We use cookies to make this site as useful as possible. Read our cookie policy or allow cookies.

A major shift

20 April 2015

A major shift - read more

New regimes introduce greater accountability for senior managers in financial services firms

The global financial crisis exposed serious shortcomings in the governance of financial services firms and the culture and behaviours which underpinned it. The Parliamentary Commission on Banking Standards (PCBS) stated that ‘a lack of personal responsibility has been commonplace throughout the industry’ and that ‘senior figures have continued to shelter behind an accountability firewall’. The PCBS’ recommendations and the Banking Reform Act established the basis for the senior managers regime (SMR).

The fundamental principle is that senior individuals at banks, building societies, credit unions and Prudential Regulation Authority (PRA) designated investment firms will be expected to take greater responsibility for their actions and regulators will hold individuals to account. The most headline-grabbing features of the new regime are the potential consequences for those senior managers captured. They will be subject to:

  • A reverse burden of proof (the ‘presumption of responsibility’) whereby senior managers will be deemed personally culpable if a firm breaches a regulatory requirement for which they were responsible, unless they can demonstrate they have taken reasonable steps.
  • A criminal offence, punishable by up to seven years in prison and/or an unlimited fine, where senior managers make a decision causing a firm to fail.  

The PRA and Financial Conduct Authority (FCA) have released consultations on the new regime ahead of the commencement date of 7 March 2016. Although some elements are still under discussion, including the application to non-executive directors (NEDs), many of the rules are now in final or near-final form.

The insurance industry is also subject to similar changes. The senior insurance managers regime (SIMR) comes into force from 1 January 2016. SIMR implements the Solvency II Directive measures relating to governance and the fitness and propriety of senior individuals. Although insurers will not be subject to the presumption of responsibility or the new criminal offence, there is an equal emphasis on the importance of clear individual accountabilities.

There are numerous practical implications of the new regimes that boards and company secretaries must consider and steps that firms should be taking now to manage the transition.

Senior managers regime

SMR will replace the existing approved persons regime in banking firms by focusing accountability on a narrower group of senior decision makers, such as the chief executive, heads of control functions (finance, risk, compliance and internal audit) and heads of key business areas. All senior management functions (SMFs) will require pre-approval by the regulators before appointment.  

Controversially, only some NED roles will be caught by the SMR – these include the chair, senior independent director and the chairs of the audit, risk, remuneration and nomination committees. Under the original proposals all NEDs would have been captured under the new regime, however, significant levels of industry feedback triggered reconsideration by regulators. The revised approach is still undergoing consultation and now focuses only on specific NED roles. It remains to be seen if this approach will deter NEDs from taking up posts chairing committees, given the need for pre-approval and greater personal liability, when other NEDs may not face similar consequences if things go wrong. Other key features of the SMR are:

  • A statement of responsibilities – applications to the regulators for approval of SMFs must include a statement setting out the aspects which the person concerned will be responsible for managing. This statement must be updated and resubmitted whenever there is a significant change in the responsibilities associated with the SMF.
  • Prescribed responsibilities – the PRA has defined specific responsibilities to be allocated to the most relevant SMF.
  • Responsibilities maps – firms will be required to produce and maintain a comprehensive map, which describes the firm’s management and governance arrangements, including reporting lines and how responsibilities have been allocated.  
  • The introduction of a group entity senior manager role to cover individuals who operate at holding or parent company level and exercise a significant influence over UK operations, regardless of whether they are based in the UK.  
  • A new set of conduct rules replacing existing principles and applying to a wider range of individuals than under the current statements of principles and code of practice for approved persons (APER).
  • A requirement to notify the regulators when firms are aware or suspect that a person has breached the conduct rules.

Alongside the SMR, a new certification regime will be introduced. This will require firms to certify individuals, whose roles are deemed to pose a risk of significant harm, as fit and proper to carry out their roles. Certification would take place at appointment stage and on an annual basis thereafter. Formerly these individuals would have been approved by the regulator. Now, the onus is on banks to make a full determination of fitness and propriety.

Senior insurance managers regime

Like the SMR, the SIMR aims to enhance governance in insurance and reinsurance firms through reinforcement of individual accountability, fitness and propriety requirements and conduct standards. Key features of the SIMR are:

  • A more focused group of senior insurance management functions (SIMFs), including the chief executive, chief financial officer and chief risk officer, will be subject to PRA pre-approval for appointments.
  • A new category of ‘key function holders’ is introduced. These are senior persons who have responsibility for key functions (such as compliance, actuarial, risk management and internal audit). Where these individuals do not also exercise SIMFs, insurers will be responsible for assessing the fitness and propriety of key function holders and notifying the regulators. The regulators will supervise these assessments on an ex-post basis.
  • As with the SMR, a new group entity senior insurance management function will be introduced to capture individuals outside the entity who exercise significant influence.
  • Insurers must keep and update (at least quarterly) a governance map, which is a comprehensive document detailing the firm’s governance arrangements and the assignment of responsibilities and key functions within the firm.
  • New conduct standards replacing APER will apply to controlled functions, key function holders and individuals performing a key function.

Practical implications

One challenge that firms are grappling with is how best to change governance documentation, which has been largely static in the past, into more of a living description of the firm’s governance and allocation of responsibilities. Historically, governance manuals and role profiles may not have been updated for long periods, but the new responsibility and governance maps must be refreshed more frequently. The need to document matrix reporting arrangements and interaction with group governance is proving challenging for larger firms, particularly those which have never attempted to express the complexity of their group and entity governance structures in the past.

Under current proposals, an individual NED will be assigned responsibility for development and oversight of implementing induction, training and professional development of all board members. This has triggered appetite for a re-examination and refresh of these practices. The changes to the fit and proper requirements are also causing nomination committees to examine how their responsibilities to monitor board skills and competencies dovetail with the new requirements.   

These changes are causing some firms to consider the need for increased company secretariat resources, and in some cases, the development of a more formal ‘office of the chair’ role.

Though the potential criminal liability is certainly a key feature of the SMR, the threshold for the offence of ‘reckless misconduct’ is so high that it may be difficult to conceive of many directors falling foul of it. It is likely that the presumption of responsibility for SMFs will be a greater concern to directors of banking firms. The new rules are already triggering consideration by SMFs on how they will be able to evidence that they have taken reasonable steps to ensure compliance with regulations.

The FCA has provided guidance on what may constitute a conduct rule breach, for example, implementing confusing or uncertain reporting lines, authorisation levels, job descriptions or responsibilities. Board members and senior executives are examining whether these arrangements are clear and robust in their areas of responsibility. In some cases, senior executives are accelerating planned improvements to management information to ensure that they are able to exercise appropriate oversight.

Timeline

For banking firms, the SMR and Certification Regime will apply from 7 March 2016. Should firms wish to take advantage of grandfathering provisions, regulatory notifications will need to be submitted by 8 February 2016. Insurers subject to the SIMR should note that Solvency II must be implemented by 1 January 2016.

The PRA and FCA will continue to issue further guidance and final rules over the course of 2015, including confirmation of the application of SMR to bank branches and the final requirements for NEDs of banking and insurance firms.

Managing the transition

Together with the compliance and HR functions, the company secretary is at the heart of managing the transition to SMR or SIMR. These functions may wish to consider three key phases to the transition:

Identification

  • Completing a gap analysis against the detailed requirements.
  • Identifying who in the organisation is captured by the new regimes.
  • Allocating responsibilities under both regimes and recording statements of responsibilities for SMR firms.
  • Compiling and drafting a responsibilities map or governance map.


Embedding

  • Allocating responsibility for ownership and updating of the responsibilities map or governance map.
  • Adapting compliance and HR processes to enable certification of the fitness and propriety of individuals captured under both regimes.
  • Implementing changes to governance and management processes to ensure that accountable individuals have the necessary infrastructure to discharge their duties.


Training and reporting

  • Rolling out new conduct training to employees.
  • Establishing procedures for escalation of potential conduct breaches and identifying and reporting actual breaches to the regulators.


A recent cost-benefit analysis of the SMR, commissioned by the FCA and carried out by Europe Economics, estimates one-off transitional costs into millions of pounds at large banks. The transition will clearly be a significant project for all firms affected.

The new regimes mark a major shift in the governance requirements of financial services firms. It remains to be seen what impact the changes will have on attracting quality board members, and whether the changes, particularly in the banking sector, may deter NEDs from taking chair positions to avoid additional responsibility and liability. What is clear is that the two regimes will have an on-going impact on company secretaries and compliance professionals in financial services.

Further information on the new regimes and governance developments can be found on the Deloitte UK website under the audit pages.

Natasha de Soysa is Director of Financial Services Governance Group and Gurdeep Rai is a Senior Manager of Financial Services Governance Group at Deloitte.

Have your say

comments powered by Disqus

Advertisements


ICSA: The Governance Institute
Saffron House, 6-10 Kirby Street, London EC1N 8TS, United Kingdom