Senior Persons Regime Implications for Senior Decision-Makers GRANT THORNTON FINANCIAL SERVICES GROUP

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1 Senior Persons Regime Implications for Senior Decision-Makers GRANT THORNTON FINANCIAL SERVICES GROUP

2 Introduction Although the governance and risk management shortcomings of many financial institutions were not the sole causes of the financial meltdown, they emphasised the need to redefine standards in the Financial Services Industry. Many institutions have been subject to significant corporate fines, yet accountability remains a significant challenge across the industry. Michael F Silva, Senior Vice President at the Federal Reserve Bank of New York, recently stated: While laws and regulations are indispensable with respect to capital liquidity and risk management, the stability of the financial system is equally dependent on the sound judgement and responsible conduct of the financial leaders themselves. Holding financial leaders accountable is the most powerful way to encourage the right behaviour 1. The Parliamentary Commission on Banking Standards (PCBS), the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) acknowledge the need to introduce greater individual accountability. Consequently, they have launched a series of measures that will undoubtedly have an enormous effect on the industry and, paraphrasing the Commission, might change financial services for good TOTAL NUMBER OF FINES FOR FINANCIAL SERVICES ENTITIES IN THE UK TOTAL VALUE OF FINES FOR FINANCIAL SERVICES ENTITIES IN THE UK (IN MILLIONS OF POUNDS) NUMBER OF APPROVED PERSONS PROHIBITIONS IN THE UK Source: FCA 1 The Economist Intelligence Unit: Society, shareholders and self-interest. Accountability of business leaders in financial services. 2 SENIOR PERSONS REGIME

3 FAILINGS IN THE APPROVAL OF SIGNIFICANT INFLUENCE FUNCTIONS Sir Tom McKillop, former chairman of the Royal Bank of Scotland, admitted, at a meeting of the Treasury Select Committee in February 2009, that he had no qualifications in banking and he did not understand some of the financial products he needed to approve. Paul Flowers, a Methodist minister, was appointed as a non-executive chairman at the Co-Op Bank, despite having limited experience in banking. The bank had to be rescued last year under a deal with bondholders after a 1.5 billion black hole was discovered. Approved Persons Regime Under the current Approved Persons Regime (APER), individuals wishing to perform a controlled function at an authorised UK firm need approval from either the FCA or the PRA. Regulators grant approval to two types of person: those who deal with customers or their property, and those that have a significant influence in a financial organisation. Both categories are governed by seven statements of principle, thoroughly defined by an accompanying code of practice. In its report Changing Banking for Good, the PCBS described the existing regime as a complex and confused mess 2. Currently, only 10% of those working in banking institutions are covered by the Approved Persons Regime; consequently, the remaining 90% don t need to comply with the statements of principle, and therefore are not subject to the regulator s sanctions. Moreover, substantial failings have been revealed in the approach adopted by the FCA for the approval of individuals having significant influence functions. Existing Approved Persons Regime Applies to all financial services Prudential Regulation Authority Financial Conduct Authority Approved Persons (FSMA 2000) Statements of Principle and Code of Conduct Significant Influence Functions Customer Dealing Function Governing Functions Systems and Controls Functions Required Functions Significant Management Functions CF1 CF2 CF3 CF4 CF5 CF6 CF28 CF8 CF10A CF40 CF10 CF11 CF50 CF29 CF30 2 Changing Banking for Good Parliamentary Commission on Banking Standards [549] SENIOR PERSONS REGIME 3

4 Senior Persons Regime To overcome the system s deficiencies, the PCBS recommended various reforms that have been broadly welcomed by the Government, the FCA and the PRA. The Commission proposed to discard the APER and replace it with a Senior Person Regime (SPR) and a Licensing Regime (LR). The Senior Persons Regime will replace the Significant Influence Function of the Approved Persons Regime; however, it will cover fewer individuals. The Commission considered that many people within these functions were not in actual effect senior decision-takers; therefore, the SPR will only cover those who sit in governing bodies and report directly to the board. Senior persons will need prior regulatory approval, which could be subject to conditions and time limits. The proposed regime should bring enhanced transparency around individual responsibilities and accountability. As Tracey McDermott, FCA Director of Enforcement and Financial Crime, stated, one of the biggest weaknesses of the APER is determining who is ultimately liable: One of the problems we often find when we start enforcement action is that we start asking questions and people cannot tell us who is in charge. All applications to perform a Senior Person Function will be supplemented by a statement of responsibilities specifying all the affairs of the firm that the individual is accountable for. In order to avoid any dilution of responsibilities, banks will have an on-going duty to update the statement as the senior person s obligations evolve. Moreover, a handover certificate detailing how these responsibilities were met will be mandatory when leaving the post. Senior Persons and Licensing Regime Applies to deposit-taking institutions Senior Persons Regime New banking standards rules Licensing Regime New powers Regulatory Enforcement Criminal Offence Approval of senior persons can be subject to conditions and time limits Extension time limit to commence disciplinary action (from three years to six years) Reversal of the burden of proof Reckless misconduct in management of a bank It will be for the bank to take action against individuals that breach the banking standards rules requirements 4 SENIOR PERSONS REGIME

5 RABOBANK FINED 105 MILLION FOLLOWING ATTESTATION In October 2013, the FCA fined Rabobank 105 million, the third highest fine ever handed out by the regulator. In 2011 Rabobank had written a statement declaring that its systems and controls concerning their LIBOR submissions were fit for purpose. Nevertheless, the FCA found that in order to improve the profitability of trading positions, Rabobank, through its managers and employees, sought to manipulate the published JPY, USD and GBP LIBOR rates. It is thought that in the future the attester might be fined directly. FCA s Approach to Personal Accountability The FCA has reiterated its desire to place greater emphasis on individual accountability and, to that end, has imposed various measures. The regulator has implemented a name and shame policy. Since October 2013, the FCA has had the option to publish information about projected enforcement actions by naming both firms and individuals. This option was first exercised on 3 February The FCA maintains that the ability to issue warning notice statements will guarantee enhanced consumer protection and enrich the integrity of the UK financial system. Additionally, senior managers are required to sign attestations stating that their firms systems and controls are fully compliant with the FCA s standards. These written statements are generally intangible and difficult to deliver against. Nevertheless, by agreeing, the signatory accepts personal liability if those systems or controls are found to be unsatisfactory. Although this option has not yet been used against individuals, an attestation was at the heart of an enforcement action taken against Rabobank. Traditionally, despite having the powers to do so, it has been challenging for the regulator to hold individuals accountable for their role in the failings of financial institutions. Martin Wheatley, FCA CEO, recently expressed his frustration: It has been hard to nail an individual against responsibility because matrix organisations structure, committee decisionmaking means that individuals always defuse responsibility and it ends up that you have to take action against a committee. So it is not the powers that are lacking, but frankly, evidence is hard to gather in a way that would allow you to take action. New Criminal Offence and Reversal of the Burden of Proof Criminal Sanction for Reckless Misconduct in the Management of a Bank The PCBS recommended the introduction of a new criminal offence, that of reckless misconduct in the management of a bank. The Commission clarified that this offence will only be applicable in cases involving the most serious failings. The offence will only apply to those listed on the Senior Persons Regime if they make decisions which lead to the failure of a bank or stop others making such decisions. Although there is uncertainty about the meaning of recklessness in the context of the offence; those found guilty could be sentenced to up to seven years and/or an unlimited fine. Reversal of the Burden of Proof Once the FCA concludes that a deposit-taking institution is or was in breach, enforcement action could be taken against the Senior Person accountable for the function in which the contravention occurred. Then, it will be for the individual to prove that he took all reasonable steps to prevent or mitigate the wrong-doing. It is important to note that the burden of proof can only be reversed for civil sanctions. Its reversal in a criminal case will contravene the presumption of innocence. SENIOR PERSONS REGIME 5

6 Implications for Senior Decision-Makers Although the report by the PCBS was positively received by the Government and financial regulators, it is important to note that many of the systematic failures identified by the Parliamentary Commission are certainly not limited to the banking industry. Critics maintain that the decision to limit these reforms to certain licensed activities may encourage a spate of regulatory arbitrage. Moreover, in order to enact the Senior Persons Regime, the regulator will need to modify an FSMA provision that currently regulates the Approved Persons Regime. Considering that the rule applies to the whole Financial Services Industry, it is likely that the SPR will be extended to include asset managers, insurers and other non-deposit taking institutions. It appears that the new regime will prompt financial institutions to reconsider every aspect of today s governance and control structures. Enhanced Management Information, escalation points and attestations will be necessary to achieve an optimal organisational structure. A clear definition of roles and responsibilities, as well as business objectives and acceptable risks, will be paramount. Currently, most institutions tend to undertake audit processes that identify problems once they have arisen. Nevertheless, in order to meet the regulator s expectations, a radical change of culture will be necessary: firms will need to ensure that their risk appetite and remuneration mechanisms guarantee fair outcomes for customers. Additionally, the foundation of an environment where employees feel secure challenging others without fearing retaliation will be essential. 6 SENIOR PERSONS REGIME ANOTHER INCENTIVE FOR REGULATORY ARBITRAGE? Regulation of deposit-taking institutions is becoming evermore thorough. Despite the necessity of some of the new rules, limiting them to deposittakers incentivises the shift of risky activities to other financial sectors. The dangers of regulatory arbitrage have been acknowledged by the Financial Stability Board. When reviewing the proposals of the PCBS, the FCA conceded that senior managers performing exactly the same job at different financial institutions might be subject to different regimes depending on the license held by their employer. Indeed, a recent study highlighted the increase of nonbank financing provided by entities subject to minimal regulatory scrutiny this could result in unpredictable consequences for the stability of the financial system as a whole. It appears that the introduction of the Senior Persons Regime, coupled with the current debate to limit remuneration in the banking sector, are the perfect ingredients to prompt firms to move as much business as possible to less regulated financial sectors.

7 The proposed changes will undoubtedly have an enormous effect on the industry and, paraphrasing the Commission, might change banking for good. In a recent compliance and risk survey, the vast majority of delegates agreed that the financial services sector will see more enforcement action against individuals. In the past, most of the regulator s enforcement actions were directed towards individuals that had been directly involved in areas where failures were detected or who had clear responsibility for the function involved, such as compliance officers or money laundering officers. However, after the measures proposed by the PCBS are implemented an increase in the number of enforcement actions against senior decision-takers is expected. 4% 5% 3% 6% 6% 8% 9% 88% 71% IN THE FUTURE, DO YOU THINK THAT THE UK WILL SEE: n More enforcement actions against individuals n Fewer enforcement actions against individuals n No change to enforcement actions n Don t know WHICH CATEGORY OF APPROVED PERSONS IS LIKELY TO FEATURE MOST IN FUTURE ENFORCEMENT ACTIONS: n Chief Executive n Compliance Officer n MLRO n Head of risk n Other Source: Thomson Reuters The financial services industry is undoubtedly becoming more sensitive to public perception. Moreover, classifying misconduct, personally, as a criminal offence will act as a further deterrent. Nevertheless, these innovative legislative changes need to be accompanied by an ultimate improvement in firm culture. Still, for 69% of financial leaders, meeting short-term financial targets is at the top of their agenda 3. Whether the perfect balance between financial pressures and a more responsible culture can be achieved through the criminalisation of behaviours, is certainly open to debate. 3 Ibid 1 SENIOR PERSONS REGIME 7

8 Contacts Sandy Kumar Jonathan Sperrin Partner Partner T T E sandy.kumar@uk.gt.com E jonathan.sperrin@uk.gt.com 2014 Grant Thornton UK LLP. All rights reserved. Grant Thornton refers to the brand under which the Grant Thornton member firms provide assurance, tax and advisory services to their clients and/or refers to one or more member firms, as the context requires. Grant Thornton UK LLP is a member firm of Grant Thornton International Ltd (GTIL). GTIL and the member firms are not a worldwide partnership. GTIL and each member firm is a separate legal entity. Services are delivered by the member firms. GTIL does not provide services to clients. GTIL and its member firms are not agents of, and do not obligate, one another and are not liable for one another s acts or omissions. This publication has been prepared only as a guide. No responsibility can be accepted by us for loss occasioned to any person acting or refraining from acting as a result of any material in this publication. grant-thornton.co.uk V23820 Grant Thornton UK