How Procurement Should Adapt to UK Financial Services and Markets Act 2023

Three years after the United Kingdom’s exit from the European Union, the U.K. government has introduced the 'Edinburgh Reforms' to overhaul financial services regulations. The cornerstone of these reforms is the Financial Services and Markets Act 2023, replacing the previous homonymous Act of 2000.

While the Act aims to make the U.K. financial market more dynamic and open, it has stirred controversy due to the extensive powers granted to governmental authorities, particularly His Majesty’s Treasury, over the financial services sector. The Treasury is the big winner of the new legislation. HM Treasury’s powers, especially over the usually apolitical regulators (the Bank of England, Prudential Regulation Authority and Financial Conduct Authority), have increased significantly, which will allow it to directly influence companies within the sector.

Overview of the Financial Services and Markets Act 2023:

• Designation as Critical Third Party:

• HM Treasury has the authority to designate any company operating in the U.K. financial services market as a critical third party.
• The designation is based on the potential impact of the company's failure or disruption of services on the stability and confidence of the U.K. financial services market.
• The decision-making power rests with HM Treasury and the Chancellor at the time.
• Third parties can submit written representations to HM Treasury, but the guidelines for decision-making are vague.

• Rules and Duties on Critical Third Parties:

• The Act allows HM Treasury to create rules and impose duties on critical third parties, although specific details are not outlined in the legislation.
• Presumably, these rules will address risk management measures to mitigate potential risks posed by critical third parties.

• Directives to Critical Third Parties:

• Regulators, including HM Treasury, have the authority to issue directives to critical third parties, specifying actions they must take or refrain from.

• Gathering Information and Investigations:

• If critical third parties fail to comply with directives or duties, HM Treasury can initiate investigations to assess their actions before considering disciplinary measures.

• Disciplinary Measures:

HM Treasury holds extensive disciplinary powers over critical third parties, including:

• Preventing them from providing services to certain financial entities
• Terminating their services to financial entities
• Setting limitations or conditions on services provided to financial entities
• Censuring critical third parties for any violations of the Act

• Regulatory Discretion and Risks:

• The Act grants HM Treasury and other regulators full discretion and power over critical third parties, which may pose risks to companies operating in the financial services sector
• Companies outside the U.K.’s regulatory perimeters might still face concerns due to the Act's proximity to regulating them
• The uncertainty of regulatory application and potential consequences can lead to increased risk considerations and "UK FS premium" pricing for critical third parties' services

• Deregulation and Protection:

• The Act aligns with the government's deregulation ambitions while providing safeguards against single points of failure in the financial services market.
• In a crisis scenario, this regulation could prevent the collapse of the entire financial services market by intervening with critical third parties.

• Uncertainty and Political Risks:

• The Act's powers could be influenced by changing political dynamics, introducing potential uncertainty for financial institutions.
• Increased control of apolitical regulatory bodies by HM Treasury may have implications for market stability.

What Does This Mean for Procurement in Financial Services?

Procurement functions need to be prepared for the impact of the new legislation on potential critical third parties (CTP) within the market. Overall, there is a need to enhance existing processes and controls to factor in the risks that the new law poses to CTPs.

1. Compliance with Resilience Standards:

Designated CTPs must meet minimum resilience standards set by HM Treasury, potentially leading to increased costs and a "UK FS premium" in pricing.

2. Sourcing Activities:

Procurement functions should ensure compliance with resilience standards for designated CTPs and consider applying similar standards to material supplier engagements.

3. Digitalization and Risk Management:

Increased scrutiny of CTPs necessitates enhanced digitalization of procurement functions and improved risk management systems to monitor supplier performance.

4. Exit Strategies:

Procurement functions should review exit strategies for CTPs in light of the Act's provisions for prohibiting or limiting firms from continuing service provision.

5. Operational Resilience:

The Act offers an opportunity for easier discussions with CTPs regarding operational resilience, benefiting both new and existing agreements.

6. Oversight and Assurance:

Firms in the financial services industry can now better oversee and obtain assurance from the CTPs they rely on.

Despite the Act's benefits in terms of deregulation and protection against single points of failure, there are inherent risks. The concentration of risk remains a threat to the U.K. financial services market, and the Act does little to address it. Moreover, the Act's powers lie with HM Treasury, leaving its interpretation and application subject to political changes, which may lead to uncertainty and challenges for financial institutions.

Conclusion

The Financial Services and Markets Act 2023 represents a significant reform for the U.K. financial markets. While it aims to boost dynamism and openness, concerns remain over the concentration of power in HM Treasury and its potential impact on the financial services sector.

Procurement functions must adapt to the Act's implications, enhancing resilience and risk management while closely monitoring regulatory changes.

How the Act's powers will be leveraged by future governments remains uncertain, adding an element of complexity and anticipation for financial institutions.