Last week the FCA published a clutch of papers on the extension of its Senior Managers and Certification Regime (“SM&CR”) to all firms authorised under Financial Services and Markets Act 2000 ("FSMA). Whilst these contained few surprises and confirmed our expectations on the timetable, we take the opportunity to delve into some of the more challenging aspects of the new regime and ask whether firms can take steps now to ease the burden of implementation. For an introduction to the reforms, see our previous alert (September 2017): Proportionate Extension of the Senior Managers and Certification Regime.
1. Over-Arching Considerations:
Why is SM&CR so Important to the FCA?
Notwithstanding the focus of resources on MiFID II and, increasingly, the UK’s departure from the EU, SM&CR remains central to the FCA’s project of putting culture at the core of improved behaviour within the industry. The intention behind the extension of the regime is to codify the precise roles, responsibilities and accountability of senior managers, throughout the industry. The FCA’s aim being that the resulting ‘culture of accountability’ will, in turn, give all employees the correct incentives to improve their standards of conduct, with management shouldering liability in the event of regulatory breach.
Confirmation of Timetable
The implementation date for the extension of SM&CR to FCA solo-regulated firms is announced to be 9 December 2019 (“commencement date”). (n.b. this is 10 December 2018 for insurers). This is subject to enactment by HM Treasury, hence the qualifier “near-final” in the FCA’s Policy Statement 18/14 which confirms the new rules, although it seems highly unlikely that this date will now move.
Is my firm “core” or “enhanced”?
The FCA confirms the previous criteria for distinguishing between Core and Enhanced firms for which, in an asset management context, the AUM threshold of £50 billion is most likely to apply. The only refinement is the addition of a three year rolling average calculation on both AUM and revenue-based criteria (£35 million for intermediary regulated revenue).
The FCA have also provided a process for opting up to the more onerous Enhanced status (using a new Form O). This is most likely to be considered in a group context where consistency of approach across different entities may be desirable.
The FCA encourages firms to re-examine whether certain junior members of LLPs should be considered Senior Managers, taking into account the guidance in SUP 10C.5 - if not, then they should not be converting the SMF27 (Partner). Since such junior partners may also not be captured by the Certification Regime due to them not being “employees”, it would appear that such individuals may fall between the two regimes (and hence would not appear in any public register). This somewhat anomalous position has been pointed out to the FCA and it is possible we may hear more on this.
The FCA’s guidance also appears to confirm that corporate entities currently approved as CF4 will no longer require registration as SMFs.
The FCA confirms that Appointed Representatives (“AR”) are not affected by SM&CR – the relevant legislation did not give them the power to do this. Instead, ARs will continue to be registered under the existing Controlled Functions, with the principal firm remaining fully responsible for their regulatory obligations.
2. Senior Managers Regime
Transitional Arrangements for Significant Influence Functions
Most existing Controlled Functions applicable to Core firms will be automatically converted to Senior Management Functions as follows:
- CF1 (Director) SMF3
- CF3 (Chief Executive) SMF1
- CF4 (Partner) SMF27
- CF10 (Compliance) SMF16
- CF11 (MLRO) SMF17
Other roles such as CF28 (Systems and Controls), CF29 (Significant Management), and CF30 (Customer) effectively disappear at commencement date, although these are likely to be caught as Certified Staff – capable of causing significant harm to either the client(s) or the firm. CF2 (Non-executive Director) also disappears, but note that the Chair of the governing body (if there is one), now designated as SMF9, can be either an Executive or Non-Executive Director.
Note also that firms will need to have the allocation of Prescribed Responsibilities, and Statements of Responsibility for each Senior Manager (see below), in place at commencement date but only for internal purposes. Subsequent changes, including both new Senior Managers and changes to existing responsibilities, will need require these to be notified to the FCA as part of the Connect applications.
The FCA made just one change to the list of Prescribed Responsibilities (“PR”) for firms, removing the responsibility for informing the governing body of its legal and regulatory obligations. Whilst every PR (typically 4 in the case of Core firms) must be assigned to a Senior Manager, the FCA clarified that not every Senior Manager need have a PR. For Core firms, the PRs need not be allocated solely to members of the governing body and, conversely, not every member of the governing body will necessarily occupy a Senior Manager function.
Statements of Responsibility
Statements of Responsibility (“SoR”) will be mandatory for all Senior Managers and must be succinct, clear documents without unnecessary detail or referencing other documents. The FCA has clarified that a Senior Manager holding more than one SMF and/or Prescribed Responsibilities should have only one SoR. Further guidance and rules on what to include will be contained in the new SYSC 10C.11, and the FCA has indicated it may provide further practical advice later this year.
Duty of Responsibility
This was one of the more contentious aspects of SM&CR in its early formulations, particularly until the burden of proof (that a Senior Manager had taken/not taken all reasonable steps) moved from the individual back to the FCA. In Final Guidance: the Duty of Responsibility for insurers and FCA solo-regulated firms (Policy Statement 18/16), the FCA confirms its view that no fundamental changes to its previous guidance (found in DEPP 6.2.9) are required. This guidance includes a lengthy but not exhaustive list of what would be considered “reasonable steps”. However, the FCA takes the opportunity to point out that Senior Managers may want to maintain their own records to explain or justify their actions in particular situations.
3. Certified Regime
Transitional Arrangements for Current CFs
Since there is no approval process by the FCA for Certified Persons, there is no formal transitional arrangement for individuals who may currently be Approved Persons but are not considered Senior Management. Firms must identify Certified staff by commencement date, but will have a further 12 months to complete the formal fit and proper assessments, ahead of the first round of re-Certification.
Both CF29 (Significant Management) and CF30 (Customer) roles map over pretty much exactly into the new Certification Functions of Significant Management and Client Dealing, respectively. New Certification Functions that previously had no exact CF equivalent include:
- Anyone supervising or managing a Certified Function, who is not a Senior Manager;
- Material risk takers - a broader concept than the Remuneration Code equivalent, taking in significant prudential, operational and reputational risks;
- Algorithmic trading – covering individuals approving new or amended algorithms those monitoring their compliance with the firm’s obligations.
A key part of implementing the Certification regime for many firms will thus be to identify such individuals who may not currently be Approved Persons.
There is no expectation that non-UK employees of the firm will be caught by the regime, unless they perform a certification role involving UK clients or are captured in the material risk taker bracket.
Assessment of Fitness and Propriety
The FCA avoids a prescriptive approach to determining how firms should carry out their fit and proper assessments, but points to existing guidance in FIT which includes:
- Honesty, integrity and reputation;
- Competence and capability;
- Financial soundness.
Although criminal checks for Senior Managers remain mandatory, the FCA has decided that this would not be proportionate in the case of Certified staff (although we believe most firms will want to do this). Regulatory references requirements for both, plus non-executive directors, will also continue to apply.
4. Conduct Rules:
As previously advised, the FCA’s new Conduct Rules replace the Statements of Principle for Approved Persons and will apply to all except ancillary staff (“Conduct Staff”). The first 5 Rules apply to all Conduct Staff, with a further 4 for Senior Managers only.
The new regime carries with it an obligation to train all Conduct Staff on these rules and their implications. Ensuring that this is carried out is one of the 4 Prescribed Responsibilities that apply to the majority of Core firms. Again firms have a further 12 months after commencement to carry this out, although we expect the majority of firms will address this much sooner, alongside the training of Senior Managers and Certified staff, which does need to take place ahead of commencement.
Reporting of Breaches
Regulatory breaches, and details of disciplinary action related to conduct, by Approved Persons must currently be reported to the FCA via a Form D, and this will continue to be the medium of reporting for Senior Managers. For all other Conduct and Certified staff, firms will be required to make an annual notification via GABRIEL (the REP008). Any instances of disciplinary action (including formal written warnings, suspension or dismissal, or any clawback of remuneration), once complete, must be reported and the REP008 must be filed even if there have been no such breaches.
5. Introducing The Directory
As expected, the FCA has responded to criticism that persons currently in CF30 (customer-facing) roles would disappear from the Financial Services Register when they move to certified status in the new regime. In Consultation Paper 18/19, it proposes a new Directory for the following individuals (collectively “Directory Persons”):
- Certified staff;
- Non-Senior Management Function Directors (i.e. members of the governing body), whether executive or non-executive;
- Sole traders and appointed representatives (including those within AR firms) where undertaking business with clients and requiring a qualification to do so.
To be clear, the FS Register will continue to exist but will contain only individuals in specified Senior Manager functions who have been approved by the FCA. The FCA also confirmed that work is underway to improve the FS Register to make it easier to use and understand.
The FCA is trying hard to make the Directory as user-friendly as possible, with searchable features such as workplace location, type of business qualified to carry on, and any regulatory sanctions history. However, these features seem unlikely to be particularly relevant in a wholesale context.
Note that firms have 12 months from the commencement date to certify staff and submit notifications via Connect for the Directory, so the deadline for this is 9 December 2020 (this also applies to staff taken on during this transition period).
However, firms do need to be aware of the more onerous notification requirements that will apply after that: individuals both joining and leaving the firm will need to be reported within one business day of that event. Firms that have made no notifications for a period of 12 months will be asked to confirm that there have in fact been no changes.
6. Next Steps
Do I need to start worrying about this now?
We continue to believe that this is largely a project to commence in early 2019, rather than taking action now. We view most of the more exacting requirements such as Statements of Responsibility and assessment of Fitness and Propriety as fairly natural extensions to existing SYSC requirements and industry best practice which firms will already be familiar with. Larger firms, particularly those with more complex organisational structures, will, however, almost certainly begin planning sooner.
Aligning HR Processes
In addition to gaining an overall appreciation of the new regime, many firms will focus their early implementation steps on aligning human resources processes with SM&CR, for example:
- Review and updating of employment contracts and employee handbooks;
- Incorporating Fit and Proper assessments into annual employee reviews.
Individuals with project responsibility for implementing SM&CR may wish to know that the FCA have published a Guide for FCA solo-regulated firms which contains many helpful, practical details.
The FCA have also indicated that they will be issuing further guidance (as well as final rules on the Directory) towards the end of 2018.
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