Senior Managers and Certification Regime review phase two

Certification regime - divergent approaches by the FCA and PRA

The PRA proposes a "competence and integrity function" to replace the certification functions.

Significant risk takers in PRA firms will be performing a "competence and integrity function". A firm will have to take reasonable care to ensure that none of its employees performs a competence and integrity function unless the employee has the personal characteristics (including being of good repute and integrity) to enable them to perform those functions effectively.

The requirement to issue a fit and proper certificate on appointment and annually thereafter would be removed, as would the current requirement to obtain a prescribed form of regulatory reference. On the face of it, this gives PRA firms greater flexibility in their approach to employee competence and integrity assessments.

A draft new section to Supervisory Statements 28/15 and 35/15 sets out the PRA’s expectations regarding the assessments. The PRA expects firms to exercise their discretion and judgement when assessing the personal characteristics of an individual performing a competence and integrity function. "The concepts of ‘good repute and integrity’ are well understood from assessments made under fitness and propriety requirements in FSMA and the PRA Rulebook. The PRA expects firms to apply the same meaning and broadly follow the same principles when making personal characteristic assessments in accordance with the requirements set out in this section."

The FCA also proposes to remove the Certification Regime completely and to retire the Directory of certified persons. Instead of the Directory, the FCA Firm Checker tool is now available. 

The FCA states that the existing competent employees rules (SYSC 3.1.6R and 5.1.1R) place sufficient responsibility on firms to assess an individual's competence and honesty on appointment and whenever there is a reason to reassess suitability. It is proposed that the application of these rules will be extended to insurers and firms regulated by the Society of Lloyd's. 

We consider that the FCA's approach is flawed. The competent employees rules refer only to "skills, knowledge and expertise". It is the accompanying guidance at 5.1.2G that sets the FCA's expectation that the assessment will include an individual's honesty and this does not refer to the broader concept of integrity familiar from the fit and proper standard that currently applies to certification staff. Nor do these rules reference good repute or financial standing as does the fit and proper standard. This is perhaps a surprising omission by the conduct regulator and we would urge that the FCA aligns its approach with that taken by the PRA.

Respondents are specifically invited to comment whether there would be value in retaining some or all of the requirements of the FCA's certification regime, including the need to obtain regulatory references, for a subset of the current FCA certification functions.

Senior manager regime

Senior management functions

The PRA does not propose the removal of any designated SMF roles. However, SMFs 5 and 6, 8, 10-12, 14 and 20 would no longer require pre-approval by the regulator but instead mere notification on appointment. SMF 7 (Group Entity Senior Manager) would only require pre-approval in certain circumstances. Two years following implementation the PRA proposes to review whether SMF 24 (Chief Operating Function) should still require pre-approval.

The FCA's approach is aligned. In addition to the PRA roles mentioned above, SMF 13 and 15 which are FCA designated roles at dual-regulated firms, would require notification not pre-approval.

The Financial Services and Markets Bill permits the regulators to require a firm to seek prior approval for a role that would otherwise be subject to mere notification. This would be used where the regulator had specific concerns about a firm and would apply to future appointments.

The FCA proposes to remove completely the FCA-only SMFs 18 (other overall responsibility) and 22 (local responsibility). There are likely to be differing views on whether this is appropriate as these SMFs have been helpful in identifying the most senior individuals responsible for a particular business area who would not otherwise have hold a SMF.

Temporary SMF cover

Both the FCA and PRA propose to extend the period of temporary cover from 12 to 18 weeks. The FCA proposals go even further removing the requirement that the temporary cover rule can only be used where an absence is "reasonably unforeseen" replacing this with a "reasonable use" requirement. The PRA proposes to retain the "reasonably unforeseen" requirement. This means that the new reasonable use requirement would apply to FCA-only designated SMF roles in dual regulated firms. We expect firms may well prefer a single test to apply for all SMF roles in dual regulated firms.

Prescribed responsibilities

Both the FCA and PRA propose to remove a number of the existing Prescribed Responsibilities.

Enhanced firm threshold

The FCA proposes to increase the financial threshold for firms to qualify as an Enhanced firm by around 50%.

Statement of Responsibilities and management responsibilities map

The requirement to resubmit a Statement of Responsibilities (SoR) whenever responsibilities change will be removed. A SoR will still need to be submitted with an approval application or notification and must be kept up to date internally.

The requirement to provide updates to the management responsibilities map to the regulators will be removed but the document must be kept up to date internally and be available to the regulators on request.

Conduct rules - training and breach reporting

The Conduct Rules, which apply to around 900,000 people in the industry, will be retained in their current form. However, the proposed legislative changes will enable the regulators to simplify the training and breach reporting requirements.

There would be a simple requirement in FCA rules that firms notify affected staff about the Conduct Rules that apply to them and the consequences of breaching the rules. This will give firms flexibility in the way they choose to do this.

The PRA and FCA appear to be proposing slightly divergent approaches to the threshold for reporting a Conduct Rule breach. This could be confusing for dual-regulated firms and we would recommend that the FCA and PRA reporting thresholds for such firms are aligned.

Both regulators consider that the current reporting threshold is set too low for staff who currently are certification employees and other junior Conduct Rules staff, so that lower level misconduct of limited relevance to the regulators' statutory objectives is being reported.

The PRA proposes a definition of reportable "disciplinary or remuneration action" which would maintain the current threshold for SMF holders, their temporary cover and for Conduct Rules non-executive directors (formal written warning, suspension (as a sanction), dismissal, reducing or recovering remuneration) but for all other Conduct Rules staff would replace "formal written warning" with "final written warning". The time period for making notifications to the PRA would remain unchanged 

The FCA also proposes to maintain the current reporting threshold for senior conduct rules staff but for other conduct rules staff the reporting threshold would simply be final written warning or dismissal, with no requirement to notify in cases of reduction or recovery of remuneration or suspension. For these other conduct rules staff the FCA proposes reporting the breach within 14 months of imposing a disciplinary sanction (with firms reporting only the final outcome after any appeal).

Helpfully, the FCA proposes guidance clarifying that firms are not expected to determine whether misconduct amounts to a Conduct Rule breach unless it results in reportable disciplinary action i.e. a notification pursuant to SUP 15.11.

Next steps

Firms should consider carefully the implications of the proposed reforms. Though there can be no certainty until the Financial Services and Markets Bill receives Royal Assent and the final rules are published, the removal of the certification regime will have significant systems implications for some firms. Albeit at a high level, firms can begin to plan their likely approach now.

If you require any further information about the matters set out in this note please contact one of the authors: Angela Hayes, Khurram Shamsee, David Sims, and David Speakman.