In March this year, the UK implemented its Senior Managers Regime which aims to impose individual accountability for high-level executives in the banking sector. Dr Axel Palmer, Department of Law, The University of the West of England, takes a look at the objectives and the requirements of the new regime.
‘Trust goes to the heart of what banking is about,’ stated the UK’s Parliamentary Commission on Banking Standards’ 2013 report – Changing banking for good – noting that, in the aftermath of the 2008 financial crisis and the scandal of the manipulation of the London Interbank Offered Rate (LIBOR) in late June 2012, public trust and confidence in UK banks had sunk to new depths. The report concluded that the industry was not just revealed as incompetent, but appeared morally bankrupt.
‘Too many bankers, 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. They then faced little realistic prospect of financial penalties or more serious sanctions commensurate with the severity of the failures with which they were associated. Individual incentives have not been consistent with high collective standards, often the opposite,’ the report stated.
The Parliamentary Commission recognised that the public were angry that senior executives had managed to evade responsibility and their first proposal was making individual responsibility in banking a reality, especially at the most senior levels. In March 2016, this saw daylight as the Senior Managers Regime, introduced by the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA).
The driving force behind the new regulatory regime is cultural change. In a speech in July 2015, Martin Wheatley (a former CEO of both the Securities and Futures Commission in Hong Kong and the FCA in the UK) explained that ‘at their heart, organisations are simply collections of individuals arranged around a common goal. And the “culture” of these organisations, the rules both spoken and unspoken, are what dictate in reality the behaviours that are acceptable and those that aren’t’. He further explained that, since corporate actions stem from individual action, then accountability has to start with individuals, in particular recognising the ‘tone from the top’.
There are three limbs to the new accountability framework: the Senior Managers Regime, the Certification Regime and the Conduct Rules.
1. under the Senior Managers Regime, ‘senior managers’, who will be individually approved, are those individuals who hold key roles or have overall responsibility for a whole area of a bank, or systemic investment firm
2. under the Certification Regime, in a change from the previous regime, firms will be able to self-certify that people who have roles such as giving investment advice or administering benchmarks are fit and proper, with an annual confirmation
3. under the Conduct Rules, high-level standards of conduct will apply directly to everyone.
‘[The Conduct Rules] seek to make explicit the common sense standards that all staff should already be adhering to. Standards like acting with integrity and observing proper standards of market conduct. They will eventually apply to nearly all staff in banks and the largest investment firms,’ Wheatley stated.
To put the changed regime into perspective, the Parliamentary Commission found that in the financial crisis individual bank failures and the recent string of conduct failings were characterised by poor regulation in the UK and in many other countries. Similar issues were faced in the US where Judge Rakoff neatly encapsulated the issue at hand by asking why no high-level executives had been prosecuted. ‘The failure of the government to bring to justice those responsible for such colossal frauds bespeaks weaknesses in our prosecutorial system that need to be addressed,’ Rakoff suggested in his article – ‘The financial crisis: why have no high-level executives been prosecuted?’ – in the New York Review of Books.
In September 2015, announcing a new US policy on individual liability in matters of corporate wrongdoing, Deputy Attorney General Sally Quillian Yates, of the US Department of Justice, pointed out the difficulties involved in prosecuting highlevel executives. ‘In modern corporations, where responsibility is often diffuse, it can be extremely difficult to identify the single person or group of people who possessed the knowledge or criminal intent necessary to establish proof beyond a reasonable doubt. This is particularly true of high-level executives, who are often insulated from the day-to-day activity in which the misconduct occurs,’ she said.
The central plank of the Senior Manager Regime is identified as ‘responsibility’, which represents a change from the previous regime of culpability. In his speech in May this year, ‘Culture in financial services – a regulator’s perspective’, Andrew Bailey, CEO of the FCA, explained that ‘we do want senior managers to feel this responsibility in all that they do, and that includes a responsibility for forming and implementing a positive culture throughout the organisation’. The second element is culture and, in his speech, Bailey recognises that responsibility is an important hook to assist in firms’ shaping their own culture, although he also emphasises that it is not the job of regulators to enforce or to change culture.
The requirements of the new regime
Having established the objectives of the Senior Managers Regime, it is now appropriate to examine in detail the specific requirements. The regime has to be set in the context of firms having to assess their business structures, and allocate and record senior management responsibilities.
The FCA/PRA require firms to ensure that the allocation of responsibilities is clear and without gaps in their coverage and, to do so, they point to consideration of the concepts of ‘senior management functions’, ‘prescribed responsibilities’ and ‘overall responsibility’. The FCA has identified, in its Strengthening accountability in banking: final rules, a number of business activities and functions in order to help firms map management responsibilities.
Senior managers for a UK bank comprises the top layer of executive management and all directors other than an ordinary non-executive director (NED). Collectively, these are known as ‘senior management function’ (SMF) holders, they must be pre-approved by the regulators. A senior manager must prepare a statement of responsibilities setting our his/her duties. The bank must prepare a map of how it links together these responsibilities and describing its governance arrangements. A senior manager must take reasonable steps to prevent a regulatory breach occurring in order to avoid being found guilty of misconduct by the regulator. It should be noted that a senior manager is liable for the criminal offence of causing a bank to fail. A person guilty of an offence relating to a decision causing a financial institution to fail is liable to imprisonment for a term not exceeding seven years or a fine, or both.
Certified staff who are individuals below the level of a senior manager and who can cause significant harm to the bank or its customers (such as managers of significant business areas, dealers, customer advisers and their managers), will not be individually approved. Instead, the bank is responsible for ensuring and certifying their fitness and properness. All other staff will be subject to the same first tier conduct rules as certified staff.
The SMF requires the person responsible for performing it to be responsible for managing (meaning taking or participating in taking decisions, so this catches board and committee membership), one or more aspects of the firm’s affairs in relation to it carrying on a regulated activity which do or might involve a risk of serious consequences for the firm or other UK interests.
SMF persons, of which there are 17 categories, are prescribed by both PRA and FCA. PRA controlled functions are: chief executive (role SMF1), chief finance function (SMF 2), chairman function (SMF9). FCA controlled functions are: executive director function (SMF 3), chair of nominations committee (SMF 13), compliance oversight function (SMF16), and money laundering reporting officer (SMF 17).
Furthermore, there are 30 prescribed functions. There are prescribed responsibilities which apply to all firms, such as the responsibility for the firm’s performance of its obligations under the Senior Managers Regime; some to larger firms, such as the responsibility for overseeing the adoption of the firm’s culture in the day-to-day management of the firm; those which apply to smaller firms, such as the responsibility for ensuring the governing body is informed of its legal and regulatory obligations; and, those applying in special circumstances, such as if the firm carries out proprietary trading, responsibility for the firm’s proprietary trading activities.
The FCA’s Strengthening accountability in banking: final rules allows firms some flexibility in allocating prescribed responsibilities. It is possible for responsibilities to be allocated to more than one senior manager, but the final rules make it clear that: ‘we expect that a firm would not normally split an FCA prescribed responsibility between several senior managers, with each only having responsibility for part, or for them to be allocated to two or more senior managers jointly.’ The FCA requires that, in such circumstances, firms explain the rationale in their responsibilities map. The PRA has also made it clear that, where the firm allocates responsibilities to more than one senior manager, each of those individuals will, in principle, be deemed wholly responsible for it.
Accountability is important for the regime applies to activities taking place wholly or in part overseas. Furthermore, the regime applies to individual legal entities rather than to, say, a whole banking group. Thus, as part of their decision-making process, firms will need to ensure that they identify the individual who is genuinely accountable in regard to the entity in question, regardless of whether or not he or she is a director or employee of that particular entity. The question of non-executive directors (NEDs) is interesting because in the UK there is no distinction between types of director. In the Senior Managers Regime, only the chairman, senior independent director and chairs of the risk, audit, remuneration and nomination committees require pre-approval by FCA/PRA.
The Senior Managers Regime aims to raise standards of governance, increase individual accountability and help restore confidence in the banking sector. The FCA states that the regime is ‘a formal expression of the common sense, good governance practice that any organisation should adhere to’. It is clear, though, that this ‘good governance’ was not present, hence the need to ensure a clear and shared understanding that a culture of personal responsibility must be embedded at the heart of financial services.
The FCA states that it is not subject to the regime, but it has voluntarily decided to apply the fundamental principles to itself. In support of this objective, the FCA has published the map of its own governance, including senior management functions, prescribed responsibilities and overall responsibilities, with details of individuals, committees, statements of responsibility and terms of reference. This provides a comprehensive example of the manner in which a firm may implement the regime.
The regime in the context of UK’s relationship with the EU
The outcome of the UK Referendum on its relationship with the European Union (EU) was that the British people have decided to leave the EU. While the outcome of the UK negotiations with the EU remain uncertain, this development does put into sharp relief the apprehensions of the Parliamentary Commission on Banking Standards.
The Commission’s Changing banking for good report voiced concern that ‘the UK’s ability to make necessary reforms to financial regulation risks being constrained by the European regulatory process, which is developing rapidly as Eurozone countries move towards banking union.’ The Commission highlighted a clash of cultures, with the EU rules having a ‘prescriptive and box-ticking tendency’ as opposed to the ‘more judgement-based approach being introduced in the UK in response to past regulatory failures’. The report suggested that some EU regulations may limit the UK’s regulatory scope for unilateral action and that this could mean ‘moving at the speed of the slowest ship in the convoy’.
The 2008 financial crisis demonstrated that too many bankers operated in an environment with insufficient personal responsibility. The Senior Managers Regime is intended to ensure that top bankers are accountable and that they face the prospect of financial penalties or more serious sanctions commensurate with the severity of the failures with which they were associated. Thus, in 2016, the framework is in place to ensure senior manager accountability, with the intention of influencing behaviours and culture leading the transition from moral bankruptcy to a more enlightened approach. However, the changed landscape of the relationship of the UK with the EU may have medium-term consequences, prompting a further review of UK regulations.
Dr Axel Palmer
Department of Law The University of the West of England
More information on the Senior Managers Regime is available on the FCA website: www.fca.org.uk. The UK’s Parliamentary Commission on Banking Standards 2013 report, ‘Changing banking for good’, is available at: www.parliament.uk/ documents/banking-commission/ Banking-final-report-volume-i.pdf