The extension of the SMCR, the fit & proper test and the increasing significance of non-financial misconduct

14 November 2018

The FCA has been determined to drive cultural change in financial services for some years now. Since the Parliamentary Commission on Banking Standards published their seminal report ‘Changing banking for good’ in 2013 there has been a concerted drive to improve the culture of financial services, to avoid future financial scandals, and ensure accountability and responsibility for risk management, compliance and wrongdoing from the top down.

This has seen the introduction of the Senior Managers and Certification Regime (SMCR) – currently applicable to UK and foreign branch office banks, building societies and PRA designated investment firms – with the stated aim of reducing harm to consumers and strengthening market integrity by making individuals more accountable for their conduct and competence.

From the beginning of this journey the FCA has made clear its intention to encourage a culture of staff at all levels taking responsibility for their actions, as well as its determination to ensure that the buck stops at the top of financial services firms, with senior managers. This is an on-going process, with the SMCR due to be extended across financial services by December 2019 and replace the Approved Persons Regime.   

For smaller FCA solo-regulated financial services firms, the need on an annual basis internally to assess and certify the fitness and propriety of their staff at senior manager and certification regime level is going to create challenges.  These include integrating the annual process of re-certification of the fitness and propriety of relevant staff into existing annual appraisal procedures; and ensuring that internal investigation and disciplinary procedures are designed and followed to ensure due process. This is going to be particularly important given the significance from an employment and regulatory perspective of a disciplinary sanction, the implication of which may be that the employer concludes that the individual is no longer fit and proper to perform their role. In that scenario, this will not only mean the individual’s employment is liable to be terminated, but also that their whole career in financial services could be on the line.   

What then does it mean to be ‘fit and proper’? Under the Financial Services and Markets Act this concept extends beyond qualifications, training, competence, capability and financial soundness to encompass ‘the personal characteristics required by general rules made by [the FCA]’. That said, the FCA has indicated that it is not going to introduce any new rules at this stage, in connection with the extension of the SMCR, and that rather than provide prescriptive guidance on the way in which firms should assess fitness and propriety, it believes generally they are best placed to decide how internal employee assessments are conducted. One obvious concern in this respect is consistency in the industry, but the FCA’s response on that point has been to emphasise the need for a flexible and proportionate approach in the extension of the SMCR, which is to be welcomed. To quote their consultation paper: ‘While we want to have consistent principles applied across financial services, we also want the new regime to be proportionate and flexible enough to accommodate the different business models and governance structures of firms’.

To understand the factors considered by the FCA to be relevant on the assessment of whether or not someone is fit and proper, the starting point is the FCA’s FIT Handbook (‘FIT’). It currently applies when it comes to assessing people as fit and proper under the Approved Persons Regime, as well as across the banking sector when firms have to assess their SMCR level staff. The FCA is now extending the application of FIT to internal fit and proper assessments at FCA solo regulated firms.  (Also planned is an extension of the regulatory references regime at the same level, across the sector).

FIT sets out a broad range of factors to which firms will be expected by the FCA to have regard in their assessments of fitness and propriety. Those factors are grouped under three headings:

  • honesty, integrity and reputation;
  • competence and capability; and
  • financial soundness.

One relevant factor is whether someone has been convicted of any criminal offence (including spent convictions), but criminal conviction will not automatically mean that someone is not fit and proper: the FCA has recently reminded firms that all relevant circumstances need to be considered on a case-by-case basis. So for example, the guidance in FIT indicates that a person may have been ‘convicted of, or dismissed or suspended from employment for, drug or alcohol abuses or other abusive acts. This will be considered by the FCA only in relation to a person’s continuing ability to perform the particular controlled function for which the person is or is to be employed. The FCA would expect a firm determining the competence and capability of staff being assessed under FIT to consider convictions, dismissals and suspensions from employment for drug or alcohol abuses or other abusive acts only in relation to a person’s continuing ability to perform the particular FCA designated senior management function or an FCA-specified significant-harm function for which the person is, or is to be, employed’.

On the face of it, this guidance offers some comfort for financial services executives who transgress and are accused of non-financial misconduct. There is in fact very little guidance in FIT on non-financial misconduct, and nothing at all on the hot topic of the moment: bullying and harassment. The FCA has recently made very clear, however, that they consider such issues to fall squarely within their remit, as part of their drive to improve the culture of financial services and ensure accountability: see for example Megan Butler’s letter to the Chair of the House of Commons’ Women and Equalities Committee on the topic of sexual harassment in the workplace. In the context of the fit and proper test, this mentions ‘sanctions for discrimination, harassment or sexual misconduct’ in the same sentence as ‘criminal conviction’, and also spells out the regulator’s view that sexual harassment and other forms of non-financial misconduct can amount to a breach of the FCA’s Conduct Rules including the requirement to act with integrity. On a similar note, the FCA’s last Enforcement Annual Performance Report from July 2018 indicated that it had 61 live culture and governance enforcement investigations, up from only 12 in March 2017.

The reality of the situation therefore is that it is increasingly the case that all forms of misconduct, non-financial, as well as financial, can come into play when it comes to the fit and proper test, and this trend is only likely to accelerate once the SMCR is extended across the financial services industry in just over a year.

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