Why do financial regulations change?

The fintech revolution is surging ahead at breakneck speed. Tech solutions that were unheard of a few years ago are now mainstream and the speed of change is accelerating. For the financial regulators, it’s a challenging environment. Protecting consumers and providing a level playing field for businesses is hard when the goal posts are constantly moving. Is it any wonder why regulations change?

Why are financial regulations necessary?

Like a referee in a football match, the regulators are there to enforce the rules. They protect consumers and businesses from widespread fraud and work to promote trust in the system. Financial regulations often get a bad rap, but a world with no financial rules would be a wild west for consumers and businesses.

For businesses and consumers, financial regulators like the Financial Conduct Authority (FCA) have 3 important functions:

1. To protect consumers: they should be able to feel confident when making financial decisions.
   
2. To promote competition between businesses: no businesses should have an unfair advantage.
    
3. To ensure the integrity of the UK finance system: this is arguably the most important function given the disastrous consequences of the 2008 financial crisis.

3 reasons why regulations change

“There is nothing permanent except change,” said Greek philosopher Heraclitus. And it’s a constant race for financial regulators to keep up with the evolving financial services industry.

But why do financial regulations change? We’ve identified 3 main factors driving regulatory change in the financial system – the failure of existing regulations, the changing nature of the financial services and the need for existing regulations to be more easily enforced.

Here are 3 case studies to explain the reasons for regulatory change in more detail.

1. Existing regulations are not fit for purpose

Like an unsafe bridge, unsuitable financial regulations are often only revealed once they are put to the test. It sometimes takes a financial shock or scandal to reveal current regulations are not fit for purpose.

A prime example is the financial crisis in 2008. Existing regulations failed to guard against the disastrous collapse of high street banks Northern Rock and Royal Bank of Scotland or protect consumers, who were only covered for up to £2,000 worth of deposits.

The system had failed and a radical overhaul was needed.

In April 2013, the UK government abolished the Financial Services Authority and set up 3 new regulatory bodies, the Financial Policy Committee, the Prudential Regulation Authority and the Financial Conduct Authority. 

Between them, they would oversee the whole financial system and regularly stress test the solvency of banks. In addition they would keep an eye on banks, supervise the financial services industry as a whole, authorise financial services providers and set financial regulations.

Existing regulations were also beefed up to protect customers in the future. The Financial Services Compensation Scheme (FSCS) ensured that customers would be protected for up to £85,000 of deposits. New capital requirements were placed on banks, with a minimum 3% leverage ratio (£3 of capital for every £100 of assets), and tougher requirements for globally important banks.

2. Regulations change to keep up with innovation

Not surprisingly, FinTech business owners don’t plan their businesses with the regulators in mind. They are relentless innovators, often developing solutions and financial products that don’t fit the current regulatory framework.

During the past 20 years the UK financial industry has changed, almost beyond recognition. Multiple and complex financial solutions have evolved to support modern consumers and businesses. Financial regulators need to respond quickly so that consumers and businesses are protected.

One recent example of galloping innovation is the explosion of cryptocurrency investment and supporting tech solutions.

Cryptocurrency investment and the new technology that supports it is proving problematic for regulators for the following reasons:

• Blockchain technology is private, making it difficult for HMRC and the FCA to access information. 
• Cryptoassets are often held across borders and in other tax regimes.
• Cryptoassets are extremely risky, not widely understood by investors. There’s a danger that some consumers are trading in assets they don’t understand.
• Cryptoassets don’t fall under current rules for financial promotion.
• Social media is a new environment which is difficult to regulate.

The FCA and the Government are currently actively reviewing cryptoasset regulations and tax rules.

In January 2022, the FCA launched a consultation on the financial promotion rules for high-risk investments including cryptoassets. And on 10 and 11 May 2022 the FCA are hosting a two-day CryptoSprint in Euston Square, London where they aim to collaborate with innovators, academics, regulators and technologists to “help inform future policy decisions” and consult on “regulatory policy changes”.

Watch this space as more crypto regulations are on the horizon.

3. Regulations change to close gaps in current frameworks

Sometimes the current rules just aren’t working. Businesses and consumers are trying to play it by the book, but frustratingly, see the regulations not enforced elsewhere. 

If the current regulations have no teeth, it’s only too easy for unscrupulous individuals and companies to slip through the net. The regulator needs to revisit the rules and attempt to close the loopholes.

A recent example of where the rules aren’t working is the current money laundering regulations. In September 2020 the FCA revealed that it had still not brought a single criminal prosecution under anti-money laundering legislation, according to private client law firm Macfarlanes. 

The problem is that money laundering is often hidden in offshore companies with complex ownership structures and is hard to identify and prosecute.

The Government’s Economic Crime (Transparency and Enforcement) Act, planned for 2022, will strengthen the current money laundering rules. It’s an attempt to give teeth to the current regime. It will add the following regulations:

• Companies House will require an overseas entity with property in the UK to identify and register its beneficial owners. Solicitors will have to declare who ultimately benefits UK property and the real owners of mansions, office blocks and luxury apartments will become visible.
  
• Company agents from overseas won’t be able to create UK companies on behalf of foreign criminals or secretive oligarchs.
  
• Businesses will face fines, even where they have no knowledge of a breach of money laundering regulations.

Conclusion

Financial regulators walk a constant tight rope between over-regulating business and not providing sufficient protection for businesses and consumers. The 2008 financial crash demonstrated that poor financial oversight could contribute to a global economic catastrophe with long term economic consequences.

An agile and responsive financial regulator is needed given the current rapidly evolving fintech revolution. Financial regulations change and that change is likely to accelerate as the fintech sector continues to evolve the way that business and consumers use money in the future.

For business in the financial services sector, it’s important to get involved in the dialogue with the Government and the FCA about regulation change and to make sure your voice is heard. 

Sharing your experiences, concerns, frustrations and practical knowledge makes it more likely that the financial regulations are workable and fit for purpose in the future.