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No place to hide – The FCA’s new approach to Non-Executive Directors

19/03/2015

 

The recent recession hit the UK’s financial services industry (the “Industry”) particularly hard. Financial institutions were seen as the cause of the crash, the now defunct regulator (the FSA) was seen as ineffectual and the Government was accused of being slow to respond. New scandals continue to emerge, seemingly on a daily basis, involving systemic abuse within the Industry, whether it be, the mis-selling of PPI, the manipulation of the LIBOR or the recent rigging of foreign exchange markets.[1]

It must be said, institutions have paid a heavy price for these scandals both in terms of their balance sheets and their reputations.[2] However, a pervasive perception has emerged, that individuals in charge of these institutions, did not and continue to not, face the same level of scrutiny and ultimately, regulatory action.[3] Set against this back drop is a regulator prompted to flex its muscles in order to prevent further malpractice in the Industry.[4]

One area the FCA and the PRA have identified as needing tighter controls is that of corporate governance. More specifically, the role of the Non-Executive Director (“NED”) has come under the FCA and PRA’s microscope.

Following a lengthy consultation with stakeholders within the Industry, the FCA and PRA have implemented a new approach to NEDs.[5] Under the new approach NEDs who have been appointed to particular roles such as Chairman or Senior Independent Director within UK banks, building societies, credit unions and other financial institutions (“Applicable Firms”) will fall within the FCA’s ‘Senior Managers Regime (“SMR”). The FCA and PRA believe that broadening the application of the SMR to cover NEDs will ensure more effective regulation because at its heart will be individual accountability.[6]

What are NEDs? 

The FCA defines NEDs as a director who has no responsibility for implementing the decisions or policies of the governing body of a firm.[7] Although the FCA’s definition recognises the limited scope NEDs have in the decision making of Applicable Firms, their role in scrutinising the performance of management is a key aspect of the UK Corporate Governance Code.[8] By including NEDs in the SMR it is hoped individuals will “behave appropriately and accept greater responsibility for their actions”.[9]

The Senior Managers Regime 

The Financial Services (Banking Reform) Act 2013 (the “Act”) significantly altered the regime surrounding management of Applicable Firms. The Act replaced the concept of a ‘Significant Influence Function’ found in the Financial Services and Markets Act 2000 (“FSMA”) with the concept of a Senior Management Function (SMF) covering: a function that will require the person performing it to be responsible for managing one or more aspects of the relevant firm’s affairs, as far as relating to regulated activities, and those aspects involve, or might involve, a risk of serious consequences for the authorised person, or for the business or other interests in the UK.[10]

The Act also granted the FCA the power to specify a function as requiring regulatory approval under the new SMR if they were satisfied that function fell within the statutory definition of a SMF as provided for above. All individuals holding a SMF require approval from the relevant regulator.

The FCA and PRA differ in the scope of their SMFs. The PRA’s designated SMFs cover considerably more roles than the FCA’s. The PRA has included NEDs appointed as Chairman, Chair of the Risk, Audit and Remuneration Committee and Senior Independent Directors within their SMR[11]. On the other hand, the FCA’s SMR only includes NEDs appointed as NEDs or Chair of the Nominations Committee.[12] Examples of key SMFs identified by the FCA include safeguarding and administration of client assets, incentive schemes for Applicable Firm’s staff and establishing and operating systems and controls in relation to financial crime.[13] What is clear from the list of functions identified by the FCA and PRA, is the intention that all key decision making functions should be held by individuals subject to their jurisdiction.

The practical effect of the SMR 

The SMR is likely to lead to further compliance costs for Applicable Firms both in terms of pecuniary cost and lost management time.

Under the SMR, all senior managers will be required to have a statement of responsibility and this statement must be kept up to date. A statement of responsibility is a statement by an Applicable Firm setting out the areas of the firm which the prospective individual will be responsible for managing.[14] These statements will be used by the relevant regulator in its initial assessment of an individual’s application for regulatory approval, during its supervision of Applicable Firms and during any enforcement action taken.[15]

Management maps will also need to be submitted to the relevant regulator setting out in detail, the Applicable Firm’s governance arrangements, individuals involved in the firm’s governance and those individual’s responsibilities. The FCA and PRA hope that these maps will provide the entire approval picture of an Applicable Firm and will ensure that all areas requiring accountability have been allocated effectively.

The SMR, as a result of the Act also reverses the burden of proof upon senior managers. Under the SMR it will be for senior managers to prove they took ‘reasonable steps’ to prevent, stop or remedy regulatory breaches by the firm which took place in their areas of responsibility.[16] Therefore it will be for the senior manager to prove they took ‘reasonable steps’ instead of the FCA and PRA having to prove that they did not. It is not yet known what reasonable steps will be. The FCA and PRA have said that such steps will be considered on a case-by-case basis.[17] Nonetheless, this is a significant departure from the previous regime whereby the burden was on the relevant regulator.

Conclusion 

In line with the FCA’s three objectives of protecting consumers, upholding market integrity and promoting effective competition one can see why the FCA and PRA have focused so heavily on senior management. By ensuring that both directors and NEDs fall within the SMR, the FCA and PRA hope to prevent a repeat of what happened during the financial crash and subsequent Industry scandals. It remains to be seen how effective the new approach will be.

This bulletin should not be taken as definitive legal advice on any of the subjects covered. If you require legal advice on any of the subjects covered or on any other regulatory matters, please contact Peter Price on 0207 955 1435 or peterp@rosenblatt-law.co.uk

Footnotes 

  1. The FCA and PRA’s Consultation Paper published in July 2014 “Strengthening accountability in banking: a new regulatory framework for individuals” pages 5, 8, 12, 14, 20 and 52.
  2. The FCA’s press release “FCA sets out approach to Non-Executive Directors and the Senior Managers Regime”, published on the FCA website on 23/02/2015.
  3. The Glossary of the Financial Conduct Authority’s Handbook.
  4. The UK Corporate Governance Code as published by the Financial Reporting Council in September 2014 found here: https://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/UK-Corporate-Governance-Code-2014.pdf.
  5. “UK financial regulation overhaul”, the overhaul of the UK’s financial services regulatory regime as expressed on the BBC News website on 1 April 2013 found here: http://www.bbc.co.uk/news/business-21987829.
  6. “Why have so few bankers gone to jail”? An article by The Economist published on 13 May 2013, found here: http://www.economist.com/blogs/economist-explains/2013/05/economist-explains-why-few-bankers-gone-to-jail.
  7. “Citigroup, JPMorgan Pay Most in $4.3 Billion FX Rig Cases”. An article published by the Bloomberg Business website and written by Suzi Ring and Liam Vaughan on 12 November 2014 found here: http://www.bloomberg.com/news/articles/2014-11-12/banks-to-pay-3-3-billion-in-fx-manipulation-probe.
[1] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 5)

[2] http://www.bloomberg.com/news/articles/2014-11-12/banks-to-pay-3-3-billion-in-fx-manipulation-probe

[3] http://www.economist.com/blogs/economist-explains/2013/05/economist-explains-why-few-bankers-gone-to-jail

[4] http://www.bbc.co.uk/news/business-21987829

[5] http://www.fca.org.uk/news/fca-sets-out-approach-to-neds-and-the-smr

[6] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 5)

[7] http://fshandbook.info/FS/glossary-html/handbook/Glossary/N?definition=G762 (Glossary of FCA Handbook)

[8] http://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/UK-Corporate-Governance-Code-2014.pdf

[9] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 8)

[10] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 12)

[11] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 14)

[12] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 20)

[13] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 22)

[14] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 8)

[15] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 56)

[16] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 52)

[17] http://www.fca.org.uk/static/documents/consultation-papers/cp14-13.pdf (page 52)

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