‘The Senior Managers’ Regime: the end of the ‘regulate/de-regulate’ cycle?

In recent times, the regulatory spotlight has been focussed strongly on the UK’s financial industry. The global financial crisis in 2008 not only caused turmoil in the markets and the world economy; it also led to many questions about regulation and accountability. Questions of who was responsible within banks; why did the regulators not step in; and how can such an event be prevented in the future were aired frequently.

Since that time, there has been a huge change in the regulation of banks and financial institutions in the UK. In April 2013 there was a move towards ‘twin peaks’ regulation: under the Financial Services Act 2012, the Financial Services Authority was replaced with the Financial Conduct Authority (FCA), which is responsible for the regulation, supervision and conduct of banks and financial institutions. The Prudential Regulation Authority (PRA) was also created, which is responsible for the prudential soundness of the firms it regulates.

Now, nearly eight years on from the peak of the global financial crisis, one of the biggest changes in financial regulation to date is afoot. The catalyst for change was the recommendations included in the Parliamentary Commission for Banking Standards (PCBS), entitled “Changing Banking for Good”, which set out proposals for legislative and other action to improve professional standards and culture in the UK banking industry. This was followed by legislation in the form of the Banking Reform Act 2013, which had the effect of imposing significant change for banks, credit unions and PRA-designated investment firms, as it imposed a new regulatory framework for individuals working within them.

The implementation of the Banking Reform Act has been at the forefront of regulatory scrutiny since it was passed by Parliament. The most notable changes under the Act are the introduction of the Senior Managers’ Regime (SMR), Certification Regime and Conduct Rules which replace the existing Approved Persons regime. We examine here the existing Approved Persons regime, the changes imposed, and what effects we believe these may have on the industry as a whole.

The current Approved Person regime
What then is the current regime? Approved Persons are those within the industry who carry out ‘Controlled Functions’, which can be either customer facing functions, or ‘Significant Influence Functions’, for example being the director of a firm, overseeing systems and controls or being responsible for compliance. Approved Persons must meet the requirements of the FCA’s ‘Fit and Proper’ test and comply with the FCA’s Statements of Principle and Code of Practice. Although firms are expected to carry out their own due diligence when an application for Approved Person status is being made, the granting of Approved Person Status is ultimately the responsibility of the FCA. The perceived difficulty with the regime is a lack of individual accountability for alleged regulatory breaches: without clear parameters of responsibilities falling within each role, the root cause of issues has been difficult to identify.

The new SMR and Certification Regime are aimed at remedying those perceived deficiencies.  They come into effect on 7 March 2016; however, preparations for grandfathering into the regimes are currently ongoing.  The regimes are aimed at promoting individual responsibility and will include the following:

• The SMR will focus on individuals who hold key roles and responsibilities in relevant firms, for example the Board (excluding certain Non Executive Directors without key responsibilities), and other senior individuals who hold significant responsibilities within the firm. Firms will be required to prepare Responsibilities Maps detailing the requirements of each role and Statements of Responsibility will be required for individuals carrying out Senior Management Functions. Individuals falling under this regime will still be required to be pre-approved by the regulators, but firms will also need to have systems in place to assess the applicant’s fitness and propriety upon application and on a yearly basis thereafter. Specific provisions of the new Conduct Rules will apply to the Senior Managers. The regulatory scrutiny of those individuals is therefore high.
• The Certification Regime covers staff who do not fall within the SMR, but who still pose a risk of significant harm to the firm or any of its customers. This category will cover a number of those individuals who previously held Approved Person status. The principal shift from a regulatory perspective is that firms themselves will be required to put in place systems for assessing the fitness and propriety of staff; this will no longer be the domain of the regulator.  This assessment will be required on a yearly basis. This is an onerous responsibility for firms, who will then have to make difficult decisions about whether an individual’s conduct is sufficiently serious to be deemed to fall foul of the Conduct Rules. Consistency in decision making across firms may be an issue, although there will be guidance in place to assist with this. A Senior Manager will ultimately be responsible for imposing consistency in decision making; whether a defensive or ‘no tolerance’ approach might be adopted by firms, for fear of being too lenient, is yet to be seen.
• The implementation of the Conduct Rules has extended the scope of regulation to not just those falling within the SMR and the Certification Regime, but to all staff, apart from those in ancillary functions. Employees in more junior roles are now potentially subject to proceedings if it is deemed that their actions fell below the prescribed conduct in the Rules. The Conduct Rules will apply to SMR and Certified persons from 7 March 2016; however, firms will have until 7 March 2017 to prepare for the wider application of the Conduct Rules to other staff.

The enforcement of regulatory action
How then will proposed regulatory breaches be pursued? When the contents of the Banking Reform Act were first published, there was considerable concern and disquiet about the imposition of a ‘presumption of responsibility’, which, arguably, effectively reversed the burden of proof. The proposal was that, in order to prove that a Senior Manager had committed misconduct, the FCA merely had to show that there had been a contravention by the firm and that the Senior Manager in question was responsible for the activities in relation to which the contravention occurred. The Senior Manager could only be absolved if he or she could satisfy the regulators that he/ she had taken such steps as a person in [the Senior Manager’s] position could reasonably be expected to take, to avoid the contravention occurring or continuing.  This was a significant move away from the current and established procedure, whereby the burden to prove its case lies exclusively with the regulator.

However, when the Treasury introduced the Bank of England Financial Services Bill on 15th October 2015, as well as extending the SMR and Certification Regime to cover all investment companies, insurers, asset managers and consumer credit firms by 2018, it contained a notable u-turn on the imposition of such a presumption of responsibility. The Government has instead decided to introduce a statutory duty on Senior Managers to take reasonable steps to prevent regulatory breaches in their areas of responsibility – the so-called “duty of responsibility”.

Whilst the “duty of responsibility” will require management to take appropriate steps to prevent a regulatory breach from occurring, the burden of proving this misconduct will fall on the regulators, as with other regulatory enforcement actions. Whether this represents a watering down of the impact of the SMR is yet to be seen. The FCA has been keen to downplay the shift in approach; as Tracy McDermott, acting CEO of the FCA stated: “While the presumption of responsibility could have been helpful, it was never a panacea”. However, it is clear that this shift will make proving misconduct more difficult.

Timetable for change
Compliance departments in banks and financial institutions are facing a very a very busy 18 months. Grandfathering into the new regime takes place over the early part of 2016, with the commencement date for the SMR and Certification Regime being 7 March 2016. The work does not stop there:  the first annual submission to the FCA notifying it of breaches of the Conduct Rules must take place by the end of October 2016, while the application of the Conduct Rules to staff who do not fall within the SMR or Conduct Rules commences on 7 March 2017, with a similar report on their breaches of the Conduct Rules to take place in October 2017. The remit of the regimes are then extended in 2018 to cover investment companies, insurers, asset managers and consumer credit firms.

The impact of change
The impact on firms, although, as yet, unmeasured, is likely to be significant.  Not only will firms need to invest to ensure they meet their new responsibility to assess fitness and propriety, they will also need to be flexible and reactive to change.  Roles and responsibilities will change organically; Responsibilities Maps will need to be updated regularly and scrutinised to make sure that no responsibilities are left uncovered.

The assessment of fitness and propriety will raise its own problems.  One firm’s attitude to a potential breach of the Conduct Rules may differ to another’s; the regulators will need to provide guidance to avoid a divergence of approaches and a consequent lack of consistency. 

The new regime also shines the spotlight on financial professionals as individuals, with an estimated 15,000 Senior Managers expected to be affected by the proposals, rising to 60,000 when the regime is widened in 2018.  Financial professionals are likely to feel more exposed, with Senior Managers being keen to ensure their responsibilities are clearly defined. In addition, more junior employees, who previously fell under the radar, will have to adhere to the new Conduct Rules.

Tracy McDermott has spoken recently of a drive to eradicate the “short-termism” view adopted by financial institutions; she has also spoken of the desire for sustainable regulation and a move away from the “regulate/ de-regulate cycle”. With those key themes in mind, it is hoped that the regulators will provide the financial world with time, guidance and a little breathing space to learn through experience and adopt the new regimes fully. Will these measures provide the long term stability and effective self-regulation that was hoped when the Banking Reform Act 2013 was drafted? Only time will provide the answer to that question.

This article was first published in the Association of Regulatory & Disciplinary Lawyers Winter 2015/2016 Bulletin, and has been republished with the kind permission of the copyright owner.

Further information

For further information, please contact Julie Matheson. You may also wish to see our Senior Managers and Certification Regime timeline.