On 30 March 2023, the FCA and PRA jointly published DP23/3: Review of the Senior Managers and Certification Regime (“SMCR”). In parallel, the HM Treasury issued a Call for Evidence on the regime. These papers signal a comprehensive reassessment of the operations and effectiveness of one of the most important pillars of the UK regulatory regime. Responses have been invited to both by 1 June 2023. The intention is that these will be considered in any subsequent consultations, with the Treasury making any proposals in the legislative framework and the FCA/PRA doing the same for regulation.
Background to the review
The review of SMCR is a significant strand of the Edinburgh Reforms announced in December 2022. The reforms are aimed at driving the growth and competitiveness of the UK financial services sector, taking advantage of Brexit to create a regulatory framework that is open, agile and with consistently high standards. To support this aim, consultation on the regulatory and legislative framework of the SMCR was announced for Q1 2023.
As with a large proportion of regulatory reform in the past 15 years, the roots of SMCR lie in the financial crisis of 2007-8. The Parliamentary Commission on Banking Standards identified, in its final report in 2013, a lack of accountability at the most senior level in firms combined with a proclivity to hide behind collective responsibility when things go wrong. This report led directly to the introduction of SMCR for banks and PRA-regulated firms in 2016 and its extension to all solo-regulated FSMA firms in 2019. Firms such as benchmark administrators, credit rating agencies and recognised investment exchanges have also either already been gathered in or will shortly do so under the Financial Services and Markets Bill, currently before Parliament.
Does SMCR need “fixing”?
SMCR was generally well received on its introduction, recognised as incorporating HR best practices and seen as driving positive behavioural changes across financial services. In operation, one major problem area has been a malfunctioning approval process for Senior Managers, creating major backlogs in applications which hinder new entrants to the industry and the movement of personnel between firms. Another criticism has been the paltry level of successful enforcement activity derived from SMCR. In the long term, this dilutes the deterrence effect which underpins the objective of individual accountability.
A breakdown of the reviews
Typically, policy discussion papers can be expected to float policy options and are likely to contain significant clues about the ultimate destination – this is less true with both papers here. Both pose a series of very general and broadly framed questions and may be read as a genuine first step in an information-gathering process. That said, closer examination reveals some interesting points of divergence between the two.
1. HM Treasury Call for Evidence
While there is significant crossover between the two papers, the Treasury is particularly focused on the international competitiveness of UK financial services. It is particularly interested in comparisons with equivalent regimes in other jurisdictions and whether SMCR acts as a negative factor for global firms or individuals looking to locate here. Clearly, there is a political dimension to this line of enquiry – a government keen to further its post-Brexit, deregulation agenda.
The meat of the Call for Evidence is to be found in Chapter 3, combining an exploration of stakeholders’ views on the regime’s overarching aims as well as on more specific questions:
- Is the regime delivering against its original aims, such has holding individuals to account, or improving governance, behaviour and culture, and are these aims right for the UK?
- Does SMCR impact on the UK’s international competitiveness, and how does it compare (both in operation and intent) with similar regimes in other jurisdictions?
- Does SMCR act as a deterrent to firms or individuals considering locating in the UK and how could the regime be reform to address such concerns?
- Could the scope of SMCR be amended to remove low risk activities or firms?
- Are there any lessons to be learned to ensure a smooth rollout to any potential changes to the regime? A presumption that reform is likely, perhaps.
2. FCA/PRA Discussion Paper
The questions in the Discussion Paper are similarly broad, although with a greater presumption that the regime is working well and seeking areas where relatively minor tweaks might be appropriate. It is noteworthy that the review will be carried out through the lens of the regulators’ statutory objectives (for the FCA, this means protecting consumers, market integrity and promoting effective competition), as well as “operational efficiency, proportionate regulation, trust and reputation”. Although international competitiveness gets a mention, broadly we may see this as placing the maintenance of high standards on an equal footing (note the contrast to the Treasury Call for Evidence).
In terms of focus, the Paper invites general comments on the effectiveness, scope and proportionality of SM&CR:
- Has SMCR has made it easier to hold individuals to account and has conduct actually improved?
- Do fitness and propriety requirements support firms in appointing appropriate individuals to Senior Manager roles (or do they deter individuals from taking up these roles)?
- Does SMCR make it easier to hold staff to account and take disciplinary action when appropriate?
- Do specific accountabilities of Senior Managers complement the collective responsibility of governing bodies?
- Does the prospect of enforcement promote individual accountability and could the approach to enforcement be enhanced to better support SMCR?
- Is the scope of SMCR appropriate or should it be amended to enhance competition and/or international competitiveness?
- Is the application of SMCR proportionate to both firms and individuals (i.e. as defined by firm types)?
The FCA and PRA also seek views on specific operational aspects of SMCR:
- How could the process for Senior Management Function (SMFs) applications be improved?
- Do criminal records checks support the aims of SMCR?
- Does the 12-week rule sufficiently help firms manage changes to SMFs?
- Are the current set of Senior Management Functions and Prescribed Responsibilities appropriate?
- Does the Duty of Responsibility and Statements of Responsibility support individual accountability?
- Is the Certification Regime effective in ensuring that individuals are fit and proper?
- Does the Directory of Certified Persons capture the right set of individuals and is it sufficiently up to date?
- Do regulatory references support better-informed decisions about fitness and propriety?
- Do the Conduct Rules effectively promote good conduct at all levels inside firms?
As in the Call for Evidence, there is also a final, open-ended question asking for any other recommendations to improve SMCR.
A further, interesting addition to the FCA/PRA paper is an Appendix: Individual accountability – international developments. This contains specific comparisons of individual accountability regimes in Australia, Singapore, Malaysia and Ireland, all of which have come into force since 2016, or are still being implemented. Statements of responsibility (or their equivalent) feature in all these jurisdictions, whereas pre-approval of senior managers and fit and proper requirements only appear in a few.
Advocates of a more radical approach (up to and including total abolition of SMCR) may look to the US. Whilst it does not operate a dedicated regime, authorities such as the SEC seek to pin down individual accountability through on-site examinations and enforcing the overall rulebook. Anyone from Directors and CEOs downwards can be held accountable where they have violated a law or regulation, engaged in ‘unsafe and unsound’ practices, or breached a fiduciary duty.
What might change?
Will these reviews lead to a fundamental rethink of SM&CR, aimed at lightening the regulatory burden on firms, or merely tinker round the edges of processes and reporting obligations? This is a matter of speculation of course, but we offer a top 5 of issues where reform seems plausible:
- Streamlining of the Senior Manager approval process: Although the backlog of applications appears to have fallen in recent months, this is still the most common criticism of the operation of SMCR and is highlighted in both papers. Much of the information required is either repetitious or largely irrelevant, and a simplification of the process (perhaps combined with a stretching of the 12-week rule to 6 months?) is surely low-hanging fruit.
- Narrowing of the Certification regime: Replacing the old CF30 (Customer) classification (also subject to FCA approval) with a regime of Certification which placed the onus on firms made some sense. Less obvious was the widening of the classification to include functions such as senior management, material risk takers and algorithmic traders. It would make sense to narrow the regime back to cover roles with direct, client-facing responsibilities (advice, dealing and investment management).
- Removal of Prescribed Responsibilities: Requiring Senior Managers to sign up to Statements of Responsibility helps clarify lines of accountability, particularly when things go wrong. Less obvious is the benefit (for example) of assigning responsibility for countering the risk that the firm might be used to further financial crime – in practice, this nearly always goes to the Money Laundering Reporting Officer.
- No requirement for criminal records checks (currently required for all SMFs): Many firms already carry out (or procure) extensive background checks for a large portion of their staff as a matter of course. Form As also ask very specific questions of the candidate about criminal records and related proceedings which could be checked by the FCA for random samples. Adding a specific requirement for criminal checks, which in practice cover (in England and Wales) the Disclosure and Barring Service, seem largely redundant.
- Greater guidance on conduct rule breaches and regulatory references: the reporting of breaches and the related obligation on regulated firms to provide regulatory references on past employees can be burdensome and contrast awkwardly with employment law. In particular, firms are reluctant to set the breach threshold at a level which captures what can seem relatively trivial offences when the potential consequences are so severe. Some of the open-ended questions currently asked (e.g. ”any other information that we reasonably consider to be relevant to your assessment of whether the individual is fit and proper”) could be sensibly narrowed to define what scenarios might be relevant.
One issue that receives very little attention in either paper is the lack of successful enforcement action against individual senior managers under SMCR. This is ironic given that this was one of the driving forces behind the Parliamentary Commission on Banking Standards push for SMCR in the first place. The backtracking on the Duty of Responsibility in the run-up to SMCR’s implementation – placing the burden of proof on the FCA, as opposed to a reverse presumption, that reasonable steps have not been taken – may have been a significant factor. One may therefore see further irony in the initiation of the SMCR review during the banking crisis of 2023 which echoes many of the features of that of 2007-8.
A further complication is the timing of the next UK General Election – possibly now as little as 12 months away. On the one hand, the Treasury will be anxious to promote its “pro-growth” credentials. On the other, a significant recasting of SMCR may require primary legislation which makes the timetable look very tight indeed. And an incoming Labour administration, whilst keen to present its pro-business credentials, seems unlikely to place regulatory reform very high on its list of priorities.
If you would like to respond to the FCA/PRA discussion paper then please do by clicking on the link here or emailing [email protected].
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