Baker and McKenzie: Impact of a New UK Regulatory Framework on Capital Markets

The UK Financial Services Act 2012, which came in to force on 1 April 2013, significantly restructures the regulatory framework in the United Kingdom for monitoring the financial markets and for supervising the banking and financial services industries. The Act implements comprehensive revisions to the regulation of financial services and markets in order to uphold the integrity of the UK financial system. This article focuses on two key reforms which affect the London capital markets: changes to the regulation of sponsors and the adoption of new market manipulation criminal offences.

General overview of regulations

The Act replaces the Financial Services Authority with a new tripartite regime comprised of:

• the Financial Conduct Authority, a focused conduct of business regulator regulating the financial markets and retail and wholesale financial services firms;
• the Prudential Regulation Authority, a focused micro-prudential regulator regulating financial firms, including banks, investment banks, building societies and insurance companies; and
• the Financial Policy Committee of the Bank of England, an expert macro-prudential regulator advising the PRA on macro-economic policy-making and risk assessment and monitoring and responding to systematic risks in the financial sector.

The FCA inherited the FSA’s authority to regulate the issuance and trading of securities, supervise multi-lateral trading platforms, establish market codes of conduct, and impose civil and criminal penalties for market abuse and insider dealing. As the FSA’s successor as market regulator, the FCA regulates securities transactions in accordance with the United Kingdom Listing Authority’s Listing Rules, Prospectus Rules, and Disclosure and Transparency Rules. Although the Act in general does not materially change the UKLA rules in effect prior to the Act, one significant change to the UKLA Listing Rules is to broaden the FCA’s authority to authorise, monitor, and discipline sponsors. These changes are designed to make the sponsor system more flexible and responsive to the market, and are summarised further below.

“The FCA inherited the FSA’s authority to regulate the issuance and trading of securities, supervise multi-lateral trading platforms, establish market codes of conduct, and impose civil and criminal penalties for market abuse and insider dealing.”

The FCA also inherited the FSA’s authority to prosecute criminal offences under the market abuse regime of the UK Financial Services and Markets Act 2000. The Act extensively amends a number of the provisions of FSMA, including repealing the misleading statements criminal offence and adopting new criminal offences for misleading statements, misleading impressions, and misleading statements and impressions relating to benchmarking activities. The changes, which are discussed further below, are intended to govern benchmarking activities in line with, and in response to, the final report of the Wheatley Review of LIBOR.

Changes to the sponsorship regime

The Act amends the UKLA Listing Rules to provide that restrictions or limitations can be placed on the services which a sponsor may provide to make the sponsor system more flexible and responsive to the market. As a result of these changes:

• it is now possible to apply to become a sponsor for a limited number of services, rather than having to become a sponsor for all purposes;
• the FCA can alter the level of approval and limit the scope of activities a firm can be a sponsor for after they have been given approval;
• the FCA has the power to suspend a sponsor’s approval, rather than cancelling it, allowing sponsors to more easily return to the market once they have regained the FCA’s approval; and
• the FCA has a wider range of disciplinary sanctions to use in its regulation of sponsors, including the ability to impose financial penalties.

These changes could provide new opportunities for firms wishing to become sponsors. In its consultation on the changes, the FSA (as the predecessor to the FCA) explicitly acknowledged that one purpose for the new powers is to make it easier for new sponsors to enter the market and therefore to increase competition. The changes mean that sponsors can now apply to be approved to carry out only certain sponsor services, requiring them to meet the eligibility criteria for those services only. This is a significant change from the previous regime, which required all sponsors to satisfy all eligibility criteria and therefore made it potentially difficult for firms to enter the market.

The recent changes will clearly be of interest to existing sponsors. They will also be of interest to firms who are considering becoming new sponsors, in particular those who have in the past been put off by the need to satisfy all of the eligibility criteria. For example, there may be firms who are keen to become sponsors in order to service their global clients on certain transactions in the UK, but only have experience and expertise in certain types of transactions. Under the previous regime, such firms would not have been able to become sponsors without first acquiring additional skills in order to satisfy all of the criteria required by a sponsor. However, under the new regime, such firms would be able to be approved as sponsors for specific types of transactions, allowing them to make an initial entry into the UK market, and then possibly expand their operations at a later date.

To become a sponsor it is necessary to meet several criteria which are set out in the Listing Rules. These criteria must not only be met upon application but continuously whilst a firm remains a sponsor. An applicant must show, to the satisfaction of the FCA, that it:

• is either an authorised person or member of a designated professional body;
• is competent to perform sponsor services; and
• has appropriate systems and controls in place to ensure that it can carry out its role as a sponsor.

There is a multi-step application process for becoming a sponsor in the UK. The process does not have a set timeline as the period taken will depend on the specific firm applying and the quality of its application. It is therefore best to begin the process as soon as possible and to contact the regulator at an early stage. The steps are:

• first, write to the Sponsor Supervision team of the UKLA, providing details of the firm. The Sponsor Supervision department will then provide guidance on how the Listing Rules will apply to the firm;
• second, submit an application form, together with the non-refundable application fee of £15,000;
• and third, the UKLA Sponsor Supervision team will then conduct an onsite assessment of the firm, examining its systems and controls.

A prospective sponsor will need to demonstrate that its systems and controls are sufficient. If a firm is considered competent it will be given approval to become a sponsor. The sponsor will be liable to pay the annual sponsor fee of £20,000.

Expanding market manipulation offences

The Act replaces the provisions of FSMA for misleading statements and misleading impressions, adopting some new standards and introducing a new offence for misleading statements and impressions relation to benchmarking activities. These changes are primarily in response to the final report of the Wheatley Review of LIBOR, which was issued in 2012 amidst increasing concerns about the accuracy and reliability of benchmarks, such as LIBOR. As a result of these changes, benchmarking activities are regulated activities under FSMA and intended to fall within the market abuse regime of FSMA.

The FCA inherited the FSA’s responsibilities for the market abuse regime under FSMA, and retains the power to prosecute the following criminal offences:

• “misleading statements”, or making a statement which is knowingly or recklessly materially false or misleading, or dishonestly concealing a material fact, to induce investment activity;
• “misleading impressions”, or any intentional or reckless act to create a false or misleading impression of the market in or price or value of an investment to induce investment activity and/or the making of an economic gain or the causing of an economic loss; and
• “misleading statements and impressions relating to benchmarks”, or making a statement or impression which is knowingly or recklessly false or misleading in connection with setting a benchmark.

The offence of “misleading statements” substantively restates the offence in effect prior to the Act, and the offence of “misleading impressions” broadens the offence in effect prior to the Act by including reckless as well as intentional acts. For example, a statement or impression which is likely to induce a shareholder to sell its shares could constitute a criminal offence if the person making the statement was reckless as to whether the statement was misleading, false or deceptive. The “misleading statements and impressions relating to benchmarks” offence is a new criminal offence which did not exist prior to the Act. All three criminal offences may be punishable by imprisonment of up to seven years or fines up to the statutory maximum.

The Act’s Misleading Statements Order clarifies which investments, activities and benchmarks fall under the new criminal offences, and the FMSA’s Regulated Activities Amendment Order affirms that providing information in relation to a specified benchmark and administering a specified benchmark constitute regulated activities. In addition, the FCA issued the new handbook General Guidance on Benchmark Submission and Administration, which includes new rules for entities carrying on benchmark related regulated activities. Although the orders specify that currently the only regulated benchmark is LIBOR, the FCA has the authority to regulate other benchmarks as well. For example, the FCA could adopt similar provisions for benchmarks for the energy or commodity markets.

Conclusion

The new financial regulatory framework is intended to increase the reliability and stability of the UK financial markets, and the Act balances the need to protect a broadening definition of financial consumers, to increase effective competition, and to enhance the integrity of the financial markets. The FCA’s powers to regulate capital markets activities have been significantly expanded as compared to its predecessor to meet these strategic objectives, and the new regulatory authorities will need to continue to work with market participants to ensure that the new regime is practical and effective.

About the Author

Edward Bibko is a partner in Baker & McKenzie’s International Capital Markets Group based in London. He joined Baker & McKenzie’s London office in February 2001. Prior to joining Baker & McKenzie, Edward practiced in New York and Chicago law firms and worked as a financial analyst for IBM. Edward is ranked as a leading capital markets practitioner in Chambers Global 2009 and currently serves as a member of the Firm’s International Capital Markets Group. Mr Bibko  specialises in international equity and debt capital markets transactions. He received a doctorate from Syracuse University.

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