Authors: Sarah Thomas, Cat Dankos and Hywel Jenkins
At the end of January, the UK Financial Conduct Authority (FCA) issued a further consultation paper (CP19/4, the CP) on the Senior Managers and Certification Regime (SMCR). Responses to the CP are requested by 23 April 2019. Alongside other minor proposed changes which seek to “optimise” the SMCR, the key proposals are:
- For all firms (banks, insurers, and all solo regulated firms), the legal function will not need to have a SMF Manager responsible for it.
- Responsibility still has to be allocated to someone, but that individual does not need to be a SMF Manager.
- The FCA expects the Head of Legal to be a certified function and that the conduct rules will apply to all legal staff.
- Banks and insurers need to think about whether to change their SMF Manager allocations in light of this confirmation (as well as statements of responsibility and responsibilities map), and how to depict the position of the legal function on their responsibilities map.
- For all firms (banks, insurers and solo regulated firms) the certification regime definition of the ‘client dealing’ function has been clarified (with a narrowing effect). It will exclude individuals who have no scope to exercise discretion.
- Insurers and banks may wish to cross-check their existing pool of client dealing staff against the proposed new definition in readiness for the final rules.
- For solo regulated firms, the FCA has expanded the scope of the forthcoming Enhanced regime to cover more intermediaries.
- For limited scope solo regulated firms, Manager Conduct Rule 4 (SC4) will be amended to cover non-approved executive directors.
Application of SMCR to the legal function
The FCA’s position on whether the legal function should have an SMF Manager was not explicit in the draft or final rules for banks issued in 2014/15. Following feedback and questions, the FCA published a discussion paper in September 2016 (DP16/4) and has now decided to consult on a proposal to exclude Head of the legal function from the requirement to be approved as an SMF Manager.
The reason this issue was previously unclear is because of the “Overall Responsibility” requirement in SYSC 26.3. This states that all SMCR Firms (currently defined as banks, insurers, large NDFs, and from December 2019 all solo regulated firms which are UK incorporated entities rather than branches) must allocate an SMF Manager to have responsibility “for each of the activities, business areas and management functions of the firm” (the so-called “no gaps” rule).
Some, though not all, banks interpreted this requirement to include the legal function. They either appointed their Head of Legal as an SMF18, or allocated the legal function to another existing SMF Manager, such as the CEO. The FCA issued a statement in January 2016 immediately ahead of commencement of the banks’ SMCR confirming that where firms had decided “in good faith” whether or not to allocate an SMF Manager to legal, they would not need to change their approach pending a decision from the FCA on how to treat the legal function.
The FCA has taken note of feedback to DP16/4. They accept that the operation of legal professional privilege may restrict them, in practice, from using their powers to carry out their supervisory and enforcement processes over the legal function. They also recognise that the Head of Legal will (in most cases) be a Certified Person and subject to the conduct rules, which they say delivers most of the benefits of being within the SMCR without compromising privilege.
The FCA therefore proposes that the Head of Legal role does not need to held by an SMF Manager. The proposed amendment creates a new rule SYSC 26.4.9R, which provides an exception to the requirement in SYSC 26.3R on all firms to identify an SMF Manager as having “overall responsibility for each of the activities, business areas and management functions”. The new draft rule provides that firms may allocate local or overall responsibility for the legal function (as defined in new proposed SYSC 26.4.10R) to someone who is not an SMF Manager.
It is expected that if the Head of Legal is not an SMF Manager, he or she will fall under the Certification Regime – either a Material Risk Taker or as a Significant Management Function. All in-house lawyers will also be subject to the Individual Conduct Rules.
Where the Head of Legal is performing other SMFs, for example as Chief Operations Officer (SMF24) or Head of Compliance (SMF16), that individual will still have responsibility as a SMF Manager for those roles. Firms will be expected to make clear in the individual’s Statement of Responsibilities the scope of each role, and the FCA does not want firms or other SMF Managers to attempt to use this position to avoid their responsibilities.
Issues for firms to consider
This, somewhat overdue, clarification is welcome and accords with the approach we have advised firms to adopt. It provides a welcome recognition that legal functions perform a largely advisory role to the business and that legal advisors should not be put in the position of a conflict of interest between their obligations under the Regulatory system and their professional duties towards their clients.
The FCA’s proposals might act as a catalyst to examine how internal functions around legal are configured. For example:
- Do all aspects of the legal function’s role fall within the list of activities in SYSC 26.4.10R? If not:
- some activities may need to be allocated to an SMF Manager. Larger firms may need to assess the different activities the legal function does to make sure they all fall within SYSC 26.4.10R.
- firms might want to tell the FCA about this in response to the CP.
- Banks and insurance firms might want to be ready to amend their current SMF Managers to remove the Head of Legal from being SMF18, to the extent this was allocated.
- If a practising lawyer is both SMF16 for Compliance and Head of Legal, they may find it difficult to identify after the event whether a particular decision was taken, or view given, with their legal hat on, and therefore outside of the SMF role, or as part of their Compliance role. Thinking about what communications to mark as privileged would be one way to identify communications made as Head of Legal.
Amending the intermediary revenue criterion for the enhanced regime
The proposals discussed in Chapter 4 of the CP have the effect of expanding the scope of the Enhanced Regime to capture more intermediaries. Firms which undertake relevant activities but do not submit section B of the Retail Mediation Activities Return (RMAR) will be required to annually assess and notify the FCA if they have over £35m (on a three-year rolling average) in regulated revenue from those relevant activities.
In order that firms are correctly categorised before the 9 December 2019 commencement, the FCA is proposing that firms must notify it by 1 September 2019 if they meet this Enhanced criterion.
Amendments to the Certification Regime (CR)
Chapter 5 of the CP sets out the FCA’s proposals for amendments to the Certification Regime, in particular to the scope of the Client Dealing Function. They propose to exclude individuals who have no scope to exercise discretion. This provides some clarity to solo regulated firms, which should be starting to identify which of their client-facing staff should be listed as certified. For banks and insurers, (for whom the rules are already in force) the FCA has also issued a web update confirming that some types of client dealing function do not include employees who perform only administrative functions. The FCA notes that these individuals are unlikely to be in roles capable of harming consumer or other users of financial services anyway, but they recognise that the rules as drafted would capture individuals taking part in managing or arranging investments. They propose to amend the definition of the Client Dealing function in SYSC 27 to exclude employees who have no scope to choose, decide or reach a judgement on what should be done in a given situation.
In Chapter 6, the FCA proposes a number of, what it terms as “minor”, amendments to the SMCR. Among these is the proposal to extend Senior Manager Conduct Rule 4 (SC4) to cover non-approved executive directors at limited scope firms. SC4 is already applied to non-executive directors at limited scope firms, so the proposal closes an obvious gap in the regime.