On 21 March 2024, HM Treasury (HMT) published a policy paper (Policy Paper) setting out its approach to designating critical third parties (CTPs). This follows the Bank of England, Prudential Regulation Authority and Financial Conduct Authority’s (together, the Regulators) December 2023 consultation on operation resilience for CTPs in the UK financial sector (Consultation). For more information on the Consultation, please see our article available here. 

Background

Under the Financial Services and Markets Act 2023 (FSM Act), HMT has the power to designate an entity that provides third-party services to the UK financial services sector as “critical”. FSM Act also gives the Regulators the power to set and enforce rules for CTPs. In the Consultation, the Regulators set out their proposed new rule requirements and accompanying expectations for CTPs.

What does the Policy Paper cover?

The Policy Paper covers the following areas: 

1. the criteria for the designation of a CTP; 
2. the process for the designation of a CTP, including an indicative process for designation;
3. how HMT will communicate a designation decision to the prospective CTP; and 
4. the process of removing a CTP’s designation (i.e., de-designation). 

Criteria for designation

HMT may only exercise its designation power if, in its opinion, a failure in or disruption to the provision of the services that the third party provides to firms could threaten the stability of, or confidence in, the UK financial system.

HMT generally expects to base its designations of CTPs on recommendations from the Regulators, and it has requested the Regulators to prepare recommendations in a way that supports its assessment of the prospective CTP against the statutory criteria for designation. However, the Policy Paper also acknowledges that HMT may designate a CTP without such a recommendation from the Regulators.

Process for designation

The Policy Paper states that HMT expects to receive recommendations for designations from the Regulators over time. HMT anticipates that each recommendation will take approximately six months to process (including where the decision is to designate, make and publish the Designation Regulations). That said, the Policy Paper notes that a particular case may proceed at a shorter or longer timeframe, and in such cases, HMT will advise the prospective CTP of the expected designation timeframe. 

The Policy Paper also sets out an indicative process for designation of CTPs. 

Although the regime is focused on the services CTPs provide, HMT will designate CTPs at the entity level rather than the service level.

Communicating a designation decision

HMT will write to the prospective CTP to confirm its designation decision. Where HMT has decided to proceed with a designation, Designation Regulations will specify the date on which the designation takes effect. 

Given that the regime intends to mitigate systemic risk, HMT expects that CTPs will represent only a small proportion of the overall number of third-party service providers in the UK financial services sector. Since designations are made by Regulations, the designations of CTPs will be public and visible on legislation.gov.uk.

De-designation

HMT has requested the Regulators to regularly assess the list of CTPs and submit recommendations to remove a CTP’s designation. HMT will generally only remove designations based on such recommendations from the Regulators. It anticipates following a similar process for de-designation as the process for designation, although possibly to a shorter timeframe, particularly if there is clear agreement between HMT, the CTP and the Regulators.

The Policy Paper is available here.