SMCR+ View - July 2022

In true British style we couldn’t start this month’s SMCR+ View without a comment on the weather…we hope that you’ve all been able to enjoy some of the sunshine and haven’t melted in the heat. Just like the temperatures, this edition is a bumper one so brace yourself!

1. SMCR and Temporary Permissions Regime – TPR firms (FCA)

We’ve been helping a number of firms in the TPR and we are seeing the FCA take a particularly robust stance on Senior Management Function allocations, particularly for those becoming third country branches. For third country branch applications, we have seen the FCA require a minimum of two Senior Managers in the UK and a push for the SMF 16 to be based in the UK (despite there being no rule requiring this). The FCA have suggested that simply mapping old EEA branch SMF structures across to a third country branch isn’t sufficient and firms need to ensure that there are adequate governance arrangements of substance in place. This guidance, plus the FCA’s pushback on SMF 19s also holding the SMF 16/17 role because of a blurring of lines of defence can be problematic for smaller firms with light senior coverage within the UK.

We are doing a lot of work in this area so please get in touch if you’d like to discuss your proposed Senior Manager allocations and the TPR more broadly.

2. Non-financial misconduct podcast

Our very own Penny Miller was a speaker on the podcast Following the Rules with Lucy McNulty and Mark Turner where the discussion focussed on non-financial misconduct (NFM). If we say so ourselves, the podcast has some really interesting insights and covers FOI data outlining that the FCA had received 194 notifications relating to NFM amongst senior staff at banks - 146 of these related to breaches of covid restrictions, 33 related to bullying, and 23 to racism. The FCA also received 552 notifications relating to senior staff at funds - 500 related to breaches of covid restrictions, 43 related to racism, and 11 to bullying.

In the FOI response the FCA said it could neither confirm nor deny whether it had opened any enforcement investigations into non-financial misconduct in 2021. This doesn’t necessarily mean that there aren’t any cases and may mean that there are a small number which is why they cannot disclose under s.31 of the FOIA. This is something we will be following closely and is particularly interesting with the backdrop of the FCA’s July 2022 Perimeter Report where they state that they may be able to take action under the SMCR against individuals for unregulated activities.

If you would like to discuss non-financial misconduct and the content of the podcast further, please contact Penny Miller (Partner) or Emma Sutcliffe (Partner).

3. FCA Operating Service Metrics 2021/2022

On theme…“hot” off the press is the FCA’s published operating service metrics for 2021/2022. Included is reference to the backlog of approved person applications. They include data showing there has been a marginal improvement from 85.7% to 85.9%....(!) of the applications for CF and SIF roles being responded to within 3 months during 21/22. The FCA reference a significant number of solo-regulated firm SMF applications received on 9 December 2019 (implementation day) and COVID-19 as being causes for the delays and flag that they have recruited 95 new people with more to follow (and in addition to temporary resource that is already supporting them). We will watch this space carefully as we know of many of you are still struggling with FCA delays in relation to SMF applications.

They also highlight that there are 2 open cases relating to voluntary requirements in respect of Individual – honesty, integrity and reputation. There is plenty more enforcement data included for those interested.

To discuss this or the enforcement data in more detail please contact Emma Sutcliffe (Partner) or Richard Sims (Partner).

4. Dear Chair letter to retail banks – FCA

Following their review of regulated SME lending, the FCA wrote to Chairs of retail banks with Small Medium Enterprise (SME) customers outlining their concerns around poor customer outcomes and failures to treat customers fairly – eg gaps in policies and procedures, inadequate training, absence of outcomes testing, amongst others.

Chairs (SMF 9) need to read and act upon the letter (eg putting the Board on notice). Boards must consider and address issues identified promptly, where necessary. Relevant Senior Manager(s) must proactively engage to achieve good practice when overseeing SME collections and recoveries and should take an active role in addressing the concerns raised in the letter and keeping the Board appraised. They should also attend meetings where key SME issues are discussed to ensure there is effective oversight and (where relevant) have clear, demonstrable oversight of third party outsourcing arrangements (things the FCA said was lacking in some firms). Senior management should also be receiving effective management information (MI) allowing holistic oversight of SME customer treatment during collections and recoveries. Senior Managers may consider this point in light of their reasonable steps and look to enhance the MI already received to the extent it doesn’t have content covering SME customer outcomes / metrics measuring fair treatment.

The FCA are keen all firms with SME customers consider their findings to see if there is read-across. The FCA is clear it doesn’t want firms to wait for the Consumer Duty final rules before acting to improve consumer outcomes. If you would like to discuss this or the incoming Consumer Duty in more detail please do get in touch with Penny Miller (Partner), Alex Ainley (Partner) and Caroline Hunter-Yeats (Partner). We are doing a significant amount of work on the Consumer Duty and would be delighted to discuss how we can help you further.

5. Model Risk Management principles for banks (CP 6/22) - PRA

CP 6/22 sets out the PRA’s proposed expectations regarding banks’ management of model risk. One proposal is that firms identify and allocate responsibility for the overall model risk management framework to a Senior Manager - likely the Chief Risk Officer (SMF 4). The FCA consider this the most effective way of creating clear responsibility for the establishment of a model risk management framework given models can be used across different parts of a firm. This might mean updating Statements of Responsibilities and management responsibilities maps.

Another proposal relates to reporting on the effectiveness of model risk management for financial reporting to the Audit Committee (at least annually) which may require updates to firms’ governance architecture and management information flows.

6. Insurance SPVs (CP10/22) – PRA

This Consultation Paper sets out proposed clarifications on the number of SMF holders needed for an Insurance SPV (ISPV), amongst other things. The PRA proposes that for ‘standard’ applications a single person with relevant skills/experience could hold/perform more than one of the three required SMF roles. However, for ‘complex’ applications, the PRA proposes that the three SMF roles may need to be held by separate individuals but that this will be assessed on a case by case basis. This clarification should help firms in having the right mix of SMFs proportionate to their complexity.

7. Resolvability assessment of major UK banks: 2022 – Bank of England

The Bank has published its findings from its first assessment of the resolvability of eight major UK firms as part of the Resolvability Framework. The Bank highlights how previously there was no management accountability or obligation to prepare for resolution, but now Boards and senior management are accountable for resolvability and must prepare for the actions they would need to take. Whilst the Board and senior management in most firms appeared to be suitably engaged on the adequacy of firms’ resolution capabilities, a minority had limited evidence of sufficient engagement. The Bank highlighted the importance of ensuring that resolvability has appropriate attention. In its section on next steps, the Bank outlined that resolvability considerations should be part of strategic decision-making and Boards / senior management should continually consider what further testing and/or exercises are required to maintain a sufficient level of assurance of their firm’s resolvability.

8. Remuneration: Unvested pay, Material Risk Takers (MRTs) and public appointments (CP 8/22) – PRA

This is already turning out to be one of our longest ever updates so we’re not going to delve into too much detail here, but we want to flag CP 8/22 - the PRA’s proposed expectations regarding changes to the instruments or claims that comprise unvested, deferred sums awarded to MRTs as part of their variable pay. The PRA propose to update SS2/17 – Remuneration with a summary of the minimum deferral and clawback requirements across MRT categories. The proposed updated wording includes reference to variable remuneration paid to SMFs.

For more information on this and remuneration / MRTs more generally, please contact Tair Hussain (Partner).

9. What will operational resilience look like going forward? Speech by Duncan Mackinnon, PRA

This speech sets out where the PRA expects firms to focus as they work towards building operational resilience by March 2025. The speech impressed the importance of Boards and senior management’s close engagement on operational resilience to ensure the relevant work gets done and the PRA highlights that firms will have to justify how they came to the conclusions they have, and demonstrate that the tolerances they have set will protect safety and soundness and financial stability. There is also reference to the Board and senior management being involved and engaged with testing results, as appropriate.

10. Four Rs: Creating the conditions for long-term sustainable growth in the life annuity sector – Speech by Charlotte Gerken, PRA

This speech relates to the bulk purchase annuity sector, and we do want to flag that there is a section on the responsibility of the Board and the PRA’s expectation that Boards are responsible for running their businesses prudently, consistent with safety and soundness expectations.

11. Anti-money laundering controls – FCA

In this decision notice the FCA fined Ghana International Bank Plc £5.8m for anti-money laundering control failings. This decision will likely be of interest to SMF 17s (MLROs) in firms conducting correspondent banking activities, but there is likely read across for other firms, particularly in relation to ensuring there is appropriate senior management engagement and escalation.

12. Financial Market Infrastructures / Payments and e-money firms – FCA

The government’s response to extend the SMCR for Financial Market Infrastructures was published in June confirming that creating an SMCR for FMIs remains a desirable and effective means of achieving the government’s objectives of enhancing individual accountability. There aren’t any specific timings published but the government will legislate to create a new SMCR “gateway”, when parliamentary time allows, enabling HM Treasury to lay statutory instruments to apply the SMCR to CCPs, CSDs, and, in the future, potentially to credit rating agencies and recognised investment exchanges (although for these latter two it would be subject to further specific consultation). The FCA’s July 2022 Perimeter Report outlined its view that extending the regime to RIEs and CRAs would promote market integrity and allow the FCA to ensure consistency in their supervisory expectations of senior individuals which was highlighted as an important issue in the recent LME/nickel episode.

The government will legislate to implement SMCR for recognised payment systems and specified service providers, but this will be done separately and to a different, longer timeframe to account for a forthcoming review of the regulatory perimeter for systemic firms in payments chains regulated by the Bank of England. The FCA’s July 2022 Perimeter Report also outlined their view that the SMCR should be extended to payments and e-money firms. For more on this and payments more generally please sign up to Payments View or email Oli Irons (Partner).

13. Enhancing climate-related disclosures by standard listed companies and seeking views on ESG topics in capital markets (CP 21/18) – FCA

In their consultation paper on extending the application of climate related disclosure requirements for commercial companies with a UK premium listing to issuers of standard listed equity shares (excluding standard listed investment entities and shell companies), there is a small section outlining that improving the quality/quantity of disclosures has a significant role for senior management. The FCA consider their proposals will enhance the ability of senior management of issuers to take responsibility for their decisions by providing a framework that will encourage them to think about the governance and risk management of climate-related risks and opportunities and their companies’ climate-related strategies. For regulated firms subject to the SMCR, the FCA believe that setting out the extended application of TCFD-aligned requirements will help senior managers discharge their obligations under the SMCR.

14. Dear CEO letter – rising cost of living - FCA

In mid-June, the FCA wrote to CEOs of firms regarding rising living costs and actions to be taken to support consumers. The FCA sets out its expectations of firms which includes providing appropriate care and support, giving tailored forbearance, supporting borrowers showing signs of financial difficulty or struggling with debt, amongst other things. There is no specific reference to the SMCR and/or the role of Senior Managers, but clearly CEOs (SMF 1s) and other Senior Managers with relevant responsibilities need to understand the FCA’s expectations and ensure that they are taking appropriate reasonable steps.

15. Diversity & Inclusion and culture

First off, if you’re not already signed up to our D&I View then you absolutely should be (sign up here). Read our latest version here.

The long awaited consultation paper on the regulatory proposals to support diversity in financial services is expected in Q3 2022 with a Policy Statement to follow in 2023 (indicated for between April-September). Despite the long wait, D&I and culture has been a common theme in Dear CEO letters and speeches of late. In particular, Nikhil Rathi (CEO of the FCA) delivered a speech on how the UK will regulate for the future. The speech touches on the use of data and technology and crypto asset regulation, amongst other things. It also reiterated that D&I is a regulatory issue as a less diverse and inclusive leadership team risks bias which when left unchecked, can result in poorer risk management. Similar comments were made in this speech made by Sarah Pritchard on Finding opportunity in a world of uncertainty at the end of June. There was also the FCA Board’s consideration of their new proposed D&I framework which they hope will put D&I at the core of firms’ culture and practices. It was noted that the FCA is seeking to have consistent standards across the industry, whilst also recognising the importance of proportionality.

D&I and culture was also a common thread running through the flurry of Dear CEO / Dear Board of Director letters sent to different types of firms (see links to these below). Some of the letters linked these topics to ESG – ie governance and culture will be critical drivers and enablers of a firm’s performance on environmental and climate matters. The FCA also outlined D&I as a key component of ESG both in its own right and as an enabler of creative solutions to other environmental/social challenges. The FCA also talked about supporting diversity of thought and repeated the narrative above that firms which lack diversity are more prone to group-think, thus may not understand customer needs, potentially leading to consumer and market harm.

In this Dear Board of Directors letter to Lloyds and London Market Insurance Intermediaries there was another example of the FCA tying prudent risk management back to culture. The FCA stated that, despite positive evidence of culture improvements, there remains “significant risk” that poor underlying cultures may lead to poor customer outcomes and impact the integrity of the market. In almost all instances of poor conduct identified by the FCA, the FCA has suggested deep cultural issues have been present. The FCA also outlined that the steps taken to address NFM throughout the firm including discrimination, harassment, victimisation and bullying is indicative of a firm’s culture.

A list of relevant letters is below.
a. Dear CEO letter – FCA Supervisory Strategy for the Debt Advice portfolio
b. Dear CEO letter - FCA Supervisory Strategy for Lifetime Mortgage Providers – the FCA also reminded relevant firms that they should have completed the certification process for relevant individuals and uploaded them to the FCA’s Directory. There was also a reminder that tailored training should have been provided to those subject to the conduct rules.
c. Dear Board of Directors letter – FCA Supervisory Strategy for Lloyd’s and London Market Insurance Intermediaries – in addition, a key area of harm identified was product suitability and price transparency. The FCA expressly state that Senior Managers and Boards must deliver regulatory changes effectively and be fully engaged on issues in relation to value and pricing.
d. Dear Board of Directors – FCA Supervisory Strategy for Personal and Commercial Lines Insurance Intermediaries - one risk highlighted was Governance and oversight. The FCA outlines some critical components of good governance – eg ensuring there are clear accountabilities, appropriate channels of escalation and a strong and independent Board oversight and challenge. The letter also has a section on the SMCR where it states that firms should be developing a culture for staff at all levels to take personal responsibility for their actions and ensuring staff can clearly understand and demonstrate where responsibility sits.

To discuss the FCA’s D&I agenda further please do get in touch. We also have our D&I Toolkit and for more information on this please contact Fiona Bolton (Partner) or Lauren Dickinson (Supervising Associate).