Banks left little time to amend ‘bad apples’ rules before SMR

Personal accountability rules will also see rise in internal attestations and impact on recruitment

New rules aim to remove 'bad apples' from the banking industry

Lack of finality around rules on the provision of individual references to regulators in the UK is raising fears banks will not have enough time to implement changes to prevent so-called "rolling of bad apples" before the Senior Managers Regime (SMR) comes into force on March 7.

Under the SMR, enforced by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA), senior management functions at banks – including chief executives, chairmen, chief risk officers and heads of key business areas such as internal audit, compliance and money laundering reporting – will need to develop and submit to the regulator clearly defined statements of responsibility, for which they will be held to account in the event of any failings.

If a senior person is found to have taken a reckless decision that causes a bank to fail, they could be given a prison sentence of up to seven years.

Although it is not uncommon for hiring firms to go back to at least one institution for a reference on a prospective employee – to find out whether an individual has engaged in unacceptable conduct in a previous position – most only do so for top executive functions, and even then, there are no specific requirements on what information to provide.

That will soon change. Separate from the SMR, the 2015 Fair and Effective Markets Review – also led by the FCA and PRA – proposes formalising the regulatory referencing process used by recruiters and firms, as a means to help prevent the 'recycling' between firms of individuals with poor conduct records.

The FCA and PRA put out a consultation as part of their heightened focus on strengthening accountability, suggesting new, stricter rules which would not only affect senior management candidates but also those applying for non-executive director positions and – casting the net much wider – for roles involving risk-taking activities and other certified positions. The proposals include a six-year time period over which such references need to be obtained. This could mean requesting information from several firms, depending on the applicant's work history during those six years. Likewise, employers would need to keep records for a longer period of time than many currently maintain.

But given the FCA and the PRA hope to publish the final rules on regulatory references just a month before the SMR rolls out in March, concerns have been raised that banks won't have enough time to amend their internal processes – and update their existing regulatory references accordingly – before the new regime kicks in.

Simon Hills, BBA

"There will be a lot to do, particularly because many firms use third-party vendors to help them with the referencing process," says Simon Hills, executive director at the British Bankers' Association (BBA). "They've got to get up to speed and understand what the new requirements are, and it just won't be long enough to do that." The BBA has recommended a transition period be granted to March 2017.

"Many of the differences in procedure will come in the recruitment process itself," says Alan McFarlane, director at recruitment and managing consulting firm Hays Financial Markets. "Firms will have a higher level of diligence to carry out on those joining them."

Consultation on the regulatory reporting rules closed in December and the FCA's policy team is currently reviewing feedback following which, in conjunction with the PRA, it will consider whether changes to the draft rules are required.

With the impending SMR, those firms who ... don't have a great relationship with the FCA may now seem less attractive to work for – Luke Davis, Robert Half Financial Services

Trevor Jones, managing director for financial services risk at consulting firm Berkeley Research Group, agrees there will be much more regulatory scrutiny to ensure firms collect and use references before employees join an organisation. Also, if a firm finds out something in a reference is wrong, particularly after a person has left, they will have to flag it up, as that information could then be used as evidence in a regulatory investigation into wrongdoing.

Hills from the BBA says previously the references could have just been a note attesting to the dates the person worked at the company. Now, it will be a more prescriptive form. "The idea that we should have proper regulatory referencing is sensible. The aim is to stop the so-called rolling of the bad apples. But there will be a burden on the firms, which is why we've asked for a transition period," he says.

It cuts both ways

Conversely, individuals are likely to become more picky about how well a potential employer gets on with its regulator. Luke Davis, vice-president at recruitment firm Robert Half Financial Services, has seen a noticeable change in the way individuals seek new positions across the sector, due to the SMR. They are now undertaking significant analysis of organisations, to ensure they are comfortable with the practices, processes and controls in place.

"With the impending SMR, those firms who may have had problems or don't have a great relationship with the FCA may now seem less attractive to work for than those seen as taking it all more seriously," says Davis.

Both he and the BBA's Hills predict a rise in the use of non-disclosure agreements, which give an incoming senior manager the opportunity to scrutinise a firm's record and relationship with its regulator.

There is absolutely no room at all for any further systematic reputational errors for the City of London – Michael Cole-Fontayn, BNY Mellon

There are also high stakes involved in the transfer of personal responsibilities if a senior staff member leaves. Michael Ruck, senior associate at UK law firm Pinsent Masons, says evidence provided in handover notes could uncover grounds for a regulatory investigation if the leaver failed to address or prevent an issue. In addition, the new hire could be accused of failing to have acted quickly or appropriately enough to tackle known issues. In such circumstances the firm itself would likely face scrutiny for failures related to its internal systems and controls.

The SMR will be rolled out to all other non-bank financial institutions including asset managers, brokers, consumer credit companies and investment firms in 2018. Under it, firms will need to maintain governance maps that set out structures and reporting lines – a task expected to prove complex for those with matrix-management structures that entail multiple reporting lines – and abide by a new certification regime for employees whose activities could pose risk to the firm and its customers.

Hills at the BBA thinks banks will experience a significant rise in internal paperwork and sign-offs as a result of the stricter rules. "If you are a senior manager you are going to want internal attestations lower down the chain confirming systems and controls are in place, allowing you to perform your prescribed function," he explains.

"It is a sobering thought when you sign a responsibility sheet."

Attestations are a regulatory tool used to obtain commitments from chief executives, chairmen, board members and other senior executives that their firm is complying with regulations – from specific requests such as the effectiveness of conflicts of interest management, for instance, through to firm-wide governance arrangements. As regulators are prepared to name and shame individuals, internal attestations from subordinates will give senior managers more confidence in signing the final attestation with the regulator.

Michael Cole-Fontayn, chairman of BNY Mellon Europe, Middle East and Africa, understands why the SMR needs to be implemented. "There is absolutely no room at all for any further systematic reputational errors for the City of London," he says.
But he also thinks the regime will be challenging to introduce in a global organisation, adding: "As you think about trading books being passed around the world, as you think about settlement processes being passed around the world, [you need to ask] is everyone in the chain operating to the same standards?"

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• Topics
• Conduct risk
• Financial Conduct Authority (FCA)
• Operational risk
• Prudential Regulation Authority (PRA)
• Recruitment
• Operational risk