A Cursory Look Into The Regulatory Framework Governing The Banking Sector In The United Kingdom: How Equiflux Capital Group Is Redefining The Finance Sector Using Guarantee Finance

This Banking Regulation guide provides a high-level overview of the governance and supervision of banks, including legislation, regulatory bodies and the role of international standards, licensing, the rules on liquidity, foreign investment requirements, liquidation regimes and recent trends in the regulation of banks.

Legislation and Regulatory Authorities

Legislation

1. What is the legal framework for banking regulation?
The primary source of framework legislation governing the regulation of banking and financial services in the UK is the Financial Services and Markets Act 2000 (FSMA). While the current UK regulatory framework derives mainly from the FSMA and related implementing legislation and rules, it is also historically substantially influenced by, and to some degree implemented, various EU laws which set minimum requirements for the regulation of banks and banking services in the European Economic Area (EEA). The architecture of the UK regulatory framework has changed, although its substance largely has not, following the UK's departure from the EU on 31 January 2020 (Brexit). Before Brexit, the UK regulatory framework included large swathes of directly applicable EU regulations, and UK legislation and rules implementing requirements of EU Directives. Following the end of the Brexit implementation period on 31 December 2020 (IP Completion Date) (IPCD), EU law ceased to apply in the UK. Under the European Union (Withdrawal) Act 2018 (as amended) (EUWA), EU and EU-derived legislation and regulation was amended and incorporated into UK domestic law. in a process colloquially known as "onshoring". Examples of EU and EU-derived legislation that is key to the UK legislative framework concerning financial services regulation and that has been onshore into the UK as a result of Brexit include:

• Capital Requirements Directive (2013/36/EU) (CRD IV) and the Capital Requirements Regulation (575/2013) (CRR).
• Markets in Financial Instruments Directive (2014/65/EU) (MiFID II) and the Markets in Financial Instruments Regulation (600/2014) (MiFIR).
• Market Abuse Regulation (596/2014) (MAR).
• Payment Services Directive ((EU) 2015/2366) (PSD2).
• European Market Infrastructure Regulation (648/2012) (EMIR).
• Short Selling Regulation (236/2012) (SSR).
• Securities Financing Transactions Regulation ((EU) 2015/2365).
• EU Benchmarks Regulation ((EU) 2016/1011) (EU BMR).

Unless otherwise specified, all references to EU legislation in this guide mean EU legislation as onshored in the UK. Onshored EU legislation is generally "frozen" as at the point of IPCD: it does not reflect any subsequent changes made by the EU authorities to EU legislation as it applies in the EU. In very broad terms, the onshoring of EU legislation has been conducted by the UK authorities in such a way as to preserve the substantive requirements that existed before IPCD, while reflecting the UK's status outside the EU by the removal of single market rights such as the "passports" for banking and investment services under CRD and MiFID. To provide market participants time to adapt to the loss of single market rights, transitional rules have been created broadly replicating such rights to permit market participants time to adapt, in particular temporary licensing under the temporary permission regime (TPR) The UK authorities are considering a number of rule changes to diverge from EU standards in particular areas in the near future.

• Tier 1 capital (CET1 and AT1 instruments combined) of at least 6% of the total risk exposure amount.
• CET1 capital of at least 4.5% of the total risk exposure amount.
• A base regulatory capital of at least 8% of the total risk exposure amount (the Pillar 1 minimum capital requirements).

In addition to the Pillar 1 regime, banks must also comply with the Pillar 2A, CRD buffer and Pillar 2B capital requirements, as applicable. Pillar 2A requirements cover risks not addressed under Pillar 1 capital requirements against which banks must hold capital. The CRD buffers comprise a capital conservation buffer and a countercyclical capital buffer, which are relevant to all firms, for G-SIIs, a G-SII buffer and for O-SIIs, an O-SII systemic risk buffer. Pillar 2B is a PRA-set requirement for additional regulatory capital to enable a bank to withstand a severe stress event.

What liquidity requirements apply?

All UK incorporated banks are subject to high-level, qualitative and quantitative liquidity requirements. Branches of foreign banks are subject to high-level requirements only. Detailed common reporting requirements also apply. All banks are subject to PRA Fundamental Rule 4, which requires a firm to maintain adequate financial resources. The qualitative requirements for UK banks focus on governance and senior management oversight of liquidity risk, measurement and management of liquidity risk, stress testing and contingency funding plans. The quantitative regime for UK banks implementing the Basel III liquidity coverage ratio (LCR) derives from the EU Delegated Regulation EU 2015/61. This ensures that banks hold a buffer of unencumbered high quality liquid assets to meet liquidity needs under a 30-day stress scenario. The reporting regime requires UK banks to provide liquidity data to the PRA, including:

• Daily liquidity reports.
• Weekly mismatch reports.
• Weekly pricing data.
• Monthly marketable assets reports.
• Monthly funding concentration reports.
• Quarterly retail funding reports.
• Quarterly systems and controls questionnaires.

Regulatory Authorities

2. What are the regulatory authorities for banking regulation in your jurisdiction? What is the role of the central bank in banking regulation?

Lead Bank Regulators
The regulation of banks in the UK is undertaken by three main regulators, the:

• Bank of England (BoE).
• Prudential Regulation Authority (PRA), a division of the BoE.
• Financial Conduct Authority (FCA).

The PRA and the FCA are the lead bank regulators. The BoE is the resolution authority, with primary responsibility for regulatory intervention and the exercise of resolution powers in relation to banks that are failing or likely to fail. For banks, the PRA is the prudential regulator and the FCA the conduct regulator. The PRA and FCA together replaced the Financial Services Authority (FSA), the UK predecessor regulator, in 2013. The BoE's Financial Policy Committee (FPC) is responsible for macro-prudential regulation of the UK financial system and has powers to make recommendations to the regulators in certain circumstances. Separate regulatory regimes exist governing the:
• Provision of payment services (Payment Services Regulations 2017 (SI 2017/752) (PSRs 2017)).
• Issuance of electronic money (Electronic Money Regulations 2011 (SI 2011/99) (EMRs)).
The FCA is the responsible regulator for both regimes.

In broad terms, banks authorised under the FSMA (see Legislation) are licensed to provide payment services and to issue e-money under the PSRs 2017 and EMRs respectively. Under the FSMA, the PRA and the FCA share overall responsibility (including supervision, enforcement and rule-making and regulatory policy) for:
• Authorisation.
• Prudential matters.
• Conduct of business.

The FSMA also sets out the regulatory objectives for each regulator. The PRA's primary objective is to promote the safety and soundness of those institutions authorised by the PRA by seeking to ensure that their business is carried on in a way which avoids any adverse effect on the stability of the UK financial system. Its secondary objective is facilitating effective competition in the markets for services provided by those institutions.

The FCA is responsible for conduct of business, effective financial markets, consumer protection and promoting effective competition. The main bank regulatory rules applicable to banks are found in the Capital Requirements Regulation (575/2013) (UK CRR) and the handbooks of the PRA and the FCA.
Banks (and other authorised persons) must therefore comply with the:
• Detailed rules in the UK CRR, the FSMA and the UK regulators' handbooks.
• PRA Fundamental Rules (PRA Rules).
• FCA Principles for Businesses (FCA Principles).

Each regulator also produces considerable amounts of non-rules based materials that establish regulatory expectations of banks, such as thematic reviews, policy statements, waivers by consent, open letters to CEOs of banks and speeches. The appropriate regulator can pursue disciplinary action where a bank has contravened an FCA Principle or PRA Rule.

Other Authorities
Her Majesty's Treasury (Treasury). The Treasury also influences bank regulation. While the BoE retains responsibility for monetary policy and financial stability, the Treasury is the government department with responsibility for economic and financial policy. The Treasury is responsible for: the overall institutional structure of banking regulation and legislation, reporting to the UK parliament on serious problems in the financial system and measures used to resolve them and monitoring banking sector resilience to operational disruption.

Payment Systems Regulator. Oversight of retail payment systems (including Bacs, CHAPs, Visa and Mastercard) is undertaken by the Payment Systems Regulator. Financial Ombudsman Service (FOS). The FOS has statutory responsibility for handling complaints from retail banking customers dissatisfied with banking and other service providers and for providing redress where due. The FOS operates independently from the other authorities but is required to maintain a memorandum of understanding with the FCA.
Financial Services Compensation Scheme (FSCS). This body is responsible for ensuring that compensation is paid to insured depositors and other eligible claimants to cover amounts due from failed banks and in other appropriate cases. The FSCS is independent from, but accountable to, both the FCA and the PRA. European Banking Authority (EBA). Post-IPCD, the EBA no longer has a formal role in the UK regulatory system. However, the BoE, the PRA and the FCA have onshored (see Legislation) much of the EBA's non-legislative material produced pre-IPCD, among other European Supervisory Authorities' materials.

Central Bank The BoE has two core purposes, ensuring monetary and financial stability and the following key roles in banking regulation:
• Oversight of the interbank payment systems regime, by seeking to reduce risks that could be posed to the UK financial systems and prioritising its activities according to the risks posed by each system.
• Role in the Special Resolution Regime, which gives the authorities a framework for dealing with distressed banks (see Question 22 to Question 24).
• Provider of liquidity and lender of last resort to the banking sector. This is not prescribed in rules; it is a discretionary power.

3. What licence(s) are required to conduct banking services and what activities do they cover?

No person can carry on "regulated activities" by way of business in the UK unless authorised or exempt (section 19, FSMA). The regulated activities are specified in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2015/544) (RAO). The UK regime regulates accepting deposits as the core regulated banking activity. Accepting deposits is a regulated activity if money received by way of deposit is lent to others or any other activity of the person accepting the deposit is financed out of the capital of or interest on money received by way of deposit (Article 5, RAO), subject to certain exclusions.
Other regulated activities include, among others:
• Issuing electronic money.
• Investment-related activities including dealing (as principal or agent) in, arranging deals in, managing, safeguarding and administering and advising on certain investments.
• Consumer lending and certain related activities.
• Lending secured by a mortgage over UK residential property and other home finance activity.
• Insurance distribution.
• Administering a benchmark.

Lending is not regulated as such except for consumer credit and home finance activity (both regulated under the FSMA). Forms of lending that involve financial instruments (such as securities or derivatives) are generally regulated under the UK MiFID framework. See UK implementation of MiFID II. Many banks also have various investment permissions under the UK MiFID framework to enable them to provide other financial services such as securities brokerage and providing investment advice.
A bank that is authorised to accept deposits under the FSMA is generally also licensed to provide payment services under the PSRs and to issue e-money under the EMRs. Passporting. Before IPCD, certain banking activities were subject to mutual recognition across the EEA. Under this framework, known as "passporting", EEA-authorised banks were entitled to conduct business for which they are authorised in their home state into the UK and vice versa. Post-IPCD, passporting rights no longer apply. The UK has implemented a temporary permissions regime (TPR) under which EEA-authorised banks that held a passport pre-IPCD can operate in the UK under the terms of their old passport for a limited period.
Following the end of the TPR, firms will have be authorised in the UK (see Question 4) or cease undertaking regulated activities in the UK (subject to a run-off regime which permits servicing of pre-existing contracts for a limited period). EEA firms that did not enter the TPR or which exit the TPR without authorization can continue to service existing contracts for a limited period to enable an orderly wind-down of their UK business (the supervised run-off regime and the contractual run-off regime).

4. What is the application process for bank licenses?

Application
The relevant license for banking in the UK is a Part 4A Permission under the FSMA to carry on deposit-taking (and any other relevant regulated activities). Applications are made to the PRA, and include a number of detailed application forms, including a permission table that sets out Part 4A Permissions by function and (in certain cases) by client type. Although the PRA manages a single administrative process, the FCA also assesses the applicant firm from a conduct perspective and authorization is granted only if both regulators are satisfied.
As well as the basic application forms, an applicant must provide a regulatory business plan (including details of the rationale for the business) and details regarding:
• Ownership of the bank.
• Business strategy.
• Financial resources.
• Non-financial resources.
• Management structure.
• Responsibilities.
• Controls and governance arrangements.

Significant additional detail about the bank's: policies including:
• capital;
• liquidity;
• financial projections;
• IT systems and processes;
• compliance;
• internal audit;
• outsourcing arrangements;
• senior managers; and
• owners and influencers.

Any prospective bank planning to apply for a deposit-taking permission should arrange a pre-application discussion with the PRA. The PRA and FCA are also expected to be in communication with the applicant throughout the process. Firms other than deposit taking institutions (which in practice includes some investment banks) usually apply only to the FCA, as the PRA's jurisdiction is limited to deposit-taking banks and certain designated investment firms classified by the PRA as being of systemic importance.

Requirements

The PRA and the FCA require prospective banks to meet their respective threshold conditions. These include the following requirements:
• Deposit-takers must be bodies corporate or partnerships.
• A UK-incorporated corporate body must maintain its head office and, if one exists, its registered office in the UK.
• The applicant must conduct its business in a prudent manner, which includes having appropriate financial and non-financial resources. The applicant's non-financial resources must be appropriate in relation to the regulated activities it seeks to carry on, having regard to the FCA's operational objectives.
• The applicant must satisfy the PRA and the FCA that it is a fit and proper person with regard to all circumstances to conduct a regulated activity. The applicant's management must have adequate skills and experience and act with integrity. The applicant must have appropriate policies and procedures in place and appropriately manage conflicts of interest.
• The applicant's business model must be suitable for a person carrying on the regulated activities it undertakes or seeks to carry on and does not pose a risk to the FCA's objectives.
• The applicant must be capable of being effectively supervised by the PRA and the FCA. Any close links of the applicant must be unlikely to prevent effective supervision of it.

Foreign Applicants

Foreign banks incorporated outside the UK are in principle permitted to operate in the UK by way of a UK-authorised branch. A non-UK bank seeking to establish a UK branch must complete a detailed branch authorisation application to the PRA and obtain authorization before establishing a branch in the UK. Post-IPCD, this regime also applies to EEA-banks leaving the TPR that wish to continue operating in the UK via a branch. Both the PRA and FCA have recently issued guidance on their respective approaches to the regulation of international firms, dealing with specific supervisory issues around the challenges and additional complexity associated with cross-border operations.

Larger and more complex firms may be subject to subsidiarisation requirements (that is, be required to house their UK business in a subsidiary rather than a branch under certain circumstances). Timing and Basis of Decision The PRA and the FCA must make their decision within six months of receipt of the completed application but can deem an application incomplete and require further information, which defers the start of the six-month period. In practice, the licensing process can take up to a year to complete.
If the regulators grant permission, each can impose such requirements or limitations on that permission as it considers appropriate.

Cost and Duration An applicant for a banking licence must pay a non-refundable application fee, which varies according to the type of banking business to be carried on. Once authorised, UK banks must pay an annual licensing fee to the PRA or FCA, based on a number of factors including annual income and types of banking business. Banks with a retail client base must also pay additional fees to cover the levies imposed by the FOS and FSCS. Banks may also be required to pay other one-off fees in connection with changes to regulatory permissions or waivers.
Banking licences are granted for an indefinite period, although the PRA retains powers to suspend or revoke licences and/or to impose financial penalties in appropriate cases, such as where the bank fails to comply with PRA or FCA rules (including fees rules).

5. Can banks headquartered in other jurisdictions operate in your jurisdiction on the basis of their home state banking licence?

Non-UK banks seeking to provide services from a place of business in the UK must generally be authorised under FSMA, although exemptions can apply in very limited circumstances. The legal position for foreign banks operating in the UK on a purely cross-border basis (without a UK place of business) is more complicated and varies across activities. Generally, for wholesale financial services, foreign banks can deal on a cross-border basis without triggering licensing requirements where they limit marketing (for example under the exclusion for investment business conducted by "overseas persons").