Water cooler and triangular chairs

HMT extends and radically changes the Senior Managers and Certification Regime

19 October 2015

The Senior Managers and Certification Regime (SM&CR) along with the Senior Insurance Managers Regime (SIMR) were designed to radically alter the playing field for personal responsibility within banks and insurers.

Whilst firms have been working to prepare for the regimes, HM Treasury has been concocting a plan to shift the goal posts.

On 14 October the first reading of the Bank of England and Financial Services Bill took place in the House of Lords. The second reading will take place on 26 October. In a policy paper published on 15 October the government has set out some of the rationale for the various significant changes that will be brought about by the Bill. The government envisages bringing these changes into force in 2018.

Extension of the SM&CR

The government has decided, to extend the SM&CR to all sectors of the financial services sector. The SM&CR will now cover insurers, investment firms, asset managers, insurance and mortgage brokers and consumer credit firms. This extension of the SM&CR to all authorised firms that had previously not been covered by the new regime means that the previously retained parts of the "discredited" Approved Persons Regime (APR) will be removed.

Whilst HMT acknowledged that SIMR and the changes to the APR applying to insurers made by the FCA "already incorporate some of the substantive ideas and principles underpinning the SM&CR" it is felt appropriate to extend the application of the SM&CR to insurers to ensure the consistent and comprehensive application of this regime across all of financial services.

The principle of proportionality

In the policy paper it is acknowledged that a one-size-fits-all approach would not be appropriate when applying the SM&CR across financial services. Therefore the government has made clear that the principle of proportionality will be important as the SM&CR is extended to the broader range of firms operating in the financial services sector. It is intended that the regulators should ensure that the extended regime appropriately reflects the diverse business models operating in the UK market and is proportionate to the size and complexity of firms.

The reversal of the burden of proof

Whilst all of those outside of banking will probably be considering with dismay the extension of the SM&CR to their sectors, senior managers within banks will no doubt be relieved to see that the government has decided to ditch the reversal of the burden of proof (also referred to as the presumption of responsibility). The reversal of the burden of proof in disciplinary proceedings would have meant that senior managers would have had to demonstrate that they were not responsible for regulatory failures in areas for which they had been ascribed personal responsibility. Instead the government has decided to introduce a statutory duty on senior managers to take reasonable steps to prevent regulatory breaches in their areas of responsibility. This will apply across all authorised financial services firms.

The policy paper explains that "in the event of such misconduct, the senior managers can be guilty of misconduct if they failed to take such steps [to take reasonable steps to prevent regulatory breaches]. The burden of proving this misconduct will fall on the regulators, as with other regulatory enforcement actions."

In a press release responding to this aspect of the government's announcement Tracey McDermott said "While the presumption of responsibility could have been helpful, it was never a panacea. There has been significant industry focus on this one, small element of the reforms, which risked distracting senior management within firms from implementing both the letter and spirit of the regime." The regulator's disappointment at the ditching of this key change is quite palpable in the tone of this announcement.

Application of the Conduct Rules to non-executive directors (NEDs)

In another significant change the Bill provides for the PRA and FCA to be able to make Rules of Conduct applying to NEDs. This change was introduced because it was felt that an unjustifiable lacuna had developed in the rules. During the implementation work on the SM&CR the regulators had decided that it would only be appropriate for certain NEDs with specific responsibilities, such as chairmen and the chairs of key board committees, to be senior managers. As a result, of the change, the regulators would not have had the ability to take enforcement action for misconduct against NEDs. In explaining the decision to close this regulatory gap, the government said that "it is difficult to justify a position where enforcement action can be taken against relatively junior staff but not against board members."

Removal of the obligation to report breaches of the conduct rules

In another change that will be welcomed by those firms that were already preparing for the SM&CR, the government has decided to remove the requirement to report to the regulators all known or suspected breaches of conduct rules by any employees subject to the rules. The government noted that the original requirement for forms to notify the regulators of all breaches presented a "potentially very costly obligation for firms, especially the larger firms which employ large numbers of staff, as they have to put in place detailed systems and controls to ensure compliance." In the policy paper it is noted that the proposed change to this rule will allow "the regulators [to] ensure that they are notified of any information about employee misconduct in a more proportionate way in their rules."

The key features of the extended SM&CR

In the policy paper HMT has suggested that key features of the extended SM&CR will be:

  • an approval regime focused on senior management, with requirements on firms to submit documentation on the scope of these individuals' responsibilities
  • a statutory requirement for senior managers to take reasonable steps to prevent regulatory breaches in their areas of responsibility
  • a requirement on firms to certify as fit and proper any individual who performs a function that could cause significant harm to the firm or its customers, both on recruitment and annually thereafter
  • a power for the regulators to apply enforceable Rules of Conduct to any individual who can impact their respective statutory objectives

This high level summary of the core elements of the extended SM&CR reflects the sparse nature of the Bill. The devil, as with all regulation, will be in the detailed guidance to be produced by the regulators in due course.

The costs of compliance

The government has suggested that the costs of preparing for this change will not be excessive because:

  • there will be a substantial reduction in the number of appointments that are subject to prior regulatory approval, (though it is accepted that each of these applications may be slightly more costly because of the need to prepare documentation such as the 'statements of responsibility');
  • there will be some costs for firms in complying with certification requirements but these are not expected to be large since firms will already have systems in place for monitoring and recording information about employees' performance and suitability to meet their own HR needs; and
  • though there will be additional costs from putting in place systems to ensure employees are notified about, and receive suitable training in, the Rules of Conduct, these costs will not be significant.

However firms that have been readying themselves for 7 March 2016 (when the new regimes come into force for banks and insurers), will be able to attest to the significant costs associated with preparing for the new regimes.

Whilst banks and insurers might mention the potential costs of preparing for the regime, they will no doubt also highlight the importance of being well prepared for this change. For the many firms who will now come within the SM&CR early consideration of the implication of these changes is vital (even if the government may yet further shift the goal posts).