The Senior Managers Regime

12 09 2015

Tom Hayes did not bring down a bank but he paid a heavy price for being a part of the wider dirty casino culture built into the world of finance. During his trial, important questions were thrown up about the degree to which his seniors were culpable in his actions. In applauding the Senior Managers Regime (SMR), which aims to fill the lacuna in the regulatory regime, it has already been argued that Sir Jeremy Cooke was right to say that those supervising Hayes were irrelevant to his crimes: they would, after all, raise the stale decades old “we didn’t know” defence. But this historical rebuttal has been stretched to its outer limits: too overworked and overloaded, it has crowded itself out. As Roger McCormick explained in a recent interview referring to the famous Swaps Case from the 1980s: “Patience has run out and it’s no longer acceptable for them to just say, ‘It’s not our fault, we didn’t know.’ Laws of this kind reflect that impatience. We’ve had enough of this. We can’t have big, unruly banks that are out of control with no one at the top really accepting responsibility for what’s going on.” We must not lose sight of the fact that a divergence of views exists in this field. Senior lawyers and academics do not necessarily see eye to eye on everything that the regulators say.

Some unknown authors in the media argue that: “The LIBOR conviction is welcome. Now directors must be held accountable too.” It is said that the trial “was a landmark moment in the cleanup of the City after the financial crisis.” Mark Carney pledged that the SMR will in principle apply to him and the Bank of England but the bank is uneasy about opening up to official auditors for fear that such proposals may reduce its autonomy. George Osborne has been, as of July, consulting in relation to a Bank of England Bill targeting accountability and transparency at Threadneedle Street. The bank is “uneasy” and “surprised” by thoughts of being swept within the audit powers of the National Audit Office outside whose scrutiny it has historically been. As regards future prospects of independence, the bank is not satisfied with the limited comfort offered by the retention of its policy making functions and potentially keeping them outside the scope of the National Audit Office’s oversight.

The Bank of England Bill is expected to be debated in Parliament soon and the Chairman of the bank’s Court of Directors, Anthony Habgood, has warned that unless its provisions are sufficiently relaxed the impending legislation would threaten “the carefully constructed independence of the policy functions of the bank.” This is so irrespective of the consultation document providing for an exemption as regards policy decisions in the bank being free from external interference. Despite the rise of socialist politics which has ushered in Jeremy Corbyn as Labour leader and John McDonnell as shadow chancellor, who want an end to the bank’s independence, Mark Carney is adamant that “[t]he construct here with a central bank that has operational independence to achieve a mandate that is defined by Parliament is the right model.”

It may be recalled that Martin Wheatley also recently opined that the banking industry has reached a “turning point” and he said that: “neither the Senior Managers’ Regime, nor the presumption of responsibility, [see here] correspond to a ‘heads on sticks’ strategy.” But what does all this add to the notion of dishonesty?

Press Punditry

As we have seen with Tom Hayes, the cure for white-collar criminals’ dishonesty is no different to anyone else, the solution turns on exponential notions of liability: the more sweets you steal the more you suffer. The legal pundits in the press, such as Joshua Rozenberg who is a metonym for the judicial establishment, have so held without asking why the sweets were stolen in the first place, and who ordered that they be stolen? As Dylan exhorts us in Lily, Rosemary and the Jack of Hearts: “The hangin’ judge was sober, he hadn’t had a drink.” These knotty philosophical questions will no doubt eternally haunt us. “The jargon of bankers and banking experts is deliberately vague,” clarify Adamti and Hellwig in navigating these dilemmas in The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about it. For them, simple opportunities are overlooked and flawed theories and narratives and invalid arguments are given a helping hand. Because the search for cure-all legal rules continues unabated, they are probably more right than wrong.

In the press things are spun in the opposite direction. “The LIBOR conviction is welcome. Now directors must be held accountable too.” In criminal law, the outstanding issue remains that if senior people were involved in wrongdoing then they should have been charged together with Tom Hayes. Up the present time, his longstanding practice was abandoned in the LIBOR trials. As a general rule, subject to the sufficiency of evidence and the public interest stages of the Code Test, accomplices should be prosecuted. There is no formal legal definition of the term “accomplice”. But the House of Lords has recognised the following as being accomplices:

  • a person who takes part in the offence or who aids, abets, counsels or procures its commission;
  • a handler at the trial of the actual thief;
  • parties to crimes, identical in type to the offence charged, evidence of which has been admitted as proving system and intent and negativing accident (Davies v DPP [1954] AC 378).

Moreover, section 8 of the Accessories and Abettors Act 1861 states:

Whosoever shall aid, abet, counsel, or procure the commission of any indictable offence, whether the same be an offence at common law or by virtue of any Act passed or to be passed, shall be liable to be tried, indicted, and punished as a principal offender.

In sentencing Hayes, Sir Jeremy Cooke said in his remarks:

High standards of probity are to be expected of those who operate in the banking system, whether they are bankers involved in dealing with deposits and the lending of money, or traders in an investment banking context. What this case has shown is the absence of that integrity which ought to characterise banking.

It does not matter whether or not traders are within the scope of the SMR because, in the event if they still misbehave after the ongoing LIBOR trials, they will fall within the parameters delineated by Hayes’ sentence. As Adamti and Hellwig say the jargon of banking is deliberately vague.

Senior Managers Regime

The SMR locks regulatory attention on a smaller set of senior persons than the Approved Persons Regime (APER/APR) and it limits regulatory pre-approval to the most senior individuals in banks, building societies, credit unions and PRA-designated investment firms, known collectively as Relevant Authorised Persons (RAPs). Firms will be required, as part of the regulatory pre-approval, to submit statements of responsibilities setting out the areas for which a prospective senior manager will be responsible. “Clear lines of a accountability,” are the goal and these are underpinned by a “presumption of responsibility” with the result that, unless managers can satisfactorily demonstrate to the concerned regulator that reasonable steps to prevent such breaches were taken, senior managers in RAPs will be held accountable for misconduct within their spheres of responsibility.

The FEMR’s terms of reference require it to consider the impact of its work on (i) the stability, efficiency and effectiveness of the financial sector, and its capacity to contribute to the growth of the UK economy in the medium and long run; (ii) the need to maintain vibrant competition in wholesale financial markets; (iii) the competitiveness of the UK financial and professional services sectors and the wider UK economy; and (iv) the resources needed for implementation. The PCBS, the underlying bedrock of reform, was clear, at para 930, that the FCA’s predecessor the FSA “suffered from insufficient expertise amongst its supervisory staff” and unlike the Bank of England and the Treasury it was unable “to attract the brightest and the best” and was being run by “extremely inexperienced people.” From what we can see, the FEMR’s terms of reference, do allow some leeway for self-criticism because the stability, efficiency and effectiveness of the financial sector do ultimately depend on the competence and fitness of the regulators. As noted above, the PCBS also said that the FCA should replicate the Bank of England’s stated intention for the PRA to operate at a lower cost than its equivalent part of the FSA.

Chapter 5 of the FEMR’s final report is devoted to raising standards of professionalism and it states that in the run up to the financial crisis firms were plagued by low levels of accountability because of three “key trends”. First, senior management remained remote and unaccountable for the maintenance of standards in day-to-day trading operations. Second, senior managers faced few apparent consequences for failing to ensure that their teams upheld appropriate standards of market practice. Third, there was an increasing shift in power within firms and their management teams towards trading staff. Moreover, the FEMR also stressed that staff with a poor conduct record must not be recycled. In that respect the provisions of the Financial Services (Banking Reform) Act 2013 (the 2013 Act) are important as Part 4 of this key legislation relates to the architecture that underpins the future conduct of persons working in the financial services sector. The 2013 Act also creates a new criminal offence, under section 36, in relation to decisions which have caused a bank to fail.

The 2013 Act implements the final recommendations of the Independent Commission on Banking (ICB), established in June 2010. In particular, the ICB recommended that retail banking should be separated from wholesale or investment banking, and that this should be achieved by ring-fencing. These issues shall be examined in another post. In the present context, the 2013 Act functions as a mechanism to implement the recommendations made by the PCBS in light of the widespread LIBOR and forex manipulation and mis-selling. As regards terms of reference, PCBS was created by Parliament in June 2012 in order to consider and report on (i) professional standards and culture of the UK banking sector, taking account of regulatory and competition investigations into the LIBOR rate-setting process; and (ii) the lessons to be learned about corporate governance, transparency and conflicts of interest, and their implications for regulation and for Government policy.

Because public trust in banking had hit rock-bottom, the PCBS was of the view that introducing a new framework for approving and holding individuals to account would restore trust and improve culture. The measures recommended to achieve this included:

  • a Senior Persons Regime (subsequently rebranded as the SMR) to replace the Significant Influence Function (SIF) element of APER for deposit-takers and PRA designated-investment firms with a Senior Management Function, covering a narrower range of individuals;
  • a Licensing Regime (subsequently rebranded as the Certification Regime) operating alongside the SMR and applying to other bank staff whose actions or behaviour could significantly harm the bank, its reputation or its customers, and;

Under section 19, the 2013 Act enables the PRA and the FCA to specify a function as Senior Management Function (SMF) and Individuals performing an SMF specified by the PRA will require pre-approval by the PRA with the FCA’s consent. Those performing an SMF specified by the FCA will require pre-approval by the FCA only. The combined list of FCA and PRA related SMFs shows 18 listed functions. The said functions range from “SMF1” (Chief Executive function) to “SMF18” (Significant Responsibility SMF).

Despite being different in some respects, the PRA’s and FCA’s proposed rules for SMFs intend to operate together as a single cohesive/composite regime in practice. The combined scope of the new regime is designed to cover every individual on the board of every relevant firm so that all key decision-makers falling within the regulatory perimeter are captured by the enhanced accountability requirements. The combined list of SMFs is divided into the following controlled functions: Chief Executive function SMF1 (PRA), Chief Finance function SMF2 (PRA), Executive Director SMF3 (FCA), Chief Risk function SMF4 (PRA), Head of Internal Audit SMF5 (PRA), Head of key business area SMF6 (PRA), Group Entity Senior Manager SMF7 (PRA), Credit union SMF (small credit unions only) SMF8 (PRA), Chairman SMF9 (PRA), Chair of the Risk Committee SMF10 (PRA), Chair of the Audit Committee SMF11 (PRA), Chair of the Remuneration Committee SMF12 (PRA), Chair of the Nominations Committee SMF13 (FCA), Senior Independent Director SMF14 (PRA), Non-Executive Director SMF15 (FCA), Compliance Oversight SMF16 (FCA), Money Laundering Reporting SMF17 (FCA) and Significant Responsibility SMF18 (FCA).

To facilitate these arrangements, section 20, which amends section 60 (applications for approval) of FSMA, requires senior managers to furnish a statement of responsibilities detailing the areas of the firm which the prospective senior manager will be responsible for managing. The 2013 Act also gives both regulators the power to approve senior managers subject to conditions or time limits. As a system, the total breadth of the FCA and PRA’s regimes captures members of a relevant firm’s board.

Moreover, section 30 empowers the FCA to make rules of conduct. Furthermore, by inserting sections 63E and 63F into FSMA, section 29 (Certification of employees by relevant authorised person) of the 2013 Act empowers the regulator to specify in its rules functions which, although not controlled functions requiring approval, are “significant-harm functions”, i.e. functions which may give rise to a risk of significant harm either to the firm or to its customers. In relation to the Certification Regime (CR), the following roles are all “significant-harm functions”: CASS oversight, benchmark submission and administration, proprietary trader, significant management, functions requiring qualifications, managers of certification employees, functions that have a material impact on risk.

The new section 63F provision lays down the rules under which a RAP may issue a certificate to one of its employees. The RAP must be satisfied that the person concerned is a fit and proper person to perform the function covered by the certificate. Consideration must be provided to whether the RAP possesses the qualifications, training, level of competence and personal characteristics required by rules made by the regulators in relation to the function in question. The certificate, which will be valid for twelve months, will not only describe the role to which the person concerned is being appointed but will also confirm that the person is fit and proper to act in that role. Where the RAP decides not to issue such a certificate, it must give the person concerned written notice of that fact, including details of the steps the RAP proposes to take in consequence and the reasons for them.

The term RAP is defined by section 33 of the 2013 Act. The provision inserts a new section 71A into FSMA which captures RAPs for the purposes of Part 5 of FSMA. All deposit-takers, including building societies and credit unions, and those investment firms which are authorised by the PRA are caught by the provision but it does not cover any insurers which are permitted to take deposits under FSMA. As regards RAPs, the terms of the 2013 Act only cover institutions incorporated in the UK or formed under the law of any part of the UK. On the other hand, by virtue of new section 71A(4) of FSMA, the Treasury enjoys the power to extend by order the definition of RAPs to include branches of non-UK credit institutions and investment firms of a specified description.

In other words, the new SMR, which replaces the present APER, applies to individuals who are subject to regulatory approval. The SMR thus focuses on senior individuals who hold key roles or have overall responsibility for key areas. As highlighted above, the roles of chairman, senior independent director, the chairs of the risk, audit, remuneration and nominations committees are all non-executive director roles that will fall within scope of the SMR.

Furthermore, the CR under section 29 of the 2013 Act applies to staff who could pose a risk of significant harm to the firm or any of its customers. As observed above, the CR applies to members of staff who administer benchmarks, give investment advice or execute client orders. In contrast to the SMR, the CR under the 2013 Act requires firms themselves to assess the fitness and propriety of certain employees, without regulatory pre-approval.

The FEMR refers to these two systems collectively by telescoping them as the Senior Managers and Certification Regimes (SM&CR) and the framework, which will enter into force in March 2016, is said to “give teeth” to the regulatory oversight mechanism. The upshot is that regulators will be able to hold individuals accountable for misconduct by requiring all traders and other relevant individuals to comply with the following fivefold formula prescribed in Individual Conduct Rules:

Rule 1: You must act with integrity.

Rule 2: You must act with due skill, care and diligence.

Rule 3: You must be open and co-operative with the FCA, the PRA and other regulators.

Rule 4: You must pay due regard to the interests of customers and treat them fairly (exclusive to FCA).

Rule 5: You must observe proper standards of market conduct (exclusive to FCA).

According to the watchdogs and the policy makers, the above will provide a strong incentive for individuals to achieve higher standards of market conduct because individuals will be personally accountable for any breach of a Conduct Rule. Moreover, the new Senior Manager Conduct Rules are clear that:

SM1: You must take reasonable steps to ensure that the business of the firm for which you are responsible is controlled effectively.

SM2: You must take reasonable steps to ensure that the business of the firm for which you are responsible complies with the relevant requirements and standards of the regulatory system.

SM3: You must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversee the discharge of the delegated responsibility effectively.

SM4: You must disclose appropriately any information of which the FCA or PRA would reasonably expect notice.

Consultation Paper FCA CP14/13, PRA CP14/14 Strengthening accountability in banking: a new regulatory framework for individuals was distributed in July 2014 and in light of the responses the feedback was published in March 2015. The statutory requirements of the 2013 Act will be transposed into the FCA’s Handbook through the Individual Accountability Instrument 2015.

From March 2016, the Code of Conduct sourcebook (C-CON) will be inserted after the Senior Management Arrangements, Systems and Controls sourcebook (SYSC) in the block of the Handbook entitled High Level Standards. Moreover, the Individual Accountability Instrument will also amend the following modules of the FCA’s Handbook: Glossary of definitions; Senior Management Arrangements, Systems and Controls sourcebook (SYSC); the Fit and Proper Test for Approved Persons (FIT); Supervision manual (SUP); and Decision Procedure and Penalties manual (DEPP).

The principles of the Individual Conduct Rules and the new Senior Manager Conduct Rules which are extracted above contain very detailed, albeit non-exhaustive, examples of what does amount to a breach of the new rules.

The requirements of the new regime are also incorporated into the PRA Handbook through the PRA Rulebook: Glossary Instrument, PRA Rulebook: Senior Management Functions Instrument, PRA Rulebook CRR Firms: Allocation of Responsibilities Instrument, PRA Rulebook: Certification of Employees Instrument, PRA Rulebook: CRR Firms: Fitness and Propriety Instrument and PRA Rulebook: CRR FIRMS: Conduct Rules and Notifications Instrument.

Moreover, a similar mechanism can be found in the proposed Senior Insurance Managers Regime (SIMR) which incorporates aspects of the SM&CR within the existing legal framework for insurers. The SIMR works in a similar manner to the SM&CR, but without the ‘presumption of responsibility’, and it will require insurance firms to adopt clearer governance arrangements, and set clearer allocations of responsibilities and accountabilities for senior managers. Among other things, PRA Consultation Paper CP26/14 Senior insurance managers regime: a new regulatory framework for individuals dealt with the SIMR (which adopts the same five Conduct Rules noted above) and resulted in Policy Statement, PS3/15 Strengthening individual accountability in banking and insurance – responses to CP14/14 and CP26/14.

Comment

Mark Carney and Martin Wheatley, who will be leaving the FCA and has been replaced by his deputy Tracey McDermott (who will temporarily act as CEO from today, 12 September 2015), disagreed over the role of asset managers being systemically important financial institutions. Wheatley argued that “big questions” confronted global regulators – such as Carney who in addition to his governorship of the Bank of England also chairs the global watchdog known as the Financial Stability Board (FSB) – and needed to be answered prior to determining whether the world’s largest asset managers should be deemed “systemically important”. Despite his awkward relationships with bankers, Wheatley did have some fans. His approach to asset managers was met with open arms by investment managers – such as BlackRock Inc and Vanguard Group Inc – who made it plain to Carney:

… stop trying to regulate us like banks.


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2 10 2015
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[…] has introduced a new code of conduct and will “in principle” apply the core principles of the Senior Managers Regime (SMR) to its own senior staff, including the governor himself. The SMR will operate in addition to […]

26 11 2015
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[…] markets as “fragile, unfair, ineffective and unaccountable”. For him, the introduction of the Senior Managers Regime next year would compel senior personnel to ensure that their juniors are aware of exactly what a […]

22 03 2016
Benchmark Manipulation and Corporate Crime: Insights on Financial Misconduct | Global Corporate Law

[…] big words and bombastic Mansion House speeches have given rise to new laws and in that regard the Senior Mangers Regime (SMR) came into force on 7 March 2016; it entails potential prison sentences of up to 10 years’ […]

28 03 2016
Navinder Sarao: ‘Flash Crash’ Trader’s Extradition Request Upheld | Global Corporate Law

[…] light of such statements it is a bit strange that BlackRock and Vanguard were unhappy that that the Senior Managers Regime should apply to their activities on the basis that they are “asset managers” and not banks, […]

1 04 2016
King and Country: Reflections on the Costs of Market Misconduct | Global Corporate Law

[…] As seen in the connected post on benchmark rigging and criminal proceedings, the arrival of the SMR brings the promise of greater responsibility being placed on senior staff and time will tell […]

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