This guest contribution examines some of the issues surrounding a new wide-reaching regulatory regime that is set to impact the money management sector in due course.

The UK’s financial watchdog has moved to bring some 47,000 firms, including wealth management houses, under a scrupulous new regime that it has claimed will be “good for business”. For the first time, money managers will be required to comply with the Financial Conduct Authority’s Senior Managers and Certification Regime, which intends to hold senior managers accountable for failings on their watch. The FCA’s announcement in July that it planned to extend the rules, which lenders have had to comply with since last March, to all financial institutions initially sparked fear among wealth and asset managers. There have even been reports that fewer people have been willing to take on more senior roles because of the additional liability. 

At a time when wealth and asset managers are already grappling with a host of new European regulations set to enter into force at staggered intervals next year, such as MiFID II and GDPR, it is crucial that they do not place incoming regulations closer to home on the back burner, otherwise they risk exposure to regulatory penalties and fines.

To shed more light on the topic and explore the finer details, Douglas Cherry, a partner at Reed Smith, the law firm, shares his comments.

The author's views aren't necessarily shared by the editors of this news service but such comments are welcome additions to debate. To contact the editor, please email tom.burroughes@wealthbriefing.com.

Background

The FCA recently released its long-awaited consultation paper1 (CP) on its planned extension to the Senior Managers and Certification Regime (SMCR) beyond the initial roll-out to Banks and Building Societies, to the vast majority of the other firms it regulates.

Description and analysis

The SMCR consists of three principal elements which are described by the FCA in its CP as the “core”, “enhanced” and “limited-scope” regimes. 

The core regime applies to all affected firms and is the principal focus of this short discussion.

The enhanced regime will apply only to the very largest firms regulated by the FCA and is expected by the FCA to capture only around 350 firms in total. The “enhancements” within this facet are that additional detail, particularly with reference to individual responsibility, will be required. 

Conversely, the limited scope regime is effectively a light version of the core regime for particular classes of FCA-regulated firms, including limited scope consumer credit, oil market participant and sole trader firms.  These firms will not be required to implement the Senior Management Functions (SMFs) and are exempt from other prescriptive requirements within the regimes, too.

Parsing the current into the future

The core and enhanced regimes will see those senior managers currently carrying out a significant influence function at firms mapping across to the newly defined SMFs. 

The precise mechanics of the transfer are yet to be determined, but we can expect to see a grandfathering process to streamline this for existing Approved Persons. New SMF holders will require pre-approval from the FCA before they commence their role.

Impact and significance of holding a SMF designation

SMF holders have a new express burden of adherence to a Statement of Responsibilities (SoR). FCA guidance is that the terms of a SoR should be expressed in approximately 300 words and articulate in positive language what is in the sphere of the SoR as opposed to limiting it.

The firm’s primary obligation in respect of SoRs is to define and articulate the duties and description of the SoR to each SMF holder.

The SoR presumptively establishes culpability on its terms, and in the event of regulatory failure or criticism of an alleged failure, the SMF holder must explain the “reasonable steps” taken by the individual to endeavour to ensure compliance with the SoR.

Failure to do so will likely result in some form of regulatory sanction.

Practical issues with SoRs

Given the presumptive nature of the SoR, senior management individuals are often focused on ensuring that the SoR is no wider than it needs to be to fulfil its purpose. This often results in negotiation between the employer and the SMF holder, including the need for independent legal advice to be made available to the senior employee, all ahead of their agreement to the SoR. 

Additional issues to be considered will include how to record obligations in individual employment contracts. From an employer perspective, typically the contractual terms will need to be modified to include meeting the regulatory requirements specific to the SMF status of senior management individuals. This fulfils various purposes, including making it very clear that the obligation exists, demonstrating to the FCA that the SoR is being taken as a matter of fundamental importance, and potentially in the future, providing a basis for consideration of clear breach of contractual employment terms if deemed appropriate by the employer and subject of course to due process and compliance with other relevant obligations.

Alongside these contractual obligations, the clear attribution of presumptive individual culpability also brings with it the reasonable expectation on the part of the SMF holders for a contractual right of support from the employer in the event of a regulatory investigation or enforcement action which relates to the SoR. This issue typically comes to the fore when, for example, there is a regulatory investigation into a systems and controls or conduct of business issue, where a SMF holder has overall responsibility on the terms of a SoR. That issue may well not involve the senior individual on a day to day basis, and may well have no direct involvement from them at the operational level, yet it arises “on their watch” and the FCA will rely upon the SoR in these circumstances. In these sorts of situations, the SMF holder typically would expect to be supported by the employer to the extent they are under scrutiny, including with legal and other advice and assistance, as may be appropriate, to deal with the regulatory inquiry.

Connected with this requirement is the expectation from those ascribing to SoRs, that they will receive a commitment from the employer to be provided with sufficient resources and support during the currency of their role, to ensure that they are able to fulfil the obligations in the SoR. There is a clear alignment of interest between the SMF holder and employer in this regard, but there is also scope for tension to the extent that a SMF holder may point to their responsibilities and a need for resource or commitment beyond what the employer considers is necessary. This would need to be addressed and resolved on a case by case basis, but may well lead to additional management time and resource being spent on these details in manner which previously they may not have been.

This point leads to the fact that there is likely to be an increased amount of time and resource dedicated to compliance with this regime and showing that SoRs are operating effectively at firms. The FCA considers that any direct costs of implementation and maintenance, as well as management time and effort, will be less than the cost of potential non-compliance with regulatory rules stemming from not having an efficiently running and implemented SMF programme supported by SoRs. This remains to be seen, and is at odds with the current trends and bullish statements emanating from the FCA’s enforcement arm.

The final issue for this exposition relates to the enforcement of FCA regulatory expectations as it relates to individuals. The consistent mantra from the FCA has been more individual culpability wherever reasonable. SoRs make it easier for the FCA to take action in respect of individuals by having an explicit document to refer to and place factual allegations of regulatory failure alongside to illustrate it view of a breach. This and the fact that anecdotally, there are more investigations into individuals and that they are being commenced sooner and more readily than in the past, all leads to a clear increased risk for enforcement action to be taken in respect of individuals.  Bearing in mind the observations above about a reasonable expectation on the part of SMF holders for support in cases of investigation from their employer firm; it is a fair assumption that there may well in fact be a significant increase in costs to firms associated with the terms and use of SoRs in the near to medium term.