Increased regulation for Financial Market Infrastructures: a Senior Managers & Certification Regime is on its way

In June 2022, HM Treasury published its response to a consultation issued in July 2021 which proposed the introduction of a Senior Managers & Certification Regime (the Regime) for certain Financial Market Infrastructures (FMIs). HM Treasury’s response confirms that the government will seek to introduce such a Regime into law when parliamentary time permits.

This article provides an overview of what the Regime is expected to involve and how it could impact individuals engaged by FMIs and management liability insurers.

FMIs

Essentially, FMIs are networks which allow financial transactions to take place. As the name suggests, they provide the infrastructure and systems central to the operation of financial markets. FMIs are used in many aspects of our daily lives, e.g. facilitating salary payments into bank accounts, withdrawing cash from an ATM and enabling e-commerce. The Bank of England (BoE) estimates that every day around £360 billion worth of these kinds of transactions are made through FMIs in the UK. As such, FMIs play a crucial role in the functioning and overall stability of the UK’s financial system. Currently, FMIs are regulated by the BoE. The existing regulatory regime focuses on the conduct of FMIs, with only limited provision for oversight of the conduct of individuals acting within FMIs.

Overview of the proposed Regime

In many respects, the Regime looks likely to mirror the Senior Managers and Certification Regime set out in Part 5 of the Financial Services and Markets Act 2000 (FSMA), which applies to firms such as banks and insurers regulated by the Financial Conduct Authority (FCA), albeit with the BoE acting as the regulator.

Importantly, the Regime would target individual (rather than organisational) conduct and seek to increase individual responsibility among those undertaking roles and functions that involve significant risk by introducing certification requirements and penalties for individual misconduct.

In particular, it is envisaged the BoE will be granted new powers to implement, supervise and enforce:

  • A Senior Managers Regime (SMR) for individuals in roles exercising Senior Management Functions (SMFs).
  • A Certification Regime (CR) for individuals carrying out other roles involving significant risk.
  • Conduct rules for all employees, contractors and secondees.

The Regime is expected to regulate the following FMIs via a new SMR gateway:

  • Central Counterparties, which sit between buyers and sellers of financial contracts with a view to providing assurance that the obligations of those contracts will be fulfilled.
  • Central Securities Depositories, which operate the securities settlement system.

The government also intends to legislate to implement a SMR for recognised payments systems, though it looks as though that will be taken forward separately.

It is envisaged that the SMR will apply to any person who manages an aspect of the FMIs’ affairs which involves, or might involve, a risk of serious consequences for FMIs or for business or other interests in the UK, termed the ‘direct, significant influence test’, i.e. SMFs. It could apply to an individual based inside or outside the UK, depending on whether they are managing affairs of UK FMIs. FMIs would be required to evaluate whether any relevant individual is a fit and proper person to be exercising SMFs, according to specified criteria. Upon the FMIs being satisfied, an application would be submitted to the BoE for the individual to be certified. FMIs would have an ongoing responsibility to assess the suitability of each individual carrying out SMFs on at least an annual basis. If FMIs discover grounds that may impact an individual’s certification, it would be required to notify the BoE, which may vary or revoke certification.

The CR would apply to individuals carrying out ‘specified functions’, being those who are not carrying out SMFs but have roles deemed capable of causing significant harm to FMIs or users. Unlike the SMR, those carrying out ‘specified functions’ would be subject to internal assessment and certification only, i.e. they would not need to be approved by the BoE.

Finally, it is envisaged that the BoE will set minimum, high-level, requirements regarding the conduct of individuals where necessary or expedient for advancing the BoE’s financial stability objective.

In terms of sanctions, the BoE would have disciplinary powers comparable to those in FSMA. In particular, penalties could be imposed where an individual performs SMFs without approval or for misconduct. Such penalties could be financial, involve suspension of approval or manifest in a statement of the person’s misconduct. The government also intends to make it a criminal offence for an individual to perform a function in breach of a prohibition order issued by the BoE.

Consultation responses

The government received 13 written responses to the consultation, the majority of which are said to have been supportive of the Regime in principle.

However, a number of concerns were expressed, including:

  • Increased regulation may hinder hiring for senior roles and the position of UK FMIs in the international market.
  • The rationale of the Regime (i.e. individual accountability of senior managers in FMIs) is already adequately addressed in the existing regulatory framework.
  • The Regime would be costly and time-consuming compared to the risk posed by FMIs.
  • The risk profile for FMIs is significantly different to other entities caught by the existing regime applicable to FCA regulated firms (e.g. banks).

The government’s consultation response confirms that it believes the creation of the Regime would be a desirable and effective means of achieving its objectives of enhancing the accountability of senior managers and improving governance arrangements at FMIs.

It also recognises that FMIs vary in nature and are subject to their own specific legislative framework. As such, it explains the Regime would be tailored to each individual type of firm and that there would be flexibility to ensure that the BoE is able to effectively apply the Regime as appropriate to different types of firms.

The government’s response does not provide a timetable for introducing the Regime. Instead, it says legislation will be introduced when parliamentary time allows.

Comment

The proposed Regime would serve to sharpen the teeth of the BoE in its role as FMI regulator. Inevitably, this will be of interest to individuals engaged by FMIs as well as their insurers given the potential exposure to regulatory action, sanctions and associated costs involved.

While the availability of cover for defence/investigation costs will always turn on policy wordings, cover is often now available for investigations involving senior managers subject to the FCA regime. Such cover will no doubt be in demand by personnel at FMIs with the implementation of the proposed Regime, especially as defence/investigation costs exposures can be significant.

The BoE may well need to scale up its regulatory arm when the Regime is introduced and there are foreseeable substantive and procedural issues that could occur, at least in the Regime’s infancy. This is especially the case where the government has emphasised the proposed Regime would have flexibility, which creates some uncertainty as to how it would operate. In particular, there may be a period where the BoE is working through an appropriate framework for determining the standard of behaviour on the part of an individual and of any penalties imposed. There may also be uncertainty as to what constitutes SMFs in the context of FMIs.

From a procedural standpoint, there could be teething issues with how the BoE investigates misconduct/withdraws SMF approval and any appeal process, which is expected to involve the Upper Tribunal.

Foreseeably, investigation/defence costs could be substantial. Insurers may consider managing increased exposures by including a sublimit on such cover in management liability policies and/or by tightening wordings to narrow the scope of cover.

The trend of increasing regulation appears set to continue with the government signalling it will look to commence consultation on a senior managers and certification regime for credit rating agencies and recognised investment exchanges in the future.

Read other items in Professions and Financial Lines Brief - July 2022

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