In the wake of the LIBOR scandal, a Parliamentary Commission on Banking Standards was created to conduct an inquiry into professional standards and culture in the UK banking sector and to make recommendations for legislative and other action.
The Commission’s June 2013 Final Report ‘Changing Banking for Good’ was scathing, with the Chairman commenting that: “trust in banking has fallen to a new low” and “a lack of personal responsibility has been commonplace throughout the industry. Senior figures have continued to shelter behind an accountability firewall”.
Key recommendations included:
- A new Senior Persons Regime, replacing the Approved Persons Regime
- A new licensing regime underpinned by Banking Standards Rules to ensure those who can do serious harm are subject to the full range of enforcement powers
- A new criminal offence for Senior Persons of reckless misconduct in the management of a bank, carrying a custodial sentence
- A new remuneration code
- A new power for the regulator to cancel all outstanding deferred remuneration for senior bank employees in the event of their banks needing taxpayer support
Following these recommendations, amendments were made to the Financial Services and Markets Act 2000 (FSMA) through the Financial Services (Banking Reform) Act 2013 to replace the Approved Persons Regime for banks, building societies, credit unions and investment firms. As a result, the Prudential Regulatory Authority (PRA) and Financial Conduct Authority (FCA) jointly consulted on a new regime for individual accountability (Strengthening accountability in banking: a new regulatory framework for individuals), with the FCA publishing ‘near final rules’ in March 2015.
The new framework comprises two regimes: the Senior Managers’ Regime (SMR); and Certification Regime (CR), together with revised Conduct Rules, with the aim of encouraging individuals to take greater responsibility for their actions and to make it easier for firms and the regulators to hold individuals to account.
Senior Managers’ Regime
Broadly speaking, the new SMR for individuals will require firms to allocate a range of responsibilities to individuals and to regularly vet their fitness and propriety. In particular:
- The FCA and PRA have specified 27 ‘Key Functions’ and 20 ‘Prescribed Responsibilities’ which must be allocated to Senior Managers undertaking 18 defined Senior Management Functions (replacing the previous ‘Significant Influence Functions’ (SIF)).
- As well as Board members, a number of other individuals will require approval as Senior Managers. These may include:
- heads of key business areas meeting certain quantitative criteria
- individuals in group or parent companies exercising significant influence on firms’ decision-making
- where appropriate, individuals not otherwise approved as Senior Managers, but ultimately responsible for important business, control or conduct-focused functions within the firm
- Senior Managers must be approved by the PRA and/ or FCA depending on the Functions being undertaken. Approvals may be conditional, time-limited or varied by the regulator
- The responsibilities of each Senior Manager must be documented in a ‘Statement of Responsibilities’
- Firms will also be required to set out their governance and reporting structure into a ‘Responsibilities Map’. Firms must confirm annually that there are no gaps within their allocation of responsibilities
- A ‘presumption of responsibility’ is introduced, placing an evidential burden on Senior Managers to demonstrate that they took ‘reasonable steps’ to prevent or stop regulatory breaches in their designated area of responsibility – or face individual sanction.
The CR seeks to complement the SPR, applying to employees in the banking sector who fall outside of the SPR, but nevertheless whose actions or behaviours could seriously harm a bank, its reputation or its customers. In summary:
- The CR introduces a new class of Certified Persons who must be approved as ‘fit and proper’ under FIT.
- Certification is undertaken by the firm itself, not the regulators.
- PRA Certified Persons include anyone classified as a ‘Material Risk Taker’ or as undertaking a ‘Significant Harm Function’ at the firm
- FCA Certified Persons include functions that were previously SIF, customer-facing roles subject to qualification requirements (e.g. retail investment advisors) and anyone other than an approved Senior Manager who supervises or manages a Certified Person
- Firms must assess and certify whether an individual is fit and proper on an annual basis or when there is a change in role
- The FCA’s assessment of fitness and propriety is broadly based on existing FIT Handbook requirements. The PRA is planning to replace FIT with a broadly similar Supervisory Statement
While the substance of the Conduct Rules (C-CON) is broadly similar to the existing Statements of Principle and Code of Practice for Approved Persons (APER); it is intended that C-CON will apply to a broader range of persons in order to achieve cultural change within firms:
- The PRA Conduct Rules will apply only to Senior Managers and individuals within the PRA’s certification regime
- The FCA Conduct Rules will apply to all employees other than those who perform a role that it not specific to the financial services business of the firm (e.g. secretaries)
Furthermore, a key difference between the old APER and new C-CON is the reversal of the burden of proof placed on Senior Managers. This presumption of responsibility has generated much comment in the press. Previously, regulators would have to prove that a SIF was knowingly concerned in a contravention, or behaved in a way contrary to the principles for such an approved person. In future, the onus will be on the Senior Manager to evidence that s/he had taken such steps as a person in his or her position could reasonably be anticipated to take to avoid the contravention occurring or continuing.
Both the PRA and FCA are due to publish policy statements and final rules in spring/summer 2015 for the SM&CR.
Related consultations into strengthening accountability in UK branches of foreign banks, the approach of the FCA and PRA towards non-executive directors and guidance relating to the presumption of responsibility will also close in the first half of 2015.
On 3 March 2015, the government announced that the new SM&CR will start on 7 March 2016, with transitional documentation to be submitted to regulators by 8 February 2016. The SMR and CR will also apply to UK branches of foreign banks from March 2016.
7 March 2016 will also mark the entry into force of Section 36 of the Financial Services (Banking Reform) Act 2013 which includes a new criminal offence relating to decisions taken by senior managers of banks, building societies and PRA-regulated investment firms that cause a financial institution to fail.
For D&O Insurers, the changes to be introduced will undoubtedly be of interest. On the one hand, the requirements for better internal controls and documentation could lead to fewer claims over time, but on the other we could see more investigations against Senior Managers in the short term.