senior managers on the hook - ernst & young · the smr will require firms to allocate...

Senior Managers on the hookBanking & Capital Markets

“Holding individuals to account is a key component of effective regulation.”

On 30 July 2014, the UK’s Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) published their proposals for how to implement a new governance regime to strengthen accountability within banking1. This followed the recommendations of the Parliamentary Commission on Banking Standards (PCBS).

These Consultation Papers represent a major change in the regulatory landscape and a challenge for firms in order to ensure that the potential regulations are adequately adhered to. With the increase of individual responsibility, risk governance in firms is crucial to the protection of senior individuals. If Senior Management can demonstrate systems are in place and have been reviewed for effectiveness then they will not be penalised if a problem occurs.

PS7/14 comes into effect on 1 January 2015, whilst the end of consultation for the two other papers is 31 October 2014.

The proposed changes affect how individuals working for UK banks, Building Societies, Credit Unions and PRA designated investment firms are assessed and held accountable for the roles they perform. The changes are significant and include:

A new Senior Managers Regime (SMR) for the most senior individuals in affected firms (in this paper referred to as Senior Managers).

A Certification Regime that affects a wider population of risk takers who could cause harm to the firm or the firm’s customers.

A new set of Conduct Rules, divided between those which apply to all non-ancillary staff within a firm and others which only apply to Senior Managers.

This paper looks at these proposals and focuses on how they might affect Senior Managers of banks. It considers the following issues which EY believe to be at the heart of issues that firms will face:

An increase in the regulatory risks for Senior Managers due to the doubling of the limitation period and the reversal of the burden of proof.

Changes to governance frameworks that will increase regulatory scrutiny on the most senior executives of the bank and require them to sign up for specifically allocated responsibilities to the regulator.

The use of Conduct Rules coupled with a large increase in the number of staff subject to the regulatory regime to drive the creation of a culture where staff have integrity and an understanding of the risks they are taking.

Major changes to how banks can remunerate their staff and, especially, the extent to which they should use claw-backs in the case of failure.

1 A Joint Consultation Paper PRA CP14/14 FCA CP14/13 introducing proposals for strengthening accountability within banking, Policy Statement PRA PS 7/14 on claw-back of variable remuneration; and Joint Consultation Paper PRA CP15/14 FCA CP14/14 on better alignment between risk and remuneration.

1Senior Managers on the hook |

Greater regulatory risk for Senior Managers

Joint regulatory approach

The regulators want to see Senior Managers being accountable to them for any issues that occur within the firms they run; both for executive and non-executive roles. The proposals clearly signal this.

Reversal of the burden of proof Of the changes in the regulatory framework, we see the most potential impact on Senior Managers as being the reversal of the burden of proof. This means that, if there is a failure on either the conduct or prudential side, it will be for Senior Managers to demonstrate that they have taken reasonable steps to prevent it. This is not linked to the criminal offence below but does significantly increase the likelihood of successful disciplinary action on individual Senior Managers in the case of major conduct or prudential failure.

New criminal offence Reckless misconduct that leads a financial institution to fail carries the potential risk of imprisonment for seven years and/or an unlimited fine. However, we expect it will be very difficult for the regulators to prove to a criminal standard.

Increase in the limitation period The length of time that the regulator can take disciplinary action against a Senior Manager has been doubled from three to six years.

Key issues that potential Senior Managers should be aware of:

• Changes increase the likelihood of the FCA being able to take public disciplinary action across a broader range of individuals.

• Senior Managers will have to be able to demonstrate they have taken effective action to prevent failures in areas they are accountable for, or the presumption is that they are guilty of misconduct.

• Regulators will be able to make approvals conditional or time-limited or even vary them at the initiative of either the firm or the regulator.

• Regulators will be making increased public information available on the regulatory history of senior people.

How Senior Managers should react:

• Individual Senior Managers will need to understand how their corporate and personal responsibilities align.

• There is a risk that Senior Managers become unwilling to take bold decisions. Senior Managers will have to balance the need for control with the need for effective and timely decision making.

The new regimes are jointly consulted on by the regulators. The PRA and the FCA have different objectives and interests that they seek to address through this regime and firms will need to address both. The regimes are aligned to the specific interests of the regulators. The PRA is focused on those who have a large potential impact on the financial health of a firm, while the FCA looks more widely at those who can have an impact on the firm’s customers.

FCA policy on attestations In an exchange of letters published on 26 August 2014, the FCA clarified the criteria for the use of attestations and the outcomes they expect to achieve through this use. The FCA’s letter confirmed that attestations have been introduced as a formal supervisory tool and are aimed at ensuring clear accountability, and that senior management focuses on specific issues where the regulator wishes to see change. It also stated that the FCA is revising internal guidance to ensure attestations are used consistently and achieve the right outcomes.

The FCA states that it expects supervisors to take into account the other issues being addressed by the firm; and that all attestations will need to be signed off at a senior level, will be reviewed by a central quality assurance function similar to that used for Skilled Persons reports, and that data will be published on the use of attestations on a quarterly basis.

So, supervision practice is already running ahead of formal policy and using existing tools to increase regulatory focus on individuals.

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The new length of time that the regulator can take disciplinary action against a Senior Manageryr

syr

s

The potential prison term for reckless misconduct that leads a financial institution to fail

2 | Banking & Capital Markets

Senior Managers Regime

PRA only SMFs FCA only SMFs

None The FCA must provide its consent before a PRA SMF is authorised.

FCA only authorised Executive:• Executive Director• Significant Responsibility Senior

Manager• Money Laundering Reporting• Compliance Oversight

Non-Executive• Non-Executive Director• Chair of Nominations Committee

PRA and FCA SMFs PRA authorised with FCA’s consent:

The SMR will require firms to allocate responsibilities to certain individuals and to vet their fitness and propriety on a regular basis. This replaces the significant influence function element of the current Approved Persons Regime for those firms within the scope of the consultation, and is intended to focus accountability on a smaller number of the most senior individuals in a firm.

Those holding Senior Management Functions (SMFs) should be a relatively small group of individuals at the top of the organisation i.e., the Board and those directly accountable to them for the business; the top two layers of governance.

As a result, not all of those currently holding Significant Influence Functions (SIFs) are expected to be SMFs under the SMR.

Firms will have the freedom to structure the SMR in a way that suits their business and should avoid a proliferation of SMF roles. This process should start with discussions at Board level to socialise the new requirements for the executive and non-executive Board members, and the decision process in determining which Senior Managers will be put forward for SMF approval by the PRA and FCA. Individuals under the scope of the regime will require pre-approval by the relevant regulator (PRA or FCA), or both if the function they are performing falls under both regulatory regimes.

Executive:• Chief Executive Function• Chief Finance Function• Chief Risk Function• Head of Internal Audit• Head of key business area• Group Entity Senior Manager• Credit Union Manager

Non-Executive:• Chairman• Chair of Risk Committee• Chair of Audit Committee• Chair of Remuneration

Committee• Senior Independent Director

Section 1

Bank governance changes


Statements of Responsibilities Firms will be required to develop and document a clear list of responsibilities for Senior Management. The list will need to reflect the responsibilities that will be included in the FCA handbook and PRA rules, and be tailored to a firm’s governance structures. Once allocated, Statements of Responsibilities showing these will need to be provided as part of any application for approval by the FCA and PRA.

Responsibilities Map The FCA and PRA will require firms to map the responsibilities and reporting structures within the firm. At this stage, firms will need to consider and document the framework and how responsibility is allocated within the organisation. This process should highlight where there are shared or unclear reporting structures and where there is no allocation of responsibility in place. The firm’s Board will need to provide annual confirmation that there are no gaps in the allocation of responsibilities within the firm.

Group functions Where a firm reports to a Group function that has a strong influence on the decision- making process within the firm, these functions may be subject to the SMR. As part of the Statement of Responsibilities and the Responsibilities Map, firms will be required to both highlight reporting lines and document the decision-making processes at Group level. Where decisions are made by an influential Group director, this may be considered a Senior Manager role within the SMR and will therefore require approval from the FCA or PRA.

New Senior Management Functions The following individuals may be subject to the regime that previously were not:

• Heads of key business areas subject to quantitative criteria. This is expected to be the actual individual accountable to the Board for the business area regardless of title.

• Individuals in parent companies who exercise significant influence on the firm’s decision making. This can include situations where those individuals are based outside the UK.

These individuals will need to quickly understand their new responsibilities to the regulator.

Removed SIFsA number of the functions of the previous regime have no parallel under the SMR. Examples include the CF10a who was responsible for CASS and the CF30 customer function. Despite this, such individuals will remain accountable, in general, to the regulators through the Certification Regime.


International scope The UK Chancellor of the Exchequer has announced his intention to extend the SMR and Certification Regime to cover all banks that operate in the UK, including branches of foreign banks.

Firms that are UK branches of foreign banks should begin to consider the implications of the SMR and the Certification Regime onto their current structures. Firms that will be affected by these changes should start to identify SMFs for the proposed PRA requirements and how current SIFs can be adapted to meet the proposed FCA requirements.


• Requirement for Senior Managers to sign up to a Statement of Responsibilities, which will be formally handed over when jobs change.

• Requirement for firms to have a Responsibilities Map; a single document that sets out the management and governance arrangements and allocates all responsibilities.


• In a matrix management structure where responsibility is shared among Senior Managers, firms will need to highlight how each individual is accountable. As part of this, they will need to take into account both business unit and geographical lines.

• Understand how committees, MI and other controls deliver the assurance of an effective and controlled business.

• Understand if the role profiles of SMFs change and whether this has any impact on their remuneration and authority.

• Understand any current gaps in fulfilling responsibilities, and define action plans and assurance processes to demonstrate they are being addressed.


The Certification Regime will apply to all employees who perform a role relating to a firm’s regulated activities but who are not in a SMF.

This is a much wider regime than the current “Fit and Proper” one and places the burden on the firm’s Senior Management to take responsibility for certification.

The proposed regime will require firms to reassess the fitness and propriety of the relevant employees at least once a year.

It introduces two new concepts:

1. Significant Harm Functions

Apply to individuals who hold roles that relate to aspects of a firm’s affairs which may involve a risk of significant harm to the firm or its customers.

2. Material Risk Takers

Relates to persons whose actions could have a material impact on the risk profile of the firm.


• Legal requirement for firms to vet individuals, with the onus clearly falling on firms to demonstrate how they have confirmed an individual is fit and proper.

• A requirement for firms to include prescribed information in regulatory references, i.e., facts that relate to breaches of Conduct Rules and a description and outcome of disciplinary action taken in relation to any breach of Conduct Rules (which can be potentially disclosed to the regulators).

• Requirements for formal annual reviews to be performed for individuals subject to the Certified Regime.


• Understand how intrusive checks and training are imperative to satisfy both themselves and the regulators that they have taken reasonable steps in this regard.

• As all employees falling within the PRA Certification Regime will also be caught within the FCA Regime, firms will be expected to put in place a single process for certifying each individual who falls into the regime.

PRA Certification Regime

FCA Certification Regime

• Individuals who could have a material impact and could cause significant harm – the Material Risk Takers for remuneration purposes

• Credit Unions

• Material Risk Takers

• Former SIF classified functions that are not SMFs

• Customer-facing roles

• Supervisors or managers of certified individuals

• Credit Unions

FCA and PRA Certification Regimes working together• All employees who perform a role

relating to a firm’s regulated activities, including Material Risk Takers and those who can cause Significant Harm that are not SMFs.

• FCA requirements are wider than the PRA. All employees falling within the PRA will also be included in the FCA requirements.

Certification Regime


Both the SMR and the Certification Regime seek to introduce a new framework that encourages individuals to take greater responsibility for their actions. A key action taken by the regulator to impact on culture is the introduction of a new set of enforceable Conduct Rules which, for relevant firms, will build on the existing APER principles and guidance applicable to Approved Persons. Strengthening risk culture and risk governance has already become a top priority for bank Boards and Senior Management. The rules will form a framework against which the regulators will make a judgement about an individual’s actions as part of the general supervision of firms. In addition to shaping the culture and standards of firms by promoting positive behaviours that reflect the regulators statutory objectives.


• All staff are subject to the Conduct Rules and will need training to understand the rules, their responsibilities and the regulators’ expectations.


• Senior Managers will perform a key role in driving the behaviours and setting the tone, values and judgement that would drive a fundamental change in the culture of banks. This will include judgement calls made on the way they respond to events. For example, how they escalate issues and notify the regulators about issues involving potential risks.

The PRA and FCA’s Conduct RulesAll individuals are subject to:

• Rule 1: You must act with integrity;

• Rule 2: You must act with due skill, care and diligence;

• Rule 3: You must be open and cooperative with the FCA, the PRA and other regulators;

• Rule 4: You must pay due regard to the interests of customers and treat them fairly (FCA); and

• Rule 5: You must observe proper standards of market conduct (FCA).

All Senior Managers are subject to:

• SM1: You must take reasonable steps to ensure that the business of the firm for which you are responsible is controlled effectively;

• SM2: You must take reasonable steps to ensure that the business of the firm for which you are responsible complies with relevant requirements and standards of the regulatory system;

• SM3: You must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversee the discharge of the delegated responsibility effectively; and

• SM4: You must disclose appropriately any information of which the FCA or PRA would reasonably expect notice.

Section 2

Driving changes in culture


Buy-outs The PRA and FCA have proposed four broad approaches to remedy the PCBS’s concern that buy-outs have the effect of “wiping the slate clean” for the purposes of malus for individuals who change employers.

The regulators’ proposals are:

• Ban buy-outs.

• Awards are no longer forfeited by former employer (i.e., firms are required to honour the award) but remain subject to malus.

• The award/s from the previous employer are held in an ESCROW account — where either the former or new employer may apply the malus.

• Make no change and rely on the claw-back rules and proposals.

Given the more onerous claw-back rules and the proposed extended time horizon over which bonuses will now be at risk, it would appear that the fourth alternative is the most pragmatic, whilst the other three alternatives would present significant, practical implications.

Remuneration regulation in financial services has developed at a fast pace ever since the G20’s Financial Stability Board issued their ‘Principles for Sound Compensation Practices’ in April 2009. Given that the initial Principles were deemed especially critical for “large, systemically important firms”, banks have been at the forefront of adapting their compensation processes, systems, structures, policies and governance to adapt to the new remuneration regulations that have been adopted by local regulators since April 2009. Regulators have become increasingly interventionist, requiring firms to actively demonstrate what they are doing to create a culture that considers risk. Systems and controls alone have failed to deliver the desired cultural and behavioural values. Overall, the new rules and issues raised in the Consultation Papers are indicative of a more stringent approach to remuneration for Senior Persons.


• Claw-backs: The new rules are stricter than in other countries (100% of variable remuneration will be subject to claw-back for at least seven years from the date of award). Although the rule is to apply to Material Risk Takers at PRA regulated firms (Level 1 and 2 only), the regulators would generally expect all firms to have a firm-wide policy. In practical terms, a robust claw-back process and policy will need to apply to all employees in order to ensure individual claw-back determinations have been assessed appropriately and with an adequate degree of transparency. For UK-regulated banks, disparities may be created because of non-UK labour law considerations meaning that UK employees are at a disadvantage compared to their colleagues working in other parts of the world. The design and communication of a claw-back policy should be viewed as an opportunity to reinforce a bank’s cultural values. Communicating the behaviours that result in negative compensation outcomes (including claw-back) is a key tool in embedding the cultural values that a bank wishes to demonstrate.

• Deferrals: The proposed changes on deferrals would make UK-regulated banks subject to a deferral regime that would be more onerous than required by other worldwide regulators with deferrals of up to seven years depending on level.


• Demonstrate that behaviours have been set in line with values and are being managed appropriately.

• Effectively and proactively design, communicate, monitor and govern behaviours, and in so doing, achieve the right outcomes for customers, shareholders and societies at large, taking into account a proportionate approach across global locations.

• Develop a model that can provide regular and ongoing assurance over behaviours and facilitate the maintenance of standards.

• To address any competitive disadvantage, firms may want to review their compensation strategy, in particular the structure and proportion of different elements of compensation. Firms would need to review their existing plans and introduce changes to the rules, plan administration and employee/key stakeholder communications.

Section 3

Remuneration requirements


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EY is actively engaged in this paradigm shift in regulation and we are helping clients respond to regulatory developments. Overall, we assist our clients to prepare a strategic response to this change. We can help adjust overarching frameworks to match the revised expectations of regulators and the requirements that Senior Managers will have as a result.

EY has strong links into national and international regulators including regular dialogue with the FCA and PRA, and other industry participants, allowing us to provide an in-depth perspective on both regulatory expectations and the response of market participants.

EY has a proven track record in helping clients assess the impact of new regulatory legislation on their organisation, together with providing assistance in the design and subsequent implementation of appropriate changes to their business models. In the case of these consultations, this will include advising senior persons on the new regulatory requirements, undertaking governance reviews, conducting regulatory interview briefings, as well as assessing the impact on their business model, for example, governance, control, design and reporting.

In particular, we can help you to Review your governance frameworks to help you determine how well these support any realignment of risk to individuals:

• Understand which individuals will be captured by each aspect of the proposed requirements.

• Develop Responsibility Maps, linking risks to individuals and to Statements of Responsibility.

• Review organisational governance, processes and controls to ensure these are appropriately designed to address the risks and responsibilities assigned to individuals caught by either the Senior Manager or Certification Regimes.

Build your framework to deliver a good culture of risk and control:

• Establish what your framework currently looks like, what future state you are aiming for and what adjustments you need to make to achieve that state.

• Review systems and processes to help you prepare for the increased requirements to demonstrate your staff are fit and proper and that you are in control of the business areas you are accountable for.

• Provide a structured assessment of the operating effectiveness of key controls, including, where appropriate, providing a formal assurance opinion for use by the Board, executives, regulators or other stakeholders.

Tailor and facilitate training sessions and workshops to provide your Board, executive team and other stakeholders with the essential information and knowledge about the upcoming remuneration and regulatory changes:

• Brief individuals in advance of their Senior Manager interviews with the regulators.

• Develop employee and key stakeholder communication strategy and materials.

• Prepare and deliver conduct briefings for all staff, across a range of products and distribution channels.

Review current compensation strategy and, in particular, compensation mix, delivery mechanisms and deferral structures:

• Review and make recommendations for documenting claw-back policies, procedures review and recommendations.

• Review bonus pool calculation methodology, including reference to making prudent valuation adjustments.

How EY can help

What does success look like?By the time the new regimes come into force, firms need to have:

• People identified and in post for all SMR roles.

• All SMFs understand their new responsibilities under the regime and what they are accountable for to the regulator.

• All non-ancillary staff within the firm understand their responsibilities under the Certification Regime.

• Any gaps or issues have been identified, defined and plans are in place to address them.

• Both regulators understand and have bought into these plans.

Senior Managers on the hook |

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About EY’s Global Banking & Capital Markets CenterIn today’s globally competitive and highly regulated environment, managing risk effectively while satisfying an array of divergent stakeholders is a key goal of banks and securities firms. EY’s Global Banking & Capital Markets Center brings together a worldwide team of professionals to help you succeed — a team with deep technical experience in providing assurance, tax, transaction and advisory services. The Center works to anticipate market trends, identify the implications and develop points of view on relevant sector issues. Ultimately it enables us to help you meet your goals and compete more effectively.

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EYG no. EK 03091310-1140949 BOSED None

This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice.

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John Liver [email protected]+44 (0) 20 7951 0843

Omar Ali [email protected]+44 (0) 20 7951 1789

Tim Rooke [email protected]+44 (0) 20 7951 1472

Julian [email protected]+44 (0) 20 7951 0933

Mark [email protected]+44 (0) 20 7806 9380

Vishal [email protected]+44 (0) 20 7951 5402

Further information

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