Executive summary


The FCA and PRA have each published a policy document on how they propose to tackle serious cultural failings in firms. Both regulators intend to achieve this using their existing supervisory processes and powers.

The one concrete development is the FCA’s new ‘Enhanced Supervision’ tool: where failings have been identified at a firm, it will be made formally subject to Enhanced Supervision; the board will normally be required to make a formal commitment to taking remedial measures, and the FCA will formally review its own supervisory strategy.

Introduction


On 19 June 2014, FCA published Tackling serious failings in firms: A response to the Special Measures proposal of the Parliamentary Commission on Banking Standards, while, at the same time, the PRA published its Statement of Policy: The use of PRA powers to address serious failings in the culture of firms.

The background to both documents is the final report of the Parliamentary Commission on Banking Standards (PCBS), Changing Banking for Good. The PCBS had observed that

many of seemingly discrete failings within the banking sector in recent years, often characterised distinctly as prudential failing or conduct failings, have common roots […] many having their origin in a failure of standards at the most senior levels of the bank concerned. Numerous incidents across a wide range of business areas within a bank may be indicative of wide-scale failings in leadership, risk management and behaviour. […] The standards and culture of a bank are a matter for the bank itself, and above all its Board. They cannot be imposed by regulators.

This led to the PCBS proposing a new ‘special measures’ tool for the regulators:

Special measures will take the form of a formal commitment by the bank to address concerns identified by the regulator. Ahead of placing a bank in special measures, we consider that the regulators should commission an independent report to examine the extent to which their initial source of concern may be an indicator of wider conduct or standards failings. […]The Commission recommends that a bank in special measures be subject to intensive and frequent monitoring by the regulators. An individual within the bank should be made responsible for ensuring that the remedial measures are implemented to the regulators’ satisfaction.

As the FCA put it, this new tool would “constitute a step between day-to-day supervision and enforcement action”.

Both the PRA and FCA concluded that they could address failings in business culture “by applying existing powers appropriately” – although, as the FCA conceded, the FSA “had many of the same powers, yet was unable to address the underlying issues of poor standards, governance, and culture in banks”. The two 19 June documents therefore set out how the two regulators will make use of their existing powers to respond to the PCBS’ specific concerns over issues with firms’ culture and governance.

For the PRA, these “regulatory practices […] are consistent with the current approach adopted by the PRA”, with no change involved.

The FCA, on the other hand, has introduced a new supervisory approach – ‘Enhanced Supervision’ – for firms with identified failings in fundamental standards, governance and culture.

Identifying cultural problems


The PCBS had warned that:

The appropriate tone and standard of behaviour at the top of a bank is a necessary condition for sustained improvements in standards and culture. However, it is far from sufficient. Improving standards and culture of major institutions, and sustaining the improvements, is a task for the long term. For lasting change, the tone in the middle and at the bottom are also important.

It is clear from the 19 June documents, however, that both FCA and PRA primarily associate ‘culture’ with the senior management and board: “we seek to tackle the underlying failings at a senior level in firms. Cultural change in the wider institution is likely to take much longer to happen”. Do the board and senior management understand the circumstances in which a firm’s viability would in question? Can they explain the risks associated with particular strategies? Do they take responsibility? Do they take the lead on good conduct? Do the board respond to and challenge executives?

The PRA and FCA both provide similar, detailed lists of potential symptoms of firm-wide cultural failings:

  • multiple cases of conduct failure;
  • conduct failures occurring across different business areas;
  • evidence that the board fails to challenge executives or take a lead in considering conduct;
  • evidence that control areas such as risk, compliance and internal audit being poorly managed, resourced, or represented on the board;
  • weaknesses with staff objectives, training, evaluation, pay and incentives; and
  • weaknesses with management and the board’s adherence to the firm’s values.

Tackling cultural problems


Supervision: FCA

The FCA paper first describes the normal FCA supervisory approach, and the place of firm culture, business models, and governance within it.

It then goes on to describe the new approach, ‘Enhanced Supervision’, which will apply in cases where a firm presents serious risks due to failures in culture, governance or standards, and the normal approach will not suffice.

Whether to move a firm into Enhanced Supervisions is a matter of judgement rather than process. Where this decision is taken, the firm will be made formally subject to Enhanced Supervision. The board of the firm will normally be required to make a formal commitment to taking measures remedying the risks identified within a certain timeframe. A skilled persons report will be considered.

This will trigger a formal review of the FCA supervisory strategy. Supervisors will devise a plan setting out the means – including use of the tools and powers listed below – by which the firm can be returned to normal approach by a specified date. Progress against this plan will be regularly monitored and corrective action taken if necessary; if the FCA is not satisfied with the remedial work of the board, it may use other tools and powers (see below); alternatively, it may make use of these from the outset.

Supervision: PRA

The PRA’s normal supervisory activity is set out in its ‘general approach’ documents. One particularly relevant aspect is that, under the ‘Proactive Intervention Framework’ (PIF), any deficiencies identified in a firm – including cultural deficiencies – could move the firm up to a higher PIF stage; which, in practice, would mean more intense supervision, additional reporting requirements, and a greater amount of regulatory attention. (The PRA may increase its monitoring of a firm notwithstanding its PIF stage, however.)

Regulators’ powers

The regulators share a similar set of powers, the most relevant of which include:

  • imposing a requirement to undertake or cease from a particular action, e.g.
    • securing customers’ money;
    • returning customers’ money;
    • writing to customers to warn them about limits of their insurance coverage;
    • putting in place appropriate governance structures and committees;
    • appointing an external party to monitor and oversee the board’s compliance with PRA requirements;
    • limiting balance sheet growth until robust governance structures in place; and
    • nominating an individual within the firm to have responsibility for implementing PRA recommendations;
  • variation of permission (including removing a firm’s permission);
  • requiring a skilled persons report;
  • requirement to provide specific information relevant to UK financial stability (PRA only);
  • powers to prohibit a firm from dealing with its own or clients’ assets; and
  • requiring formal ‘attestations’ from responsible senior individuals that they will take all reasonable steps to deal with an issue, and accept accountability for doing so.

In some, but not all, cases, a period of Enhanced Supervision will be followed by an enforcement investigation; action against approved individuals (under APER) may also be contemplated.

Joint action

The FCA and PRA have a statutory duty to co-ordinate their functions, and will be expected to share views on firms: “Supervisors of dual-regulated firms co-operate routinely and meet at least once a year (twice a year for the most significant firms) at domestic colleges to discuss issues of common interest or ad hoc on specific issues”.

In particular:

  • where either regulator identifies concerns with a specific firm, it will discuss these with the other to try and obtain a ‘common view’, and will seek to take a joint course of action if appropriate;
  • the FCA will inform the PRA if it is going to place a firm under Enhanced Supervision – although it anticipates that, in such a case, it will have discussed the firm with the PRA already;
  • the regulators are required by their joint Memorandum of Understanding to consult with each other before imposing requirements on firms or varying firms’ permissions; and
  • notwithstanding the above, one regulator may still choose to take action where the other decides not to.

Next steps


Both 19 June documents describe how the supervisory systems of FCA and PRA function at present.

However, the FCA paper also notes that it will begin consultation on the Senior Persons and Certified Persons regimes – which were also suggested by the PCBS, and which will also have a bearing in how the regulators deal with cultural failings in firms – in summer 2014.