The FSA has published a consultation paper (CP10/3) entitled "Effective corporate governance (significant influence controlled functions and the Walker review)" which discusses the following:

  • Changes to the approved persons regime including a new framework of classification of controlled functions and extension of the scope and definition of certain controlled functions.
  • Significant influence functions (SIFs) interviews. The FSA is using the consultation paper to provide more information on its approach to approving and supervising persons performing SIFs.
  • Sir David Walker's final recommendations in relation to non-executive directors (NEDs), the governance of risk, and shareholder engagement, which require implementation by the FSA.

Responses to the consultation are requested by 28 April 2010. The FSA hopes to publish final rules during the third quarter of 2010.

This bulletin summarises the proposals. A more detailed briefing will be produced in due course.  

Changes to approved persons regime

A new framework of classification of controlled functions

The FSA is keen to identify separately roles which the FSA deems critical to delivering effective corporate governance and which are currently subsumed within other significant influence controlled functions. The FSA is proposing to introduce nine new significant influence controlled functions:

  • Chairman (CF2a)
  • Chairman of risk committee (CF2c)
  • Chairman of audit committee (CF2d)
  • Chairman of remuneration committee (CF2e)
  • Senior independent director (CF2b)
  • Parent entity significant influence function (CF00)
  • Finance function (CF13)
  • Risk function (CF14)
  • Internal audit function (CF15)

All firms which have individuals carrying out these functions within their current approval as one of the governing functions or systems and controls function, will be affected by the proposals.

Extending the scope of the parent entity SIF controlled function

The new parent entity SIF controlled function (CF00) separates out individuals who were brought within the scope of the CF1 (director) and CF2 (non-executive director) functions by the rule changes set out in PS09/14. This includes individuals at the holding company or parent undertaking level who are likely to exert significant influence over a UK regulated firm. The following situations currently fall outside of the scope of the approved persons regime:

  • where the UK regulated entity is a limited liability partnership or a non-body corporate
  • where the parent entity or holding company is itself regulated by the FSA

The FSA is proposing to extend the proposed CF00 function so that the approved persons regime will apply irrespective of the corporate status of the UK regulated entity and regardless of the FSA regulated status of the parent undertaking or holding company.

Extending CF29 (significant management function) to UK branches of EEA firms accepting retail deposits

The FSA is proposing to extend CF29 (significant management function) to UK branches of incoming EEA firms accepting retail deposits. At present, CF29 only applies to individuals in UK branches of EEA firms in relation to their responsibilities for designated investment business regulated in the UK and not retail banking activities.

Compromise agreements

The FSA has said that FSA principles and rules override any duty of confidentiality between a firm and its employee which arises, for example, from compromise agreements. The FSA will publish guidance on rules that require firms to disclose information where:

  • an individual is suspected of doing something that may result in dismissal
  • resigns while under investigation by the firm
  • there are issues that may affect the FSA's assessment of the individual's fitness and propriety to perform a controlled function

Client assets controlled function

In the HM Treasury consultation "Establishing resolution arrangements for investment banks" published in December 2009, HM Treasury asked the FSA to consider how the approved persons regime might apply to two roles relating to client money and assets:

  • individuals responsible for firms' protection of client assets and money
  • Business Resolution Officers (BRO)

The FSA has not had a chance to consider the proposals in detail. CP10/3 does not contain any proposals in relation to these roles, but the FSA is inviting views on how the approved persons regime should apply to them. The FSA will be publishing a consultation paper on client assets in the first quarter of 2010 which will contain proposals relating to the protection of client assets controlled function. As to the BRO, the FSA will respond to this when it responds to the rest of the proposals found in the HM Treasury consultation.

"Guidance" on SIF interview process

The FSA is using CP10/3 as a platform for disseminating information on the SIF interview process. This follows on from the"Dear CEO" letter published in October 2009 which clarified the FSA's new approach to approving and supervising those performing SIFs. The FSA is keen to point out that there is no reason for the FSA's oversight processes to have a deterrent effect where firms themselves have adequately vetted their candidates and that it is not the FSA's intention to deter competent individuals from carrying out significant influence functions within firms.

It is helpful to have a clearer understanding of the FSA's expectations in this area and firms should take note of what the FSA says if they are considering recruitment for SIF roles. Firms should bear in mind that the information within CP10/3 does not constitute formal guidance. See our article on the FSA's use of soft guidance.

The key messages:

Information to be given to the FSA

The onus is on firms to provide sufficient information in the application process and failure to do so is an indicator of the quality of the firm's systems and controls for recruitment.

The FSA has listed the types of information (which may include reports from third parties such as head hunters) it would expect to see before it makes an approval decision (e.g. responsibilities of the role and the required competencies, due diligence conducted by the firm, firm's rationale for concluding that the candidate is fit and proper).

Timing of application

To avoid the need to caveat in an announcement that an appointment is subject to regulatory approval, firms should engage with the FSA at an early stage of recruitment (e.g. final short-listing of candidates), at least for the roles of chair, chief executive and senior independent director.

The need for interviews

Whether or not the FSA interviews a candidate depends on the type and size of the firm, the role being applied for, the candidate concerned and any matters arising from the application. Interviews by the FSA may not be necessary if the firm can show that it has conducted appropriate due diligence. However, it is likely that those applying for the following roles in larger, more complex or risky firms will be interviewed:

  • Chairman
  • Chief executive
  • Senior independent director
  • Finance director/Chief Finance Officer
  • Risk director/Chief Risk Officer (CRO)
  • NEDs whose responsibilities include chair of audit, risk or remuneration committees

The FSA may also interview representatives from the applicant firm if the FSA decides it needs to understand how the applicant firm has undertaken due diligence over the recruitment of the candidate.

Competence and capability checks

The FSA had in the past focussed on confirming the honesty, integrity and reputation of the candidate and checking a candidate's financial soundness. Without reducing the importance of these criteria, the FSA is now increasing its focus on competence and capability. It has identified the following key competencies against which the FSA will assess the majority of candidates before and during the interview:

  • market knowledge
  • business strategy and model
  • risk management and control
  • financial analysis and controls
  • governance, oversight and controls
  • regulatory framework and requirements

The level of competence each candidate is expected to demonstrate will depend on the role to be performed and the type and size of the firm. Firms themselves are also expected to have considered the candidate against the competencies above and to be in a position to provide evidence that they have done so.

Where a candidate does not meet some of the competencies but is still considered to be a good candidate for the firm (e.g. a NED without a good level of market knowledge), firms will need to demonstrate that there will be enough industry knowledge across all the NEDs for the board to meet its collective responsibilities and that there is a plan to ensure that the candidate will be trained to the appropriate standard quickly.

The FSA will also assess a candidate's non-technical skills and behaviour in relation to his ability to play his role in delivering corporate governance and his willingness to work with the FSA in an open manner.

To ensure that NEDs in particular are up-to-date with the FSA's regulatory expectations, the FSA intends to develop a programme of briefings on regulatory matters aimed at NEDs.

Sir David Walker's final recommendations

The FSA has made a number of proposals, as below, which implement some of Sir David Walker's final recommendations. The consultation paper does not include any new policy proposals on remuneration policies.

NEDs

  • Firms and individuals must demonstrate they have given due consideration to the amount of time required for a NED role, and whether the individual has capacity. Firms would be expected to take into account NEDs and chairpersons' commitment to other roles. The FSA will consider the extent to which the proposed NED is capable of meeting the required time commitment.
  • The Handbook guidance which states that: where a NED is an approved person his liability will be limited by the role undertaken, and that provided that he has personally taken due care, a NED will not be held disciplinarily liable (SYSC 2.1.2G & 4.4.4G), will be deleted. The FSA is concerned that the existing guidance could be taken to mean that it would not hold NEDs responsible for, for example, failing to intervene and challenge executive management.

Governance of risk

The FSA has proposed to implement Sir David Walker's final recommendations in relation to:

  • requiring and enhancing the remit of board risk committees, in particular in FTSE 100-listed banks and insurers
  • ensuring that board risk committees have appropriate access to external risk information
  • due diligence by board risk committees on significant acquisitions and disposals
  • strengthening the role and independence of CROs

Shareholder engagement

The FSA plans to consult on a rule to require investment firms to disclose the extent to which they comply with the Stewardship Code, and on new guidance on the interpretation of the expression ‘acting in concert’ as used in the regulatory change of control approval regime.