UK: Is It All Getting A Bit Out Of Hand? FCA Consultation Paper 17/40 On Transitioning FCA Firms And Individuals To The Senior Managers And Certification Regime (SMCR)

Last Updated: 30 January 2018
Article by Celyn Armstrong, Craig Neilson, Katharine Harle and Alexandra Doucas

The SMCR for banks has now been in place for almost two years, but only a few months after it was implemented, statutory amendments were made to allow for its extension to virtually all firms. During the second half of 2017, the FCA published its proposals in relation to that extension, and (most recently) in relation to transition to the new regime. An inevitable consequence of this is that the FCA has had to try to adapt a regime designed for use in a sophisticated and well-resourced banking sector, for use by a huge range of firms of very differing size and sophistication. The FCA's recent publication of its proposed transitional provisions (in Consultation Paper 17/40, referred to below as "the CP") illustrate some of the many complexities that are on their way for firms moving into the SMCR.

What type of firm are you?

The FCA has proposed different categories of SMCR firm. Core scope SMCR firms (the majority) will be subject to a "baseline" of requirements. Limited scope core SMCR firms will be subject to rather fewer requirements, and enhanced scope SMCR firms will be subject to significantly more. Banking sector SMCR firms and insurance sector SMCR firms are not intended to form part of any of these three categories, but are covered by industry-specific aspects of the FCA's SMCR regime, frequently in tandem with the PRA. The way in which firms (other than those already subject to it) transition to the SMCR depends on what type of firm they are. That said, the differences between the requirements on each firm type can be overstated, and all firms will have to make significant changes to implement the regime.

The most obvious difference in the transition process is that enhanced scope SMCR firms will need to submit a conversion notification to the FCA, showing which existing approved persons they wish to convert across to corresponding Senior Management Functions (SMFs), subject to the FCA's list of potentially corresponding functions. Such firms will also need to submit a management responsibilities map, and ensure that, on the commencement of the SMCR, there are no gaps in the allocation of responsibilities within their business, such that responsibility for each activity, business area and management function is allocated to a senior manager. If such firms do not submit the required notification, then, on commencement, their senior managers will be deemed to be performing an SMF without approval. 

By contrast, core SMCR firms and limited scope core SMCR firms do not need to submit a notification. The FCA will (subject to exceptions) transfer their existing approved persons automatically to prescribed corresponding SMFs, but the list of SMFs is different depending on whether the firm is a limited scope core or core SMCR firm (and, indeed, there are different lists of SMFs even within those categories, depending on the type of firm). 

All this means that, by the time transitional provisions take effect, firms will need to know what type of SMCR firm they are, in order to know which transitional regime applies to them and what they need to do. There is no suggestion that firms should expect to receive a letter from the FCA telling them which category they fall into. Instead, enhanced scope firms and limited scope firms in particular will need to sit down with the numerical and other criteria proposed in the FCA's consultations and assess whether they meet them. Many of the criteria are determined by reference to data in firms' regulatory returns; given the importance of correct categorisation, firms may wish to do some additional quality assurance on their figures. Should such criteria prove difficult or controversial to apply, there is no prescribed mechanism for resolving such issues. 

In the case of enhanced scope firms, they may have a  sufficiently close supervisory relationship with the FCA that they have a channel for communicating any concerns. For core and limited scope SMCR firms, however, the same close supervisory relationship is unlikely to exist, but the designation is still important. Core scope firms will also need to allocate prescribed responsibilities, but limited scope firms will not, so it will be important for them to know which type of firm they are. Firms have also been told that they should have their statements of responsibilities ready, even if they do not need to submit them to the FCA. Again, this means that they will need to understand who their SMF managers will be after transition and into which SMFs the FCA will move them.

Handbook changes and layout

The text of the FCA's consultation papers in relation to the substance of the extended SMCR and in relation to transitional provisions are admirably clear. Drafting a consultation paper, however, and drafting detailed Handbook rules are rather different exercises, and the draft rules and guidance the FCA has so far provided are not so straightforward. The draft rules appended to the CP, for example, run to in excess of 1,000 pages. The issue is not so much length – most of the appendices contain draft forms, not all of which will apply to every firm or need necessarily be referred to in detail at this stage. The problem is the sheer complexity of navigating the SMCR rules, which are spread over a number of sections of the Handbook.

Two decisions have arguably exacerbated this problem. One is that the FCA decided not to separate out the different rules applicable to different types of SMCR firm by creating, for example, a section containing all the requirements relevant to core SMCR firms. Instead, all the rules appear together, and a series of tables or application provisions indicate which apply to different types of firm. This was clearly a deliberate decision by the FCA, and in some respects an understandable one, but it has the somewhat unfortunate consequence of creating a law of diminishing returns for firms at the lower end of the SMCR scale (limited scope core and core SMCR firms) – they still have to sift through the entire body of relevant rules and guidance, but be ever vigilant to spot the elements of it that actually apply to them, because there are many that do not.

The second decision, probably dictated by the complexity of the exercise the FCA is undertaking, is communicated in the CP, and is the decision to stagger the introduction of the SMCR for insurers, and for all remaining solo-regulated firms. While this is again an understandable decision, it creates additional complication in terms of understanding the Handbook. For a firm wanting to know how the SYSC rules in the Handbook will change, for example, the CP appends no fewer than three different iterations, with reference to a fourth (being the draft appended to the FCA's earlier consultation on the extension of the SMCR). The position in relation to SUP is similar. The reason for this is that the FCA needs one version of SYSC to exist for commencement of the SMCR for insurers, and another to come into being a year or so later for the roll-out to other firms. This leaves aside the rules that need to come into effect slightly in advance of those commencement dates, in order to allow firms to prepare. The outcome is that not only will firms need to sift through a significant amount of drafting that may be irrelevant to them anyway, but they will also need to flip between different versions of the rules appearing at different times. One obvious example is that the Handbook sections defining what the different types of SMCR firm are do not come into force until the commencement of the regime for remaining solo-regulated firms in 2019, but in order to comply with the transitional provisions which will be in force (and which use the definitions), firms will need to refer back to proposed Handbook amendments not yet in force.

The reality is that it will be impractical for most firms to do this themselves and so firms will need a massive amount of help from legal and compliance experts just in order to identify what they are actually required to do, and this may hit the smallest firms hardest in comparison to their size, which does not sit easily with the intended proportionate application of the regime.

Pitfalls of automatic conversion

The alternative for core and limited scope SMCR firms is to read the consultation papers, understand roughly how the new regime is going to work, and then sit back and let the FCA deal with transition by automatically converting existing approved persons across to corresponding SMFs. There are a few problems with this approach.

First, it does not chime with a regulatory approach the purpose of which is to promote individual accountability.

Second, there are some pitfalls to relying solely on automatic conversion. The one the FCA mentions is the role of chairman. Non-executive director (NED) is not an SMF under the SMCR, so existing approvals of any NEDs will lapse on commencement. The exception is where a firm has a NED acting as chair of the governing body, in which case he or she must be converted to the relevant SMF (SMF9), but this will only happen if the firm notifies the FCA. If a firm has an executive chair, the individual will be converted across automatically to the executive director SMF (SMF3), but the SMF9, chair of the governing body SMF, is not a corresponding function, so the executive chair cannot transfer to that role even with a notification. Instead, the firm will need to submit a Form A in order for the director to carry on as chair.

Third, the FCA clearly expects that firms will put in some work in advance in order to get senior managers into the right place for automatic conversion. This means that firms will need either to apply for individuals to be approved to perform an existing controlled function that maps to the SMF they will be performing on commencement (there are rules for applications that have not been approved by commencement), or they will need to apply using the new SMCR forms for individuals to be approved to perform SMFs from commencement. Different rules will apply to applications made under the different regimes, including in relation to regulatory references.

Finally, firms must check the FCA Register within the month following commencement of the SMCR, to make sure that the correct people have been taken across as senior managers into the new regime. 

Identification of certification staff

As with the start of the SMCR for banks, the FCA has decided to delay implementation of the full certification regime for a year following initial commencement of the SMCR as a whole. This means that firms will have a further year before they are required to ensure that no employee performs a significant harm function without being certified as fit and proper to do so. This does not mean, however, that firms can simply park the issue.

First, the conduct rules will apply to certification employees from initial commencement of the SMCR, before the obligation to certify them applies, and firms will need to notify them of this, carry out appropriate training, and implement procedures for assessing whether disciplinary action results from a conduct rule breach and is therefore reportable to the regulator. (The conduct rules will start to apply to other employees at the same time as the main certification rule bites.) This is also the case in relation to individuals who would have been certification employees but for the application of the temporary UK role and emergency appointments rules. This means that firms will need to have identified such individuals, in the UK and (where relevant) overseas, by day one of the SMCR.

Second, rules on regulatory references will start to apply from commencement, and firms will need to seek a reference in relation to existing certification employees whose role changes significantly during the year prior to the implementation of the main certification requirements.

Finally, firms will, of course, need to undertake a significant amount of preparatory work on related employment issues, such as amending relevant employment contracts and considering incorporating a fitness and propriety assessment into existing performance review structures.

Conclusions

The spirit behind the SMCR, its broad character and the FCA's aim to extend it in a proportionate way are hard to fault. The problem with it, in the present context, is that the reality of the regime is in its detail. There is no way that the FCA can implement change on this scale in a way that does not inconvenience firms at all, but the FCA's usual principles of proportionality should aim to target greatest inconvenience at the firms most able to deal with it. This is clearly what it is trying to achieve in its transitional provisions, but the effect of some of its other decisions, on timing and on Handbook layout, arguably have the opposite effect.  

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