What Impact Will the FSMA 2023 Have on the UK Payment Sector?

On June 29, 2023, the Financial Services and Markets (FSM) Bill received royal assent to become the Financial Services and Markets Act 2023 (FSMA 2023). The FSMA 2023 revokes the EU retained law relating to financial services and markets in the UK and aims to promote investment and to support innovation within the economy. It introduces new secondary objectives for the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) to facilitate the growth and international competitiveness of the UK economy through Sections 25 and 26. Section 25 covers the competitiveness and growth objective, while Section 26 covers the reporting requirements of this. The act enters into force at different dates.

The intention of HM Treasury is for these objectives to be pursued in the medium and long term, while the safety and soundness of UK firms are ensured. The intentions are also for there to be fair competition within the UK market and for the safeguarding of consumer protection. This regulatory analysis focuses on the main regulatory changes made by the act and how these will affect the payment sector. 

Key objectives of the act

As specified by the UK government’s press release confirming that the act had received royal assent, the act aims to achieve the following in relation to payments:  

• Strengthening control of the financial services regulators.
• Introducing protections for victims of authorised push payment (APP) scams.
• Ensuring free access to cash.
• Enabling the regulation of crypto-assets.
• Establishing “sandboxes” to support the use of new technologies by financial markets infrastructure (FMI) firms.

Strengthening control of the financial services regulators

Following Brexit, the UK regulators — the FCA, the PRA and the Payment Systems Regulator (PSR) — have been given more powers to re-regulate areas previously regulated by EU law. This has created the need for enhancing regulators’ accountability towards HM Treasury, which is, in turn, responsible for the UK’s financial services regulatory framework.

Among the provisions to enhance regulators’ accountability:

• Section 3RB of the FSMA 2000, as amended by Section 29 of the FSMA 2023, requires each regulator to prepare and publish statements of their policies on how they will carry out the review of the rules they make.
• Section 3RC enables HM Treasury to direct the regulators to review their rules in certain cases, such as when the rules have been in force for at least 12 months or the Treasury considers that the review is in the public interest.
• Section 35 amends Section 1JA of the FSMA 2000 to introduce a requirement for the regulators (FCA and PRA) to respond annually to HM Treasury’s recommendation letters. A similar provision has been made for the PSR, by adding Section 102A into the Financial Services (Banking Reform) Act (FSBRA) 2013.

These provisions entered into force on August 29, 2023, as established by Regulation 4 of the Financial Services and Markets Act 2023 (Commencement No. 1) Regulations 2023. 

New powers for the regulators will mean that the rules applicable to the financial industry will be reviewed and some of them will be changed. As a result, the regulators have undertaken different initiatives.

In May 2023, the HM Treasury launched the Financial Services Regulation: Measuring Success – Call for Proposals, which invited feedback on which metrics the regulators should publish to ensure that reporting on the new secondary objectives is sufficient to evaluate how the regulators are working towards their new objectives. The call ended on July 4, 2023. Outcomes of this consultation have not been published to date.

The Bank of England (BoE) published the discussion paper DP4/22 ‘The Prudential Regulation Authority’s future approach to policy’ in September 2022, inviting feedback until December 8, 2022. The discussion paper described the PRA’s proposed approach to policy-making following the introduction of the FSM bill. In June 2023, CP11/23 – PRA statement on the review of rules followed. The Annex 1 of the consultation paper (CP11/23) sets out the PRA’s proposed framework for reviewing its rules. It consists of four key steps:

• Monitoring the rules.
• Selecting which rules to review.
• Establishing the appropriate methods and timing for the review.
• Executing the review and any follow-up decisions.

The consultation will close on September 29, 2023.

Furthermore, on September 19, 2023, the PRA published two staff background papers for discussion during a conference held on the role of financial regulation in international competitiveness and economic growth held at the BoE. These two papers are:

1. The links between prudential regulation, competitiveness and growth - presenting the staff’s analysis on the connections between competitiveness, growth and prudential standards.
2. How to measure the contribution of prudential regulation to competitiveness and growth - presenting a set of options of metrics and their respective advantages and disadvantages.

On the same day, the BOE released the results of a pilot survey titled: “Secondary Competitiveness and Growth Objective” based on 145 responses collected from May 18, 2023 to June 30, 2023. The questions were grouped in following four main categories:

1. The PRA will make rules that harness the UK’s strengths as a global financial centre (Q1 – 6). 
2. The PRA will act to maintain trust (Q7 – 10).
3. The PRA will tailor rules to UK circumstances (Q11 – 14).
4. Further questions (Q15 – 16).

Overall, the majority of the respondents agreed on the above statements. The lowest percentage expressing agreement was provided on Q14: “Based on the PRA’s communications to-date, I believe the PRA’s approach to its [Secondary Competitiveness and Growth Objective] SCGO is clear and appropriate” with 38.6 percent of respondents agreeing with the statements. Meanwhile, the highest was provided on Q7: “The PRA provides a stable and predictable regulatory environment” with 63.4 percent of respondents agreeing with the statements. 

A consultation paper on the PRA’s approach to prudential policy is expected later this year, according to the speech delivered by Victoria Saporta, Executive Director of Prudential Policy Directorate at the BoE, at the mentioned conference.

The FCA launched a consultation on a draft Rule Review Framework in July 2023, with the aim of gathering comments on the FCA’s plans to monitor and review its rules. This framework applies to all FCA rules, which are found in the FCA’s Handbook. The consultation closed on September 15, 2023.

The draft set out three main kinds of reviews that the FCA may adopt:

• Evidence assessment - consisting of gathering data and evidence to check whether a rule meets the established outcomes. 
• Post implementation review - involving assessment on whether a rule allows the desired result and consideration of implementation difficulties and potential unintended consequences. This kind of review also implies an analysis of the market situation after the implementation.
• Ex post impact evaluation (or impact evaluations) - is based on quantitative evidence to ensure regulations are proportionate, to repeal obsolete regulation and to explain the FCA’s actions.

The FCA and PRA also published an additional Regulatory Initiatives Grid Update in July 2023 in consideration of the impact of the FSMA 2023, to inform the sector on any important and imminent changes. The grid sets out the planned regulatory initiatives for the next two years and it is usually published twice per year, last one was in February 2023, and next one is expected later this year.

APP scams customer protection

Section 72 of the FSMA 2023, which entered into force two months after the act received royal assent, requires the PSR to prepare and publish a draft of a relevant requirement for reimbursement in cases where the regulator considers it to be necessary. For this purpose, in September 2022, following HM Treasury’s announcement on its intention to legislate in this sense, the PSR launched a consultation on proposals to give greater protection against APP scams. 

In June 2023, the PSR announced the introduction of a new reimbursement requirement for APP fraud within the Faster Payments system. The new requirement will:

• Require payment firms to reimburse customers who fall victim to APP fraud in most cases.
• Equally split the cost of reimbursing victims between issuer and acquirer.
• Provide enhanced protections for vulnerable customers.

In July 2023, the PSR launched another consultation on draft legal instruments for the APP fraud reimbursement requirement to seek feedback on two draft directions on how to implement the new requirement. The draft directions focus respectively on:

• Faster Payments APP scam reimbursement rules.
• APP scams Faster Payments operator monitoring. 

The consultation closed on August 25, 2023. At the time of writing, there had been no updates on its outcome. However, the PSR had proposed an implementation date for the reimbursement requirement of April 2, 2024.

The consultation document also includes a draft general direction on reimbursement requirements, compliance with rules and data provision. A further consultation on this draft is expected in October.

On August 15, 2023, the PSR issued two more consultation papers:

• CP23/7: APP fraud: The consumer standard of caution, which describes the policy approach proposed by the PSR to be taken with the consumer standard of caution (gross negligence) and a draft guidance the PSR intends to produce alongside it.   
• CP23/6: APP fraud: Excess and maximum reimbursement level for FPS and CHAPS, which concerns the value of the excess and maximum reimbursement level for Faster Payments and seeks feedback on the topic of a maximum reimbursement level for CHAPS on behalf of the Bank of England. It also proposes options for the excess and maximum level of reimbursement and the application of the latter to vulnerable customers. 

Both consultations closed on September 12, 2023.

Access to cash

In recent years, the use of cash has declined, according to UK Finance, mainly due to the increased use of digital payment methods. In October 2020, the UK government issued a call for evidence on cash access, stating its objective was “to maintain a sustainable infrastructure for cash in the UK, to ensure financial inclusion for all parts of society, including the most vulnerable who rely on cash in their daily lives”. Research by UK Finance in the past has shown that cash remains the second most frequently used payment method in the UK and more recent data has confirmed this, even if its overall use has declined. In July 2021, the government published a summary of responses to the call for evidence, alongside another consultation on legislative proposals to ensure access to cash, which proposed the introduction of geographic requirements on (at least at first limited to banks and building societies) to ensure cash access points across the UK. On May 19, 2022, the government released another summary of responses to the consultation confirming its approach to legislating via the FSMA. 

Part 2 of the FSMA 2023 regulates access to cash and entered into force two months after the act received royal assent. Schedule 8 establishes the FCA as the main regulator for retail cash access and gives it monitoring, supervision and enforcement powers to ensure that firms, such as banks and building societies, maintain appropriate deposit and withdrawal facilities across the UK. 

Enabling the regulation of crypto-assets

Section 23(2) of the FSMA 2023 introduces a definition for “digital settlement asset” (DSA) and Section 23(6) gives HM Treasury the power to amend this definition in case of changes in the features, relevant technology or use of these assets. A DSA is defined as “a digital representation of value or rights, whether or not cryptographically secured, that:

• Can be used for the settlement of payment obligations,
• Can be transferred, stored or traded electronically, and
• Uses technology supporting the recording or storage of data (which may include distributed ledger technology).”

The definition includes stablecoins or other crypto-assets that are used for payments. The explanatory notes to the bill define stablecoins as “a form of crypto-asset which aim to maintain a stable value relative to other assets. [...] Stablecoins which reference their value in relation to fiat currencies can be seen as more akin to traditional payment instruments”.

Section 23(3)(a) provides HM Treasury with the power to make regulations, including applying legislation relating to the regulation of electronic money and payments to DSAs and adapt it where the Treasury considers it appropriate. 

Furthermore, Section 23(3)(f) allows HM Treasury to recognise the operators of systemic payment systems and systemic service providers using DSAs, enabling the Bank of England (BoE) to regulate and supervise systemically important DSAs. 

These provisions allow HM Treasury to bring DSAs used as payments means into the UK regulatory perimeter, to ensure that fiat-referenced stablecoins, where used for payments, are subject to the same requirements and protections as other similar payment methods.

The act also enables the PSR to regulate payment systems using DSAs, by extending Part 5 on regulation of payment systems of the Financial Services (Banking Reform) Act 2013 to payment systems using DSAs.

These provisions entered into force on August 29, 2023, as established by Regulation 4 of the Financial Services and Markets Act 2023 (Commencement No. 1) Regulations 2023.

Sandboxes to support use of new technologies by FMI firms

Financial market infrastructures (FMIs) “allow the clearing, settlement, and recording of financial transactions. They enable millions of transactions to take place each day.”

Section 13 enables HM Treasury to set up one or more FMI sandboxes, which will temporarily allow participating firms to test the efficiency or effectiveness of the use of developing technology and the adoption of new or different practices in the carrying out of FMI activities, as well as to assess whether or how relevant enactments should apply. 

Section 15 provides HM Treasury with the power to make permanent implementation of arrangements tested under an FMI sandbox. This is carried out via a statutory instrument subject to the affirmative procedure, in cases where it is determined that the arrangement should have effect after the expiry date.

These provisions entered into force on August 29, 2023, as established by Regulation 4 of the Financial Services and Markets Act 2023 (Commencement No. 1) Regulations 2023.

Conclusion

The FSMA 2023 aims, among other things, to cover areas which as a consequence of the UK’s exit from the EU the UK has decided to re-regulate. Therefore, it provides UK financial regulators with more power, such as powers to HM Treasury to regulate crypto-assets and to the PSR to introduce new requirements on PSPs to protect victims of APP fraud scams. It also establishes the FCA as the main regulator for ensuring access to cash, so as to support financial inclusion.

The act also introduces a new secondary objective for the FCA and the PRA of boosting growth and international competitiveness within the UK economy, when carrying out their general functions, as established by the FSMA 2020.

The act reforms have led to various initiatives from regulators, such as the FCA’s proposals to strengthen its accountability and several additional PSR consultations to regulate APP fraud scam reimbursement, which will lead to new requirements being imposed on PSPs. 

The act is bringing about major changes to the financial sector, although its practical effects, especially in relation to the secondary objective, are still to be seen.