Grand Committee

Tuesday 2nd May 2023 Grand Committee

Tuesday 2 May 2023

Arrangement of Business

Tuesday 2nd May 2023 Grand Committee

Announcement

15:45

[The Deputy Chairman of Committees (Lord Geddes) (Con)]

My Lords, as is usual at the beginning of a Grand Committee, I should advise the Grand Committee that if there is a Division in the Chamber while we are sitting, which I am told is unlikely, this Committee will adjourn as soon as the Division Bells are rung and resume after 10 minutes.

Register of Overseas Entities (Definition of Foreign Limited Partner, Protection and Rectification) Regulations 2023

Tuesday 2nd May 2023 Grand Committee

Considered in Grand Committee

15:45

Moved by

[The Earl of Minto]

That the Grand Committee do consider the Register of Overseas Entities (Definition of Foreign Limited Partner, Protection and Rectification) Regulations 2023.

[The Minister of State, Department for Business and Trade (The Earl of Minto) (Con)]

My Lords, I beg to move that these regulations, which were laid before the House on 15 March 2023, be considered. These regulations form part of a series of secondary legislation needed to effectively implement the register of overseas entities, which I will refer to as the register.

The register was created under Part 1 of the Economic Crime (Transparency and Enforcement) Act, which gained Royal Assent last year. The register will help to crack down on dirty Russian money in the UK and corrupt foreign elites abusing the openness of our economy. It requires overseas entities owning or buying property in the UK to give information about their beneficial owners or managing officers to Companies House, and provides greater information for law enforcement officers to help them track down those using UK property as a vehicle for money laundering.

The register went live on 1 August 2022 and the deadline for registration was set at 31 January this year. There has been a high rate of compliance, with over 27,500 overseas entities registering to date. A further 700 have provided details to Companies House, having disposed of all their interests in land before the end of the transitional period. This means that over 28,000 entities have complied with the requirements. While that likely leaves a few thousand entities still to register, some of these are believed to have been dissolved or struck off while others have not kept their address details up to date with the Land Registry. Companies House continues to work to increase compliance even further; it is now also assessing cases for compliance action.

Noble Lords will recall my noble friend Lord Callanan introducing the first tranche of regulations last year. These included the Register of Overseas Entities (Delivery, Protection and Trust Services) Regulations, the Register of Overseas Entities (Verification and Provision of Information) Regulations, and the Land Registration (Amendment) Rules. The subject of today’s debate is the first regulations in the latest tranche that is subject to the affirmative resolution procedure. Other instruments are being prepared to ensure that the register can function even more effectively.

I turn to the details of this instrument. These regulations are laid under the powers of the Economic Crime (Transparency and Enforcement) Act 2022, which I will refer to as the Act. They deal with three main elements: first, prescribing the characteristics of a foreign limited partner for the purposes of the Act; secondly, allowing for information held within the register to be removed on application under circumstances; and, thirdly, amending the protection elements of the Register of Overseas Entities (Delivery, Protection and Trust Services) Regulations 2022.

The first part of this instrument sets out the characteristics of a foreign limited partner for the purposes of the register. These regulations provide that such individuals participate in a foreign limited partnership as a limited liability participant or hold shares or a right, either directly or indirectly, in a legal entity that participates in a foreign limited partnership as a limited liability participant. The regulations also define exactly what is meant by a foreign limited partnership and how a person would qualify as a limited liability participant in such a partnership. These provisions will assist overseas entities in identifying registerable beneficial owners under the legislation for the register.

As regards the measure on rectification, Regulation 4 sets out the grounds for rectifying the register. There may be occasions when information submitted to and visible on the register is factually inaccurate, forged, or has been submitted without the consent of the overseas entity. This regulation therefore allows for the register to be rectified by removing such information.

Regulation 5 of the instrument establishes the criteria for those entitled to receive notice of an application for rectification. It also specifies the information that must be included in the notice.

Accordingly, Regulation 6 lays down the grounds for interested parties objecting to such an application while confirming how objections should be made and the time limit for making them. Regulation 6 also sets out how the register is to determine whether to accept an application for rectification where an objection has been received.

Without these regulations, it would not be possible for a person to apply for the removal of inaccurate or forged information from the register. These measures therefore strengthen the accuracy and utility of the register.

On the third measure, on protection, Regulation 7 sets out details of an amendment to the existing protection regime. The regime deals with the protection of personal information from public inspection; “protection” means that information is not displayed by Companies House on the public register, although protected information must be provided to Companies House and is available to law enforcement. As it stands, protection can be granted only on an application subject to strict criteria. Applicants must provide evidence that they are, or a person living with them is, at risk of serious violence or intimidation if their details are publicly disclosed. Such a disclosure must result directly from their link with the overseas entity.

The amending provision will remove the requirement to demonstrate the risk of violence or intimidation arising directly from the individual’s association with the overseas entity. The measure will subsequently allow applications for protection that are needed because an individual is at serious risk. They would still need to demonstrate that risk before protection is granted but the risk would no longer need to be linked to the overseas entity.

The amendment will also allow for relevant individuals’ usual residential addresses to be protected if, for example, an individual provides a usual residential address as a service address without realising that it will be displayed on the public register. The person will then have to provide an alternative address to protect their usual residential address. These changes are necessary because it has become apparent that the current criteria lack flexibility. Without these changes, there is a real risk that, by publicly disclosing their details, some people will be in danger of serious violence or intimidation due to the ease with which a link could be made to their residential address.

To sum up, the measures in these regulations are crucial for the effective operation of the register of overseas entities. I hope that noble Lords will support these measures and their objectives. I commend these draft regulations to the Committee.

[Lord Wallace of Saltaire (LD)]

My Lords, we welcome this small adjustment to last year’s Act. I think we all approach it from the angle of the Committee on this year’s economic crime Bill, and the Minister is well aware that the largest concern coming out of its successive sittings is about how serious the Government are on enforcement. That question will continue all the way through our consideration of that Bill and it relates to this SI a little.

We are aware of the problem we have with properties in London owned by foreign companies, particularly where it is not clear who owns them, and, to a more limited extent, with land across the UK. We are conscious that this leads to a loss of tax revenue because, if you cannot identify the owner, you cannot get the rates paid or whatever. I have not yet seen an assessment of how much revenue is being lost to local councils and others from this hole, but it must be considerable.

I was told that 40% of properties in the Nine Elms development around Battersea Power Station have been sold to people from outside the UK. That is a large amount, and we know that there are a considerable number of areas, including Belgravia, where the lights are off.

Over the weekend, I was quite surprised to get some interesting statistics from an organisation with which I was not previously familiar called Open Ownership. I note that Transparency International is one of the entities that funds and supports this new body. It gave me some very interesting figures including that, of the beneficial owners personally registered, some 70 appear to be under the age of 12, one appears to have been born in 1897, which makes him 126 now, and another was born in 1907, which makes him 116. There are possibly one or two inaccuracies in what is being reported. Perhaps the Minister will say a little about how checks will be made on what comes in, so that rectification can take place.

I was even more interested to discover that the overwhelming majority of individuals identified as beneficial owners so far were British, by both nationality and residence. I had expected more to be from Asia—Hong Kong, mainland China and Singapore—and areas of eastern Europe, Cyprus and elsewhere. The large majority of companies mentioned as beneficial owners were registered in either the UK or the three Crown dependencies. If what I have received is accurate, it suggests a considerable amount of a different sort of economic crime under way here, which is called tax evasion. There may be a substantial loss of revenue to the United Kingdom that, as we proceed further down this line, we might at last begin to tackle.

While I welcome this small step forward, we have a long way to go. There are a lot of questions about what we do with this information as we gather it and if this information is correct. One of the questions raised in the Committee on the Bill was how much capacity Companies House will have to go through this and trigger action on it, and with which agencies the Government will then pursue that action.

I apologise to the Minister for not having given notice of the questions I have just thrown at him, but I received this SI only two or three days ago. I welcome the regulations, but we still have a lot of other things to do in this large and complicated area in which the United Kingdom Government and, as we know from other areas of economic crime, British citizens lose a lot of money.

16:00

[Baroness Blake of Leeds (Lab)]

My Lords, I thank the Minister for his opening comments. I think he will be aware that several of us are spending quite a lot of our time on the Economic Crime and Corporate Transparency Bill, which is going through the House at the moment, and many of the issues in the statutory instrument we are discussing today are the subject of ongoing conversations.

We recognise that this is secondary legislation to amend the Act that went through last year. I welcome the Minister’s comment that this is work in progress and that further revisions will be required because there are still some gaps that we may need to consider in future.

I preface my remarks by highlighting the scale of the problem that we are dealing with. I do not think any of us should shy away from the real problem we have in this country now as a result of not taking action sooner. It is a tragedy in many ways that it was the onset of the conflict in Ukraine that necessitated swift action, and it is regrettable that this problem, which had been highlighted before, had not come into our focus and received the attention necessary.

I welcome in the main the provisions in the statutory instrument, but I shall make a couple of comments and ask a couple of questions. I make it clear, as we have done throughout the discussions in this area, that we recognise that the vast majority of companies investing in the UK do so with good intentions and bring great benefit to the country and that we are concentrating on the actions of the relatively small number of bad actors. Sadly, their contribution to this is profound and has done an enormous amount to damage the reputation of the UK on the world stage. I hope that we are united across the Committee in making sure that we take every opportunity to improve the chances of our reputation being recovered and are seeking out problems as they arise.

My main hope is that those at serious risk if information is given out are protected. It is very important that we recognise that there are genuine cases where protection needs to be secured. By the same token, we have to avoid disproportionate burdens and make sure that legitimate investors are welcome to operate in our country.

I seek some clarification. There seems to be some concern that the Act still does not provide a complete definition of what a foreign limited partner is. The description in the Explanatory Memorandum seems rather abstract. I wonder whether this may lead to practical implications where the confusion continues to exist. Reassurance on this point would be gratefully received. Most of all, we want to make sure that the register is populated correctly and effectively. Throughout the discussions on this matters, transparency is paramount in the context of those who will need further protection, as the Minister outlined.

I thank the Minister for his comments about risk, but I want to understand if bringing this instrument forward has led to further thought on the definition of risk. Have we gone far enough? I would like to understand how this is demonstrated and whether there has been an assessment of how well this is working so far. As has been highlighted, the issue of the alternative address could still be problematic. I understand the need for flexibility, but is there a risk remaining? We would like to be confident of the success of this provision. Again, this links to the balance between protection and transparency.

The other area is—if you can describe it as this—cleaning up the register and recognising, as we have heard, that some of the information held is clearly not factually accurate or even worse, as we know there is certainly a measure of intent in some of the entries. Do we know the extent of this? On how many occasions is this going to be necessary? Do we have an estimate of how much of a problem this is and how regular it is? Most importantly—I think this runs through all the debates on the Bill itself—how will this work be resourced? Can we be reassured that there are adequate personnel and resources at our disposal to make sure that we get this done successfully?

What are the sanctions once a forgery or anything factually inaccurate has been identified? Are there punishments? Do we have any evidence of this? Can we have a general clarification around the deterrent factor to make sure that we do not have problems going forward? Obviously, with there being an equivalent provision in the Companies Act 2006, I would hope that we have learned from the experience of working on this. I wonder if there are examples of that that would help to inform the debate.

I understand the Minister’s comments about the deadline of 31 January, but I have heard an estimate that 7,000 companies failed to register. Is that about the ballpark he is suggesting? Since January—we are now in May—has there been an understanding of how successful the action taken against the remaining numbers has been?

There are still other issues and I look forward to other measures coming forward to fill the loopholes. In conclusion, of course we welcome the provisions being made, but are seeking reassurance and confidence that concerns will be addressed, and the necessary changes will be made as we go forward.

[The Earl of Minto (Con)]

I thank both noble Lords for their valuable contributions to the debate. The Government are committed to ensuring that the register of overseas entities is robust and effective at tackling the use of UK property to launder money. These regulations provide the mechanisms that ensure that the register of overseas entities operates effectively. A clear definition of “foreign limited partner” provides greater certainty concerning registrable beneficial owners of overseas entities; I have a full definition for the noble Baroness that I can share. Applicants will be able to identify registrable beneficial owners more easily with a definition that is recognisable across multiple jurisdictions.

The amendment to the protection regime will address the unintended consequences of the regulations as they stand, by removing the requirement to demonstrate the risk of violence or intimidation arising directly from the individual’s association with the overseas entity. The measure on rectification ensures that errors on the register, whether deliberate or accidental, are identified and removed. The points raised by noble Lords highlight the necessity of the measures in these regulations, and I will answer some of them now.

The noble Lord, Lord Wallace, raised the question of accuracy—that is definitely ongoing. I do not think Companies House fully knows the number of inaccurate entries, but it still stands by the estimate it has used before of there being 32,000 registrable entities in total. We are up above 28,000 now. Although there will be some inaccuracies, I hope that by continuing to approach these organisations, Companies House will iron them out. I have not been involved in this sort of thing before but, despite the fact that it has taken some time to get there—it took the atrocious situation in Ukraine to bring this to the fore—it has certainly made some significant progress in getting that many people to register in such a short period of time. However, the point is well made that the accuracy of the register is paramount, including in terms of lost revenue.

On the younger people mentioned, I understand there are issues of family trusts, particularly with UK beneficial owners. That point, too, was well made. I could go through what is meant by the “foreign limited partner”, but I would rather share that with the noble Baroness. I hope that answers some of the more direct questions, and I will write to noble Lords if there is anything that I have not answered.

[Lord Wallace of Saltaire (LD)]

May I ask two questions, not to be answered now but perhaps in a letter? First, checking the accuracy of everybody’s name on the register will not be easy. Particularly for those that are not registered in Britain—those relying on co-operation from foreign authorities—it raises a large number of questions about how we get other authorities to co-operate with us and what multilateral network there is to ensure that they provide accurate information. I would appreciate knowing more about that.

Secondly, we are all familiar with the cascade of companies that one often finds—you go to the first company, which is owned by two different companies in two different jurisdictions and so on. If we are serious about this, how are we going to work through that, given that we are dealing not simply with overseas territories officially under British sovereignty but with other offshore financial centres which do not have a good record of co-operating to provide accurate information?

[The Earl of Minto (Con)]

Behind the noble Lord’s question is the question of resource. Companies House has 120 full-time equivalent staff working on this and pursuing precisely what the noble Lord referred to. I hope that will continue to improve the situation as time moves on, but the point was very well made.

[Baroness Blake of Leeds (Lab)]

Can I link that to the question I asked about what punishment or sanction there is? I apologise if the Minister is coming to that.

16:15

[The Earl of Minto (Con)]

At the moment, the main emphasis is trying to get the accuracy of the data. No punishment has been meted out yet, but there is power—both financial and legal—to punish as and when. Companies House is working hard to get those cases under way, but its main emphasis has been on trying to get the information as accurate as possible so that a lot of the anomalies that sit within it can be effectively eliminated. As the noble Lord said, some of these corporate structures are quite complicated, so it takes a while to get to the bottom of them. I promise that I will write.

The register of overseas entities provides sets of new global standards for transparency and levels the playing field with property owned by UK companies, which must already disclose their beneficial owners to Companies House. The register is a crucial part of the Government’s fight against illicit finance. The Economic Crime and Corporate Transparency Bill, currently before Parliament, will feature substantial changes to UK economic and partnership law and complement the Economic Crime (Transparency and Enforcement) Act. The Bill will introduce amendments to the Act that provide further operational detail on the register of overseas entities. For example, new measures in the Bill will require more information about overseas entities, including the title numbers of the properties held by overseas entities. It also introduces minimum age limits for managing officers to ensure that details of a person over 16 years of age are always be provided.

The Bill will also make further provisions for registrable beneficial owners in cases involving trusts and includes an anti-avoidance mechanism to ensure that those in scope of the register at the time that the Act was first published as a Bill to Parliament cannot circumvent its requirements. The laying of these regulations will complement the measures in the Bill to ensure that the register is as effective as possible, and I commend them to the Committee.

Motion agreed.

Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023

Tuesday 2nd May 2023 Grand Committee

Considered in Grand Committee

16:19

Moved by

[Baroness Penn]

That the Grand Committee do consider the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023.

Relevant document: 36th Report from the Secondary Legislation Scrutiny Committee

[The Parliamentary Secretary, HM Treasury (Baroness Penn) (Con)]

My Lords, this Government have a clear vision for financial services—that is, for an open, sustainable and technologically advanced financial services sector that is globally competitive and acts in the interests of communities and citizens by creating jobs, supporting businesses and powering growth across all four nations of the UK. The two statutory instruments that we are debating today complement some of the measures that are being delivered through the Financial Services and Markets Bill, which is currently before this House. I note that both statutory instruments were raised as instruments of interest by the Secondary Legislation Scrutiny Committee.

I turn first to the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023. In recent years, multiple reports from the Cryptoasset Taskforce and the Financial Conduct Authority have identified that misleading advertising and a lack of suitable information are key consumer protection issues in crypto asset markets. This statutory instrument seeks to address those issues by ensuring that crypto asset promotions are held to the same standards as broader financial services products carrying similar risk.

To do this, the SI expands the scope of the financial promotion restriction provided by the Financial Services and Markets Act 2000 by amending the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 to include financial promotions in respect of in-scope crypto assets. This will mean that businesses that intend to make qualifying crypto asset promotions would need to have their promotions approved by an authorised person under the Financial Services and Markets Act if they are not FSMA-authorised persons or exempt.

At present, most crypto firms do not hold such FSMA authorisation in respect of their crypto activities under existing regulations, so the requirement to be authorised means that most crypto firms will not be able to communicate their own promotions, unlike other financial services firms. As set out in the February 2023 policy statement, there is also evidence of a lack of suitable FSMA-authorised persons in the market willing and able to approve crypto promotions.

In practice, the net effect of these issues would be to restrict significantly or amount to an effective ban on crypto asset financial promotions because there are unlikely to be FSMA-authorised persons willing to approve the promotions of unauthorised firms. To avoid the unintended consequence of an effective ban on crypto asset promotions, the SI introduces an exemption for crypto asset firms registered with the FCA under its anti-money laundering regime. This will enable qualifying firms to communicate their own crypto asset financial promotions without seeking approval from a FSMA-authorised person.

Crucially, the SI confers powers to the FCA to ensure that AML-registered crypto asset businesses relying on this exemption will still be subject to the same financial promotion rules as FSMA-authorised persons communicating equivalent promotions. Firms using this exemption will not be able to approve others’ financial promotions or to communicate their own financial promotions in relation to other controlled investments.

The Government intend this AML exemption to be temporary in nature. It will be in place only until the proposed broader regulatory regime for crypto assets is established. The Government are preparing to bring stablecoins used for payment into the scope of regulation and are also consulting further on their regulatory approach to unbacked crypto assets.

When in force, the SI and the FCA rules will apply to all businesses making crypto asset promotions to UK-based consumers, whether from the UK or abroad. The SI provides for a four-month implementation period, which will commence when this SI is made and on the publication of the FCA’s detailed rules subsequent to this SI. As set out in the policy statement published in February 2023, this period is intended to ensure that crypto asset firms have suitable time to understand and prepare for the financial promotions regime before it comes into force.

This SI will reduce a key risk to consumers, particularly that of consumers suffering unexpected or large losses without regulatory protection as a result of buying crypto asset products while being unaware of the associated risks. This complements and forms part of our wider, proportionate approach to regulation, harnessing the advantages of crypto technologies while mitigating the most significant risks.

Turning to the Financial Services and Markets Act 2000 (Commodity Derivatives and Emission Allowances) Order 2023, this second instrument reduces the burdens that firms face when determining their trading in commodity derivatives and emission allowances by requiring them to be authorised as an investment firm. Effective commodities markets regulation is key to ensuring that market speculation does not lead to economic harm. The regulator should be able effectively to regulate and supervise firms that trade commodity derivatives for investment purposes.

As well as financial services firms, a number of corporates trade on commodity markets to protect their business from market fluctuations. In regulation, this is referred to as trading that is ancillary to the main business. The regime that we have inherited from the EU uses something called the ancillary activities test to determine whether the activities of a firm trading commodity derivatives are primarily for investment purposes or only support the firm’s commercial business. The ancillary activities test currently requires firms to undertake complex calculations; they are also required to notify the FCA about the outcome of these calculations on an annual basis.

Taken together, this regime is overly burdensome for firms. Prior to the implementation of the ancillary activities test in EU law, the UK had a simpler test for determining whether firms were trading in commodity derivatives or emission allowances as an ancillary activity. This regime was cheaper for firms to comply with and resulted in the same outcomes as the current regime.

In 2021, as part of the wholesale markets review, the Government consulted on reverting to a simpler regime while maintaining the same regulatory outcomes. The proposal was to remove the annual notification requirement and revert to a principles-based approach. Respondents to the consultation agreed with the proposed changes, stating that the current regime was onerous and complicated. Consequently, the Government committed to bringing forward these changes when they responded to the consultation last year.

This SI delivers on that commitment by removing the annual notification requirement and omitting references to the calculations, which are no longer needed in legislation. This will pave the way for the Financial Conduct Authority to adopt a simpler and more streamlined approach to determining whether firms need to be authorised, alongside this SI. To reflect the FCA’s adoption of a simpler approach, this instrument also amends part of the regulated activities order, which exempts firms from having to perform the current calculations. As the FCA’s new approach will be based on different information, this exemption is no longer relevant.

The SI will come into force on 1 January 2025. This will ensure that industry has sufficient time to reflect on the changes that the FCA will be making and to make the necessary system changes. I understand that the FCA plans to consult on these changes later this year.

Maintaining the ancillary activities test as it currently stands would impose continuing costs on both firms and the FCA, as evidenced by feedback received through the consultation process. The changes outlined will reduce costs for firms and make the UK a more attractive place to do business, while maintaining high regulatory standards. I beg to move.

[Lord Sharkey (LD)]

My Lords, we support both of these instruments, with some reservations and a few questions.

I will speak first to the commodity derivatives and emission allowances order. As the Minister said, it proposes a very sensible reduction to regulatory burdens. I note that the procedure followed in this case was a kind of super-affirmative, as prescribed in Schedule 8 to the European Union (Withdrawal) Act 2018. The instrument was published in draft to enable recommendations to be made by a committee of either House; no such recommendations were made but some questions nevertheless arise.

Perhaps the key question is when we will see the FCA’s new replacement regime, mentioned in paragraph 7.8 of the Explanatory Memorandum. Paragraph 10.2 of the EM notes that respondents to the consultation

“did not want to return to a wholly qualitative definition of ‘ancillary trading’”

and

“were in favour of the FCA developing a simplified method to determine when an activity is ancillary”—

one that would give them the legal certainty that qualitative definitions would not. I think this means that, until January 2025, when the SI comes into force, the current rules continue to apply. If that is the case, and if the current regulatory burden is so obviously unnecessary, why do we have to wait so long for the new regime?

The EM also notes:

“HMT is committed … to ensuring that the FCA has the right powers to set any transitional provisions that may be necessary to deal with the situation in which a firm’s trading activity can no longer be regarded as ancillary”.


I take this to mean that the FCA does not currently have these powers. If that is the case, perhaps the Minister can say why the usual transitional powers article was not included in this SI.

I now turn to the financial promotion SI. I agree that that it is vital both to increase consumers’ understanding of the risks associated with crypto assets and to ensure that the promotion of these assets is subject to the same standard of regulation as is the case for broader financial services; I welcome the proposed order. I am glad to see that the proposed implementation period has been reduced from six months to four months but I wonder whether this is still too long and invites an avalanche of unregulated promotion in those four months. Can the Minister explain why the four-month period was chosen and say what consideration was given to a shorter period? I would also be grateful for more explanation of the exemption mentioned in paragraph 6.4 of the EM— specifically why it is necessary and how long it will last—and for an assurance that it does not create any unhelpful loopholes.

16:30

Paragraph 7.8 of the EM notes that the Government are

“preparing to bring stablecoins with propensity to be used for payment into the scope of regulation and is also consulting on its future regulatory approach to unbacked cryptoassets”,

as the Minister pointed out. We welcome this but we would be grateful for an assurance that this current SI does not extend the reach of the FSCS and that extension—or not—of this reach will be a major consideration in the future regulatory approach. It would be very helpful if the Minister could give the Committee some indication of the timescale involved in this future extension to the regulation of crypto assets. The potential for significant customer losses is obviously high and we see the need for urgency in bringing new regulations into force.

Paragraph 6.8 of the EM makes explicit that this current SI does not extend to non-fungible tokens. This seems a curious omission. Until very recently, the Treasury was enthusiastic about NFTs, going so far as to commission the Royal Mint to produce a collection of them. However, a couple of weeks ago, the Treasury publicly abandoned the scheme. The timing seems rather odd, coming as it does at a time of strong growth in NFTs worldwide and in the trading of NFTs. In February, the NFT sales volume was just over $2 billion, up 117% from January. In the UK, the NFT segment was projected to reach $85 million this year and to grow annually at around 20%, rising to $184 million in 2027 according to Statista data. Also according to Statista, we can expect the number of UK users to reach 340,000 at around the same time.

This is obviously a fast-growing and unregulated sector, full of perils for incautious or uninformed purchasers—perhaps especially for younger investors. Will the Minister urgently reconsider the inclusion of NFTs in the new financial promotions regime? It would be easy to do and would provide some protection before the sector becomes damagingly large.

Finally, I shall make a more general observation about consumer protection. The SI before us will regulate promotion but will not educate, inform or warn. The FCA website tries to do those things. I would be interested know what the traffic to those FCA website pages is and how it measures their effectiveness. When I looked at them, they seemed to me to be a little overcomplicated and perhaps rather difficult to understand. It would be better to be more direct and, more importantly, to have an effective outreach and education campaign that does not chiefly rely on visits to the regulator’s website. I am sure that the Minister has noticed that many tokens are obviously directed at young people, who are perhaps not the most natural or frequent visitors to the FCA’s site and are probably most at risk in making token purchases. I would be grateful for the Minister’s thoughts on the matter. Finally, I repeat that we support both the SIs we are discussing.

[Lord Naseby (Con)]

My Lords, I am going to talk to the crypto assets SI only. This is a vital SI at this point in time. I am delighted that the objectives are,

“improving consumers’ understanding of the risks associated … and ensuring that cryptoasset promotions are held to the same standards as for broader financial services”.

The taskforce reported way back in 2018 and, my goodness, the world has changed dramatically since then. Paragraph 7.3 of the Explanatory Memorandum records what happened to the market a few months ago. Recent failures happened in November and, for all we know, there may be some just around the corner.

My noble friend and those who decide these things are absolutely right that the FCA should now be involved. However, I, too, question whether the four-month gap after the SI is passed is really necessary. In today’s modern world, I would have thought three months would be the absolute maximum—if even that long is needed. We also know, as highlighted in paragraph 10.3, that since the publication of this SI, the Government have recognised

“that risks to consumers have increased”

and they are still increasing.

I am no longer involved in the world of advertising and promotion, but I was in a previous incarnation. People are extraordinarily creative when it comes to financial promotion. Direct mail, in all its varying forms, and telephonic communications, in all their current sophisticated manners, are a very difficult area to control and to have a regime for. Therefore, His Majesty’s Government must look at this very carefully, take the best advice of those doing the communicating—I hope my noble friend has access to the genuine people who are communicating—and look at what developments are happening in communication. In paragraph 13.4 the Government quite rightly say that they do

“not have an estimate of the number of small or micro businesses in the UK that are liable to be affected by this measure”.

I know from experience that number is growing. Therefore, this is needed urgently. Again, I emphasise that four months is a little too generous.

Finally, I see in paragraph 14.3 that the Minister with responsibility for small business, enterprise and employment has claimed that this SI does not need a review clause. If there is a market that really needs a review clause, this one is a wonderful case history. I cannot believe that we really believe that. It is up to His Majesty’s Government to decide at what stage there should be a review, which is entirely right, but this is a market that needs to be kept in total focus, otherwise things will go wrong again.

[Lord Tunnicliffe (Lab)]

My Lords, I am grateful to the Minister for introducing these orders. Let me also express thanks to the Secondary Legislation Scrutiny Committee for flagging the orders as instruments of interest in its 36th report of the Session. As the Minister outlined, the first order brings crypto assets into the regulatory regime for financial promotions. This is not the first time we have debated the risks associated with crypto assets, and I doubt it will be the last.

As the Explanatory Memorandum notes, crypto assets have been subject to severe market instability in recent years. Some assets have seen significant reductions in their value, and we have also witnessed the failure of several high-profile firms, including the bankruptcy of FTX late last year. With that instability in mind, we welcome any steps to reduce the risk posed to consumers, particularly through the misleading advertising which seems to have become commonplace as crypto popularity has soared.

However, this order is only one piece in an increasingly complex regulatory puzzle, with supplementary steps being taken through other vehicles, including the ongoing Financial Services and Markets Bill. I hope the Minister can provide assurance that the Treasury and the regulators are moving as quickly as they can in this area. Financial regulation is iterative and new measures need to be properly consulted on, but the Minister will understand concerns that remaining regulatory gaps will continue to be exploited. The implementation period for this measure has been shortened, which appears to be a sensible step. Can the Minister comment on the likely implementation period for related future measures?

The Explanatory Memorandum helpfully explains the exemptions granted to UK-based businesses on the FCA’s anti-money laundering register. However, the SLSC’s comments on the exemption raise an important question: if it is intended to be temporary, why has no end date been specified? I appreciate that this order is part of a bigger package but, in the interests of good legislating, can the Minister identify at what point a review of the exemption is likely to be carried out?

Finally on this topic, the Minister will be familiar with the suggestion that the Government regulate stablecoins in a similar way to bank deposits—that is, protect funds under the Financial Services Compensation Scheme. What consideration, if any, is the Treasury giving to that proposal? If the Government do not plan to take that approach, how will the Treasury and the FCA ensure that consumers are aware that their stablecoins holdings are not protected?

The second order relates to commodity derivatives and emission allowances, specifically when relevant firms will need to be authorised as investment firms. The Explanatory Memorandum promises

“a simpler and therefore lower cost regime”,

with the EU-derived markets in financial legislation regulations rolled back in favour of a new principles-based approach, to be implemented by the FCA. Again, this is part of a broader reform package being undertaken by the Treasury, with part of that package contained in the Financial Services and Markets Bill.

We recognise that the current ancillary activities test is too complicated and burdensome. However, can the Minister outline the proposed timelines associated with these changes, with a particular focus on the FCA’s creation of the new regime? As with crypto assets and many other areas of financial regulation, the FCA is being left to do a lot of heavy lifting but questions remain as to whether current parliamentary oversight of the financial regulators is sufficient. I realise that there are ongoing discussions on this subject between the Minister and interested colleagues across the House, but does she feel that we are getting any closer to a satisfactory outcome? While the risks associated with changes to these elements of financial regulation might be low, that should be as much a judgment for legislators as it is for Ministers and regulators. I hope that we will be able to achieve consensus on that matter as the aforesaid Bill proceeds to Report.

We support the passage of these orders but, as I am sure the Minister will acknowledge, they do not offer the final word on either subject. These are small pieces of a much bigger, more complicated puzzle. I hope that she will be able to speak to that bigger picture in her response and provide both answers and reassurance around some of the issues raised in this debate.

[Baroness Penn (Con)]

My Lords, I thank noble Lords for participating in today’s debate. I turn first to the changes to the financial promotions regime in respect of crypto assets. Several noble Lords asked about the exemption that applies to anti-money laundering regulated firms. I set out some of this in my opening speech but it is worth returning to it now. As set out in the policy statement published in February this year, the anti-money laundering exemption will exempt firms that are not FSMA-authorised but are included on the FCA’s anti-money laundering register from the requirement to have their crypto asset promotion approved by a FSMA-authorised firm. This is subject to said promotions also complying with the same rules set by the FCA for equivalent promotions made by FSMA-authorised firms. The purpose of the AML exemption is to avoid the unintended consequence of an effective ban on crypto asset financial promotions as there are not currently sufficient numbers of FSMA-authorised firms in the crypto space.

16:45

The decision to introduce the AML exemption reflects the FCA’s rigorous process of assessing crypto asset businesses for registration under the AML/CFT regulations, in line with the Financial Action Task Force’s agreed standards. The exemption is intended to be temporary, in that it will be in place only until the proposed broader regulatory regime for crypto assets is established. As noble Lords have noted, we are preparing to bring stablecoin used for payment into the scope of regulation; we are also consulting on our future regulatory approach to unbacked crypto assets. When in force, these regulatory regimes will enable more crypto asset firms to apply instead to become FSMA-authorised, removing the need for the AML exemption as, when FSMA-authorised, more firms could issue their own crypto promotions or approve suitable promotions for unauthorised firms. This approach balances enhancing consumer protection with continuing to promote responsible innovation.

To answer the noble Lord, Lord Tunnicliffe, on the temporary nature of this exemption, it is there until we have the broader regime in place for crypto asset regulation. When it will be replaced is not time-limited but policy-limited. The question of the noble Lord, Lord Sharkey, which I will address specifically, was perhaps on the most important point: does this create loopholes or a difference in treatment, apart from the fact that an AML authorisation can be used rather than a FSMA authorisation? We are clear that it will not and does not. It will apply the same standards to those promotions as would be expected without this exemption. That is very much the intention behind the policy.

I believe that both noble Lords asked about FSCS compensation in looking to extend the regime. They will know that this SI extends the scope of only the promotions regime. It would not be appropriate to extend the FSCS here, but the Government will continue to consider consumer protection measures as we develop a more comprehensive regime. On that regime, the Government have sought in our approach to crypto assets to look at the highest risk areas first and take swifter action in them, while also developing the more comprehensive approach that noble Lords can see in the consultation that is out at the moment on crypto assets. That is why we are tackling financial promotions in this SI, and why we have the provisions on stablecoins in the Financial Services and Markets Bill and the more comprehensive approach that we are also consulting on.

My noble friend Lord Naseby welcomed this change and asked what engagement we have had with industry. The Government and the FCA have engaged closely with industry throughout the policy development process. One outcome of this was that, in our 2022 consultation response, the Government announced a six-month transition period for the implementation of this regime. I think all noble Lords asked about the timelines for that. That six-month implementation period was introduced to allow industry suitable time to understand how the regime will be implemented practically and to prepare for it, with the aim of ensuring compliance across the industry.

However, we also recognise that crypto asset market instability continues to be a significant factor, underscoring the risk to consumers. We have seen that in recent market volatility, including the collapse of FTX. We have therefore reduced the implementation period to four months. We think that strikes the appropriate balance between providing industry with suitable time to prepare for compliance with the regime with ensuring that suitable consumer protections are in place.

The noble Lord, Lord Sharkey, asked about the extension of this regime to NFTs. A qualifying crypto asset is defined as

“any cryptographically secured digital representation of value or contractual rights”

which is fungible and transferable. For the purposes of this regime, the Government do not currently consider NFTs to be used primarily as investments, but we will continue to monitor the market when it comes to NFTs.

I turn to the SI on ancillary activities. There were a number of questions on the timing of this approach and how the FCA intends to take forward its rules under the SI. The Treasury consulted industry on the timeline, and we are keen to ensure that it has certainty about what the new regime will look like before making any changes to its internal systems. Delaying entry into force until 2025 is necessary to ensure that the FCA can consult this year on changes to the ancillary activities exemption and that industry can engage with this. then adapt its internal processes to take account of the future regime.

Although I accept the point made by the noble Lord, Lord Sharkey, about the burdens the current regime places on businesses, we have taken this approach in consultation with industry about the processes needed to transition to a new regime. The FCA has already been using its supervisory powers to waive the most bureaucratic requirements and therefore ease some of the burden. More broadly, the FCA already has the necessary powers to put in place the new regime. This SI paves the way for that by making consequential amendments to legislation for elements of the previous regime that were set out in legislation.

The noble Lord asked about the reference in the Explanatory Memorandum for the second order to

“transitional provisions that may be necessary to deal with the situation in which a firm’s trading activity can no longer be regarded as ancillary under the terms of the test”.

To explain what we mean by this, the regulated activities order included an exclusion that removed the need for firms to do the market threshold calculation, which formed part of the quantitative test, if there was no data available to perform that test. It also provided a firm with relief from the need to seek authorisation if it could meet the other components of the ancillary exemption. Feedback from firms suggests that this exemption gave them important legal certainty. This exclusion was based on EU data which is no longer produced and relates to the AAT, which is to be revoked. In any case, as we move towards a more proportionate approach, this exemption is no longer relevant. However, we want to ensure that the FCA can continue providing the legal certainty that firms need, and we are currently discussing this with the FCA.

On the question of how the FCA will carry out these changes more broadly, the FCA worked closely with what was then Her Majesty’s Treasury on the wholesale markets review in 2021, and has been involved in subsequent discussions about what the ancillary activities exemption and test will look like once changed. The FCA will take the outcome of the consultation and follow-up discussions into account when progressing its work on the ancillary activities test. It will also be required to consult on specific changes, following its normal processes. As the noble Lord, Lord Sharkey, noted, maintaining this obligation as it currently stands would impose continuing costs on firms and the FCA. Therefore, we hope that this work happens with sufficient pace, but we have also allowed sufficient time for firms to put in the arrangements that they need to.

A number of detailed questions were asked on both the SIs that we have discussed. I have endeavoured to answer most of them, but I will read Hansard back to see whether there are any that I have missed out.

In terms of setting these statutory instruments in the context of the Financial Services and Markets Bill, which is before the House, and our future financial regulation process, in some respects the noble Lord, Lord Sharkey, noted how this area is different because we are still operating under the previous provisions, so we have had the SIs—or at least one of them—out for consultation. However, it shows us how some of this regulation will be taken forward; we can reflect on that as we continue to reflect on the Financial Services and Markets Bill. I will continue to engage with all noble Lords as we move towards Report on that Bill.

Motion agreed.

Financial Services and Markets Act 2000 (Commodity Derivatives and Emission Allowances) Order 2023

Tuesday 2nd May 2023 Grand Committee

Considered in Grand Committee

16:55

Moved by

[Baroness Penn]

That the Grand Committee do consider the Financial Services and Markets Act 2000 (Commodity Derivatives and Emission Allowances) Order 2023.

Relevant document: 36th Report from the Secondary Legislation Scrutiny Committee

Motion agreed.

Committee adjourned at 4.56 pm.