On 1 October, the UK Government published its proposed amendments to the Financial Services (Banking Reform) Bill. These include the introduction of a criminal offence of reckless misconduct that leads to the failure of a bank which has attracted considerable press comment. The likelihood of a such a prosecution in the near future, however, is probably remote. Of more immediate concern to the banking industry is the proposed introduction of a Senior Persons Regime. This regulatory change may have significant consequences for banks and their directors and senior managers. We summarize the proposal below.
- The draft Bill introduces, in the case of UK deposit-taking institutions including banks, building societies and credit unions ("banks"), functions that will be designated by the PRA or FCA as "senior management functions". All PRA-controlled functions will be senior management functions, and some but not all FCA-controlled functions will be.
- A "senior management function " is one which requires the person performing it to be responsible for managing one or more aspects of the bank's regulated activities where those aspects involve or might involve serious consequences for the bank (ie key risks) or for "business or other interests in the UK".
- The definition of "managing" the affairs of a bank is wide. It includes taking decisions or participating in the taking of decisions about how one or more aspects of those affairs should be carried on. It will for example extend to non-executive directors and potentially directors of parent undertakings to the extent they are involved in decisions that affect the business of the bank.
- Applications to the PRA or FCA to assume senior management functions will have to be accompanied by a statement of responsibility identifying the aspects of the affairs of the bank which the person is intended to be responsible for managing.
- The PRA or FCA will be able to take enforcement action against a senior manager of a bank with senior management functions if there has been a contravention of a requirement imposed by FSMA or qualifying EU provision and the senior manager was at that time responsible for the management of the bank's activities in relation to which the contravention occurred. In the case of such enforcement action, the burden of proof will be reversed, meaning that the senior manager will have to prove that he or she had taken such steps as a person in their position could reasonably be expected to take to avoid the contravention occurring (or continuing).
- The PRA and FCA will be able to make rules about the conduct of persons approved to perform controlled functions (including senior management functions) and employees of banks (at whatever level).
The Government's objective, as originally proposed by the Parliamentary Commission on Banking Standards, is to assign and allocate more clearly personal responsibility and accountability for key risks to senior individuals within banks. In his evidence to the Treasury Committee of the House of Commons on 10 September this year, Martin Wheatley, Chief Executive of the FCA, lamented that it had been "hard to nail an individual against responsibility because matrix organisation structures, committee decision-making means that individuals can always defuse responsibility". To assist in achieving this objective, in the event of an enforcement action, the burden of proof will be on the individual with responsibility for the relevant aspect of the bank's business to show that they had properly performed their duties and responsibilities.
These changes may lead banks to reconsider or hasten any ongoing review of their corporate governance framework and principles. They may also lead to reviews of the structure of the organisation and reporting lines and, in some cases, their replacement by a more simple architecture where risk and responsibility can more easily be identified, defined and allocated. Senior managers may seek more clarity about what aspects of the bank's business they are and are not responsible for and the extent of these responsibilities. The statement of responsibility, which will have to be revised from time to time as responsibilities change, is likely to become an important and possibly contentious document and will have to be carefully prepared and closely aligned with the functions that the PRA and FCA designate as senior management functions.
Senior managers are also likely to be concerned about the timeliness and reliability of the information received from the parts of the business for which they have responsibility, including information relating to both financial and non-financial risks. They may seek stronger validation of policies, processes and products in the areas for which they are responsible, as well as periodic testing of assumptions and behaviour, in case of later challenge by the regulator. Such validation would not necessarily be a good defence to an enforcement action since responsibility cannot be delegated within or outside the bank but it would certainly help.
For the first time, the PRA and FCA will be able to bring enforcement actions against employees of banks who do not have controlled functions. This may result in more whistle-blowing. These employees may also want to be covered by the bank's D&O policies (defence costs in particular) which currently do not normally extend so far down the employment ladder.
Although the Government's proposals are currently limited to banks, there must be a chance that once implemented, they will be extended to other authorised persons under FSMA and possibly other sectors. For the moment, the focus is on banks, bankers and banking standards, but this may change when the next crisis comes along.