Extending individual accountability in financial services—no need to panic

Extending individual accountability in financial services—no need to panic

Simon Lovegrove of Norton Rose Fulbright discusses HM Treasury’s proposed changes to the senior managers and certification regime and what firms should do to prepare for the changes?

Original news

Senior Managers and Certification Regime to be extended across financial sector, LNB News 15/10/2015 113

HM Treasury intends to reform the Senior Managers and Certification Regime (SM&CR) to extend its coverage to all sectors of the financial services industry, replacing the discredited Approved Persons Regime (APR). A policy paper has been released detailing the measures in the Bank of England and Financial Services Bill to give effect to these proposals. It is intended for the full implementation of the newly extended regime to come into operation during 2018.

What is the background to this policy paper?

On 14 October 2015, HM Treasury published a policy paper that contained important changes to the individual accountability regime that comprises the senior managers’ regime, certification regime and conduct rules. The statutory basis for the individual accountability regime can be found in the Financial Services and Markets Act 2000 (FSMA 2000) as amended by the Financial Services (Banking Reform) Act 2013 (FS(BR)A 2013). To effect the changes set out in the policy paper certain amendments to FSMA 2000 have been tabled in the Bank of England and Financial Services Bill (the Bill).

One of two key changes that the policy paper introduces is the extension of the individual accountability regime to all financial services firms that are authorised under FSMA 2000. Originally the regime was designed for banks and then modified for insurance firms subject to the Solvency II regime.

The debate concerning individual accountability in the banking sector has been with us since the financial crisis. The final report of the Independent Commission on Banking (the so called Vickers Commission) set out a number of recommendations designed to reform the UK banking industry. These recommendations were centred on five key themes which included making individual responsibility in banking a reality. In 2012 following the LIBOR scandal the government established a Parliamentary Commission on Banking Standards (PCBS). Like the Vickers Commission before it in its recommendations to reform the UK banking industry, the PCBS criticised the APR and argued that too many bankers, particularly at the senior level operated in an environment with insufficient personal responsibility. Importantly, the PCBS expected the deficiencies that were identified in the APR to not be confined to the banking sector. However, it was concerned that extending its recommendations for an individual accountability regime to all financial services sectors would delay implementation. It therefore recommended that the reforms be initially introduced only to the UK banking sector.

The government accepted many of the PCBS’ recommendations including that the APR had failed and that it should be replaced in the banking sector with a new individual accountability regime. The government introduced to Parliament the then Financial Services (Banking Reform) Bill which proposed amendments to FSMA 2000 and give the regime its statutory basis. The regime would apply to banks, building societies, credit unions and PRA-regulated investment firms.

During the summer of 2014 the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) published their first joint consultation paper setting out proposals to amend their rules and guidance to accommodate the individual accountability regime. Also, the government announced the Fair and Effective Markets Review (FEMR) which would assess how UK wholesale financial markets operate. FEMR’s final report was published a year later in June 2015 and its recommendations included that HM Treasury consult on legislation to extend elements of the senior managers and certification regimes to a wider range of regulated firms, covering at least those active in the fixed income, currencies and commodities wholesale markets.

The HM Treasury policy paper and the Bill’s provisions that extend the individual accountability regime to all financial services firms have been some time in the making and should not have come as a surprise particularly given the government’s dissatisfaction with the APR.

However, the HM Treasury policy paper contained a few surprises.

What are the main proposals within the paper?

As stated above a key proposal by HM Treasury is the extension of the individual accountability regime to all financial services firms that are authorised under FSMA. However, there is an important line in the policy paper which states that the ‘principle of proportionality will be particularly important’ and that the ‘regulators will ensure that the extended regime appropriately reflects the diverse business models operating in the UK market and is proportionate to the size and complexity of firms’.

How proportionality will be applied remains to be seen and this may become clearer once we have sight of the PRA and FCA consultation papers. However, it is worth noting that certain amendments to the individual accountability regime for particular parts of a financial services sector is nothing new with modified requirements already in place for insurance firms subject to Solvency II and UK branches of third country banks. The key for firms is to have a good understanding of the overall framework of the individual accountability regime and take note of where any deviations are. Like so many things in financial services, the devil will be in the detail.

The second key change that the policy paper sets out is the abandonment of the ‘reverse burden of proof’ in favour of a statutory duty of responsibility.

The reverse burden of proof was one of the key components of the senior managers’ regime and its removal even before the regime comes into effect for banks on 7 March 2016 is surprising. Why the change in policy? The official line from the government can be found in the impact assessment that accompanies the Bill. It states that one of the unintended consequences of enforcing the new obligation would have been that firms would have had to incur greater costs than originally envisaged in preparing documentation required by the regulators setting out the allocation of responsibilities in firms, and in negotiating with senior managers on these documents (which may have meant having to take legal advice). The statutory duty of responsibility essentially takes us back to the current position of the regulators having to prove their case. In the Lords’ debate on the Bill some concerns were raised that with this change of policy there might be less comprehensive documents, less awareness of responsibilities and less detailed examination of the relationship between responsibility and risk. Perhaps it is too early to tell whether this will be the case.

Among the other proposals that stand out in the policy paper is the application of conduct rules to non-executive directors (NEDs) and the removal of the obligation to report all breaches of the conduct rules to the regulators.

The position regarding NEDs is interesting as a limited number of them—chairman, senior independent director, and chairs of certain committees—are in-scope of the regulators’ senior managers’ regime for banks and are subject to certain conduct rules. However, NEDs not performing these functions, known as Notified NEDs, are not (although the PRA expects them to ‘observe’ certain conduct rules). The policy paper states that the change is to plug a gap as there are provisions in certain EU Directives (for example the Capital Requirements Directive (CRD) IV) that require Member States to be able to take action against members of an institution’s management body (including NEDs). The policy paper also adds that there may be circumstances when it is appropriate to take enforcement action against NEDs and that it is difficult to justify a position where enforcement action can be taken against relatively junior staff but not against board members.

The application of the individual accountability regime to NEDs in banks has been debated extensively and featured in a number of FCA and PRA papers. It would be surprising if the reasons mentioned in the policy paper had not already been extensively debated. However, with the FCA applying conduct rules to a very wide range of staff, many of whom will be junior, the final reason given by HM Treasury seems to be the most compelling.

HM Treasury has also removed the statutory obligation to report to the regulators all known or suspected breaches of the conduct rules by any employee subject to them. HM Treasury noted that this was potentially a very costly obligation for firms, especially the larger firms that employ large numbers of staff, as they would have had to put in place detailed systems and controls to ensure compliance. With the removal of the statutory obligation it will be interesting to see whether the regulators opt to implement a rules based requirement.

What will firms have to do to comply with the proposals?

In its current form the individual accountability regime comes into force on 7 March 2016. Banks and other firms caught within its scope should already be making preparations. For other financial services firms the extended regime is not due to come into operation until 2018.

The key for these firms at the moment is to get a basic understanding of the individual accountability regime. Firms should also keep an eye out for the relevant PRA and FCA papers when they are published and spot what changes the regulators propose so as to make the regime proportionate for their sector.

In the policy paper it was noted that the main effects for financial services firms falling within the scope of the extended regime are:

  • a substantial reduction in the number of appointments that are subject to prior regulatory approval, although there may be some increase in costs per application, as firms prepare the documentation required by the new regime including ‘statements of responsibility’ and other required information
  • most current Approved Persons below senior management level are expected to become certified persons. Some roles in firms where prior regulatory approval is not currently required may also become certified person roles. There will be some costs for firms in complying with certification requirements but these are not expected to be large, and
  • firms may incur some additional costs from putting in place systems to ensure employees are notified about, and receive suitable training in, the conduct rules that will apply to them

What advice should lawyers give to their clients?

Arguably with the removal of the ‘reverse burden of proof’ the individual accountability regime has fewer teeth. However, there are still some important requirements that should make it easier for the regulators to bring enforcement action against senior managers with the key one being statements of responsibilities which will define the scope of a senior manager’s responsibilities and therefore his/her potential liability.

The extension of the individual accountability regime to all financial services firms is going to take time and the policy paper recognises this by stating that it should not come into operation until 2018. In addition to the steps mentioned in the previous section it might be worth remembering the phrase used by Corporal Jones in Dads Army—‘Don’t panic!’

Simon Lovegrove is head of financial services knowledge—global at Norton Rose Fulbright. He focuses on both knowledge management and financial services and markets regulation. Before joining the practice in January 2006, Simon worked for several years in the funds and financial services team of another city practice and is a regular contributor to various publications on regulatory topics.

Interviewed by Barbara Bergin.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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