On 10 June 2015, Mark Carney delivered his annual Mansion House speech as Governor of the Bank of England, this year entitled “Real markets for the good of the people”.  His speech heralded the publication of the Fair and Effective Markets Review’s final report (the “FEMR Report”), published earlier that day.

The FEMR Report itself sets out a series of 21 policy recommendations to improve fairness and efficiency in the fixed income, currency and commodity (“FICC”) markets, ranging from near-term domestic measures, to more forward-looking proposals which will require coordination on an international scale.  Whilst understandably there is a strong focus on particular areas such as FX spot markets, several of the proposals will have implications for all firms operating in wholesale FICC markets, including platforms and buy-side firms such as asset managers.  In this alert we focus on some of the most noteworthy proposals likely to affect this broader range of FICC market participants.

In particular, recommendations for short-term UK measures which it appears would affect firms and individuals across the FICC sector include:

  • extending the new Senior Managers and Certification Regime (the “SM&CR”), in slightly modified form, to firms active in FICC markets which are currently out of scope;
  • mandating the format for regulatory references, to reduce the scope for individuals with poor conduct records moving between firms with their behavioural history going undetected;
  • introducing expected minimum standards of training and qualifications for individuals working in wholesale FICC markets in the UK, along with a requirement for those individuals to undertake continuing professional development; and
  • going beyond the forthcoming MiFID II and MAR extensions of regulation of FICC markets to propose that spot FX be the subject of a new civil and criminal market abuse regime.

The FEMR Report also throws light on the expected regulatory approach in other areas, re-emphasising the regulators’ expectations in terms of firms’ control and governance structures, as well as indicating the regulators’ enthusiasm for some of the more troublesome areas of MiFID II, and giving pointers to their likely future approach to remuneration and to the use of competition powers in financial markets.

Ending the "Age of Irresponsibility"

In his speech, Mr Carney was not afraid to level criticism at the failings within FICC markets, nor to acknowledge the failings in regulatory oversight.  He spoke about need to create “real markets”, “Not markets where transactions occur in chat rooms.  Not markets where no one appears accountable for anything”, emphasising the feeling that there is still some way to go before FICC markets can safely move on from the recent misconduct scandals. 

Commenting on the FEMR Report’s recommendations in relation to firms and individuals specifically, Mr Carney stated “For the best in the industry, this won’t be new. This is just how you run your business.  But for others, who free ride on your reputations: the Age of Irresponsibility is over”, sending out a clear warning to industry participants that they must be able to demonstrate that they meet expected standards and have achieved (or are at least working to achieve) the ‘right’ sort of culture.

Background to the FEMR Report

The FEMR was established by the Chancellor in June 2014, essentially to consider how best to clean up, and restore the reputation of, wholesale markets.  Thus, it was given a mandate to conduct an assessment of the way these markets operate, with the aim of helping to restore trust in the wake of recent high profile abuses such as the Libor and FX scandals, and influence the international debate on trading practices.

The FEMR made an early recommendation to extend the UK’s new regulatory framework for benchmarks to a further seven major UK FICC benchmarks and this was swiftly adopted, with the extension taking effect from 1 April 2015.  The FEMR has since been consulting on what remains to be done to achieve fairness and effectiveness in FICC markets.

The FEMR Report’s conclusions

The FEMR Report summarises a range of identified “root causes” for the deficiencies in FICC markets.  It says that firms’ systems of governance and control failed to prevent individuals from effectively doing as they pleased, a problem that was exacerbated by remuneration structures rewarding short-termism, and that a "culture of impunity" arose, based on the perception that misconduct would not be discovered or punished.  It concludes that this led to “ethical drift”, whereby misconduct went unchecked, leading to it becoming accepted as normal market behaviour.

The FEMR Report indicates that, notwithstanding existing reforms and initiatives at UK, EU and global levels, gaps remain in four key areas:

  1. the professionalism and accountability of individuals in FICC markets remains too low and variable;
  2. key FICC markets lack effective mechanisms for agreeing, promulgating and adhering to common standards of market practice;
  3. gaps remain in the coverage of regulation; and
  4. there is more to do to raise standards in global markets.

These feed in to the four main principles underlying the recommendations: that individuals should be more accountable; that firms should develop clear and practical standards of market practice; that the UK regulators should extend their reach and toughen sanctions; and that international authorities need to collaborate to raise standards globally.

What does this mean for firms operating in wholesale FICC markets?

The first main ‘gap’ listed above gives rise to various recommendations for near-term actions to improve conduct in FICC markets.  The recommendations are designed not only to check the behaviour of those in roles which have been vulnerable to misconduct, but also to impose higher standards of conduct across wholesale FICC markets more generally, including within secondary markets.  Therefore, it is not just investment banks and brokers that will be affected by these proposals, but other investment businesses, platforms and fund managers.

Extending accountability

Following the announcement of plans for the new SM&CR in July last year, it seemed it was only a matter of time before this new framework for individuals in banks and large investment firms was rolled out more widely, and that is precisely what the FEMR Report proposes.  Although many firms in FICC markets will be subject to the new SM&CR, many will not, and so the FEMR Report recommends that the regime be extended to apply to certain other types of firm, albeit in slightly modified form.

Any such extension would need to be consulted on by HM Treasury, and so we will have to wait for further consultation to see the final scope of the proposals.  However, the FEMR Report recommends that any extension ought to apply to firms active in FICC markets which are currently out of scope of the SM&CR, such as MiFID investment firms (including asset managers and interdealer brokers), hedge fund managers authorised under the AIFMD, and fund managers under the UCITS Directive. 

The FEMR Report recommends that certain of the more severe elements of the regime ought not to apply to individuals in the firms to be brought into scope, including: (i) the ‘presumption of responsibility’, whereby a Senior Manager will be presumed to be guilty of misconduct when a regulatory contravention occurs in an area for which he is responsible, unless he can successfully make use of the ‘reasonable steps’ defence; and (ii) the new ‘reckless misconduct’ criminal offence, relating to a decision by a Senior Manager causing a firm to fail.  

Even without a formal presumption of responsibility, however, if the rest of the SM&CR framework is to apply and require firms to maintain much more detailed documentary evidence of all Senior Managers’ responsibilities, the regulators will find it much easier to hold individuals to account where there has been a breach by the firm, which is clearly their goal.

Interestingly, the FEMR seems to have concluded that there was a case to extend the SM&CR, despite the feedback it received on this issue having been decidedly mixed; in particular, its Market Practitioner Panel felt that, on balance, it would be preferable to have some time to see the impact of the SM&CR before extending it to other firms. 

There may be some consolation for potentially affected firms in that Mark Carney mentioned that the Bank of England would be applying the “core principles” of the Senior Managers Regime to its own senior staff, including to himself as Governor.  Yet the fact remains that many potentially affected firms are likely to find implementing the regime an unwelcome and costly burden.  Although there are ambitions to internationalise the UK approach, unless and until this is realised the SM&CR will be a significant factor for those considering doing business in the UK.

No more “rolling bad apples”

Another recommendation of the FEMR is that, given the desire to prevent individuals with poor conduct records moving between firms unchecked, the regulators should mandate a standard form for regulatory references.  Under the new SM&CR, the reference process will be strengthened to a certain extent, as firms will be required to provide references covering a five-year employment history and to disclose breaches of the new Conduct Rules.  However, there will also be a greater reliance on references by firms, due to new requirements to assess fitness and propriety and the fact that individuals falling within the Certification Regime will not require regulatory approval.

Therefore, the FEMR Report recommends that the SM&CR rules on references be amended to include a template, and that the PRA and the FCA consult on this with a view to having the template ready for the commencement of the SM&CR on 7 March 2016.  As there seems to be some appetite for the inclusion of information about matters which could be uncertain or disputed, such as outstanding complaints and ongoing investigations, firms and the regulators will need to think carefully about what would be appropriate in practice.  Whilst firms may be keen to receive more detailed references, firms giving references will be concerned about potential challenges from former staff should they disclose contentious matters as well as the proposal to prevent firms using non-disclosure agreements with outgoing staff to limit the information disclosed, as is common practice in the industry at present.

Minimum standards

In the spirit of going back to root causes, in order to try to ensure that poor conduct does not arise in the first place, the FEMR Report also suggests that its proposed FICC Market Standards Board provide guidance on expected minimum standards of training and qualifications for individuals working in wholesale FICC markets in the UK, to address the perceived paucity of specific and effective training focused on conduct standards.  This would also include a requirement for individuals to undertake continuing professional development.  This proposal does not appear to be limited to particular aspects of, or roles within, FICC markets and if implemented will represent a significant change in approach for relevant firms and individuals.  However, given the difficulty of devising appropriate standards for a wide variety of market participants, it may be some time before we see a definitive work product.

Culture change

The FEMR Report also stresses that firms themselves have a big part to play and must use their control and governance structures to raise standards and promote good practice.  It suggests that firms will need to be particularly diligent about reinforcing their ‘first line of defence’, placing more emphasis on front-line staff upholding standards, and finding methods to monitor conduct, making sure that issues are identified effectively and escalated where appropriate.    

Although none of these ideas are new (echoing some of the themes in the FCA’s Business Plan for 2015/16) and firms should be well aware of the regulators’ expectations, the repetition of these points serves as a reminder that this is an area in which the regulators are becoming increasingly prescriptive in their expectations. 

What next?

Elements of the recommendations to be taken forward by HM Treasury and/or the UK regulators, such as the extension of the SM&CR and the template for regulatory references, will be consulted on in the usual way.  It is not clear at this stage how quickly such consultations might take place, although given the momentum in this area we might expect there to be swift progress on aspects which can be progressed domestically.

The Bank of England plans to hold an “Open Forum” in autumn 2015, with the idea being to bring together relevant stakeholders “to take stock and discuss the way forward”.  Further down the line, the Chairs of the FEMR will provide a full implementation update to the Chancellor and to the Governor of the Bank of England by June 2016.