Individuals at private equity firms that operate in the UK will be held directly responsible for business failures when the Senior Managers’ & Certification Regime is extended to all Financial Conduct Authority-regulated firms in summer 2018.
Much like the US Compliance Program Rule, SM&CR requires firms to develop good compliance procedures and culture, and holds senior managers accountable for oversight.
It replaces the Approved Persons Regime, which dictates who can carry out controlled functions such as being a director or being responsible for compliance on behalf of an authorized firm.
“Implementing the SM&CR’s complex rules and ensuring ongoing compliance will place a significant burden on firms, across management, the front office and the legal, HR and compliance departments,” says Simon Witney, special counsel at Debevoise.
The three parts of the rule include a requirement to clearly assign areas of responsibilities for senior managers at the firm. First, a specific individual must be in charge of areas including financial crime prevention and compliance with client asset rules. These managers will receive FCA approval and be listed on the FCA register.
The second aspect is to subject all members of staff to five conduct rules, and senior managers to a further five rules. Third, firms must certify each year that staff below senior manager level are fit and proper to carry out those jobs not covered by the SM&CR but that significantly impact customers or firms.
Firms will be affected by the regulation in three circumstances: if the firm itself is regulated by the FCA; if a firm acquires an authorized entity as a target; or if a firm has FCA or Prudential Regulatory Authority authorized entities within their group.
“The SM&CR will apply at differing levels of detail depending on the size of the organization, and most firms falling under the ‘core’ regime, with some needing to comply with the ‘enhanced’ requirements that largely reflect the regime that banks had to implement last year,” Michael Thomas, regulatory lawyer at Hogan Lovells, tells pfm.
Taking to task
The implementation and ongoing compliance burden is likely to be high for private fund managers, legal sources say, and may even require a rethink of the management structure.
“In organizations where there are multiple reporting lines or where responsibilities are shared between individuals, this is likely to require a degree of analysis and soul searching to define what should be appropriate under the new regime. This might involve changing management structures or role definitions,” Thomas says.
Under the new rules, private fund firms must maintain a number of documents that highlight how responsibilities are allocated among senior personnel, reflecting the increased accountability of individual senior managers under the regime.
The first of these is a Statement of Responsibilities. This would identify the areas of a firm’s regulated activities for which each identified senior manager is responsible.
“We would expect the regulators to consider whether the responsibilities listed in it are appropriately allocated to the relevant senior manager,” Thomas says. “Firms will need to consider issues such as the capacity of the senior manager, as well as potential conflicts between different responsibilities which may mean they shouldn’t be allocated to the same person.”
Examples of duties that should be shared across different senior managers include responsibilities for compliance with the senior managers’ regime, and acting as the whistleblower champion.
The second document is the Responsibilities Map, which defines the roles of senior managers and other senior personnel at a firm and give a clear indication of their responsibilities. It should also highlight any gaps in accountability and indicate whether the firm has a clear organizational structure.
“Preparing the Responsibilities Map and Statements of Responsibilities can be complex and time-consuming. There are a wide range of issues that need to be considered. It is also an area where different firms have interpreted the requirements differently,” Thomas says.
The SM&CR also introduces a new regulatory referencing scheme, which could change the way firms hire. Under the scheme, firms must request a reference covering the person’s previous six years of employment, regardless of whether previous employers were authorized firms. Authorized firms must also provide references on request. These references must be provided in a specific template, and there is an obligation to update them if the firm becomes aware of new information.
“Although final rules will not be published until the summer of 2018, the difficulties experienced by banks in implementing the SM&CR over the last few years makes it vital that asset managers, private equity firms, hedge funds and other firms start preparing as soon as possible,” says Witney.
When enforcing the rule, the FCA will take into account the Statement of Responsibilities and the Responsibilities Map to determine the extent of a senior manager’s accountability. Public censure, financial penalties, suspension, restricting or imposing limits on an individual are among the measures the FCA may take against someone who flouts the rule.
The regulator is currently consulting on the extension of the regime, and firms and other stakeholders are invited to comment until November 3. The British Private Equity and Venture Capital Association says it will make it clear to the FCA that the plans need to be proportionate.
“The FCA has said that it is committed to ensuring the regime is proportionate according to the size of the firm, and the BVCA has been in discussions with the FCA on the application of the regime to the industry,” the industry body says.
While the extension of the regime may be painful for private equity firms, it is likely to simplify the UK’s financial services regulatory landscape.
“After the introduction of SM&CR for banks and Senior Insurance Managers Regime for insurers, we now have three different individual approval regimes for financial institutions, given that firms that are neither banks or insurers are still subject to the approved persons regime. This results in a complicated rulebook that can lead to confusion regarding the applicable requirements,” Thomas says.
The expansion of SM&CR to cover all regulated firms will provide a more harmonized framework for the regulation of individuals across the financial sector, he adds. This always seemed to be where we would end up, after the SM&CR regime was originally introduced for banks, so the extension shouldn’t come as a surprise. Time to start preparing. ?