SMCR View - September 2021

1. What do artificial intelligence (AI) and machine learning (ML) have in common with SMCR?

This September the International Organization of Securities Commissions (IOSCO) published a report on the use of AI and ML by market intermediaries and asset managers and proposed best practices for firms to address conduct risks associated with the development, testing and deployment of AI and ML. The report has a global focus, but it is unsurprising that in the sections relating to senior manager accountability, it specifically calls out the SMCR. So, for firms with relevant AI and ML activities this is definitely something of which to take note.

The report references the FCA's expectations that a firm's governing body approves the governance framework for algorithmic trading, and its management body should identify the relevant Senior Manager with responsibility for algorithmic trading. In terms of reasonable steps (and interpreting the report through a UK-SMCR lens) the report suggests that there should also be appropriately skilled, knowledgeable senior individuals that senior management delegate sign off to on deployment and substantial updates of the technology (particularly if the responsible SMF doesn't have sufficient technical expertise). Finally, the report suggests that regulators may consider subjecting a wider range of individuals to regulatory scrutiny (i.e. data analysts, data scientists, data engineers) - under the SMCR, this suggests the FCA consulting in the future on widening the scope of the certification functions to capture those with critical roles to firms' use of AI / ML. Simmons has a dedicated AI Group which focuses on legal, regulatory and ethical AI issues, including those raised in the IOSCO report. Please feel free to contact us if you have any queries on this report or on AI-related issues more generally.

2. Dear Remuneration Committee (RemCo) Chair Letter - August 2021

In August 2021 the FCA wrote to RemCo Chairs on their critical role in relation to a range of topics including accountability, non-financial measures and diversity and inclusion (D&I). In particular, the FCA:

• reiterated that SMCR is a key tool for driving high standards of conduct and culture and that, for instances of poor behaviour/misconduct, appropriate and timely and transparent ex-post risk adjustments should be made.
• set out its expectation for firms to use non-financial measures in scorecards to support ESG (Environmental, Social and Governance) matters. In particular, the FCA has observed firms redefining their purpose based on what really matters to them in the context of ESG matters and want firms' remuneration policies to support/connect remuneration outcomes to their purpose, strategy and values.
• stressed that D&I is a key element of a healthy culture and urged RemCo Chairs to review pay data across all protected characteristics and act swiftly to address disparities. They also asked RemCo Chairs to consider the FCA's recent discussion paper on D&I and provide views by 30 September, particularly on linking remuneration to D&I metrics as part of non-financial performance. We have been engaging with clients on this topic and are planning to submit a response to the regulators. If you would like to discuss, please let us know. 

Further information is available here. We are also doing a lot of Board training sessions on ESG, Conduct Risk and Culture - please let us know if this is something you would be interested in.

3. Annual conduct rule breach reporting deadline

A quick reminder that you must submit your firm's annual conduct rule (CR) breach report to the FCA by Monday 1 November 2021 (the 31 October 2021 is a Sunday, so the deadline is the following working day). The return should be submitted even if it simply confirms the firm has nothing to report. The form doesn't cover CR breaches by Senior Managers (those are reported by a Form C or Form D). Given the transitional provisions included in the implementation of the SMCR the report will cover any relevant CR breaches by (1) certification staff and non-Senior Manager directors for the period 1 September 2020 to 31 August 2021, and (2) all other conduct rules staff from 1 April 2021 to 31 August 2021. The form should be completed and submitted using RegData. More information can be found here.

For completeness, a reminder that dual regulated firms are also obliged to report breaches on Form L in respect of persons performing PRA certification functions and Conduct Rules non-executive directors within 7 days of the point at which they determine that the relevant requirement applied.

4. Senior Manager applications - September 2021

The FCA has provided an update following its December 2020 admission that there were delays in determining Senior Manager applications. They have noted that despite increasing resources to deal with determining applications they received significantly more applications in Q1 2021 than anticipated and so applications will likely still face delays. One tip we have for firms is to check in Connect whether the application has been allocated to a case officer towards the end of the 90 day period and, if not, email the FCA to ask if it will be allocated. We have found that this nudge can often move the application forwards.

The FCA has reiterated its (largely obvious) guidance on how to progress an application as quickly as possible including: (1) checking it is completed in full before submitting it, (2) completing relevant DBS checks before submission, (3) conduct all appropriate due diligence checks including regulatory references before submitting the candidate, and (4) responding promptly and fulsomely if the FCA ask questions about the application.

5. Dear CEO Letter - regulatory returns

The PRA has sent a Dear CEO letter this month regarding its thematic findings on the reliability of regulatory returns. In particular the letter highlighted the PRA's disappointment in finding significant deficiencies in firms' processes used to deliver accurate and reliable regulatory returns. The PRA said that there has been a historic lack of focus, prioritisation, and investment in this area and less attention placed on these compared to financial reports made to the market/counter parties despite their importance. There is a section on governance and ownership where the PRA highlight that senior accountability and ownership is fundamental to the production and integrity of a firm's financial information and its regulatory reporting. Relevant senior manager(s) should be empowered to have overall oversight of the effectiveness of front-to-back processes and cross-functional processes to ensure the delivery of accurate and reliable regulatory returns. In some cases, the PRA found that responsibilities were dispersed across multiple individuals and teams, and delegated too far down the organisation (particularly where firms had complex and fragmented end to end processes). The PRA expect responsibilities to be clear for those involved in all stages of the end to end regulatory returns process. The PRA also observed instances of poor governance around key regulatory interpretations including a lack of basic documentation, periodic reviews, and/or appropriate sign-off.

We urge both the CEO (SMF 1) and Senior Manager(s) with regulatory reporting responsibilities to consider this letter in full and take reasonable steps to address the PRA's concerns / expectations to the extent required.

6. New UK prudential regime for MiFID investment firms and SMCR - MiFIDPRU firms - August 2021

The FCA published its third (yes, third) consultation paper in August 2021 on the new UK prudential regime for MiFID investment firms (IFPR), which provided some clarity on matters relating to governance and SMCR matters. It would be impossible to cover all matters here, but here are some headlines:

• the SMCR borrowed the 'significant IFPRU' definition to determine which firms would be categorised as enhanced. With IFPR scrapping the IFPRU regime and therefore removing the significant IFPRU definition there were questions around how this would impact firms' SMCR categorisation. The FCA has confirmed that it will retain the 'significant IFPRU' definition but rename the definition to be 'significant SYSC'. The substantive thresholds that underpin this term will not change. This means all firms who are currently significant IFPRU firms will remain Enhanced firms and other firms should be aware that, once the different UK classifications of MiFID firm (IFPRU, BIPRU, Exempt CAD etc.) are abolished on 1 January 2022, if they meet significant SYSC thresholds in the future they too will become Enhanced firms.
• currently, members of significant IFPRU firm management bodies are subject to specific limits on the number of directorships they may hold at any one time (SYSC 4.3A.6R). The FCA will change 'significant IFPRU firm' to 'significant SYSC firm' for this rule also.

We are doing a significant amount of work on IFPR, including in relation to the governance aspects. The volume of information provided in the consultation papers can be quite daunting so please get in touch with us or alex.ainley@simmons-simmons.com (Partner, FS Regulatory) if you have questions.

7. Issuing statutory notices - a new approach to decision makers - FCA

It might not sound like the most interesting topic, but in July the FCA made proposals on issuing statutory notices (CP 21/25) which (if implemented) would involve significant erosions of the Regulatory Decisions Committee's (RDC) role in authorisation and supervisory decisions. Whilst we can see the benefits of the FCA being able to make quick decisions (e.g. where delay can negatively impact the protection of consumers or where a firm or individual cannot progress in their role without confirmation of their approvals), we know many clients have felt unsettled by the proposals and there is a concern that the RDC plays an important role in providing a check and balance to the decisions made by the Supervision, Authorisation and Enforcement teams at the FCA.

As a result, we have worked with many of our clients to put together a comprehensive response to the consultation paper. If you would like to know more, please contact us by reply or emma.sutcliffe@simmons-simmons.com (Partner, Contentious Regulatory and Investigations).

8. FCA's final notice in relation to Jon Frensham - relevance of non-financial misconduct outside the workplace to F&P

The FCA's final notice in relation to Jon Frensham withdraws his current SMF approvals as SMF 3 (Executive Director), SMF 16 (Compliance Officer) and SMF 17 (MLRO) and prohibits him from performing any function in regulated financial services on the basis that he is not fit and proper (lacking integrity and reputation) following a conviction for attempting to meet a child under the age of 16, following acts of sexual grooming. This follows the 31 August 2021 direction from the Tribunal dismissing Mr Frensham's reference.

The Tribunal's decision was interesting, particularly in the context of the High Court's decision in connection with Ryan Beckwith which the Upper Tribunal referenced because whilst it ultimately upheld the FCA's decision (i.e. that his actions deviated from legal and ethical standards and exploiting those more vulnerable) due to his dishonesty during the process, it also said that the basis on which the FCA linked Mr Frensham's lack of personal integrity to his professional role on the basis of the nature of the offence alone was "speculative and unconvincing". The Tribunal went so far as to say that if it had been asked to decide the case on the basis of the conviction alone then it may have asked the FCA to reconsider its finding.

This decision reflects the current challenges which firms have in establishing which matters outside the workplace should properly form part of the assessment of fitness and propriety and/or amount to conduct rule breaches. To discuss this in further detail please do get in touch.

9. Financial crime risks and Afghanistan

We have all been shocked by the news in relation to Afghanistan and continue to follow the situation closely. However, we want to flag the FCA's reminder that firms should be aware of the possible impact these events may have on patterns of financial activity when they assess risks related to particular customers and flows of funds.

This will be particularly relevant to the Senior Manager with prescribed responsibility (d) for financial crime and they may want to consider the reasonable steps they are taking to ensure that they are compliant with the FCA's expectations in this regard.

10. Global legal and business outlook

Finally, our agenda went live yesterday for our flagship event, the Global legal and business outlook (formerly the Autumn legal update). This two-day, virtual event on 12 and 13 October will help you to shape your thinking of what the future will hold from a legal and business perspective. The event is free to join and you can choose which sessions to attend to suit your interest and availability. We'll cover topics over 40 virtual sessions, including:

• Regulatory change
• Horizon scanning
• The future of work
• Culture
• ESG
• Managing risk
• Strategic growth
• Digital transformation
• The future of financing 

Read more about the event, and register here.