Improving Individual Accountability

April 2016

The rules on individual accountability are being introduced following changes set out in the Banking Reform Act, to improve professional standards and culture within the UK banking industry. The main rules will come into effect on 7 March 2016.

The rules will make it easier for firms and regulators to be clear about who is responsible for what. Its effect should drive up standards, and make firms easier to run and to supervise. The rules will also allow senior managers to be held to account for misconduct that falls within their area of responsibility. It will also hold individuals working at all levels within relevant firms to appropriate standards of conduct.

Who it Applies to
The rules apply to:

  • banks
  • building societies
  • credit unions
  • the nine largest investment banks that are regulated by the PRA
  • branches of foreign banks operating in the UK

Key Features
The key features of the new rules are:

  • Senior Managers Regime. This focuses on the most senior individuals in firms who hold key roles or have overall responsibility for whole areas of relevant firms. Firms need to:
    • ensure each Senior Manager has a Statement of Responsibilities setting out the areas for which they are personally accountable
    • introduce a Firm Responsibilities Map: and
    • ensure that all Senior Managers are pre-approved by the regulators before carrying out their roles.

The good news is that existing Approved Persons will not be required to go through a fresh round of pre-approval in order to be ‘grandfathered’ into the new regime. Firms will be required to submit a grandfathering notification, which will let firms map existing approved persons to an equivalent Senior Manager Function.

The Government has also proposed that Senior Managers in the banking sector should be subject to a ‘duty of responsibility’ which means senior managers will be required to take the steps that it is reasonable for a person in that position to take to prevent a regulatory breach from occurring. This replaces the Presumption of Responsibility and is currently being debated in Parliament. 

The main changes are:

  • Certification Regime. This applies to ‘material risk-takers’ and other staff who pose a risk of significant harm to the firm or any of its customers (eg, staff who give investment or mortgage advice or who administer benchmarks). Firms need to:
    • identify all certified individuals by 7 March 2016
    • assess them as fit and proper by 7 March 2017, and
    • have procedures in place to re-assess the fitness and propriety of certified staff on an annual basis
  • Conduct Rules. These are high-level rules that apply directly to nearly all staff (apart from ancillary staff e.g. catering staff). Firms need to:
    • ensure that staff who are subject to the rules are aware of them and how they apply to their jobs

      The Conduct Rules apply for Senior Managers and staff in the Certification Regime from March 2016, and apply to everyone else from March 2017.
  • The regime for branches. The rules apply the same principles to branches of foreign banks, but tailor them to account for the different governance structures in branches (notably that the ultimate Board will likely reside overseas). For branches of European banks the rules also reflect the split of responsibilities between the FCA as the ‘Host state regulator’, and the European ‘Home state regulator’ as set out in EU law.
  • Remuneration. Changes have been made to the Remuneration Code to encourage more effective risk management and better align individual decision making with good standards of conduct. 
  • Whistleblowing. New rules introduced to strengthen whistleblowing systems and controls in firms and to promote a culture where people can speak up were published in October 2015 and take effect in September 2016. These rules apply to deposit-takers (meaning banks, building societies and credit unions) with assets over £250m, Solvency II insurers and PRA-designated investment firms.
Timing of the Rule Changes 
The rule changes for the banking sector will occur in stages – the main rules come into effect on 7 March 2016.

What does this mean for board structures?
The regulator (whether this be the PRA or the FCA) intends to work very closely with Boards, more so than in the past . The PRA’s objectives is around the safety and soundness of firms that they supervise. Their secondary objective is in respect of competition.

The PRA will have a focus on risk assessment and will want to understand how firms take and manage risk, the controls they have and the quality of risk management. The PRA will be raising the standards in this area. The PRA have made it clear that they are a judgement-based supervisor through applying judgement against a framework of rules and regulation.

The regulator has made it clear that: -“Ensuring the Bank of England has the instruments necessary to achieve its financial stability objective will depend on the EU continuing to have regulations of the highest standards, which strike the appropriate balance between harmonisation and flexibility, and which accommodate necessary national responsibilities, including for supervision”. Narrow rules-based approaches to regulation create inflexibility and can be easy to arbitrage. The sensible application of judgement involves looking at a situation from several angles, and employing forward-looking tools such as stress tests.

The role of Boards will be a focus of the regulator to include Executive Senior Management of firms; Boards (with Non-Executives in the majority); and Supervisors.

The PRA will expect Senior Executives to exercise judgement on risks and returns on a day-to-day basis. The regulator want firms to earn sustained and thus sustainable returns through the exercise of good business judgement. Senior Executives are expected to exercise that judgement within frameworks set by, and overseen by, their Boards, namely the overall strategy, the risk appetite and assessment frameworks and the oversight of controls and compliance. 

Board should be reminded of their role expected by the regulator be able to set a strategy and risk appetite and oversee implementation. The role of the Executive. Supervisor will be to challenge hard and ask for changes, but they do not substitute for the Board or the Executive.

So, what does the Regulator expect of Boards?
In a recent speech by the PRA the three that mentioned where:

  1. Boards should exercise good judgment in overseeing the running of the firm and to do so on a forward-looking basis;
  2. Such judgement is improved by good constructive challenge from Non-Executives. A firm’s culture should promote discussion.
  3. The regulator will look to Non-Executives, under the leadership of the Chair, to challenge the Executives in all aspects of the firm’s strategy, which includes the viability and sustainability of the business model and the establishment, maintenance and use of the risk appetite and management framework. The Regulator will also look to the Non-Executives to mentor and coach the Executives and balancing this with the essential ability to challenge is a vital component of an effective Board.
In the terms of the Senior Managers Regime, this frames the responsibility of Boards and serves as a usual reminder to Boards to make sure that they review their board structures to met the regulators expectations.

The regulator makes it clear that it is the job of the Executive to be able to explain in simple and transparent terms these complex matters to Non-Executives. In doing so, they should understand the uncertainty around judgements, in what circumstances they could be wrong, and how there can reasonably be different ways to measure things like liquidity. Non-Executives should not be left to find the answers for themselves, and they should not feel that they have to do so out of a lack of sufficient confidence in what they are being told. 

What does a Board need to understand?
The regulator makes it very clear that boards must understand:

  • key elements of model design;
  • significant assumptions and expert judgements;
  • key sensitivities; and
  • significant limitations and uncertainty in the model.
  • where is the model expected to work well;
  • in what circumstances is it likely to break down;
  • is the overall model output credible;
  • what “moves the dial” in terms of key assumptions or judgments; and
  • are those assumptions and judgements reasonable?

Non-Executives should be put in a position to possess a general understanding of the model and meet these expectations without detailed technical knowledge. That’s the job of the Executive, to explain complexity, provide good Management Information and enable challenge and thus accountability. 

The PRA will overhaul its approach to supervision of governance in firms. Executives should be able to rigorous challenge. Executives should see that their Non-Executive colleagues’ experience and knowledge as a means of improving the effectiveness of the Board’s judgment through constructive support and challenge.