Something Borrowed, Something New: The FCA's Plan for Extending the SMCR

• United Kingdom

• Financial services and markets regulation
• HR Consultancy
• Financial services - Senior Managers and Certification Regime

27-07-2017

The FCA has issued its long awaited consultation on extension of the Senior Managers and Certification Regime (also known as “Accountability II”). Consultation Paper (CP17/25), which sets out the “what” and the “why” of the Regime borrows from the PRA regime for banks and other PRA firms. These include the core legislative requirements: the Senior Managers Regime, Certification Regime and Conduct Rules. Many of the proposals will, therefore, be familiar.

The Regime, however, introduces some new concepts, most notably a three tiered approach to compliance depending on the size, scale and complexity of a firm. The FCA will consult further on “how” it proposes to implement the Regime, including its plans for the transition of existing “approved persons” into the Regime.

The FCA is also consulting on extension of the regime for insurers (CP17/26), as the Senior Insurance Managers Regime will morph into the Senior Managers and Certification Regime and achieve more of a level playing field in how the certified regime and conduct rules will be applied to insurance companies in addition to the requirements on senior managers.

The FCA has asked for comments by 3 November 2018. The Regime is expected to come into effect in late 2018.

Our briefing sets out an initial overview, likely impact and our initial 10 “Take-aways.”

What does the extended regime look like?

The key aims of Accountability II are the same as those that have applied to the Banks and other PRA firms under the current Senior Managers and Certification Regime (“SMCR”):

• To reduce harm to consumers
• To raise the standards of conduct for everyone who works in financial services

These aims form a backdrop to a key priority of the regulator being the improvement of culture and governance as articulated in the FCA’s Business Plan for the past two years.

It is clear that the FCA wants staff to take personal responsibility for their actions and achieve an overall improvement in conduct. It is also clear that firms and staff need to understand and can evidence who does what within the firm. It is apparent that the implementation of the conduct rules to almost all employees in financial services firms is a key driver for meeting the regime’s aims.

In the run up to the consultation release there has been significant media reference to proportionality and tailoring of the regime to fit the diversity of firms who will be impacted. The comments below reflect the proportionate approach that that the FCA is looking to adopt. In planning to implement the regime, The FCA has made it clear that there is no requirement for firms to change their governance and organisational structures or to hire new people to fill specific functions unless the firm considers that changes would be beneficial.

The Impact Analysis

In looking at how the regime has now been adapted for the majority of regulated firms, we have the following initial comments;

1. The Core Regime

A basic legislative requirements will apply to approximately 14,000 firms – known as the ‘Core Regime’. These are the:

• Senior Managers Regime
• Certification Regime
• Conduct Rules

Senior Managers Regime

This will apply to the most senior managers within a firm. The senior managers will need to be approved by the FCA before they start their role (as is currently the case under the Approved Persons regime) and firms will need to make sure their managers are suitably competent to do their roles including obtaining references and do background checks such as criminal records. A cornerstone to the Senior Managers Regime is the requirement to have a ‘Statement of Responsibilities’ (“SoR”) which is a concise and clear record around a particular individual role be provided to the FCA and updated when there are major changes. As is the case with the existing regime, senior managers will also have a ‘Duty of Responsibility’ - which means that if something goes wrong in an area the manager is responsible for, the FCA will consider whether the manager took reasonable steps to stop this happening.

The FCA is proposing the following Senior Management Functions for all core firms.

Governing Functions

• SMF9 – Chair
• SMF1 – Chief Executive
• SMF3 – Executive Director
• SMF27 – Partner (recognising the variety of differing corporate structures that exist particularly in the asset management and insurance broking sectors)

Required Functions

• SMF16 – Compliance Oversight
• SMF17 – Money Laundering Reporting Officer

Certification Regime

The certification regime will apply to staff who are not Senior Managers but whose roles mean they can be deemed material risk takers or have “significant harm” on customers, the markets or the firm itself. These staff will be certified by the firm who will need to deem the individual fit and proper on an annual basis.

The certification regime will apply to staff who have the following functions:

• Significant Management Function (typically individuals who have held CF29 functions)
• Proprietary traders
• CASS oversight function
• Functions that are subject to qualification requirements (CF30s and mortgage advisers)
• Client-dealing function
• Algorithmic traders
• Material risk takers
• Anyone who supervises or manages anyone performing one of these functions.

Conduct Rules

These five rules will apply to almost everyone who works in financial services. They include ‘integrity’, “being open with the regulator” and ‘treating customers fairly’. There are a further four Senior Manager Conduct Rules, covering areas such as delegation and effective control.

2. The Enhanced Regime

The FCA recognises that there are a number of significant, larger firms (accounting for fewer than 1% of regulated firms) which will come within the Enhanced Regime and have additional responsibilities very much akin to the existing regime for banks and building societies. These firms will require responsibilities maps, handover procedures and will need to make sure there is a senior manager responsible for every area of their firm including operations, HR and IT.

The types of the firms caught will include:

• Firms that are significant IFPRU firms
• Large CASS firms
• Firms with assets under management of £50billion
• Firms with a total intermediary regulated business revenue of £35million or more per annum
• Firms with annual regulated revenue generated by consumer credit lending of £100 million or more per annum
• Mortgage lenders (that are not banks) with 10,000 or more regulated mortgages outstanding

3. Limited Scope Firms

As is currently the case, there will be a reduced set of requirements for Limited Scope Firms where financial services activity is secondary to the main activity, such as retail firms, motor dealers etc amounting to around 33,000 firms. These firms will need just the one senior manager, as exists today.

Ten initial take-aways

1. The consistent principles applied across financial services versus a proportionate and flexible regime to accommodate the different business models and governance structures of firms is sensible and not unexpected.
2. The point that the FCA has no choice over certain aspects of the regime and that the Senior Managers Regime, Certification Regime and Conduct Rules will apply to every firm is well made: FSMA prescribes these.
3. The three tiered approach to SMCR needs to be understood in light of both points above.
4. A separate set of requirements for UK branches of overseas firms will be relevant both to current non-EU27 third country firms and current inward passporting EEA-firms in the event of a “Hard Brexit”: current requirements for EEA branches, as is the case with banks, are lighter than those for third country firms.
5. Highlighting the role of SMF in outsourcing “amongst SMF managers” is noteworthy.
6. Clarification on extent of SMF 27 Partner function application is welcome: this links approval with actual governance and is helpful in the context of LLP structures for managers, insurance brokers, advisory firms and other types of firm in limiting number of persons who require approval (an improvement from the Approved Persons regime).
7. Clarity on the interaction of CASS oversight certification function and SMF compliance with CASS prescribed responsibility is welcome but may be an area for debate within firms: The FCA statement indicates that it does not have to be the case that SMF with compliance oversight should also have to discharge this responsibility.
8. The extension without change of FIT to SMF and Certified Staff is noteworthy as is regulatory reference requirement, although this already driven by FEMR.
9. Recommendations on rules for moving between core and enhanced regimes, including transitioning rules, and six month period for compliance likely to draw interest to the extent any firm is on or near the “cusp” of triggering the enhanced regime.
10. Reiteration of the “12-week rule” for unforeseen circumstances currently operating under the Approved Person Regime is helpful.

What to do next?

We are aware that many firms are already setting up project teams and steering committees (depending on size and complexity) and commencing their communication strategies. The extended consultation period for the CPs to 3rd November is useful given current holiday challenges and we know the regulators are very keen to get feedback and market intelligence as they further shape the regime. It will be important for firms to keep momentum given competing demands on resource due to other regulatory changes around GDPR, MIFID II and the IDD as well as PSD II and the 4th Money Laundering Directive.

Given our experience of working with firms and their regime implementation first time around, we will be hosting a number of webinars and events over the coming months to provide insight on the areas that will be of most interest to firms.

SIMR

The PRA and FCA intend to align the individual accountability regime for insurers as closely as possible with that for banking. To this end the proposals include:

• extending the SMCR to Solvency II insurers (UK Solvency II firms, Society of Lloyds and Lloyds managing agents and third country (re)insurance branches), insurance special purpose vehicles (ISPVs) and large non-directive firms (NDFs). Currently the senior insurance managers regime (SIMR) applies to these firms
• extending (with modifications) the SMCR regime to small NDFs to whom the SIMR does not currently apply
• aligning the scope of the certification regime as closely as possible with the population identified for the purpose of applying the firm's remuneration policy (including members of the governing body, employees with key functions and staff whose professional activities have a material impact on the firm's risk profile)

Whilst the Senior Managers Regime will apply to all insurers some features will not apply to small NDFs and ISPVs. For example, not all insurers will be subject to the same list of senior management functions.

It is expected that the biggest challenge for insurers will be the proposed certification regime. As a consequence of the extended SMCR, some of the PRA conduct rules that currently apply to those performing key functions will be extended to employees holding a certification function. The FCA conduct rules will apply to senior managers, anyone covered by the certification regime and all other employees other than ancillary staff. Firms will need to take all reasonable steps to ensure that staff covered by the conduct rules understand how those rules apply to them, including through the provision of suitable training.

The statutory duty of responsibility will apply to senior managers and directors at insurers and the regulators will set out their expectations on this.

A new rule will be added requiring Solvency II insurers and large NDFs to take reasonable steps to ensure a senior manager is provided with handover information and materials.

The regulators will make rules for the notification to them of conduct rule breaches by senior managers or those to whom the conduct rules apply.

In CP17/26 the FCA explains that it proposes to extend the full set of regulatory reference rules to all insurance firms. The PRA proposes to mirror these proposals and to extend all regulatory reference rules to small NDFs.

The SIMR will be amended to extend the SMCR to insurers and there will be a new Insurance - Certification Part to the Solvency II section of the PRA Rulebook.

The new regime will be renamed the SMCR rather than the SIMR and there will be an additional consultation about terminology to align the regime more closely with that for the banking sector.

The consultation papers can be read here.

How can Eversheds Sutherland help?

We have already been undertaking workshops for individual firms and with our combined legal and consulting teams of regulatory lawyers and compliance professionals we are able to support you in many ways from project management, subject matter expertise, technical queries to assurance reviews.