With the financial services sector still reeling from the aftermath of recent banking failures, financial services reform is something of a sensitive – but highly topical – subject.
On 9 December 2022, the Chancellor of the Exchequer announced the “Edinburgh reforms”, a set of reforms to the regulation of the UK financial services sector. They include a review into reforming the FCA and PRA’s Senior Managers and Certification Regime (SMCR).
Clearly, any attempt to loosen responsibilities or to compromise the current internationally-respected regulatory standards would not go down well. For that reason, the government says its approach to financial services reform recognises and protects “the foundations on which the UK’s success as a financial services hub is built: namely agility, consistently high regulatory standards, and openness.”
At the same time, the government wants to ‘ensure that the sector benefits from dynamic and proportionate regulation, and that consumers and citizens benefit from high quality services, appropriate consumer protection, and a sector that embraces the latest technology’.
In total, 31 measures have been announced all with the objective of meeting four broad objectives for the UK financial services sector: that it is a competitive marketplace promoting effective use of capital, a word leader in sustainable finance, at the forefront of technology and regulation; and delivering for consumers and businesses.
Reform of SMCR is part of a strategy to maintain and build the UK’s attractive and internationally-respected ecosystem for financial services regulation. “Taking advantage of the UK’s position outside the EU, the government is setting out how the framework for financial services regulation will adapt to support a dynamic, stable and competitive financial services sector,” the Chancellor explained in a written statement to Parliament.
The SMCR was introduced in the aftermath of the 2008 banking crisis and the 2012 London Inter-bank Offered Rate (LIBOR) scandal as a framework that encouraged individuals to take greater responsibility for their actions, while making it easier for firms and regulators to hold individuals to account.
There are three key parts to the regime. The Senior Managers Regime imposes obligations on those performing a specified senior management function. The Certification Regime is applicable to all people in a firm who may pose a risk of causing significant harm to a firm, its customers or the market. These people are certified by a firm as fit and proper annually. Finally, Conduct Rules set minimum standards of behaviour for almost all staff, with additional rules applicable to senior managers.
The next stage of the process is the Call for Evidence, which formally commenced on 30 March 2023. This will look at the legislative framework of the regime, and garner views on the regime's effectiveness, scope and proportionality, before seeking views on potential improvements and reforms . The FCA and PRA have published a joint discussion document (“Discussion Paper”), as have the HM Treasury (“the Call for Evidence”). These consultations invite responses by 1 June 2023.
The two papers are largely descriptive in setting out the existing rules and do not set out concrete proposals of what the reforms may look like. They do ask a number of questions to narrow the areas upon evidence is sought, which in conjunction with Economic Secretary to the Treasury Andrew Griffith’s remarks to the Treasury Committee on 10 January 2023 offer an insight into the Government’s intended approach.
The government’s intention appears to be one of consolidation of the existing regime. In his oral evidence on ‘The crypto-asset industry’ to the Treasury Committee on 10 January 2023, Andrew Griffith said it is “entirely unobjectionable to have some sort of ‘fit and proper’ or certification for those who are involved in pushing systemic risk into the financial system.” Therefore, ‘the core underlying principles remain the same’.
The FCA and PRA’s Discussion Paper is in line with Griffith in endorsing the current measures. Indeed, both the FCA and PRA agreed that the measures had strengthened individual accountability of senior individuals and standards of conduct in financial services, as evidenced by the Discussion Paper drawing heavily on the PRA’s December 2020 review.
As noted by the PRA in that review, “the introduction of the SM&CR has helped ensure that senior individuals in PRA-regulated firms take greater responsibility for their actions and has made it easier for both firms and the PRA to hold individuals to account.
“As with any new regime, there were some upfront implementation costs for firms and regulators, but the work involved in introducing the regime is now bearing fruit and it is being employed in a range of areas to support better prudential outcomes. It is also welcome that a large majority (around 95%) of the firms surveyed said the SM&CR was having a positive effect on individual behaviour,” the PRA review concluded.
Given the regulators’ endorsement of the current regime, it is unlikely that there will be any significant changes that would weaken the protections currently in place. To do so would risk undermining the government’s policy ambition for the reforms to maintain consistently high regulatory standards and the UK’s attractive and internationally respected ecosystem for financial services regulation which the present regime fulfils.
The SMCR was originally introduced in the Financial Services (Banking Reform) Act 2013 in response to the 2008 financial crisis and the 2012 LIBOR scandal. These issues remain live and highly relevant for consumers today, as recently demonstrated by the collapse of Silicon Valley bank and emergency rescue of Credit Suisse by UBS.
Whilst the Treasury’s Call for Evidence asks questions on whether the present regime affects international competitiveness, the government should be mindful that the existing measures are respected internationally; the IMF called SMCR a “major and welcome improvement” and noted that the individual accountability provisions were “an important step towards bolstering public confidence in the banking system.” Moreover, the measures build upon internationally recognised standards, which the PRA says has put the UK at the forefront of emerging regulatory practice in this area.
Initially rules were applicable to UK banks, building societies, credit unions and PRA-designated investment firms. Since then, the measures have been further extended by the Bank of England and Financial Services Act 2016 to cover the majority of firms solely regulated by the FCA.
Contrary to other proposed Edinburgh reforms, any justification for change to the SMCR cannot be said to originate from an effort to take advantage of the UK’s position outside the EU. The UK established the regime on its own accord and there is presently no comparable EU wide law that replicates this.
Griffith offers an indication of the areas reforms may focus on. In particular, he speaks of “calibrating measures for financial risk in the system in a thoughtful way with as much industry input and expertise as possible.”
Griffith has already said that the government does not try to eliminate risk from the system by crucifying some of those smaller, more nimble actors that do not pose the same systemic risk. To meet the government’s stated ambition for an ‘agile’ system, the government may look to reduced application of SMCR for smaller firms.
Certainly, the PRA’s 2020 review suggests it was open to reviewing proportionality of the regime . “Most respondents believed that the regime is proportionate. However, medium-sized and smaller firms held this view less strongly. The PRA would welcome further feedback on options for enhancing proportionality,” it says . Consistent with this position, evidence is sought on this in the Discussion Paper.
Clearly, different rules for smaller firms would need to strike the right balance between enhancing agility while maintaining high regulatory standards – both high on the government’s list of ambitions. It remains to be seen how the government would class an actor as ‘small’ and ‘nimble’ and the extent to which the various elements of the SMCR would accordingly apply to them, if at all.
While these firms may not pose the same systematic risk, risks remain nonetheless. The current regime is sensitive to this: under current rules, the size of a firm dictates whether it falls under the limited scope, core or enhanced tier and the measures that apply will change accordingly.
The government has also stated its ambition to speed up FCA approval of senior managers to carry out their senior management function, although this is unlikely to be resolved by regulatory reform. Instead, Griffith suggests that the answer here lies with the FCA committing greater “management bandwidth and some systems investment.”
Griffith believes the focus of the regime should be on key decision makers rather than people further down the organisation just being brought into scope. Interestingly, Griffith’s concerns of scope creep are not shared by respondents to a PRA survey the vast majority of whom said the Senior Managers Regime (95%) and Certification Regime (89%) did capture the appropriate individuals in their firm.
As for the substance of reform, Griffith is keen that the focus of the regime does not deviate from its objective of managing financial risk. While there may be an overlap with how firms are run and the control of financial risk, the strength of the regime and respect it commands are largely due the measures that ensure senior management can be held to account for significant business failures that occurred on their watch. Any change should be mindful of ensuring the regime still meets this aim.
Concrete proposals are yet to emerge, however it appears that the government is not seeking to drastically alter the existing SMCR. This is a sensible ambition given the respect of the existing measures internationally, their continued relevance and positive evaluation by the PRA and FCA. At the same time, this position would be in line with the government’s policy aim to maintain an internationally respected ecosystem for financial services regulation.
The government’s suggestions to make the regulations more proportionate for smaller actors, reducing the scope of people the regulations apply to and the extent to which the regulations influence the running of firms support the ambition for a more agile regime. However, in pursuing this ambition, the government must not lose sight of the regime’s original aim to provide protection to consumers. To do so would risk compromising its ambition to maintain high regulatory standards.
Consumers will be mindful of the extent the changes may detrimentally affect the responsibilities of firms amid a challenging economic backdrop. Some firms who having implemented SMCR and are now preparing to adopt the FCA’s new consumer duty may also need persuading of the benefits of further regulatory change. In light of this, the Government’s proposed approach following the conclusion of the Call for Evidence will be observed with interest. The devil, as they say, will be in the detail.