The consultation period for firms to respond to the Financial Conduct Authority's (the "FCA") and the Prudential Regulation Authority's (the "PRA") proposals regarding the new regulatory framework for increased individual accountability in UK banks, building societies and PRA designated investment firms is drawing to a close. The proposals reflect the recommendations of the Parliamentary Commission on Banking Standards and implement changes required under the Financial Services (Banking Reform) Act 2013. The new regulatory regime aims to ensure greater accountability across a wider range of individuals, with particular focus on senior management responsibility. As discussed in our November 2013 and January 2014 editions of the Legal & Financial Risk Newsletter, the reforms introduce a criminal offence for reckless misconduct by senior managers, with a maximum penalty of up to 7 years imprisonment. However, from a practical perspective the new Senior Managers' and Certification Regimes are likely to have the biggest impact on the day-to-day functioning of affected firms.
Under the Consultation Paper the FCA and PRA propose the following key changes to the current regulatory regime:
1. Senior Managers’ Regime
Individuals who carry out a Senior Management Function ("SMF") will be subject to a new Senior Managers' Regime. This regime focuses on key decision makers, and requires that firms regularly monitor the propriety and fitness of the individuals who carry out SMFs. From a practical perspective, when an individual becomes a senior manager, firms will have to submit a statement of responsibility to the relevant regulator which will provide a record of that manager's specific role and responsibilities. The regulator must be informed, if and when these responsibilities change, to enable it to track who is responsible for a particular business area. Firms must also maintain responsibility maps which provide an up-to-date overview of the firm's management and governance arrangements and set out lines and allocation of responsibility within the firm.
The new rules also introduce a controversial reversal of the burden of proof, whereby those subject to the Senior Managers' Regime are presumed to be culpable if a firm breaches a regulatory requirement in an area for which they are responsible, unless they can prove that they took reasonable steps to prevent the breach. The Senior Managers’ Regime introduces important changes to the existing regulatory framework which will make it easier for the FCA/PRA to hold senior management responsible for failures within a firm.
2. Certification Regime
The Certification Regime will apply to individuals who are not carrying out an SMF, but whose role and responsibility mean that they could pose a risk of significant harm to the firm or to its customers. This will bring a much wider group of employees within the scope of FCA/PRA regulation.
Firm's senior managers will be obliged to assume responsibility for internal assessment and certification of those carrying out a 'significant harm' function, to ensure that employees carrying out such functions are certified as being fit and proper to perform that role. Certification will need to be reassessed by firms at least annually.
3. Conduct Rules
The FCA and PRA will implement a new set of conduct rules which will replace the existing Statements of Principle and Code of Practice for Approved Persons. These new rules will apply a core set of conduct rules to all employees of relevant firms, except for a specific list of employees who carry out support or ancillary functions. The rules focus on integrity, diligence, accountability and openness with regulators, with a view to changing firms' culture at all levels.
In addition to these widely applicable rules, the FCA/PRA have listed four additional rules, which apply only to individuals subject to the Senior Managers' Regime. These rules require senior managers to take ‘reasonable steps’ to ensure that firms are compliant with legal and regulatory standards and are controlled effectively, along with ensuring that responsibilities are properly and effectively delegated and discharged. The proposed rules also require senior managers to notify the relevant regulator if they take disciplinary action against individuals for breach of the conduct rules or if they know of, or suspect, a breach.
Practical impact of the proposed changes
The proposed changes, in particular the Senior Managers and the Certification Regimes, are likely to pose a number of new challenges, both for firms and their senior management.
The requirement to submit responsibility statements and responsibility maps means that firms will need to ensure that there are clearly defined, transparent reporting lines and robust governance structures in place. This has been an area of focus for the FCA for some time, and the FCA is increasingly looking at firms' systems and controls and accountability frameworks where they have concerns about a particular business area.
On a personal level, senior managers need to have a clear understanding of each of the matters for which they are responsible, and take an active role in ensuring that they have adequate levels of information from other areas of the firm to be confident that their responsibilities in these areas are being fully discharged. Firms will need to be comfortable explaining how accountability frameworks operate in practice in their often complex business structures, and demonstrating that there are no gaps in accountability/areas of responsibility.
In addition to the certification process, which will take place at least once a year, firms will need to undertake additional due diligence when recruiting an individual for a role which falls within the Certification Regime. Firms will need to put systems in place to provide senior managers with the time, training and support to carry out the necessary additional checks and processes, as well as coping with the increased documentation burden.
Regulators have confirmed that individuals who currently exercise a Significant Influence function will be ‘grandfathered’ into the equivalent SMF function under the new Senior Managers' Regime. Effectively, this will mean that senior individuals who are not changing roles will not need to go through the approval process afresh to carry out the equivalent SMF. However, firms will still need to produce detailed responsibility maps and statements of responsibility demonstrating how the existing set of approvals and functions will transfer over to the SMF regime.
Although the PRA’s cost benefit analysis states that firms are "unlikely to experience a material change to the regulatory scope for approvals", it is clear that firms and senior managers will need to increase their focus on implementing more robust approval processes, regular vetting and individual accountability. This will inevitably be challenging in circumstances where senior management are already extremely busy focusing on the day-to-day operational aspects of their demanding roles.
This consultation should prompt firms to review their current structures and processes to ensure that they are well equipped to meet the new regulatory requirements when they come into force. In particular, firms will need to focus on clarifying reporting lines up to senior managers, which are rarely straightforward in what are often inevitably complex business structures. With the continuing regulatory focus on senior management responsibility, senior managers will need to ensure they have robust reporting processes in place to ensure that they receive the necessary information from their reports. More junior employees will need to facilitate this process and be aware of their part in ensuring that they maintain an open dialogue with their managers, reporting issues or concerns as soon as they arise. Alongside the new Conduct Rules, these new regulations aim to implement changes to the working practices and culture of firms.
The consultation closes on 31 October 2014, with a Policy Statement expected to be published at the end of 2014/early 2015.