UK payments regulation and the systemic perimeter: HM Treasury consultation response published

Bank of England to move from entity-defined systemic payments perimeter to end-to-end perimeter

In recognition of the significant transformations across the payments landscape since the Banking Act 2009, the government confirms in its response that it is committed to taking forward the reforms described below to the Bank’s systemic perimeter. The changes will need to be enacted by primary legislation ‘at a future legislative opportunity’, so the government will issue a further policy statement setting out its legislative approach. The government notes that it will be for the Bank itself, as the competent authority, to set out how it intends to supervise the reformed perimeter after the relevant legislation is published.

Adoption of the reform principle ‘same risk, same regulatory outcome’

This means that instead of focusing on an entity’s form, regulation should reflect the risk posed by an entity’s activities and its relationship to other market participants and the wider economy (an approach widely welcomed by respondents to the government’s 2020 Payments Landscape Review).

Use of the essential design of the Bank’s current systemic payments perimeter within Part 5 of the Banking Act 2009 for any reformed perimeter

Entities should be examined and recognised as systemically important by HMT directly on a case-by-case basis, and against clear criteria, ensuring that any reformed systemic perimeter would remain reserved only for those payments entities that – through any deficiencies in their design or any disruption to their operations – had the potential to threaten the UK’s financial stability or have wider economic consequences.

Points of interest from the consultation response include:

• The government’s view is that the recognition criteria in section 185(2) of the Banking Act are already suitably broad to apply to other types of systemic payments entities. However, it agrees with respondents’ feedback that clear guidance setting out how HMT and the Bank engage with prospectively systemic entities, and the steps involved in recognition, would provide valuable transparency and will work with the Bank to consider when such guidance should be provided. It clarifies that this will not include establishing quantified systemic thresholds.  This is because to do so – either in legislation or guidance – is ‘ultimately likely to be difficult’, because an assessment of financial stability risk is likely to involve a combination of factors, relevant context, and available evidence.
• The government expects the practical regulatory effect of the reforms on the overall sector will be limited, and states that no entities will automatically enter Bank regulation following the reforms themselves.

Introducing an additional category of ‘service provider’ within Part 5 of the Banking Act to allow for the recognition of payments providers that pose systemic risks in their own right

The source of risk would be in relation to the provider itself, not its relationship with an already-recognised payment system, as the Banking Act currently operates. This is similar to the approach to enable the recognition of future systemically important stablecoins used as a means of payment (‘digital settlement assets’) in the Financial Services and Markets Act 2023 (FSMA 2023).

Narrowing Part 5’s section 206A to explicitly remove non-payments related critical third parties from regulation through the Banking Act

The aim here is to provide clarity on the scope of Part 5 in light of the new, specific critical third parties regime established under FSMA 2023.

Points of interest from the consultation response include:

• Where a recognised systemic payments entity is found to also meet the statutory criteria for designation as a critical third party, HMT would need to assess (with input from the regulators) which potentially applicable regime or regimes would be most appropriate taking into account the services the entity provides to the sector and their risks. Likewise, if a designated critical third party were to specifically begin offering payment services that were believed to be of systemic significance to the UK financial system, HMT would need to assess with the Bank whether separate recognition under the Banking Act’s regime would be required, given the differing powers available to the regulators under the two regimes.

Enhancements to the Bank’s ability to gather relevant information from market participants

This would allow the Bank to source relevant data from unsupervised, non-systemic firms operating within relevant payment chains. There is existing precedent for these powers in the FSBRA’s sections 64 and 81, which enable the PSR to effectively ‘keep markets under review’ as part of its general functions.

Points of interest from the consultation response include:

• There is a memorandum of understanding between the Bank, the FCA and the PSR that sets out a framework for cooperation in relation to payments systems. The government expects this MoU to be updated following legislation enacting the reforms to reflect the Bank’s revised capacity to gather relevant information, and how the regulators appropriately coordinate data requests to market participants. The government recognises that this particular power would provide scope for the Bank to require information from entities that are not formally recognised as systemic by HMT for the purpose of its market surveillance and horizon scanning function. It therefore expects the Bank – like the PSR does today - to proactively engage those it requests information from to set clear expectations on how it is provided, and to what timeframe.

Further clarification of the Bank’s existing regulatory toolkit

This would include codifying its powers in legislation, and making clear which aspects of a recognised entity’s operations the Bank may exercise its broad supervisory powers over. It would also include clarifying its power to set limits on a business activity where appropriate to manage financial stability or serious economic risk, and its ability to mandate a firm’s location within the UK.

Points of interest from the consultation response include:

• Regarding the Bank’s power to set limitations on a recognised payments entity’s business operations or processing, the government agrees with feedback that the Bank should provide further detail within its future guidance as to what the power means in practice for affected firms. For example (and as mentioned in the consultation), its use might apply to new market entrants that are being prospectively recognised by HMT where regulatory intervention is required in order to ensure new activity scales safely, avoiding risks to UK financial stability. Or it may be applied in the ‘rare, unlikely circumstances’ where an already systemic entity was to cease part of or exit its obligations. In addition, the government recognises that limits might be set to mitigate broader financial stability risks, such as the financial and monetary stability risks posed by new forms of digital money such as stablecoins (as already explored in a 2021 Bank discussion paper). The government will consider in consultation with the Bank how best to provide further guidance, as appropriate, on how the power might be used.
• On the adequacy of the FCA’s existing rules on establishment within the PSRs 2017 and the EMRs 2011, most of the respondents to this question noted the need for consistent standards in relation to the size of the entity providing services, as opposed to their legal form, and welcomed a chance for making this approach institution agnostic as part of any future PSRs 2017/EMRs 2011 review. The government states that it will consider this as part of its next steps in relation to its now-closed January 2023 PSRs 2017 review and call for evidence (as to which, see our Engage article ‘UK government reviews Payment Services Regulations and Payment Card Interchange Fee Regulations’).

Clarifications on how the Bank and the FCA would co-supervise any future systemic payments firms

This includes a requirement to establish a memorandum of understanding between the regulators, the need for a clear transition process and a Treasury-held power to disapply relevant regulator rules. Broadly, the consultation proposed extending the agreed-upon approach for systemic digital settlement assets, under which the Bank would lead on prudential matters, and the FCA on conduct. In cases of insolvency, systemically important PSPs or EMIs would migrate from the Payments and Electronic Money SAR overseen by the FCA and into the Financial Market Infrastructure SAR overseen by the Bank.

Points of interest from the consultation response include:

• The government agrees with respondents that any MoU on systemic payments co-supervision should clearly set out which aspects of a payments entity the Bank would lead in making directions to; what role the FCA (and where relevant the PSR or PRA) retains in relation to its existing supervisory objectives; how firms are communicated with, and the timings associated with any firm’s transition. In practice, the government expects - as is currently the case - that the Bank clearly communicate directly with the newly recognised firm throughout the recognition process.

Extending the Future Regulatory Framework (FRF) Review’s enhanced accountability framework to apply to any revised systemic payments perimeter

The aim here would be to hold the Bank’s supervision of payments accountable to equivalent or similar standards and rules as for its remit over central counterparties and systemic central securities depositories, as legislated for under FSMA 2023. This would include a secondary innovation objective, renewed regulatory principles and ways in which HMT, Parliament and stakeholders could scrutinise the Bank’s supervisory approach.

Points of interest from the consultation response include:

• Following respondents’ feedback - including calls for regulation to not inhibit the sector’s ability to remain competitive and world leading - the government will reconsider the precise drafting of an innovation objective and set this out in its future policy statement ahead of future primary legislation. However, overall the government intends to progress the accountability framework to apply to the Bank’s systemic perimeter in the Banking Act, including its new scope over systemic digital settlement assets and its existing scope over systemic payment systems.

Smarter Regulatory Framework: Enhanced payments regulatory powers for FCA and PSR…

There was unanimous support from respondents to the government’s intentions to provide the FCA and the PSR with relevant powers over their respective retained EU law for payment services, as part of the approach to application of the Future Regulatory Framework (FRF) Review to their payments mandates. The government has subsequently laid the  Electronic Money, Payment Card Interchange Fee and Payment Services (Amendment) Regulations 2023 to provide these powers to the FCA and the PSR following the Chancellor’s July 2023 Mansion House speech.

…and heading towards replacement of PSRs 2017 and EMRs 2011

HMT has also subsequently announced the first two tranches of its Smarter Regulatory Framework programme for UK financial services, coming out of the FRF Review. The Payment Services Regulations 2017 (PSRs 2017) and the Electronic Money Regulations 2011 (EMRs 2011) are in tranche 2, on which the government intends to make significant progress by the end of this year. The government will provide further detail on its approach to replacing these Regulations in response to its January 2023 call for evidence (which closed in April) later in 2023.

Several respondents noted a longer-term desire for the government to eventually migrate payments regulation and regulator rulemaking into FSMA 2000. The response states that the government intends to ‘carefully consider the merits of this approach as part of building a Smarter Regulatory Framework’.

For more on developments relevant to payments contained in the Chancellor’s Mansion House speech and related publications, take a look at this Engage article: ‘Payments aspects of UK Mansion House reforms’.

More broadly on the application of the FRF Review to the FCA and PSR’s respective payments mandates, the government had proposed that:

• the FRF Review’s proposals in relation to the statutory objectives and accountability mechanisms of the FCA and PRA would also largely apply to the FCA with respect to its role supervising payment services and e-money emanating from retained EU law; and
• these same accountability mechanisms, but not the FRF Review’s proposed secondary growth and competitiveness objectives, would also be extended to the PSR (as the PSR’s existing economic objectives were felt to be already reflective of the intentions of the revised objectives and would otherwise be largely duplicative).

The government has now legislated to extend these accountability frameworks and regulatory objectives to the FCA and PSR as part of FSMA 2023.

Remit of Senior Managers & Certification Regime in relation to payments to be progressed after broader SM&CR review

The government committed to launching a review into the Senior Managers & Certification Regime (SM&CR) as part of the Edinburgh Reforms announced in December 2022. A government call for evidence on the current SM&CR legislative framework was launched in March 2023, together with a joint discussion paper from the PRA and the FCA considering the regime’s regulatory framework, and both reviews closed in June. The Treasury will consider responses received in conjunction with the regulators and plans to set out next steps ‘in due course’. For more on this, take a look at our Engage article ‘UK SMCR: HMT Call for Evidence and FCA/PRA Discussion Paper’.

Industry’s views on the extension of the SM&CR to both recognised systemic payments entities and authorised PSPs and EMIs have already been sought via the payments regulation and the systemic perimeter consultation. The response provides that the government will set out next steps regarding the future, consulted-on extensions to the Bank or FCA’s remit over payments after the conclusion of its broader SM&CR review.

Prioritising reforms to PSR’s payment systems access framework

The government is also planning to reform the PSR’s payment system access framework (as consulted on in the 2022 consultation and supported by respondents) as a priority via secondary legislation using powers provided to HMT under FSMA 2023. This will mean revoking the access framework within Part 8 (regulations 102-104) of the PSRs 2017, leaving the PSR to apply its framework within Part 5 of the Financial Services (Banking Reform) Act 2013 (FSBRA) in all cases. The government notes that the PSR already imposes a requirement for POND (proportionate, objective, and non-discriminatory) access criteria under its General Direction 2. It expects the PSR to continue this approach and to consider - following revocation of the PSRs 2017 regime - how to reflect POND principles in cases of dispute over indirect access. The government will set out more detail on its approach to achieving these reforms when it publishes a draft statutory instrument in Parliament.

Other changes to FSBRA to better enable PSR within its existing remit to be taken forward more slowly

The rest of the government’s proposed reforms to FSBRA relating to the PSR will require primary legislative change, and it will return to them in a policy statement once a future primary legislative vehicle is determined. Those proposals were to:

• give greater discretion as to the powers the PSR may use in response to an application made under section 56 or section 57;
• remove the phrase ‘primary purpose’ from section 41, which sets out the scope of payment systems capable of being designated as under PSR supervision by HMT;
• align the PSR with the ability of the FCA and the Competition & Markets Authority (CMA) to vary or revoke an existing direction;
• provide powers to allow the PSR to fine designated entities that, for example, knowingly or repeatedly provide misleading or incomplete information, similar to powers already held by the FCA;
• clarify routes of appeal against PSR decisions, confirming that PSR decisions to either intervene or not intervene are equally challengeable to the CMA within two months from the date appellants are notified;
• introduce a means of redress for service users, providing powers for the PSR to ensure restitution of affected users where relevant, similar to the FCA; and
• confirm in statute that the PSR is in scope of rules requiring regulators to make arrangements for the investigation of complaints made against them, as set out in the Financial Services Act 2012 (the PSR already voluntarily submits to this regime).

On the government’s proposal to provide the PSR with a capacity to fine designated entities, ahead of any legislative change the government states that it will carefully consider how the PSR may be allowed to use this power in proportion to its narrower scope compared to the FCA, including as to how those in receipt of fines may appeal requests where needed (including to whom).

Regarding the proposal to introduce a process for the PSR to provide redress for affected service users, the government recognises that there is a wider policy question to be considered as to whether the right outcome is to provide the PSR itself with means for compensating victims where it has intervened, or if clearer and potentially more stringent requirements on system operators to provide their own means of redress would be more effective and proportionate. The government will consider this further in consultation with the PSR and industry before deciding whether to progress legislative reforms to enable redress for users of payment systems.

Next steps

The reforms to the Bank’s systemic payments perimeter will need to be enacted by primary legislation ‘at a future legislative opportunity’, so the government’s immediate next step will be to issue a further policy statement setting out its legislative approach (although timing on this is currently unclear). The government notes that it will be for the Bank itself, as the competent authority, to set out how it intends to supervise the reformed perimeter after the relevant legislation is published.

The reforms to the PSR’s payment systems access framework will be fast-tracked via secondary legislation using powers conferred on HMT by FSMA 2023. As the rest of the proposed reforms to FSBRA relating to the PSR will require primary legislation, the government will return to them in a policy statement once a future primary legislative vehicle is determined.

Further consideration of the proposed extension of the SM&CR to payments is being postponed until after the government’s broader SM&CR review.

The PSRs 2017 and the EMRs 2011 are in tranche 2 of HMT’s Smarter Regulatory Framework programme, on which the government intends to make significant progress by the end of this year. It will provide further detail on its approach to replacing these Regulations in response to its January 2023 call for evidence later in 2023.

If you would like to discuss any aspects of HM Treasury’s consultation response, please get in touch with us.

Authored by Roger Tym and Virginia Montgomery.