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A greater regulatory and liability burden for senior executives in the financial services sector

A greater regulatory and liability burden for senior executives in the financial services 

Further sweeping regulatory reforms are in the pipe-line for executives in the financial services. The result will be a significant change to the way in which senior executives in the banking sector are regulated and their personal accountability.

Background

In 2014, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) (together, the “regulators”) issued a joint consultation paper on proposals to overhaul regulation of the UK’s financial services, with a particular focus on individual accountability for senior management.

The proposals are based on the recommendations of the Government’s Parliamentary Commission on Banking Standards, set up following the financial crisis of 2008-2009 and the ensuing loss of public confidence in the banking sector.

The proposals include the introduction of:

  •  A new senior managers regime;
  • A new certification regime; and
  • A new set of conduct rules (the details of which are outside the scope of this alert).

As well as hugely impacting financial services’ employers, specifically their Compliance and HR functions who will be faced with implementing the new regimes and the detailed preparatory work that entails, the changes are likely to affect a large number of financial services’ executives, particularly on joining or departing a new employer.

In this alert we look – in high level overview – at the two new regimes and what steps senior executives should take when the regime is in force.  The proposals and draft rules are still subject to consultation so remain subject to change.

Senior Managers Regime – who will this affect?

The new senior managers’ regime (‘SMR’) will replace the current Significant Influence Function (SIF) element of the ‘approved persons regime’ in the Financial Services Markets Act 2000 and will cover a narrower range of senior individuals. In broad terms, those individuals who partake in major activities, responsibilities and risks will be part of the SMR, this could include e.g.:

  • board members;
  • individuals one level below the board;
  • certain heads of key business areas; and
  • individuals responsible for important business or who have significant influence

(this list is not exhaustive).

Individuals who perform a senior management function will require pre-approval from the FCA or the PRA.  Both regulatory bodies will be entitled to specify functions as requiring approval within the scope of their own regimes.

The actual regulatory approval process is unlikely to change substantially from the current process.  Those individuals who are to be senior managers will be invited to an interview with the FCA and/or the PRA.  However, employers will need to satisfy themselves that the candidate is fit and proper to perform the function and new documentation will need to be submitted on behalf of the prospective candidate, including the statement of responsibilities (see below).

Approval by the FCA and PRA can be subject to any condition that they consider appropriate and approval can be varied at any time.

It will be possible under the new regime for individuals who are currently approved to perform a SIF and who will be performing a corresponding senior management role under the new regime (and one which doesn’t change substantially) to be grandfathered into that role (by the employer submitting a grandfathering notification form).

Liability for Senior Managers – the Presumption of Responsibility

A big change in the new regime is that senior managers could be held responsible (and face individual sanctions) for their area of responsibility, where a contravention has occurred.  This liability will be incurred unless they are able to satisfy the regulators that they have taken ‘reasonable steps’ to prevent or stop the contravention, so the evidential burden is now on the individual.  This is known as the ‘Presumption of Responsibility’ and effectively reverses the current burden of proof (at present regulators must prove that the individual failed to take reasonable steps to e.g. prevent the regulatory breach).

Statement of Responsibilities

When applying for regulatory pre-approval for senior managers, employers will need to include a Statement of Responsibilities setting out the areas of the firm which the prospective senior manager will be responsible for managing.  It will be a requirement of firms to keep these Statement of Responsibilities up to date and they must be resubmitted every time there is a ‘significant change’ in the senior manager’s responsibilities.

This document will be critical in determining the liability of the senior manager should there be a breach of a regulatory requirement.  It will also be used at the out-set by the regulators in determining whether regulatory approval should be granted in the first place.

Management Responsibilities Map

Firms will also have to maintain and update a ‘Responsibilities Map’ which will need to be submitted in a firm’s application for approval to perform a SMF. This is a document which describes the firm’s management and governance arrangements, including reporting lines and responsibilities. It will detail how responsibilities have been allocated.  The key aim of the Responsibilities Map is to ensure that there are not any gaps in accountability.

Handover Arrangements

The regulators also propose to implement handover arrangements between departing and newly appointed senior managers. The aim is for newly appointed senior managers to be made aware of all necessary materials/information and risks of regulatory concern in order to perform their responsibilities effectively.

Certification Regime – who will this affect?

The Certification Regime, separate to the SMR, will apply to other banking staff whose role could significantly harm the bank, its reputation or its customers.  The Certification Regime will require relevant firms to assess those individuals’ fitness and propriety.

The Certification Regime applies to a wider number of individuals than the current ‘approved persons regime’.  It was born firstly from the concern that the existing ‘approved persons regime’ regulated too narrow a scope of individuals and secondly, the concern that financial services’ institutions were taking insufficient responsibility for the fitness and propriety of their staff.

Whereas previously the regulators were responsible for approving individuals, firms will now be required to assess the fitness and propriety of employees performing a role which is within the scope of the Certification Regime, at least annually and renew the certificate accordingly.  It will be the responsibility of senior managers to assume responsibility for this assessment.

Assessment for SMF or Certification Regime

Individuals who are applying for a SMF or Certification Regime role will have their employment history for the last five years checked and will need to disclose, if relevant:

  • Facts that led a former employer to conclude that they breached the new conduct rules; and
  • A description of the basis and outcome of disciplinary action taken in relation to breach by the individual of the new conduct rules.

Criminal record checking by firms of prospective candidates will continue under the new regime (as it does currently).  However, there is also a proposal that firms should be checking criminal records in other jurisdictions where the individual has spent a time abroad.

What next?

A subsequent consultation was published by the FCA and PRA in December 2014; this remains open until 27 February 2015 and is primarily focused on transitional arrangements and documentation to support the new regime outlined above.

The response to the proposals contained in the July 2014 consultation is still awaited and the timing of the new accountability regime is due to be announced shortly by the Government. It is not yet known when the regime will come into force but the original intention was for it to be implemented during 2015.  We will keep you updated.

What do the proposals mean for senior executives in the financial services sector?

  • Individuals who will become senior managers under the new regime will need to ensure that they feel comfortable with their individual responsibilities, reporting lines, the requirements of the role and its level of risk. As part of this assessment, specialist independent legal advice should be sought during any contractual negotiation and executives should consider asking for this advice to be paid for by their current or prospective employer (as relevant).
  • Senior managers will need to carefully consider their individual Statement of Responsibilities: it is more than a simple job description. It is the document which is likely to outline their level of liability should anything go wrong, so the executive needs to ensure that its scope is not too wide and that the level of responsibility detailed is manageable and achievable.
  • The management responsibility map should also be carefully considered to ensure that it reflects the agreed role and responsibilities of the senior executive within the business.
  • Incoming senior managers involved in any handover process will need to ensure that they feel comfortable with the risk and accountability they are taking on, including receipt of all the necessary documentation to aid this understanding from their prospective employer. Incoming managers may want to enquire as to what procedures and policies are in place to ensure that an effective handover is carried out by a departing senior manager (particularly where their departure has not been an amicable one). Again, it may be appropriate to take specialist legal advice.
  • Outgoing senior managers should also consider what access they will have to documentation and legal advice should they leave their firm and they later face accusations that they have breached their regulatory responsibilities. Such detail should be ideally agreed up front, in writing, before assuming the role of a senior manager.
  • Senior executives should consider what, if any, protection they have in the form of Directors’ and Officers’ Insurance (or equivalent) cover in the event of any regulatory investigation or breach. It will be important for the executive to understand the scope of that insurance cover including its exclusions.
  • And finally, when the new regime comes into force, senior managers may want to consider whether the increase in regulatory burden should be reflected in any future remuneration discussions with their employer.

Summary

The reform of the regulatory regime for senior executives in financial services should not be underestimated.  Some commentators have questioned why any executive would want to take on the role of an SMF given the level of responsibility and potential exposure it entails.  Along with the new bonus claw back rules, which came into force earlier this year (bonuses will be subject to a 7 – 10 year claw back), the impact on senior executive recruitment in financial services remains to be seen.  What is more certain, however, is that senior executives need to be comfortable and confident with the scope of the roles they are assuming and their obligations and liabilities those roles create for them under this new regime.