet need to be reviewed when UK measures are finalised.
How do you think the practice of financial services law is going to develop in 2017?
CF: In some respects, 2017 will be like every other year for financial services professionals. Change is coming. There are a lot of moving parts. Some of the detail is still missing, and it will only become available quite late in the day. Perhaps this time, the change will be more fundamental than it’s been before—and, for some businesses, it could be existential. Work out what’s real, and prepare for it, without being distracted by gossip, speculation, and noise (even if that would be more interesting).
ER & AB: Despite Brexit, the practice of financial services law is unlikely to change significantly during 2017. Financial services lawyers always need to be alive to forthcoming and proposed changes, so they can anticipate their clients’ needs and, critically, help their clients to prepare for change at the right time. There will be several changes to primary and secondary legislation, as well as regulatory requirements, during 2017, that financial services lawyers need to keep up to date with and provide their clients with focused, helpful updates about. At least until Brexit, though, financial services lawyers will increasingly have to refer to a combination of domestic and EU measures when advising clients, as the EU internal market legislation moves towards a greater proportion of directly applicable regulations, which the UK regulators are not required to implement into UK law and increasingly are not doing. As a result, key requirements that apply to UK businesses are not addressed in UK legislation, and are referred to only by way of reference in Prudential Regulation Authority (PRA) and FCA rules. It will be a key role of financial services lawyers to help their clients easily understand how to apply policies and procedures that reflect all relevant strands of requirements.
Also, as Brexit negotiations begin, lawyers will need to closely track developments, so they are in a position to advise their clients on likely consequences whenever the terms of Brexit become clearer.
How is Brexit likely to affect these?
JP: The biggest problem with Brexit is the ongoing uncertainty. Until Article 50 is triggered, and we know how the negotiations are going to progress, things will remain up in the air. It’s impossible to plan for the unknown. What we do know is that clients are going to need more support rather than less. What that will mean in reality is unclear, but for us it has to be business as usual. We have seen a lot of confidence from our clients since the EU referendum, which is a positive sign. We share that approach, so at present Brexit won’t change or affect our plans moving forward. The general mood is upbeat, but clearly there will also be some challenges. The key thing will be for organisations of all sizes in all sectors to be agile, responsive and strategic—many of our clients are up for the challenge, and so are we.
Legal developments and practical impact
What are likely going to be the most important cases in 2017 and why?
CF: We expect another year of enforcement action from the FCA, perhaps building on its current thematic reviews, particularly around the asset management sector, and its new initiative to make periodic and random inspections of firms to assess compliance with financial crime laws. We also expect further prosecutions and deferred prosecution agreements in both the regulated and unregulated sectors for breaches of the Bribery Act 2010.
ER & AB: The majority of significant legal and regulatory changes are likely to be driven by the EU, Brexit notwithstanding. The key changes should be:
Implementation of the MiFID 2 package, comprising changes to primary and secondary legislation, and PRA and FCA rules
The changes will both transpose the mandatory and discretionary provisions of the MiFID 2 Directive and its Level 2 Directives, and address changes necessary to make UK law and regulation consistent with the directly applicable MiFIR and the Level 2 Regulations. The greatest changes for UK firms will be around:
- the regulatory perimeter—to introduce new investment services and investments
- trading of both equities and non-equities, including pre- and post-trade transparency requirements
- organisational requirements
- provision of advisory services
- payments of commission and inducements
- re-categorisation of certain customers
- product governance, and
- greater protections for non-retail clients
Additionally, there are restrictions on provision of cross-border services by third-country firms to retail investors, with the possibility of a passport for those providing services in the wholesale markets.
Member States must transpose all measures by 3 July 2017 and have them take effect from 3 January 2018. The UK regulators are already consulting on various necessary measures, and 2017 will be a busy year for authorised firms, who will need to undertake extensive gap analyses and plan for changes to internal controls and customer-facing materials.
Implementation of MLD4 and the Regulation on Transfer of Funds, which take effect on 26 June 2017
All UK ‘obliged entities’ will need to update their policies and procedures to comply with regulations which will replace the current Money Laundering Regulations 2007, SI 2007/2157, and revised JMLSG and FCA guidance. HM Treasury has published a consultation paper on some of the key changes (including changes to the definitions of politically exposed persons and beneficial ownership), but there are currently no public drafts of the new legislation or guidance. Also, we do not know whether the EU’s desire to make further changes (for example, to lower the beneficial ownership threshold for certain types of vehicle) might also be rushed through for implementation in 2017.
Firms should spend early 2017 assessing the changes they will need to make to their policies and procedures, and specifically in their due diligence expectations from new and existing clients.
Criminal Finances Bill
It is likely the Criminal Finances Bill will receive Royal Assent during 2017, which will give enforcement agencies greater powers in respect of money laundering prevention measures. Firms should prepare, for example, to receive more requests and requirements for information from the National Crime Agency, and to be aware of any changes to suspicious activity reporting (SAR) requirements which may also be introduced during the year.
PSD2 also falls to be implemented in January 2018, so the UK legislators and regulators will be consulting on implementation during early 2017, in order to finalise new laws and rules in time. Equally, firms affected by the changes should be planning for compliance, particularly in terms of changes to their customer-facing documentation and, where relevant, to comply with the new regime on account information services.
The PRIIPs Regulation will now take effect on 1 January 2018, almost alongside MiFID 2. Firms will still need to prepare for it during 2017, so they have their key information in PRIIPs-compliant form in time for the implementation date.
CF: 2017 will be about change, and planning for change. The change that’s likely to be on everybody’s mind is, of course, Brexit (see below), but 2017 will bring some other significant changes too. For example, the UK’s Money Laundering Regulations 2007 and Transfer of Funds (Information on the Payer) Regulations 2007, SI 2007/3298 are due to be replaced by the Money Laundering and Transfer of Funds (Information on the Payer) Regulations 2017 on 26 June 2017. That will have some impact on all of the firms that have to comply with the existing AML rules. But the biggest impact will be on Bitcoin exchanges and wallet providers, because they don’t have to comply with the existing rules, and the new Bitcoin AML rules are still in draft.
We should also see the final Level 2 and Level 3 texts for PSD2 and the recast Insurance Distribution Directive (Directive 2016/97/EU), in 2017. Payment services firms, insurers and insurance distributors will spend some of 2017 analysing, and most of 2017 preparing for, the changes these Directives will bring at the beginning of 2018.
PSD2 will have a significant impact on all kinds of payment services providers. The biggest beneficiaries are likely to be consumers, and two new types of payment services provider—the account information service provider, and the payment initiation service provider. These firms already exist, but there aren’t many of them, and their services aren’t widely known about or used. That will begin to change in 2017.
The recast Insurance Distribution Directive is more likely to affect life and investment product producers and distributers, than non-life—and the biggest impact might be on non-UK European product producers and distributors, rather than those in the UK, because the new requirements aren’t so very different from the FCA’s existing rules.
Of course, there is also Solvency II (Directive 2009/138/EC, as amended). Some of Solvency II’s transitional provisions will expire in 2017. We should also expect a call for information from, and a draft discussion paper to be published by, the European Insurance and Occupational Pensions Authority (EIOPA). This will mark the start of the formal standard formula solvency capital requirement review process, to be completed by EIOPA and the European Commission in 2018 (at the earliest).
How is Brexit likely to affect these?
CF: It’s difficult to say, because at this stage, we still don’t really know what Brexit means. But things should become clearer in 2017. Many firms will spend the first part of 2017 developing and fine-tuning their contingency plans, and the rest of 2017 implementing them, to make sure they can still operate across the EU post-Brexit, if that’s what they want to do.
ER & AB: At present, Brexit should have no effect on any of the EU measures falling due for implementation during 2017 (and beyond). Since the outcome of the referendum, the government and regulators have been at pains to stress that the UK will still be a member of the EU until it officially leaves and therefore will continue to meet its obligations to comply with relevant legislation. Thus there will be no excuse for firms to fail to comply with the new requirements at the appropriate time.
Interviewed by Duncan Wood.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.