NEW PROPOSALS TO INCREASE SENIOR MANAGEMENT ACCOUNTAbILITY
On 30 July 2014, the UK Financial Regulators, the Prudential Regulation Authority (“PRA”) and the Financial Conduct Authority (“FCA”) published a joint consultation paper setting out their proposals for a new framework for individuals working in banks, building society and credit unions and PRA-designated firms (“Relevant Firms”). The consultation proposals implement changes made by the Financial Services (Banking Reform) Act 2013 (the “Act”) to the Financial Services and Markets Act 2000 (“FSMA”) and reflect recommendations by the Parliamentary Commission on Banking Standards (“PCBS”). The PRA and FCA also published a joint consultation paper on their proposals to enhance the remuneration rules to address weaknesses highlighted in the PCBS report.
The deadline for responses to the consultation papers is 31 October 2014 and the PRA and FCA aim to publish final rules in early 2015.
Impact of the New Regime
In addition, the Act created a new criminal offence of reckless misconduct leading to the
“failure” of a bank or building society. Although not yet in force and no commencement
date has been set, this new criminal offence combined with the increased risk of disciplinary action against senior persons arising from the new senior persons regime is likely to cause concern and impact the day-to-day decision making processes of senior persons.
With the regulators armed with additional enforcement tools Relevant Firms will need to pay careful attention to the preparation of any documents (e.g. statement of responsibilities, responsibilities maps and handover certificates) that could be used by the regulators to prepare their case against the bank and the senior person.
Scope of the New Regime
The new Senior Persons Regime will apply to individuals performing a PRA or FCA Senior Management Function (“SMF”), whether such individuals are physically based in the UK or overseas, although only the PRA Certification Regime is likely to apply to UK branches of overseas firms and employees of overseas subsidiaries of UK-regulated firms.
At his 2014 Mansion House Speech, the Chancellor of the Exchequer announced his intention to extend the regime to cover branches of foreign banks. HM Treasury intends to consult on the proposals later in 2014.
- The proposed new framework comprises:
- A new Senior Managers Regime: This will replace the existing Approved Persons Regime for individuals working at Relevant Firms. The Act replaces the concept of a Significant Influence Function in FSMA for Relevant Firms with that of a SMF.
The combined scope of the PRA and FCA regimes capture the relevant firm’s boards, heads of key business areas and group entity senior managers, heads of the money laundering reporting and compliance oversight functions and Significant Responsibility Senior Managers (who are to be allocated “Key Functions”). Persons performing a SMF will continue to require pre-approval from the relevant regulator, although certain additional information will be required, such as a Statement of Responsibilities, Responsibilities Map, organisational charts and learning and development plans. The regulators have also been given new statutory powers to impose conditions and time-limits on approvals of senior managers.
- A new Certification Regime: This will apply to all employees performing a role relating to a relevant firm’s regulated activities which, although not SMF holders, could nonetheless pose “a risk of significant harm to the firm or its customers”.
The regime will require firms to certify certain employees as “fit and proper” to perform these roles. The PRA and FCA are taking a similar approach to the factors
that they will require firms to take into account. Fitness and propriety need to be reassessed annually and certificates renewed accordingly. As individuals falling within the Certification Regime will be assessed by firms (instead of by the regulators), firms: (i) should sign up to Disclosure and Barring Service; (ii) run comparable checks on employees coming from overseas; and (iii) keep records about employee conduct for 5 years, (particular those concerning any breaches of the Conduct Rules below).
- New Conduct Rules: These rules will replace the Principles and Code of Practice for Approved Persons (“APER”) and will apply to a much larger pool of persons, including individuals within the Senior Managers Regime, Certification Regime and any other person not performing an “ancillary function”. The new Conduct Rules are split into two tiers: the first tier rules will apply to everyone subject to the Conduct Rules and the second tier rules will only apply to senior managers. Rules 1 to 3 of the first tier rules (integrity; due care; cooperation with the regulators) will be familiar to existing approved persons. However rules 4 and 5 (due regard to the interests of customers and treat them fairly; observe proper standards of market conduct) have previously only been applied at firm level.
- Handover Requirements: Relevant Firms will be obliged to provide newly-appointed senior managers with “all necessary materials/information and risks of regulatory concern in order to perform their responsibilities effectively”. The FCA proposes to require SMF holders to prepare handover certificates when changing roles.
- Introduction of the Presumption of Responsibility: The senior manager responsible for the area in which a contravention (by the firm) has occurred could be held accountable, unless they are able to satisfy regulators that they took “reasonable steps to prevent, stop or remedy” the relevant breach. The PRA will determine what constitutes “reasonable steps” on a case-by-case basis; but have said it may include the appropriate delegation of certain tasks. The FCA’s decision whether to take action will be made on the basis of their published criteria in the Decision and Procedure and Penalties Manual (“DEPP”).
- Key changes to the remuneration rules
- Deferral: The minimum deferral periods have been increased to no less than seven years for senior managers and no less than five years for other material risk takers. The first vesting of deferred remuneration for senior managers is to occur no earlier than the third anniversary of award and must vest no faster than pro rata between years three and seven. The first vesting of deferred remuneration for all other material risk takers is to occur no earlier than the first anniversary of award and must vest no faster than pro rata.
- Clawback: The regulators propose that in certain scenarios firms should provide for an option to extend the clawback period for senior managers for up to ten years (three more than the current seven).
New Criminal Offence
Section 36 of the Act created a new criminal offence of reckless misconduct leading
to the “failure” of a bank or building society, although no commencement date has yet been set for this new offence. Proving that a senior person’s behaviour fell far below the expected standard might be difficult in all but the most egregious cases. It might also be difficult to prove that a particular decision was the cause of the firm’s failure, as there will often be a number of contributory factors leading to a bank or building society’s failure. However, the sanctions are robust – offenders can be punished with an unlimited fine and/or sentenced to up to seven years’ imprisonment.
Three elements that must be present for the offence to be committed:
- a senior person takes a decision (or agrees to it being taken or fails to prevent the taking of a decision) and that decision leads to the failure of the bank or another bank in the same group;
- at the time of taking the decision the senior person is aware that it may lead to failure
of the bank;
his conduct in relation to the decision ‘falls far below’ what could have been reasonably
expected of a person in his position.
PREPARATIONS UNDERWAY FOR RING FENCING IN 2019
The FSMA 2000 (Ring-fenced Bodies and Core Activities) Order 2014 (“RBCAO”) and FSMA 2000 (Excluded Activities and Prohibitions) Order 2014 (“EAPO”) have been published on legislation.gov.uk. These orders are designed to facilitate the planned ring- fencing of banks in 2019, whereby financial institutions who conduct one or more core activities will not be permitted to carry out certain activities.
RBCAO defines when accepting a deposit is a core activity under section 142B FSMA 2000. It allows certain banks which are not ring-fenced bodies to hold deposits. The order is set to come into force on 1 January 2015.
EAPO expands on section 142D FSMA 2000 outlining when ring fenced bodies are able to deal in investments as a principal. It further restricts ring-fenced bodies from certain exposures to other financial institutions and imposes a ban on operating branches or subsidiaries outside the EEA. Articles 1, 2 and 3 come into force on 1 January 2015, with the other provisions coming into effect on 1 January 2019.
RECORD FINE FOR bARCLAYS FOR “SIGNIFICANT WEAKNESSES” IN HANDLING OF CLIENT ASSETS
The FCA, the UK’s financial regulator, has imposed a record £37,745,000 fine on Barclays for serious breaches relating to clients assets.
The final notice, published on 23 September 2014, found Barclays had breached Principle 3 (management and control) and Principle 10 (Clients Assets) of the FCA’s Principles of Business and breached the Clients Assets Sourcebook for a period spanning over four years.
Between 1 November 2007 and 24 January 2012, Barclays was found to have failed to:
- take reasonable care to in relation to their risk management systems for external account handling, when client accounts were held by custodians outside the Barclays Group (Principle 3)
- arrange adequate protection or record keeping for the safe custody assets for which
Barclays was responsible (Principle 10)
Cumulatively, the FCA stated these failings put £16.5 billion of safe custody assets belonging to clients at risk in their investment banking division. The FCA did stress, however, these failings were not related to their personal or corporate businesses.
The FCA noted that the fine would have been almost £54 million, but for the bank’s decision to settle at an early stage, thus qualifying for a 30% discount.
In its accompanying press statement, the FCA announced this is the highest fine that either it, or its predecessor the Financial Services Authority (“FSA”), has ever imposed in relation to client assets failings. Previously, the highest fine in relation to client assets failings had been the £33.3 million penalty issued by the FSA to JP Morgan.
FCA director of markets, David Lawton, stated that “safeguarding client assets is key to maintaining market confidence if firms fail. Barclays’ lack of focus on the rules was unacceptable.”
Director of enforcement and financial crime at the FCA, Tracy McDermott, pointed out that “Barclays failed to apply the lessons from our previous enforcement actions, numerous industry-wide warnings, and exposed its clients to unnecessary risk.”
“All firms should be clear after Lehman that there is no excuse for failing to safeguard client assets.”
This is not the first time that Barclays has been fined over failing to ring-fence client assets. In January 2011, it was fined £1.1 million for failings relating to £750 million of client money.
The fine reflects further regulatory enforcement action against the bank, having been one of the first firms to be implicated in the LIBOR rigging scandal back in 2012 and, earlier this year, one of its traders was found to have been involved in rigging the London Gold Fixing market.
LLOYDS bANK IN £105 MILLION FINE FOR bENCHMARK MANIPULATION
On 28 July 2014, the FCA handed the third highest penalty ever imposed, either by itself or the FSA, to Lloyds Bank for manipulating a number of important benchmarks.
The final notice highlighted that two thirds of the fine was apportioned to the firm’s manipulation of the pricing mechanism behind the Special Liquidity Scheme (“SLS”), the scheme designed by the Bank of England (“BoE”) to support ailing UK banks during the financial crisis. The fees payable to the BoE under this scheme were determined by the interest rate benchmark known as the repo rate, which has now been discontinued. By artificially inflating their repo rate submission, Lloyds were adjudged to have deliberately sought to minimise their fees payable to the BoE.
The other third of the fine related to Lloyds’ manipulation of its LIBOR submissions, which the FCA described as similar, in many ways, to the malpractice that has seen a number of contributing banks fined since 2012.
The breaches involved violations of Principle 5 (proper standards of market conduct) and Principle 3 (management and control) of the FCA’s Principles of Businesses.
In the accompanying press release, Tracy McDermott, director of enforcement at the FCA, stated “The firm was a significant beneficiary of financial assistance from the BoE through the SLS. Colluding to benefit the firm at the expense, ultimately, of the UK taxpayer was unacceptable.”
“The abuse of the SLS is a novel feature of this case but the underlying conduct and the underlying failings – to identify, mitigate and monitor for obvious risks – are not new.”
The fine represents the seventh penalty for LIBOR manipulation.
DEUTSCHE bANK FINED £4.7 MILLION OVER REPORTING FAILURES
The FCA has fined Deutsche Bank after “particularly serious” reporting discrepancies, which led to the bank failing to properly account for almost 30 million equity swap CFD transactions. The transactions date from November 2007 and span almost five and a half years.
The final notice stated the failings were aggravated by the fact that the importance of accurate transaction reporting was repeatedly emphasised by the regulator and Deutsche had previously received a private warning in 2010 for other similar reporting failures.
The FCA stated the fine would have been larger had it not been for the 30% reduction Deutsche Bank received resulting from early settlement.
In the press release, Tracey McDermott, director of enforcement at the FCA, stated that “there is no excuse for Deutsche’s failure to get this right. Other firms should be in no doubt about our continued focus on this issue.”
FCA USES SUSPENSION POWER
Financial Limited and Investments Limited have been suspended from appointing new representatives and individual advisors as a result of a breaching principle 3 (management and control) of the Conduct of Business Rules.
Both firms were deemed to have failed to properly supervise their appointed representatives and individual advisors, which resulted in a higher risk of mis-selling and providing unsuitable advice to consumers.
In the accompanying press release, it was noted that this is the first time the FCA has used its suspension power.
bROKER bANNED FOR HIS CONDUCT IN HIGH COURT
The Upper Tribunal upheld a ruling by the Regulatory Decisions Committee (“RDC”) against a former insurance broker, Stephen Allen, banning him from carrying on a regulated activity, after his conduct in the High Court was deemed to be not in keeping with that of a fit and proper person.
Mr Allen had given untrue evidence during the court case, included submitting forged documentation, and was found to have attempted to mislead the court during proceedings.
The reasoning behind the Upper Tribunal ban was different to that of the RDC. The RDC had based its ruling on allegations of secret fees having been added to clients’ premiums. The witness behind these allegations was subsequently considered not to be credible in the High Court proceedings.
Significantly, the Upper Tribunal did not require the FCA to bring the case in front of the RDC again in light of the change in evidence. Instead Upper Tribunal upheld the ban, which it still considered appropriate, in light of Mr Allen’s conduct in the high court.
FCA FINES RbS AND NATWEST FOR MORTGAGE ADVICE
The FCA has imposed a £14.5 million fine on RBS and NatWest in relation to failings in mortgage advice given by the banks.
In its final notice, the FCA stated that there was an “unacceptable risk” that the banks could have been giving unsuitable advice. The FCA stated inadequate record keeping and failure to respond to regulator advice were further reasons for the penalty.
In the accompanying press statement, it was noted that only 2 of the 164 sales sampled met the standards of recording required by the FCA to assess the suitability of advice given to consumers.
Tracy McDermott, director of enforcement and financial crime, said “we made our concerns clear to the firms in November 2011 but it was almost a year later before the firms started to take proper steps to put things right. Where we raise concerns with firms, we expect them to take effective action to resolve them without delay. This simply failed to happen in this case.”
INSIDER TRADERS JAILED
In a case brought by the FCA, six people found guilty of insider dealing have been given
jail terms spanning from 18 months to three and a half years.
The individuals were also served with confiscation orders totalling £3.2 million, which exceeded the profits generated from the dealing.
In the press release, Tracy McDermott stated “these individuals engaged in a sophisticated scheme to try and make easy money by exploiting inside information. As a result they have not only lost their liberty, their livelihoods and their reputations but they have also now been ordered to pay significant sums in confiscation. This should be a clear message to others that insider dealing does not pay.”
bOE PUbLISHES REPORT ON REGULATING ADDITIONAL FINANCIAL bENCHMARKS
The BoE has published a report to HM Treasury recommending further financial benchmarks to be brought within the regulatory scope of the UK.
The report, drawn up by the Fair and Effective Markets Review, recommended seven benchmarks to be brought within regulatory oversight, including the Sterling Overnight Index Average (SONIA) and the Repurchase Overnight Index Average (RONIA).
It is significant that the gold and silver fixings are also being recommended for inclusion following the recent fine for a Barclays trader found to have engaged in manipulation of the gold market.
The Treasury has published a consultation paper, closing on 23 October 2014, which seeks views on implementation of the recommendations and also a draft statutory instrument to make amendments to existing legislation.
FCA OUTLINES LATEST FINDINGS OF EMIR IMPLEMENTATION REVIEW
On 4 September 2014, the FCA published a report on its latest findings on the implementation of EMIR for non-financial counterparties (“NFCs”).
The FCA stated they wanted an understanding of how NFCs were defining and monitoring their hedging activities with regards to their clearing threshold. They found that, in general, NFCs were accurately classifying their hedging transactions.
EMIR, the regulation on OTC derivatives, came into force in February this year.
FCA CONSULT ON SOCIAL MEDIA AND CUSTOMER COMMUNICATIONS
In August 2014, the FCA issued a guidance consultation paper outlining their approach
to financial promotions in social media.
The guidance reminds firms that the definition of a financial promotion can be construed extremely widely: any communication in the course of business, on whatever platform
and by whatever means, which includes an invitation or inducement to engage in
The suggested guidance reminds firms that the requirement to be fair, clear and not misleading applies even if such a post is re-tweeted or re-posted out of its original context. It further suggests firms are aware of the limitations of character limited advertisements in advertising complex financial products. Firms must still ensure they highlight, in a fair and prominent location, the relevant risks and drawbacks of any product. The FCA is seeking to be media-neutral in its approach, so no account is taken of the platform (and its limitations) when deciding whether a promotion falls outside the guidance.
The report emphasises the importance of being able to limit advertising campaigns to target certain, more complex financial promotions to a specific audience. It also suggests using clear image advertising, particularly when there are limitations on the number of characters in the message that can be displayed.
The guidance is open for consultation and is accepting comments and queries until
6 November 2014.
FCA AND PRA CONSULT ON bONUS CLAWbACK
The FCA and PRA have published a joint consultation paper seeking views on the
changes in regulatory approach regarding remuneration.
The Remuneration Code, the handbook designed to ensure a greater link between risk and reward in the banking sector, is to be updated to address weaknesses identified in the Parliamentary Commission on Banking Standard’s report published in June 2013.
The particular areas being consulted on are:
- Bailed-out banks
- Risk adjustment
- Remuneration of non-executive directors
PRA AND TREASURY CONSULT ON THE bANK RECOVERY AND RESOLUTION DIRECTIVE (“bRRD”)
In July 2014, the Treasury and PRA issued separate consultation papers on implementing the BRRD into UK law.
The BRRD, published in June 2014, was designed to harmonise the framework across Europe for dealing with recovery and resolution issues relating to large banking institutions. The directive takes effect from 1 January 2015.
The PRA paper outlines its proposed approach to:
- Recovery plans
- General information provision
- Intra-group financial support arrangements
- Notification requirements for banks at risk of failure
- Recognizing the contracts that may be subject to bail-in.
The PRA announced that it is proposing to make new rules concerning the above and
also to amend its recovery planning supervisory statement.
The Treasury paper outlines the government’s approach to the BRRD. It notes that the BoE will be the UK resolution authority, and the Treasury will be the competent ministry. The report covers a wide range of implementation areas, including:
- Recovery and resolution planning
- Removing impediments to resolvability
- Intra-group financial support
- Early intervention
- Resolution objectives and principles of resolution
FCA MAINTAINS REGULATORY PERIMETER bETWEEN LOANS AND DEbENTURES
The City of London Law Society has published a letter from the FCA addressing concerns about the verdict from the Court of Appeal in Fons Hf (In Liquidation) v Corporal Limited and another  EWCA Civ 304 (“Fons”).
The letter stated the FCA did not consider Fons to have altered the regulatory perimeter
to FSMA 2000.
The Court of Appeal in Fons had held that a loan agreement acknowledges a debt and is therefore a debenture. This would have the effect of regulating loan agreements more tightly than had been the case previously.
PRA CLARIFIES APPROACH ON INTERNATIONAL bANKS
The PRA has issued a supervisory statement outlining its approach to international
banks and their branch supervision.
The statement outlines the UK’s distinction between international branches and subsidiaries and how these entities should be regulated if they are within the EEA. The statement goes on to state the PRA’s risk appetite for non-EEA branches.
The PRA states that its note is particularly relevant to all PRA-supervised firms operating in the UK but whose headquarters are overseas.
INCREASED REGULATORY FOCUS ON PAY-DAY LENDERS
There has been increased scrutiny of lenders who offer high-cost, short term credit
(known as “pay-day” lending in the UK).
The Financial Ombudsman Service (“FOS”) published a report in August 2014 looking into complaints arising from “pay-day” loans practices. The FOS stated that complaints were up 46% from 2013 and that most of the complaints demonstrated a general inadequacy in administration procedures and poor customer care.
The report found that although many complaints were multi-faceted, most complaints
were predominantly centred around five key areas:
- Poor administration and record keeping
- Billing practices
- Failure to agree debt repayment plans
- Poor customer care procedures The report can be accessed here.
The FCA expects to publish its own report on the “pay-day” lenders market in early 2015. This was revealed in an answer published in Hansard to the House of Commons to a written question addressed to the Chancellor to the Exchequer. In the response, it was stated that the report will cover both an analysis of current market conduct and how to ensure observation of the regulations are met.
In July 2014, the FCA published a press release to remind lenders of the new rules on pay-day lending including a limit on roll-over extensions of unpaid loans, a limit on unsuccessful attempts to use a payment authority and warnings on risk during financial promotions.
Wonga, the UK’s largest pay-day lender, agreed to write off £220 million of debts, after implementing new affordability checks in October 2014. The move, which affected 330,000 people, came as a result of a “voluntary arrangement” with the regulator.
FCA AND PRA NOTE ON FINANCIAL INCENTIVES FOR WHISTLEbLOWERS
In July 2014, the PRA and FCA issued a joint note to the Treasury Select Committee on
financial incentives to whistleblowers.
The note stated that neither regulator believed providing financial incentives to whistleblowers would encourage more to come forward, nor would it encourage a corresponding increase in integrity or transparency of the process, and this had been borne out by the empirical evidence from the USA.
Instead, both regulators have stated their focus would remain on ensuring better protection of whistleblowers through effective whistleblowing procedures and senior management accountability.
The note predates the award of a record $30 million payout to a non-US whistleblower by the US Securities and Exchange Commission (“SEC”).
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