SMCR+ View – January 2023

We hope you had a restful festive period and enjoyable start to the New Year. We bring you the first SMCR+ View of 2023 all the way from New Zealand with some guest editors in London. There’s certainly enough to keep us busy - a lot of Final Notices with some lessons learned as well as a section on the PRA/FCA’s consultation on bonus caps! On the Edinburgh Reforms front, we’ve provided the most recent position from Government – we think it is unlikely radical changes would be made to the Regime, or that it will be scrapped altogether.

As always, please do reach out to us with any feedback or questions, or any enhancements you would like to see throughout 2023.

1. Edinburgh Reforms

Andrew Griffith, Economic Secretary to HM Treasury, gave evidence in the Treasury Select Committee on 10th January in which he made the following comments:

• The UK needs some form of SMCR and so it will absolutely not be scrapped.
• It appears that SMF authorisations are taking too long, which can interfere with business. Depending on consultation feedback, action may need to be taken.
• There is a question as to how far down within an organisation SMCR should go.
• The key point is that SMCR is about financial risk. Broader areas are perhaps less relevant and matters such as diversity, inclusion and environmental issues are important but perhaps better dealt with elsewhere.
• Proportionate application of SMCR, particularly to smaller banks, is worth considering.
• Views will be sought on what the significance is of the relative lack of SMCR enforcements.
• The Treasury might consider asking whether people think SMCR is making it harder to recruit from overseas.

The highlighted comments are particularly interesting because they do hint at a possible change in scope. It is not clear whether Mr Griffith meant that too many people are being certified or whether he was saying that there is not much point in having conduct rules staff below certified staff. We shall have to see what the consultation says.

The point about financial risk being key seems to suggest that the ambit of the conduct rules and potentially the fit and proper regime might be revisited and narrowed.

At this stage, this is still just talk and so much of this may or may not happen. But it is fascinating that the Government is looking at SMCR through the competitiveness and commerciality lens and beginning to ask whether SMCR is a brake on business. Watch this space!

2. CP 15/23 – The PRA and FCA’s joint Consultation Paper on the bonus cap – dual regulated firms

As part of the UK’s post-Brexit drive to become more competitive and with the backdrop of the UK regulators opposing the bonus cap during EU negotiations originally, this joint PRA and FCA Consultation Paper effectively proposes the removal of the current bonus cap requirements. The aim is to undo the unintended consequences of the bonus cap, such as the growth in the proportion of the fixed component of total remuneration, which then impacts firms’ ability to adjust costs to absorb losses, amongst other things. This is applicable to banks, PRA-designated investment firms and building societies. It isn’t relevant for solo-regulated firms, insurers or credit unions, but solo-regulated firms which are part of a group to which the dual regulated firms’ remuneration code applies on a consolidated basis will find this of interest.

We’re not going to go into detail here on the proposals, but the regulators are looking to delete certain rules in both the PRA Rulebook (Remuneration) and SYSC 19D of the FCA Handbook as well as amending others and the PRA guidance in Supervisory Statement 2/17.

The Bank of England also published a Staff Working Paper on bank remuneration rules and their impact. The study considers data on remuneration in six major UK banks between 2014 and 2019, focussing on the bonus cap requirements and deferrals. Perhaps unsurprisingly, the Paper found that for bankers most affected by the bonus cap, total pay growth did not decrease, but compensation shifted from bonuses to fixed remuneration. There was also evidence that requiring bankers’ bonuses to be deferred for longer periods correlated with increases in total compensation and a lower proportion of bonuses being deferred.

These publications will be of particular interest to SMF 12s (Remuneration Committee Chairs) and the regulators state that where appropriate they may discuss firms’ approach to incentive setting and remuneration with the relevant SMF. In addition, Heads of HR (who may also be SMFs) as well as reward/incentives teams will find this of interest. The regulators also outline that these changes may also mean there is scope to improve the alignment/interlock between the SMCR and remuneration regimes to further support accountability for risk taking.

The consultation closes on 31 March 2023, and the regulators anticipate the proposed changes coming into force in Q2 2023 and applying to firms’ performance year starting after that date (so likely performance years starting 2024).

For more information, please do reach out to Tair Hussain (Partner).

3. Future supervision priorities of Financial Market Infrastructure (“FMIs”) – BoE

In December, the Bank of England published its Annual Report on its supervision of FMIs, detailing the approach of the BoE over the period of December 2021 to December 2022, as well as the BoE’s future priorities in relation to FMIs. In relation to SMCR, the BoE flags that one of its priorities for 2023 is to develop the SMCR for CCPs and CSDs - the rationale being the establishment of clear personal responsibility for decisions made by CCPs and CSDs which could have a material impact on firms’ operations and therefore their financial stability. The BoE has confirmed that it will continue to design and develop policy in this area throughout 2023 and it will be interesting to see how this develops in light of Jeremy Hunt’s Edinburgh Reforms proposals in relation to the SMCR Call for Evidence.

If you missed our Edinburgh Reforms webinar ahead of the festive break please see a replay here. For future updates on the Edinburgh Reforms, please sign up to Edinburgh Reforms View here and contact Alex Ainley (Partner) if you���d like to discuss further.

4. Consumer Duty – FCA webpage updates and podcast

For many of you, implementation of the Consumer Duty (“Duty”) will be a 2023 priority. The FCA has released an “Inside FCA Podcast” on the Duty which explains how they expect firms to assess their products and services, and can best prepare for the implementation deadline in July 2023. A transcript is also available. We expect this podcast series from the FCA will touch on the Consumer Duty again, perhaps focusing on other outcomes and/or cross cutting rules, so watch this space.

The FCA has helpfully updated its webpage on Consumer Duty to provide information on the following matters including Outcome monitoring; requirements on firms seeking authorisation; the application of the Duty to non-UK firms and non-UK customers, together with how the Duty applies throughout the distribution chain (including those with no direct customer relationship).

Aside from implementation teams, firms may wish to also post their Consumer Duty Champions (“CDC”s) who may also be Senior Managers on these updates.

More generally we are supporting CDCs on how to define their key roles and responsibilities. Please do get in touch with Penny Miller (Partner), Caroline Hunter-Yeats (Partner), or Rosie Davies (Supervising Associate) if you have questions on the intersection of the SMCR and the Consumer Duty, or if we can assist you with your Consumer Duty implementation more broadly. Sign up for Consumer Duty View here.

5. Portfolio Letter – Claims Management Companies (“CMCs”)

The FCA’s Portfolio Letter to CMCs sets out the FCA’s view on the key areas of harm and risk that CMCs pose to their consumers or markets, and confirms the FCA’s expectations of CMCs and their supervisory strategy in this regard. On a governance front, the FCA highlighted that one of the key harms was the inappropriate sourcing of customers, and this originated from poor-quality governance and a lack of oversight within CMCs, amongst other things. The FCA confirms that ensuring CMCs have appropriate governance and systems in place is a key priority, and the FCA will expect CMCs to be able to demonstrate this.

6. FCA Portfolio Letter – Wholesale Brokers

The FCA has published a Portfolio Letter to wholesale broker firms detailing what the FCA considers to be the most important risks for these firms, what drives these risks and the FCA’s supervisory focus for the next two years. In relation to governance, the FCA notes that although it has seen some improvements in larger firms, wholesale broking firms are seen generally to be behind other firms when it comes to preventing poor conduct and improving culture. As a result of this, the FCA has confirmed that improving governance and culture will be a key focus, especially in relation to the following:

• The role of the board in instilling a healthy culture at the firm, and providing effective challenge to management to improve decision-making;
• Ensuring Senior Managers possess adequate and appropriate skills to make decisions with appropriate consideration of the risks involved. The FCA confirms that, particularly in firms that have been subject to whistleblowing or enforcement investigations, poor decision making and failures in oversight played a key role. The FCA therefore reiterates the importance of embracing the SMCR;
• Ensuring regulatory references are taken into account when hiring new certified staff and considering appropriate risk mitigations when adverse information comes to light. This is an area which the FCA has identified as being particularly weak; and
• Ensuring boards are informed on financial resilience and remuneration, as the FCA flagged that where weaknesses in these areas are seen, the FCA will scrutinise the effectiveness of the Board’s decision making.

The FCA expects all CEOs of wholesale broking firms to have discussed this letter with the board and agreed upon actions by the end of February 2023.

7. Whistleblowing quarterly report - FCA

The FCA have published their quarterly whistleblowing data showing the number of reports made July-September 2022 (Q3). In Q3, the FCA received 291 new whistleblowing reports containing 734 allegations (the majority were reported via the online form). 120 allegations relating to compliance (i.e. allegations where a firm is not applying governance to an activity), 100 allegations related to F&P, and 99 allegations related to firm culture. To discuss this further, please contact Richard Sims (Partner).

8. PRA and FCA fine TSB Bank plc (“TSB”) for operational resilience failings

The PRA and the FCA have collectively fined TSB over £48 million for operational risk management and governance failures. We’re paraphrasing, but essentially in 2018, TSB undertook what the regulators considered an ambitious and complex programme to migrate TSB’s IT platform to a new one – the migration involved a high level of operational risk and its success was crucial to the continuity of critical functions. Following the main migration event, the new platform experienced serious issues resulting in significant disruption to TSB’s banking services and impacting customers’ access to their accounts. The issue caused over 225,000 complaints from customers and over £32 million being paid in redress.

The regulators found that TSB had failed to take reasonable care to organise and control the migration programme adequately – including managing outsourcing arrangements with a third party supplier and finding that risks had not been adequately identified, assessed or dealt with and there were also governance failings regarding escalation and challenge. Specifically, the FCA reference decisions being taken outside of the appropriate governance forums and structures and there being insufficient discussion of key matters relating to the programme with the TSB Board (such as the timetable for migration, deviations from approved aspects of the plan and related implications to the risks arising from the migration).

Not only does this highlight the importance of good governance structures and their importance for firms, Senior Managers and their reasonable steps, but it also should be considered by firms in the context of system changes and/or mergers/acquisitions and the transition of firms from one platform to another and their broader integration.

For more information on this please contact Emma Sutcliffe (Partner).

9. FCA publishes Final Notice against Bellamachina

This Final Notice against Bellamachina Ltd cancelled the firm’s Part 4A permission. In 2020, as a result of the company’s transfer to a third party, the sole approved person resigned as a director leaving no other individuals in the company approved to perform the SMF. The FCA repeatedly requested that the firm complete and submit a Form A (SMF application form), but the firm failed to co-operate and respond adequately to the FCA. Following a Warning Notice, the FCA concluded that the company was not a fit and proper person as it had failed to satisfy the FCA that its business was being managed in such a way to ensure its affairs would be conducted in a sound and prudent manner.

Whilst this is a fairly unusual set of facts, this is a good chance to remind firms of the FCA’s expectations around succession planning of SMFs and putting in place appropriate transition plans for SMFs moving out of and into new SMF roles.

To discuss this further please contact Emma Sutcliffe (Partner).

10. FCA publishes Final Notice against Guaranty Trust Bank (UK) Limited (“GT Bank”)

A less happy start to 2023 for GT Bank following the FCA’s Final Notice fining the firm over £7.5 million for serious weaknesses in its anti-money laundering systems and controls. A focus of the FCA’s Notice is GT Bank’s failure to implement a culture where customer facing teams gave adequate consideration to the money laundering risks posed by customers. The FCA found that this failure stemmed from a lack of understanding within these teams, consistent disregard for processes and procedures, and insufficient steps being taken to improve the culture when the issue was known at senior management level. Reference is made in this Notice to the failure of senior management and may be of particular interest to those holding the SMF 17 (MLROs) function and/or with prescribed responsibility (d) for financial crime. However, there is a more general point here for Senior Managers to consider in relation to their reasonable steps and ensuring that they are overseeing their teams effectively, ensuring they have the right knowledge and skills to perform their responsibilities effectively and that the relevant processes and procedures for their areas of the business are operated appropriately.

To discuss this further please contact Emma Sutcliffe (Partner).

10. FCA publishes First Supervisory Notice for Pello Capital Limited (“Pello”)

The FCA published a First Supervisory Notice placing certain restrictions on Pello. By way of background, in 2021, the FCA required Pello to commission a section 166 review of its governance and oversight framework, including its senior management’s effectiveness in their oversight of regulated activities, amongst other things. The section 166 report made 51 “high” priority recommendations, some relating to failings in Pello’s governance and oversight framework (a summary of which are below) – these will be interesting to firms in relation to their governance and SMCR frameworks and operation internally. It’s also worth noting that Pello did not have a large SMF or certification population. Often smaller firms consider themselves less exposed to regulatory scrutiny in relation to governance / SMCR matters but this is an example of the FCA taking an interest in a smaller firm and how onerous restrictions/requirements imposed by the FCA can be on resources.

• Governance framework: The board and committee structures were not sufficiently or consistently documented, nor had the overarching governance framework been fully implemented. There were also inconsistencies in recording and staff understanding of their roles, responsibilities and reporting lines;
• Lack of independent challenge: Pello’s executive directors were involved in the daily management of Pello and there are no independent, non-executive directors;
• Decision-making: The review found the decision-making process unclear, with an absence of formal terms of reference for key committees, creating a risk of decisions being made outside of the formal governance structures;
• Management information: The information was primarily comprised of financial information with no analysis or commentary and was found to be significantly under-developed. There were also no formally documented management information packs for the committees;
• Risk function: There was not a defined Risk Function, nor allocated risk resources, and it was therefore unclear who was responsible for risk at Pello;
• Compliance function: The Compliance Function did not have formal skills matrices or adequate training to ensure staff were prepared for their roles. Compliance resources were stretched and deficiencies were found on compliance reviews; and
• Statements of Responsibility: Pello did not have accurate and current Statements of Responsibility for its SMFs, and fitness and propriety assessments had not been completed for all relevant individuals. Training on SMCR was also found to be lacking.

To discuss this further please contact Emma Sutcliffe (Partner).