SMCR+ View - June 2023

With temperatures and humidity inching upwards, Glastonbury fever still upon us and Wimbledon just around the corner, summer is now well and truly here! This month saw us submit responses to HM Treasury's Call for Evidence and the PRA/FCA's joint Discussion Paper on the SMCR. Thank you to all of those who participated in discussions with us and completed our questionnaire - we had 66 responses to this, which was very helpful for framing our responses. If you'd like to discuss our responses then please do let us know.

This SMCR+ View focuses on culture and non-financial misconduct (a hot topic), a PRA Dear CRO Letter, FCA consultation on remuneration rules for dual-regulated firms, and several final notices.

As always, please do reach out with any questions or feedback you have.

1.     FCA - Non-financial misconduct and culture within financial services: FCA speech, Treasury Select Committee letter to the FCA and more

While culture and non-financial misconduct has always been on the FCA's agenda, it is making something of a resurgence at the moment: from the incoming Consumer Duty and the FCA's expectation that it drives a culture shift for relevant firms, to the FCA's speech this week on how culture is central to the FCA's supervisory model and how culture must change to meet expectations. The speech reiterated the importance of senior individuals working in financial services being assessed as fit and proper (they state that not disclosing arrests or convictions may lead to a ban from financial services) and firms' key role in preventing "rolling bad apples" (there is specific mention here to wholesale brokers and some firms turning a blind eye to previous misconduct including sexual harassment). This is particularly interesting in terms of how firms respond to adverse regulatory references and the scope for putting in place appropriate controls to prevent individuals who do have a history of misconduct from repeating their behaviour.

This topic is something that we know is at the forefront of firms' minds given the recent press around non-financial misconduct and the latest Treasury Select Committee letter to the FCA, in which Harriet Baldwin MP (Chair of the Committee) stated "Culture in financial services, and the experiences of women in the industry, are ongoing concerns of the Treasury Committee." There is also the latest press on the Lloyd’s Enforcement Tribunal’s decision in relation to the Lloyd’s Atrium misconduct probe (we mentioned the initial matter in March 2022’s SMCR+ View) which will be of interest to insurers particularly.

As you will know from SMCR+ View and our Conduct Hotline, we have a wealth of experience amongst our cross-practice Employment, Regulatory, Investigations and Disputes team. This covers advising firms on culture, conduct risk and misconduct (both financial and non-financial) matters, when there is a live complaint which needs to be addressed properly, when firms are taking a proactive review of their broader policies and processes or if they are doing a retrospective audit of past processes and decisions. In addition to advising on employee litigation and regulatory scrutiny, we do several briefings for firms and Boards (particularly around the risks associated with poor culture from both a regulatory, litigation, reputational and commercial perspective), culture reviews, and more. We would be delighted to come and speak to you about this if it would be of interest.

One final area mentioned in the FCA's speech which is particularly interesting and which firms may also want to discuss is the FCA's example of 'good practice' where firms which receive a qualified regulatory reference proactively contacted previous employers for more information and clarification of the facts included, and carried out their own investigations.

If you have any questions, please reach out to any of the following individuals: Emma Sutcliffe (Partner), Penny Miller (Partner), Andrea Finn (Partner), Fiona Bolton (Partner), Darren Fox (Partner), Richard Sims (Partner) or Amy Sumaria (Supervising Associate).

2.     PRA - PS 6/23 on model risk management ("MRM") principles -- banks, building societies, and designated investment firms

Cast your mind back to SMCR+ View in June 2022 (a stretch, we know) where the PRA published CP 6/22 which set out its proposed expectations regarding banks' management of model risk. The PRA has now published PS 6/23 together with its final text of a new SS 1/23 on MRM principles which will be effective from 17 May 2024. Importantly there has been a change in scope and the final policy in SS1/23 only applies to firms with internal model (IM) approval to calculate regulatory capital requirements (IM firms). This is broadly because in the consultation it proposed that the principles were adopted in a proportionate way and there was reference to ensuring proportionality in respect of "simpler regime firms". However, the definition of 'simpler regime firms' has not been finalised and so the scope of the PRA's expectations has been narrowed to only apply to IM firms.

There are a few key SMCR+ points to note (and we would recommend reading through Principle 2 guidance particularly):

• In CP 6/22, Principle 2 stated that firms must"have strong governance oversight with a board that promotes an MRM culture from the top through setting clear model risk appetite. The board approves the MRM policy and appoints an accountable individual to assume the responsibility to implement a sound MRM framework that will ensure effective MRM practice". The PRA has clarified that an appropriate Senior Manager is expected to assume overall responsibility for the MRM framework, its implementation, and the execution and maintenance of the framework. Firms have flexibility to allocate responsibilities to more than Senior Managers and their statements of responsibilities should be updated accordingly. The PRA considers the responsibilities to be additional and complementary to responsibilities of SMFs for business, risk and control functions. Principle 2.2 (page 12/13) has more on the PRA's expectations of the SMF(s) responsible.
• Whilst no changes have been made to the rules and expectations relating to Audit Committees, SS 1/23 has clarified that the intent is for a report on the effectiveness of MRM for financial reporting to be made available to the Audit Committee on a regular basis (at least annually).
• Before the policy comes into effect, firms should conduct an initial self-assessment of their implemented MRM frameworks against the PRA's principles and (where relevant) prepare remediation plans to address any enhancements required. This should be reviewed/updated at least annually and findings from both the self-assessment and the remediation plans should be documented and shared with firms' Boards in a timely manner. The Boards should also be updated regularly on remediation progress. Relevant accountable Senior Manager(s) will be responsible for ensuring that remediation plans are put in place where necessary with clear ownership of necessary actions. Principle 2.1 (page 11/12) has more on the PRA's expectations of the Board.

If you have any questions, please contact Penny Miller (Partner) or Amy Sumaria (Supervising Associate).

3.     Upper Tribunal Decision on FCA Decision Notices against 3 individuals

More recently, in December 2022 SMCR+ View, you may remember we discussed the Decision Notices published by the FCA against three individuals at Julius Baer International Limited (JBI) for lacking integrity in relation to certain transactions entered into resulting in serious risks of financial crime. The individuals referred the Decision Notices to the Upper Tribunal (UT), which disagreed with the FCA and, in a decision published on 12 June 2023, remitted the matter to the FCA with a direction for the FCA to reconsider its decision to prohibit the individuals in light of the Tribunal's findings.

The UT was of the view that it would be "irrational" for the FCA to make a prohibition order against any of the individuals on the grounds that they acted without integrity. The UT noted several instances where the individuals demonstrated "varying degrees of a lack of competence and capability" and instructed the FCA to reconsider the decision taking into account specific matters, including:

• There was no allegation of wrongdoing in the UK by Mr Selier or Mr Raitzin, and the primary regulator was FINMA (the Swiss regulator), who reviewed the matter and decided to take no action;
• The FCA took no action against any individual in the UK who was responsible for the systems and controls at JBI which it found to be "severely deficient";
• The serious delays in bringing the proceedings against the individuals given the events happened in 2010 and 2011 (and such proceedings have been unduly prolonged);
• There is evidence of rehabilitation in respect of Mrs Whitestone starting some time ago.

This isn't the first time the UT has disagreed with the FCA's grounds for a decision notice (although in this case the UT fell short of concluding that the FCA's decision was unreasonable). The FCA's statement pointed to the UT's criticism of many aspects of each individual's conduct, albeit the UT found that such conduct was negligent rather than reckless. The FCA also recognised some of the characterisation surrounding delays, stating that many were outside their control.

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

4.     FCA - Consumer Duty

The 31 July 2023 implementation deadline for firms subject to the Consumer Duty is fast approaching. On the SMCR side we are doing a lot of work delivering effective Consumer Duty/Individual Conduct Rule 6 training to relevant individuals. This also includes Board and Consumer Duty Champion training. We have also been looking at relevant updates to Senior Managers' statements of responsibilities and the management responsibility maps (where relevant) and more broadly at updates to firms' Matters Reserved for the Board and Board Terms of Reference. More generally, we continue to work with financial services firms, including banks, asset managers, insurers, brokers and managing general agents, to support Consumer Duty enhancements such as product governance and value assessments, data requirements and broader Consumer Duty gap analysis.

You may also have seen today's recent Dear CEO letter on the rising cost of living and the expectations of Ofcom, Ofgem, Ofwat and the FCA for firms. This is something to flag to relevant firms' CEOs and also Consumer Duty working groups alongside this recent news article from Government on reaching an agreement with regulators to support consumers. The FCA have agreed to:

• Deliver better deals for savers by driving competition, including reporting by the end of July on how the savings market is supporting savers to benefit from higher interest rates. The Government have said that they fully support the FCA's review and the new Consumer Duty gives them stronger powers to take action if necessary
• Require the largest banks and building societies as part of this to explain the pace and extent of their pass through of interest rates, and how they are proactively supporting savers to switch to high interest rate products.

If any of these workstreams may be helpful in respect of your firms then please let Penny Miller (Partner), Jonathan Thorpe (Partner) or Amy Sumaria (Supervising Associate) know. Further, if you'd like to sign up to our Consumer Duty View, please click here.

5.     PRA - Dear CRO Letter - Life insurance sector

The PRA published a Dear CRO Letter, sharing insights from its thematic review of funded reinsurance arrangements in the UK life insurance sector. The review focussed on understanding transactions relevant firms enter in to, how insurers assess the benefits and risks relating to them and how this approach may impact the PRA's statutory objectives. The PRA indicates that, given the CRO is responsible for identifying, assessing, and mitigating risks to the business, and being a source of independent challenge, they are well placed to assess the applicability of the points raised in the Dear CRO letter to their business and how they are being addressed.

Firms should ensure that relevant CROs are apprised of this letter and that they appropriately consider its contents and take any remedial action necessary. The PRA notes that it is planning further supervisory work in this area. If you have any questions, please reach out to Jonathan Thorpe (Partner).

6.     FCA - CP 23/11 - Enhancing Proportionality for Dual-Regulated Firms

It feels like there's always something on remuneration these days and a signal of the UK diverging from the EU/CRD V rules post-Brexit. CP 23/11 sets out the FCA's proposals to ensure that the remuneration rules for small dual-regulated firms are proportionate. Unsurprisingly, the proposed amendments are broadly consistent with the proposals outlined by the PRA in CP 5/23, details of which we included in the March version of SMCR+ View.  In summary, the key points are that the FCA are proposing to allow smaller, less complex dual-regulated firms to be excluded from some of the prescriptive remuneration rules by increasing the applicable proportionality thresholds, as well as by removing the requirement for these firms to apply the rules on malus and clawback.

The FCA consultation closed on 9 June 2023, with final rules and guidance expected to be published in Q4 2023. For more information, please contact Tair Hussain (Partner).

7.     FCA Final Notice for ED&F Man Capital Markets Ltd ("MCM")

The FCA published a Final Notice fining MCM, a global financial brokerage firm, £17,219,300 for breach of Principle 2 (act with due skill, care and diligence) and Principle 3 (take reasonable care to organise and control its affairs responsibly and effectively). The relevant period is February 2012 to March 2015, so before the SMCR was implemented.

In summary, through its Equity Finance Desk, MCM was engaged in dividend arbitrage trading in shares of issuers in several foreign jurisdictions, with this business being approved by MCM on the basis that there would be legal and tax advice supporting every trade. Heavy reliance was placed on this legal and tax advice, given that both the Compliance Function and senior management only had a basic understanding of the Equity Finance Desk business. Despite this, the FCA found that no meaningful checks occurred regarding the existence of the legal and tax opinions and key personnel relying on them never actually saw them, with the Compliance Function also failing to probe / test the existence of them. There was also no system to ensure that the trading was carried out in accordance with the current legal and tax advice.

The FCA found that MCM had breached Principle 2 on the grounds that Compliance and senior management failed to take steps to increase their understanding of the activities of the Desk and failed to ensure risks arising from the dividend arbitrage trading were properly considered, understood, reviewed and monitored. It also found a breach of Principle 3 on the grounds that there was no system in place to ensure the tax and legal opinions were obtained, nor that the trading was undertaken in line with the opinions. The lack of challenge and oversight of the trading activity was also seen to be a breach of Principle 3.

Clearly this was before SMCR came into force, but it is not hard to see how this might have had implications for the individuals under the Duty of Responsibility and the Individual/Senior Manager Conduct Rules. There are also synergies with the recent Mr. Abarca Final Notice and his breach of Senior Manager Conduct Rule 2 which, was in part, due to an overreliance on third/fourth party communications and a lack of sufficient check and challenge (see our analysis of this here).

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

8.     FCA - Final Notice for Mr Mark Abley

Pre-SMCR, but in this Final Notice Mr Abley is fined £106,100 and prohibited from financial services, after the FCA determined he had acted without due skill, care and diligence in his role as a financial adviser providing defined benefit Pension Transfer advice. He held the CF1 (Director), CF 10 (Compliance Oversight), CF11 (MLRO) and CF30 (Customer) roles.

Mr Abley advised customers to transfer out of their Defined Benefit Pension Schemes, notwithstanding guidance from the FCA which created a presumption against providing such advice. As a result, the FCA found that Mr Abley had given unsuitable advice to customers, including failing to obtain necessary information, failing to properly consider customers' financial situation, failing to demonstrate that customers had the necessary attitude to risk and failing to provide sufficient justification to advise customers to give up their previous schemes. The FCA also found that Mr Abley had made personal recommendations to customers despite having failed to obtain satisfactory information to enable him to assess whether the Pension Transfer was suitable. In coming to its decision, the FCA noted the seriousness of Mr Abely's failings, on the basis that many of the customers were in a vulnerable position, there was a significant risk of loss as a result of Mr Abley's advice and there would be a lasting impact on customers from the decision to transfer.

Again, pre-SMCR but another one where you can see the clear implications for Mr Abley under the SMCR and potentially the new Consumer Duty Individual Conduct Rule 6 which applies from 31 July 2023. As mentioned above we are doing a lot of work on the Consumer Duty (including relevant Conduct Rules training / Consumer Duty Champion and Board briefings) so do get in touch if it would be helpful to hear more.

For further information, please contact Emma Sutcliffe (Partner) or Richard Sims (Partner)..

9.     Financial Reporting Council ("FRC") Consultation Paper on changes to the UK Corporate Governance Code

Following the Government's 31 May 2022 response to its consultation on proposed changes to the UK's corporate governance regime (see a summary here), the FRC has now published a consultation paper on proposed changes to the UK Corporate Governance Code. The key focus of the reforms is strengthening the governance systems of companies - i.e. the "G" of ESG. For our analysis of the proposals please see this article here. This will be of interest to Board members of listed companies / companies looking to list in the future, as well as Senior Managers in certain second and third line functions - e.g. risk and internal audit.

For any further information please contact Sally Childs (Practice Development Lawyer) or Caroline Chambers (Senior Professional Development Lawyer).

10.     FCA update webpage on new international competitiveness objective

The FCA has updated its regulatory framework reforms webpage to include further information about its new secondary international competitiveness and growth objective. This includes "seven drivers of productivity" that will shape the FCA's work to facilitate this objective. The webpage also indicates the approaches of the PRA and FCA will need to be consistent, and the FCA will report annually on how it has delivered against the new objective, with the first report expected in July 2024. Although not specifically SMCR related, this does link to the questions posed in the Edinburgh Reforms driven SMCR review and in the subsequent HMT Call for Evidence and PRA / FCA Discussion Paper, and perhaps highlights that this is a key area of focus.