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Expert comment on FCA proposals to extend SM&CR

Expert comment on today’s announcement by the Financial Conduct Authority (FCA), outlining its proposals to extend the Senior Managers and Certification Regime to all financial services firms

Gavin Stewart, regulatory specialist at Grant Thornton UK LLP, said: “Today’s publication by the FCA of its long-awaited consultation paper on the extension of the Senior Managers & Certification Regime (SM&CR) bravely attempts to square the circle between proportionality and the universal implementation of the underlying concept. Inevitably, in the end it falls short, but the real questions are whether parliament should have required it to try and what will be the consequences for the industry.

To satisfy the demands of proportionality, the FCA is introducing an enhanced regime, applying to less than 1% of firms, and a core regime for the remaining 99%. Crucially, however, in an attempt to meet the requirements of consistency, the central elements of the existing regime are applied to all. Only time will tell if this is an elegant solution or an unworkable mismatch.

There are three important but less obvious aspects to note:

  • As we expected, there is a much more explicit emphasis on firms’ culture in an attempt to create a “culture of accountability”. This partly reflects the fact that this is solely an FCA paper – the original banking regime was more PRA-driven – but also regulators’ evolving experience of how the banks’ regime works in practice
  • The extension of the Certification Regime (as required by the legislation) and regulatory references to all firms will have a profound effect on firms’ HR functions and, unless a clever solution is found, will greatly expand the level of administration around annual assessments
  • The “enhanced” regime, which will apply only to the largest solo-regulated firms, has fewer requirements than the existing banking regime, which of course applies to the very small as well as the largest deposit-takers. Also, firms with only ‘limited scope’ permission will have fewer requirements, so in effect there will be four tiers of SM&CR

Impact on business model and culture

The over-riding challenge for firms will be to understand how the new proposals will affect their underlying business model and culture. On the face of it, SM&CR is all about accountability maps and statements of responsibility for Senior Manager Functions (SMFs). Underneath, however, it will affect who is involved (or wants to be) in certain decisions, and whose responsibility it will be to sort out problems in specific areas. And if your accountability map does not give a true reflection of how your business operates in practice, you will almost certainly tie yourself in knots.

The good news, if you are not an enhanced firm, is that you can’t make too many individuals into SMFs. The bad news is, for those firms, some of whom will be quite large and risky, the few SMFs there are will have a lot of accountability on their shoulders.

It is also quite international investor friendly, by taking all non-UK staff out of the certification regime unless they are UK customer facing. The challenge of setting up shop in the UK is not going to get more burdensome as a result of this consultation.

How we got here

Before looking at the FCA’s proposals in more detail, we should briefly recap how we got here. SM&CR originated from the Parliamentary Commission on Banking Standards, chaired by Andrew Tyrie, which reported in June 2013. Set up largely in response to the political and public fury that no one was individually held accountable for the financial crisis, it is worth reminding ourselves of some of its rhetoric.

‘Too many bankers,’ it said, “especially at the most senior levels, have operated in an environment with insufficient personal responsibility. Top bankers dodged accountability for failings on their watch by claiming ignorance or hiding behind collective decision-making.”

Whether we agree or not with the sentiments, their target (senior bankers) is quite specific, and the purpose (to hold individuals accountable) is equally clear. However, four years on, SM&CR already exists for all deposit takers (not just banks) and insurance companies, and this consultation will extend it to cover a further c.47,000 financial firms.

A cocktail of factors - some of them regulatory, more of them political – has contributed to this massive expansion of scope, and firms and regulators should both be wary of the unintended consequences. What is obvious is that SM&CR is likely to change the nature of their relationships, particular for those firms caught by the enhanced regime.

By starting with the totality of an enhanced regime firm’s activities - as opposed to the old Approved Persons Regime which started by identifying key roles - SM&CR throws a comprehensive net over each firm’s business model. It then expects the firm to be able to articulate how it operates through the innately artificial medium of a single Responsibilities’ Map. This will create a range of different relationships and incentives, and these firms will need to pay close attention to how these develop over time.

Summary and analysis of the FCA’s proposals

Core elements are consistent across all firms

  • Senior Managers Regime: This remains the central feature of the regime, and each SMF will need to have a Statement of Responsibilities, and a Duty of Responsibility to take “reasonable steps” to prevent things going wrong. There are also some new “Prescribed Responsibilities”. How firms divide up and define these roles will have a profound effect on their culture
  • Certification Regime: This will apply to roles, beyond Senior Managers, that can have “a big impact on customers markets or the firm” (e.g. CASS Oversight, Client dealing functions and Material risk takers) and is required by the legislation. Interestingly, and probably unhelpfully, these are referred to as “significant harm functions”. Certification will extend the direct reach of regulation to individuals whose previous relationship with the FCA has been only through the Handbook or, in some cases, non-existent
  • Conduct Rules: There are five of these. On one level they are quite basic (eg acting with integrity and treating customers fairly), and of the type firms would naturally expect of their staff. The unknown element is that they effectively apply the FCA’s Principles of Business, until now focused on firms and controlled functions only, to everyone working in financial services (the only exception being ancillary staff)

Elements that are proportionately applied depending on size/complexity

  • Senior Manager Roles: The example given is of a Dentist with limited permission to offer credit (1 SMF) compared to a large Asset Manager (up to 17 SMFs). Some of this is the natural effect of scale but the FCA has also explicitly allowed certain SM roles to be combined
  • Enhanced” regime: Firms in this group – those qualifying include ‘significant investment’ (IFPRU) and CASS ‘Large’ firms (as defined in the Handbook), and those with regulated consumer lending above £100mn per year – will have some additional requirements such as a single Responsibilities Map for the firm and handover procedures for each SMF
  • Overall Responsibility: This is the pivotal requirement for every area, activity and management function of a firm to have a Senior Manager responsible for it. Under the proposals, this will only apply to the Enhanced Regime, and depending on how the FCA uses it in practice, may have a pivotal role in how SM&CR plays out over time.

Looking forward

This consultation paper is the start of a long and detailed process that will alter the landscape of financial regulation in the UK. In many ways it is a child of the financial crisis, designed to prevent a repeat. The FCA has tried hard to avoid a “one size fits all” solution and has probably achieved as much as it could given the requirements of the legislation. However the burden on all but the largest firms is still likely to be significant.

The overall effect of SM&CR, especially now it is being extended to cover almost all regulated firms, is impossible to predict, except that it will inevitably contain several surprises. Firms will need to pay extra attention to its impact on both their regulatory relationships, which will change as a result, and on their own culture and operating model. A flexible approach and some new thinking will be required on all sides.”