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Financial Regulatory Observer - Autumn 2021

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The Financial Regulatory Observer spotlights selected topics currently driving regulatory and technological changes in the financial industry.

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Financial Regulatory Observer

Regulatory Hot Topics: Highlights

It has been a period rife with notable shifts on the global stage; a new administration in the US, the end of the Brexit transition period and the reaching of key milestones in the discontinuation of LIBOR, to name but a few. This section provides an overview of recent developments in some key regulatory hot topics

Financial Regulatory Observer
Financial Regulatory Observer

Regulatory Hot Topics: Highlights

It has been a period rife with notable shifts on the global stage; a new administration in the US, the end of the Brexit transition period and the reaching of key milestones in the discontinuation of LIBOR, to name but a few. This section provides an overview of recent developments in some key regulatory hot topics

15 min read

ESG and regulating sustainable finance

In the financial markets, ESG is undoubtedly a hot topic and momentum, in respect of both the creation and acceptance of ESG-linked financial products, continues unabated. The question of how to regulate the transition to a carbon-neutral economy, however, is one that is yet to be answered unequivocally. Below we detail recent developments in this area in each of the United States, Europe and the United Kingdom. 

United States

The US banking regulators are considering ways to integrate climate risk and other ESG considerations into the supervisory framework for the banks they supervise, including:

  • Potential implementation of mandatory climate risk stress tests by the Federal Reserve Board for large banks and large nonbank financial service providers that could require legislative action by Congress and would need to address concerns related to test subjectivity, remediation variability and sharp differences among covered-firm business models that are seen as potentially undermining the goals of stress testing and creating regulatory-arbitrage opportunities
  • The OCC decision not to implement its so-called "fair access" rule, which would have required banks to ensure fair access to financial services, credit and capital for all customers, including fossil fuel companies and other corporate borrowers on the basis of climate risk or other ESG-related considerations 
  • The DOL decision not to enforce the so-called ESG rule issued at the end of the Trump Administration, which would have prohibited ERISA plan managers from making investment decisions based on non-pecuniary considerations, such as climate risk
  • The Federal Reserve Board's reported consideration of the needed bank climate risk management policies, including privately asking member banks to detail the steps they are taking to mitigate the potential climate-related financial risks of their loan portfolios, such as by conducting risk management exercises to identify and provide the regulators with data on the geographical exposure of bank assets to physical risks, such as floods and wildfires and tests on bank exposures to particular sectors, such as oil and gas

European Union

The Commission has established an EU framework that puts ESG considerations at the heart of the financial system to help transform Europe's economy into a greener, more resilient and circular system.

On July 6, 2021, the European Commission published a new strategy for financing the transition to a sustainable economy. This strategy builds on the 2018 action plan on financing sustainable growth, recognizes the need for an updated approach given that global cooperation on sustainable finance has increased and the international context has evolved. The strategy identifies four main areas where additional actions are deemed necessary for the financial system to support sustainability (transition finance, inclusiveness, resilience and contribution of the financial sector and global ambition) and includes the following six actions:

  1. Improve access to transition finance by extending the existing sustainable finance toolbox
  2. Improve inclusiveness by giving SMEs and consumers the necessary tools and incentives to access transition finance
  3. Enhance the resilience of the economic and financial system to sustainability risks
  4. Increase the contribution of the financial sector to sustainability
  5. Ensure the integrity of the EU financial system and monitor its orderly transition to sustainability
  6. Develop international sustainable finance initiatives and standards, and support EU partner countries

The Commission will report on the implementation of the strategy by the end of 2023.

On the same day, the Commission also proposed a Regulation to create the "European Green Bond Standard," a voluntary "gold standard" for green bonds, the use of which will facilitate the raising of large-scale financings for climate and environmentally friendly investments, while protecting investors from greenwashing.

United Kingdom

The FCA recently published two consultation papers to enhance climate-related disclosures; the first, CP21/17, relates to disclosures by asset managers, life insurers and FCA-regulated pension providers, and the second, CP21/18, relates to disclosures by standard listed companies. Both consultations closed on September 10, 2021 and the FCA is expected to publish a policy statement containing final rules later in 2021.

CP 21/17

CP 21/17 sets out proposals to introduce climate-related financial disclosure rules and guidance consistent with the TCFD's recommendations and recommended disclosures. Furthermore, the FCA is introducing a new "Environmental, Social and Governance Sourcebook" in the FCA Handbook, where the proposed rules and guidance will be set out. The key elements of the proposals are:

Entity-level disclosures—On an annual basis, firms would be required to publish an entity-level TCFD report on how they take climate-related risks and opportunities into account in managing or administering investments on behalf of clients and consumers. These disclosures must be made in a prominent place on the main website for the firm's business, and would cover the entity-level approach to all assets managed by the UK firm.

Product or portfolio-level disclosures—Firms would be required to produce an annual baseline set of consistent, comparable disclosures in respect of their products and portfolios, including a core set of metrics. Depending on the type of firm and/or product, these disclosures would either be in a TCFD product report made available on the firm's website or be made upon request to certain institutional clients. 

CP 21/18

In CP21/18, the FCA is extending the application of the disclosure requirements for premium listed companies (which was set out in PS20/17) to issuers of standard listed equity shares. These proposals would require such issuers to include a statement in their annual financial report detailing:

  • Whether they have made disclosures consistent with the TCFD's recommendations and recommended disclosures in their annual financial report
  • Where they have not made disclosures consistent with some or all of the TCFD's recommendations and/or recommended disclosures, an explanation of why, and a description of any steps they are taking or plan to take to be able to make consistent disclosures in the future and the timeframe within which they expect to be able to make those disclosures
  • Where they have included some, or all, of their disclosures against the TCFD's recommendations and/or recommended disclosures in a document other than their annual financial report, an explanation of why
  • Where in their annual financial report the various disclosures can be found.

In an effort to generate discussion and engage stakeholders in respect of sustainable debt instruments and ESG data and rating providers, the consultation paper also includes a discussion component on various ESG topics. 

Separately to the above consultation papers, the UK Government has committed to implement a UK taxonomy, taking the scientific metrics in the EU taxonomy as its basis. On June 9, 2021, a new independent expert group, called the Green Technical Advisory Group ("GTAG"), was established to advise on standards for green investment. GTAG will provide independent, non-binding advice to the Government on developing and implementing a green taxonomy in the UK context. GTAG is expected to provide its initial recommendations to the Government in September 2021.


Changing political landscape

Of late, the global political stage has been subject to considerable levels of drama. In the US, there has been a change in administration, and President Biden's 100-day speech gave insight into the big-ticket items on his agenda, which include addressing climate change, investing in infrastructure, expanding healthcare coverage and reforming immigration laws. The big question for financial services is to what extent the regulatory agenda will change and how much of the Trump Administration's tailoring of prudential regulatory requirements will be undone. On the other side of the pond, the evolution of the post-Brexit regulatory landscape garners considerable attention as we continue to monitor the extent to which the UK will diverge from the EU and consider the impact of the divergence.

United States

While banking regulation has not been high on the regulatory agenda, the Biden Administration has proposed a number of regulatory initiatives that are focused on fintechs, cryptocurrencies and the extent to which activities related to each should be regulated, including:

  • A Congressional resolution signed by President Biden in June that formally invalidated the "true lender" rule implemented by the OCC under the Trump Administration in an effort to create a single simple test to allow a bank loan acquired by a fintech to continue to benefit from preemption of state usury laws and draws into question the "valid when made" rule also implemented by the OCC to establish that the interest permissible before a loan transfer from a bank to a fintech continues to be permissible after the transfer at rates that may exceed state usury laws 
  • Indications from the Biden appointee for SEC Chair Gary Gensler that the SEC is likely to actively regulate crypto trading and lending platforms and stablecoins and to treat cryptocurrency as both a commodity and a security 
  • Guidance from the OCC clarifying that banks may use stablecoins in payments, custody and other activities and offering leeway for banks to issue stablecoins
  • An executive order signed by President Biden on July 7 requires the CFPB to establish open banking and a more open banking ecosystem that facilitates data sharing across platforms by giving consumers access to their bank data and the ability to transfer data between banks and banking apps 

European Union and United Kingdom

The UK's departure from the EU has created new uncertainties in EU-UK cross-border financial services. One such area is the regulatory landscape that EU and UK financial services firms will have to navigate when doing business in the EU and UK. As an automatic consequence of the UK's departure from the single market, passporting rights to and from the UK ended, and the lack of provisions in the Withdrawal Agreement and the EU-UK Trade and Cooperation Agreement has left financial services providers with little guidance on the long-term cross-border regulatory framework. In March 2021, the UK and the EU agreed on the text of a memorandum of understanding establishing the framework for this cooperation, but this has not yet been ratified.

In preparation for the end of the transition period, the UK and the EU adopted various, often temporary, equivalence determinations in respect of each other. Full details of these are contained in our Equivalence Tracker, available on our Equivalence Microsite

EU and UK policies have largely remained aligned to date, but each side is now able to pursue their own regulatory agenda and market participants may soon be forced to deal with more pronounced regulatory divergence. 


LIBOR and the transition to RFRs

The London Interbank Offered Rate, more commonly known as LIBOR, is one of the most significant global benchmarks for calculating interest and underpins much of the global financial system. Yet in 2017, the Financial Conduct Authority ("FCA") called for LIBOR to be phased out by 2021 and replaced by alternative, risk-free rates. LIBOR's discontinuation is considered one of the biggest challenges to ever affect the global financial markets, and market participants need to keep up with the ensuing changes, including the regulatory complexities. Below we set out recent developments in the transition to alternative rates since the beginning of 2021.

United States

While USD LIBOR will be available until June 30, 2023, US financial regulators have imposed a hard deadline of December 31, 2021, on the cessation of the origination of LIBOR-referenced contracts and are pressing market participants to ensure speedy progress toward a post-LIBOR financial system. The Financial Stability Oversight Council ("FSOC"), which comprises the US federal financial regulators, expressed concern at its June meeting that loans tied to LIBOR continued to grow and emphasized that "deniers and laggards" not moving swiftly enough to replace the benchmark will not be tolerated. While market participants and the regulators continue to question the efficacy of SOFR as the alternative to USD LIBOR, considerable progress has been made in its adoption, including: 

  • ARRC's formal recommendation of the CME's forward-looking SOFR term rate, following the July 26 adoption of "SOFR First" best practices to be used in switching interdealer trading conventions to SOFR for USD linear rate swaps 
  • ARRC adoption of best practices and conventions for the use of forward-looking SOFR for all products
  • The implementation of legislation in New York to address the conversion of "tough" legacy contracts from LIBOR
  • The issuance of guidance by US banking regulators on the continued regulatory capital eligibility of LIBOR-based instruments 

European Union

Although there is currently no plan to discontinue EURIBOR, on May 11, 2021, the Working Group on Euro Risk-Free Rates published recommendations on EURIBOR fallbacks, covering events that could trigger fallbacks in EURIBOR-linked contracts and the rates that could be used if a fallback is triggered. The recommendations include an €STR-based EURIBOR fallback rate for specific use cases, including corporate lending, debt securities, securitizations and trade finance, as well as recommendations for a spread adjustment to be added to the fallback rate. 

The Working Group on Euro Risk-Free Rates felt that it was necessary to develop more robust fallback language in order to address the risk of a potential permanent discontinuation, to enhance legal certainty and bring it in line with the EU Benchmarks Regulation.

United Kingdom

The market continues to work towards the Sterling Working Group's roadmap so that by the end of 2021, the market will be fully prepared for the end of GBP LIBOR. At the end of Q3, we will have passed the next milestone in the roadmap, which requires active conversion of all legacy GBP LIBOR contracts that expire after the end of 2021 where viable and, if not viable, ensure robust fallbacks are adopted where possible. 

On September 8, HMT introduced to Parliament the Critical Benchmarks (References and Administrators' Liability) Bill ("the Bill"), an important piece in the UK's "safe harbour" legislation for the transition away from LIBOR. The Bill aims to provide certainty that contractual references to LIBOR will continue to be treated as references to that benchmark where the FCA has directed a change in how it is calculated; i.e., synthetic LIBOR. The Bill also aims to prevent the operation of fallback clauses that are triggered on the cessation (or unavailability) of the relevant benchmark where the FCA continues to publish that benchmark under a revised methodology. The Bill also provides, however, that where a contract or other arrangement includes a fallback clause to operate by reference to something other than the benchmark in question, the operation of that fallback clause is not affected. The intention is to not override contracts that provide for alternative arrangements to be triggered either before or during LIBOR's wind-down. In addition, the Bill aims to provide certainty to parties that, unless their contract provides otherwise, the designation of a benchmark under the Benchmarks Regulation, and any subsequent changes to that benchmark imposed by the FCA, are not in themselves grounds for termination of the relevant contract.


Prudential Regulation

Even in a healthy, competitive market, some firms may and do fail, and so it is to be expected that both during and following a prolonged global pandemic with numerous lockdowns, the regulators will be closely monitoring the outlook for firms. The regulator's role, however, is not to prevent firms from failing but to minimize detrimental spillover for customers, counterparties and market stability, and mitigate the impact of failure. Below, we consider some recent developments in the area of prudential regulation:

United States

While the banking regulators continue to express overall satisfaction at the level of prudential regulation in protecting the resilience of systemically important banks, the Treasury Department increased its scrutiny of technology companies that are key to the financial system and considered too-big-to-fail, including to investigate the growing dependence of banks on these technology providers, who risk "locking" them in.

European Union

The final Basel III standards are a package of reforms that were mostly agreed by the Basel Committee on Banking Supervision ("BCBS") in December 2017. The BCBS' implementation date for most of these reforms is January 1, 2023 (postponed from an original date of January 1, 2022, as a result of the COVID-19 pandemic). 

In September 2021, the EBA and the ECB sent a joint letter to the Commission calling on it to implement the final Basel III standards "in a full, timely and faithful manner" and the Commission is widely expected to adopt a legislative package to implement the final Basel III standards in October 2021.

United Kingdom

The UK Investment Firm Prudential Regime ("IFPR") is a new streamlined and simplified regime for the prudential regulation of investment firms in the UK. The IFPR is being introduced by the FCA in accordance with the new Financial Services Bill and new Part 9C of the Financial Services and Markets Act 2000. The IFPR is heavily based on the EU Investment Firms Regulation ((EU) 2019/2033) ("IFR") and the Investment Firms Directive ((EU) 2019/2034) ("IFD"), which HMT and the FCA are adapting for the prudential regulation of FCA-regulated investment firms.

The intention behind the new proposal is to create a new prudential regime tailored specifically for investment firms that better aligns the standards and rules which apply with the business model of this type of firm (as well as the possible sources of possible harm). The key changes involve:

  • New liquidity rules for UK investment firms
  • Changes to the level of initial capital to be held, which will increase for most firms
  • A brand new approach to calculating capital known as the "K factor" approach
  • New rules on remuneration and disclosure, which allow less scope for firms to determine their approach based upon proportionality principles.

The FCA has published three consultation papers on the new regime, the last of which closed for responses on September 17, 2021, and the new rules are expected to come into effect in January 2022, subject to HMT making the necessary secondary legislation under the Financial Services Act.



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This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.

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