The UK regulators’ overhaul of the approved persons regime in relation to banks and PRA-designated investment firms is to be extended to UK branches of equivalent foreign institutions meaning that, from 7 March 2016, relevant branches will be obliged to comply with a tailored version of the new Senior Managers and Certification Regime (the SM&CR).
The SM&CR has been designed to implement some of the key recommendations from the Parliamentary Commission on Banking Standards’ June 2013 report ‘Changing banking for good’ in relation to the approved persons regime, in order to address the perceived lack of accountability at an individual level for persons in a position of responsibility in the banking sector. The new regime will lead to some significant changes in the way that individuals at affected firms are overseen, and held accountable, by both the regulators and the firm itself. Consultation on the SM&CR for UK firms began in July 2014, and we await the finalisation of the regulators’ rules and guidance, which is expected over the coming months.
The legal framework for these reforms (the Financial Services (Banking Reform) Act 2013) also gave the UK Treasury the power to extend the application of the SM&CR to UK branches of foreign banks and PRA-designated investment firms, on which it consulted between November 2014 and January 2015. Following confirmation that the regime will be extended to incoming branches of relevant foreign institutions (as announced on 3 March 2015), the PRA and the FCA are consulting on how a modified version of the SM&CR will apply to such branches (although it should be noted that the secondary legislation which will extend the application of the regime is still subject to Parliamentary approval).
In this briefing we do not propose to cover the detail of the SM&CR as a whole, the broad concepts of which are by now at least generally familiar to many, but rather to focus on the key aspects of the proposed application of the SM&CR to UK branches of non-EEA banks. Although not described further in this briefing, we note for completeness that there is yet another variation of the SM&CR proposed for UK branches of relevant EEA firms, which takes into account the limitations of the UK regulators’ role as host state regulators under the relevant European Directives.
The challenge ahead
Whilst the intention is for branches in scope to be subject to a version of the SM&CR that is proportionate to their size and complexity, relevant foreign institutions will be required to invest considerable time, effort and resource in preparing themselves if they wish to be adequately primed for compliance with the new regime. Accordingly, firms with UK branches which either are inactive (the FCA estimates that 273 of 447 incoming branches are unlikely to be active) or do not use their UK deposit-taking permission are strongly encouraged to take the opportunity to assess their business requirements in the UK.
With the SM&CR set to kick in on 7 March 2016 for both UK firms and incoming branches of relevant foreign institutions, firms that will be subject to the regime are left with a relatively short time to get their house in order, particularly given that various aspects of the regime are still being consulted on and timeframes have already slipped for the delivery of the final rules under the main regime (which were initially expected to be published around the end of 2014). This is compounded by the fact that, in practice, due to the amount of preparatory work required, firms will need to be ready to comply well in advance of the go-live date (for example, they will need to prepare the relevant documentation and ensure that they notify the regulators of current approved persons who are to be grandfathered into the new regime by the deadline of 8 February 2016).
Although incoming branches will be subject to a lighter version of the SM&CR, realistically they will need to have a fairly comprehensive grasp of the full regime (which is not described in any detail in the consultation on branches) in order to understand the rules that apply to them. The consultation on branches assumes prior familiarity with the SM&CR for UK firms and only discusses the areas in which the regime will be modified for branches, with the expectation that foreign banks will be reading all of the other materials in circulation. This is quite an ask, particularly for those with very small UK branches, given that since July 2014 a series of rather weighty consultation papers have been published which even well-resourced UK firms will have found challenging to follow.
By way of brief reminder, the now familiar key elements of the SM&CR for UK firms include:
1. The Senior Managers Regime
A new set of Senior Management Functions, narrower in scope and more precisely drawn than the present set of controlled functions under the approved persons regime, will need to be allocated amongst the most senior decision-makers in relevant firms, who will require pre-approval to perform such functions. For the first time, the regulators will have the power to impose conditions and time limits on approvals, either at the time of approval or subsequently.
Senior Managers will be subject to a presumption of responsibility such that where a breach occurs in an area in relation to which that individual holds responsibility, he will be guilty of misconduct unless he can demonstrate to the regulators that he took such steps as could reasonably be expected of a person in his position to prevent or stop the contravention.
In terms of documentation, firms will need to prepare a “Statement of Responsibility” for each Senior Manager setting out the individual’s responsibilities, and update this whenever there is a “significant change” to those responsibilities. Firms will also be required to set out their management and governance arrangements in a management responsibilities map, which must be maintained and updated on an ongoing basis.
Further, senior Managers will be subject to the much-publicised new criminal offence of “reckless misconduct”, relating to a decision by a Senior Manager which causes their institution to fail.
2. The Certification Regime
Employees in certain positions which make them capable of causing “significant harm” to the firm or its customers will not require pre-approval, but firms must certify that such individuals are fit and proper to perform these functions, both when appointing an individual to a relevant role and on an annual basis thereafter.
3. Conduct Rules
New sets of PRA and FCA conduct rules will be introduced by the regulators which will apply to individuals within the SM&CR as well as to most other employees of relevant firms. Firms will be required to notify the regulators of actual and suspected breaches by its employees, as well as when they have taken formal disciplinary action against an employee.
Incoming non-EEA branches
Whilst under the proposals the above elements will all be applied to incoming branches (with the exception of the new criminal offence, which will not apply to Senior Managers of incoming branches), the regulators state that they will be applied in an “appropriate and proportionate” manner, with the focus being on ensuring that persons responsible for the branch itself, rather than the institution as a whole, are accountable. Thus, the intended result is that only larger and more complex branches will require more than a minimal number of Senior Managers.
1. The Senior Managers Regime
The overarching principle the regulators wish to maintain is that an individual who is responsible for implementing strategy or overseeing transactions in the UK (rather than those responsible for setting strategy at a group level) is likely to be performing a Senior Management Function and thus to require approval. In total, up to eight PRA and FCA Senior Management Functions will be applicable to an incoming branch.
Under the proposals, as a minimum the PRA will require the most senior individual(s) within the branch to be approved for the Head of Overseas Branch function, so that each branch will have at least one PRA-approved Senior Manager. Other individuals may also need to be approved if any of the other specified PRA Senior Management Functions apply to them. Thus, an individual in another group entity with responsibility over the branch's UK regulated activities (such as a UK head or head of EMEA) would need to be approved as Group Entity Senior Manager, and any individuals performing the Chief Finance, Chief Risk or Head of Internal Audit functions in respect of the branch would need to be approved. This is more likely to be the case in respect of larger, more complex, branches.
The FCA proposes that senior individuals with certain local responsibilities will need to be approved for its Overseas Branch Senior Manager function, which will apply to an individual’s responsibilities in relation to the branch only. It also proposes that all branches will need to have someone appointed to perform the Money Laundering Reporting Officer and Compliance Oversight functions. The FCA envisages that very small branches may not have an Overseas Branch Senior Manager if relevant responsibilities lie with the Head of Overseas Branch only (a Head of Overseas Branch would not also require approval as Overseas Branch Senior Manager, although his statement of responsibilities would need to describe all relevant responsibilities).
Given the potential for a variety of management structures, some of which may involve individuals outside of the branch or even outside of the UK, the FCA does not propose to place a territorial limitation on the scope of its Senior Manager Functions for incoming branches, meaning that in some circumstances individuals based overseas could require approval. Whilst in one sense it is helpful that the FCA is not requiring persons performing certain functions to be based in the UK, equally overseas firms may be concerned about individuals outside of the UK needing to understand and comply with UK regulatory requirements.
No specific functions in relation to non-executive directors have been designated by either regulator, although some non-executive directors may still require approval if they are in fact performing any of the other applicable Senior Management Functions. In particular, the regulators consider that an individual who is approved as a non-executive director in relation to a branch under the current approved persons regime may require approval as a Group Entity Senior Manager.
The regulators are proposing a condensed list of prescribed responsibilities to be allocated amongst Senior Managers in incoming branches, acknowledging the fact that it would not be proportionate to apply the full list as applicable to UK firms to incoming branches.
The regulators also propose that incoming branches will be subject to less onerous requirements as regards responsibilities maps, such that they will only need to cover the responsibilities of the governing body of the branch, although they will be required to illustrate how the branch fits within the wider management and governance arrangements of the head office and the group as a whole. It is proposed that firms with several UK operations will be able to prepare a single map covering all UK branches and subsidiaries, provided that the details of each entity are clear. Whether in practice firms will feel that such concessions make a tangible difference to the regulatory burden remains to be seen, as one can envisage that this may still entail the production of relatively complex documents.
2. The Certification Regime
The regulators propose to align the scope of the Certification Regime with the approach for UK firms. In the case of the PRA, this means that the proposal is to base the scope of the regime upon the scope of its remuneration rules, thus broadly applying it to “material risk takers” within UK branches. In the case of the FCA, this means proposing to apply the regime such that line managers of certified persons will also need to be certified, although only where a relevant manager is either UK-based or deals with UK clients. Therefore, managers based overseas may need to be certified, to the extent that they deal with UK clients.
Again there will no doubt be concern about potential jurisdictional creep, although in theory this approach should mean that only individuals with a tangible link to the UK operations should be captured.
3. Conduct Rules
The PRA intends to apply its Conduct Rules to individuals within the modified SM&CR for incoming branches, and the FCA intends to apply its Conduct Rules to individuals within its SM&CR for incoming branches, as well as to all other branch employees, excepting ancillary staff (being staff whose role is not specific to the firm’s financial services business). Therefore, branches will need to ensure that relevant staff are appropriately trained on the new rules.
It is unsurprising that the government and the regulators have chosen to apply the SM&CR framework to incoming branches with relatively few concessions, particularly given the general regulatory apprehension around, and policy towards, foreign banks with branches in the UK. The proposals reinforce the fact that the demands of regulatory compliance for branches are becoming tougher and that the branch option does not necessarily provide easy access to the UK banking market, at least as far as non-EEA banks are concerned.
Regardless of the number of Senior Managers within a branch under the new regime, the ongoing burden of keeping statements of responsibility and responsibilities maps up to date, regularly assessing fitness and propriety for both Senior Managers and certified persons, training relevant staff on the Conduct Rules and making the required regulatory notifications will likely prove to be challenging.
Ensuring that there are people within the organisation who fully understand the new regime and its requirements will be vital and as we await the final rules and guidance the time available for getting to grips with the new regime, analysing its application and making the necessary adjustments is diminishing.
The consultation for branches runs until 25 May 2015, providing a limited window of opportunity for comment if there are concerns about the practicalities of UK branches complying with the proposed requirements.
In the meantime, the UK regulators continue to develop a similar but distinct “Senior Insurance Managers Regime” for insurers, which will also apply to UK branches of relevant foreign institutions. As for UK groups, this will mean that overseas groups which have UK operations covering both the banking and insurance sectors will have to grapple with the different requirements in relation to different group entities, adding a further layer of complexity.
Similarly, groups which also contain entities that are not captured by either the SM&CR or the Senior Insurance Managers Regime will need to comply with two or even three different regimes within the group, as entities not captured by either of the two new regimes will continue to be subject to the current approved persons regime (which will remain in place in relation to all other UK authorised firms and UK branches of foreign firms, although it is likely that this too will be reformed in due course).