The United Kingdom Financial Services Authority (FSA) is due to finalise proposals extending the scope of the approved persons regime, and publish final rules in the second quarter of 2009.
In a consultation paper published in December 2008, “The Approved Persons Regime – Significant Influence Function Review” (Consultation Paper), a consultation which closed on 31 March 2009 and a policy statement on which is due towards the end of the second quarter of 2009, the Financial Services Authority (FSA) proposed an extension to the scope of the approved persons regime, in particular, to individuals retaining controlled functions at authorised firms, including their parent undertakings and holding companies.
This proposal will affect market participants that are authorised under Part IV of the Financial Services and Markets Act 2000 (FSMA 2000), including energy market participants, by placing greater emphasis on directors ensuring that a firm is being run compliantly, and potentially changing the way firms structure the roles of individuals working in holding companies.
The Consultation Paper focused on individuals who have significant influence at a firm. Currently, the test under FSMA 2000 in relation to an individual performing a significant influence controlled function, thereby being subject to the approved persons regime, is that the individual must be acting in relation to an authorised firm's regulated activity, with the function being performed “likely” to enable him/her to exercise “significant influence” on the firm’s affairs.
The key amendments proposed in the Consultation Paper included:
- Extending the definition of the controlled functions of director (CF1) and non-executive director (CF2) to include those individuals whose decisions, opinions or actions are regularly taken into account by the governing body of the authorised firm and, therefore, are likely to have a significant influence on the conduct of an authorised firm’s affairs. This would include regulated and unregulated third country parent undertakings and holding companies.
- Extending the definition of significant management function (CF29) to include all proprietary traders who are not senior managers, but who are likely to exercise a significant influence on their firm through their trading activities, with the FSA’s expectation that this will capture all proprietary traders. The practical consequence of this would be all such traders having to apply to the FSA to perform a controlled function under the approved persons regime.
- Extending the rule requiring firms to provide references, to include candidates applying to perform customer function (CF30). This would result in a change to Form A (Application to Perform a Controlled Function) to require firms to provide supplementary information about the competence and capability of the candidate.
- Extending the application of the approved persons regime to UK branches of overseas firms based outside the European Economic Area (EEA), so that all the controlled functions will apply to UK branches of overseas firms. Currently, only certain controlled functions apply to UK branches of overseas firms, with most notably CF1 and CF2 not applying.
- Clarifying the role of non-executive directors to allow a closer monitoring of them by the FSA, where it considers they should be more actively involved in a firm’s management.
Notwithstanding the fact that a majority of the respondents are, in principle, supportive of the FSA’s proposals, the following observations made by respondents to the consultation are noteworthy:
- In relation to extending the controlled functions of director (CF1) and non-executive director (CF2), it would be helpful if the FSA could clarify that such extension is not intended to dilute the responsibility of the existing controlled functions by including all global heads of businesses. Otherwise, this will have the potential to dilute the accountability of those senior decision makers already registered. In addition, it is desirable that firms continue to have the flexibility to determine their own arrangements regarding the appointment and roles of non-executive directors, as a ‘one-size fits all approach’ may not be a sensible strategy for firms with a global matrix management structure. This has the potential to create confusion over the role of existing controlled functions as the FSA proposal will extend regulation to senior managers of unregulated firms who are not otherwise subject to UK regulation, and also do not have direct responsibility for the management of those firms. The Futures and Options Association has stated, “Commodity market participants have questioned what purpose it would serve to bring senior managers from a group company into the approved persons regime when they might be, for example, engineers and chemists who are running an industrial group.”
- In relation to extending the significant management function (CF29) to include all proprietary traders, questions have been raised as to whether FSMA 2000 envisaged the use of the “significant influence” test, to extend to all proprietary traders. Extending the approved persons regime in this instance should not be based simply on the fact that a trader has the ability to commit, and potentially lose, capital on their firm’s trading book. For example, a junior trader with a relatively low risk profile, low commitment of capital and low contribution to a firm’s profit would be highly unlikely to be able to exercise a significant influence on the conduct of his/her firm.
- Further supervision by the FSA of non-executive directors could lead to individuals being deterred from becoming non-executive directors, if they feel that they might be subject to disciplinary action where they have demonstrably “acted in accordance with their roles and responsibilities” but “things go wrong”. In addition, it contains ambiguous standards, e.g. what constitutes “intervening” and “sustained poor decisions”. The risk of this approach is that it may result in closer executive involvement by those non-executive directors who are not deterred, which may detract from their independence from decision-making.
- The position on third country firms from equivalent jurisdictions requires further clarification. The FSA proposals did not take into account the equivalence of existing governance arrangements in non-EEA jurisdictions, for example, the United States, Switzerland and Japan. In addition, UK branches of overseas firms based outside the EEA may face other practical issues such as resistance from non-UK resident senior staff, due to privacy of personal information, to provide information for applications for approval.
The Consultation Paper highlighted the concerns of the FSA that whilst the governance structures of many firms have developed over time, the approved persons regime has not been evolved in any significant detail. A majority of the respondents appreciate change is necessary, and the FSA is likely to be mindful of the respondents’ observations highlighted above, before publishing its final rules.
Further, the FSA will need to ensure that it has sufficient resources to enforce the requirements of the extended regime swiftly and rigorously. The FSA will finalise its proposals, and publish a policy statement during the second quarter of 2009. Subsequently, there will be a six-month transition period for firms to identify those individuals who need to apply for approved person status under the extended scheme.
Authorised firms, and those applying for authorisation, will await the FSA final rules with interest. The extension of the FSA’s approved persons regime will also be of particular interest to entities that have established, or are seeking to establish, themselves as energy market participants or oil market participants in the UK, particularly where strategy and decision making, initially at least, is in part led by individuals at parent undertakings or holding companies.
Firms will invariably need to review their regulatory compliance and corporate governance policies to ensure that they adequately identify where significant influence lies. Corporate governance arrangements will also need to ensure that the authorised firm does not rely heavily on the governing bodies or other individuals within another group company, otherwise the proposed extended FSA regime will attach itself to those arrangements.