The genesis of the Senior Managers and Certification Regime (SMCR) lies in the financial crisis. The FCA thought they had adequate powers to hold people to account under the Approved Persons Regime (APR), but actually struggled to identify the key decision makers, as some senior managers were able to deflect responsibility and pass the buck. The UK Government instructed the FCA to create a regime of personal accountability. The extent to which politicians want to lay blame on the financial sector was seen in early proposals to remove the presumption of innocence – dubbed “the golden thread of English law” – from senior managers. This did not materialise, but senior managers will need to demonstrate that they have taken “reasonable steps” to prevent a breach of their assigned responsibilities. The latest legislation will extend the regime to asset managers, from December 9th 2019.
Robert Quinn Consulting (RQC) founder, Robert Quinn, observes that, “unlike MiFID II, which is intellectually very complicated, SMCR is relatively easy to understand, but not necessarily easy to implement”.
The experience of banks, which have applied SMCR since March 7, 2016, suggests that challenges can relate to time, internal politics and personalities. “Where small firms have a simple business model and are run by their founders it may be clear who is in what role, but in other firms there can be differences of opinion,” says Quinn. The wrangling can even escalate into internecine disputes about which senior management functions to assign to which people.
The extent to which politicians want to lay blame on the financial sector was seen in early proposals to remove the presumption of innocence – dubbed “the golden thread of English law” – from senior managers.
Most hedge fund managers are expected to come under the “core” regime of SMCR, subject to standard requirements. A handful of hedge fund managers that are part of firms running over £50 billion could face extra requirements under the “enhanced” category, as could some proprietary trading firms with perhaps only 20 or so staff, by dint of the size of their trading books (and these firms dealing as principal also have a different regulatory capital regime, points out Quinn). Those running internal AIFs, meeting certain criteria, could be in the limited scope regime, with reduced requirements.
RQC, which received The Hedge Fund Journal’s 2019 award for “Best Boutique UK & US Regulatory Advisory Firm”, is working with asset managers ranging from global firms running over $500 billion down to “two people and a laptop” boutiques, and is also being sought out by other firms such as insurance companies on SMCR issues.
“The job functions and responsibilities for senior managers covered by SMCR are prescribed, and include: partner, director, compliance, money laundering reporting officer. For core firms, the FCA has mapped out the senior management functions (enhanced firms need to make a filing to inform the FCA who fits into what role). One senior manager individual must be given responsibility for complying with the SMCR itself,” explains Quinn.
“There is some degree of flexibility over how Statements of Responsibilities (SoR) map to one or more people. Normally each SoR function maps onto one individual, but some SoR responsibilities can be held by more than one person, in cases such as job-sharing or job-splitting. Certain job titles – such as Money Laundering Reporting Officer (MLRO) – must be held by one individual however,” says Quinn.
In smaller firms of course it is not unusual for one individual to be wearing three, four or five hats, and “SMCR does not provide any new guidance or requirements on segregation of duties,” according to Quinn.
The Certification Regime (CR) covers a lot of “front office” investment management functions that might well command higher remuneration than some SMR jobs, including: proprietary traders; client dealing function; material risk takers (MRT); and algorithmic traders, as well as CASS oversight function. Those supervising CR jobholders must themselves be covered by CR. Whereas some of these functions required FCA approval under the APR, going forward the onus is on firms to certify staff suitability, annually.
Some job descriptions could straddle both the SMR and the CR, in which cases duties could be split between the two regimes. Job titles as well as functions can trigger coverage. For instance, research is not a controlled function under APR, and is not a senior management function under SMCR – unless the individual also has a title, such as director or partner, which could come under SMCR. The third plank of SMCR – the Individual Conduct regime – applies to all employees, bar ancillary staff. Currently, Appointed Representatives (ARs) are outside SMCR but they could be covered if the FCA and HM Treasury so decide. Though SMCR seems prescriptive in terms of job title and functions, it still leaves latitude for the culture of firms to play a strong role in determining who does what. For instance, “the scope of the compliance officer role can vary enormously according to personalities. At some firms, everything runs through the compliance officer. At other firms, it is embedded in the business units, and compliance monitors them. Where there is a weak compliance culture and it has low status, it can be handled by junior staff. Some compliance officers are box-tickers while others are strategic advisers,” Quinn declares.
SMR will include outsourced Chief Compliance Officers, such as Quinn himself, who in this capacity is classified as a “contractor” rather than an employee of his clients. “Those with a CF10 (Compliance Oversight) or CF11 (Money Laundering Oversight) permission are automatically transferred to SMCR,” he says.
Quinn is of the opinion that SMCR might prompt some managers to rethink their outsourcing policies in some areas however, because it underscores how senior managers retain liability. “Matters such as AML checks can be outsourced to, say, an administrator, but the manager would still be liable, which means that due diligence and oversight need to be exercised over the delegated service providers,” he observes.
The two current offerings are toolkits providing a roadmap of policies, procedures, manuals and training for senior managers, and e-learning modules training all staff in the conduct rules. (A third will address the background checks that will be required under SMCR. RQC is developing a joint venture for cost-efficient background checks, slated for roll-out later this year.)
“Our online toolkits are a suite of documents to help firms transition from the current to the next regime. It is easy enough to understand but there are many moving parts. For instance, our operational procedures in toolkits are 120 pages long, and we also provide extensive guidance on what happens when a senior manager is hired. This entails a lot of complexity for compliance and human resources functions,” says Quinn. “Clients can download a set of word documents, and then copy and paste the templates of policies and procedures, adapting and tailoring them to their own requirements.”
“Senior managers may at some stage need to demonstrate that they have taken reasonable steps to prevent breaches of their SoR, and the templates can help to some degree. The templates set out a framework for applying facts to deliver the desired outcome,” he continues.
The iterations continue: “Additional work will come later on around the SoR, how it fills out, what does fit and proper mean. Senior managers must demonstrate that the firm understands the obligations, potentially in compliance manual restrictions and obligations.” But the firm need not always be held responsible. “For instance, if PA dealing has not been disclosed, this may be the fault of the employee.”
SMCR touches many facets of HR, from references to appraisals and disciplinary procedures. Assigning roles to people is one task: “Some firms may have their own agenda in terms of who they want to be a senior manager or certified employee. This runs into both internal politics and issues such as who needs to be covered by D&O insurance,” Quinn points out.
One question for firms to consider is whether, to what extent, and how, SMCR SoRs should be incorporated into employment contracts. “This is not our area of speciality, and it depends on how they are drafted. They may need to be amended in a generic way, referencing SMCR functions, but not the specifics. They could be amended annually,” suggests Quinn.
SMCR could have unintended consequences for the tax status of some partners. “The FCA definition of a CF4 partner is broad enough for relatively junior staff to meet it, and does not synchronise with HMRC’s three criteria, which include directing part of a business. Those who were classified as CF4 partners, and who may have ownership, are not necessarily classified as Senior Managers under SMR. Real scrutiny of these issues could take months. Firms are taking advice from tax lawyers and accountants to explore the options, which could include giving somebody a department to manage so that they meet the HMRC definition of partner,” explains Quinn.
Quinn set up RQC in 2008 because he felt, “a need for a consultancy focused on cross-border regulatory advice, considering the UK, the US and Europe, offering advice in an integrated and fluent way, not in a vacuum”.
But SMCR may prove to be an anti-climax for those who had expected a game of musical chairs. “Grandfathering” will initially be the default option for most staff who will already have been approved under APR and need not be approved afresh under SMCR. “In core firms, the FCA has mapped out the new functions, and assumes that firms have already assessed staff as fit and proper,” says Quinn.
It is after December 9, 2019 that new senior management staff will need to be pre-approved by the FCA. Judging by the experience of the APR, this process could take anything from days to months. Quinn “is not sure what would happen pending approval – or if somebody fails to obtain it. They might sometimes continue in their role in the capacity of a certified function.”
Professional designations and qualifications (eg IMC, CFA, CAIA, law, accountancy) can go a long way to satisfying the technical criteria for SMCR roles, which are one element of fitness and properness. This also includes honesty, integrity, competence and capability, and financial soundness.
The FCA leaves firms some latitude for defining fitness and properness. “It is a question of fact. We look at the totality of the individual including any incidents and put a weight on them. We look at the business and take a sense of proportionality, assessing the situation and building the case in one direction or another. The FCA give you a lot of rope – enough rope to hang yourself,” he says. RQC has made the case one way or the other in relation to incidents identified in background checks.
A topical issue under the integrity umbrella is sexual harassment and misconduct. The FCA’s director Megan Butler has flagged up that this should be considered as a criterion. But the FCA has given no guidance on what thresholds of harassment and misconduct might disqualify anyone, or indeed on other questions such as whether the activity would relate to colleagues, and what view would be taken of activity proscribed overseas, that would be legal in the UK. “We urgently need guidelines. This is a can of worms,” says Quinn.
Whistleblowing seems to be a growing trend on both sides of the Atlantic, and SMCR may lead to more such disclosures which could also be an obstacle to SMR roles.
SMCR is far from a mechanical box-ticking exercise.
One of the FCA’s objectives with SMCR is to engender cultural change. This cannot entirely be objectively measured, and requires the FCA to exercise some subjective and qualitative judgement. “Our e-learning modules can help to some degree, by training managers and employees subject to the senior managers regime, certification regime and conduct rules,” says Quinn.
“The personal qualities required of senior managers, such as leadership qualities, can be assessed under the ‘competence and capability’ criteria, but could also entail some judgement of their ability to manage people,” he adds.
SMCR is intended to “be proportionate and flexible enough to accommodate the different business models and governance structure of firms,” the FCA has stated. Nonetheless, some firms may need to raise their game. At some firms, governance will need to change for the SMCR, and to help get through investor due diligence exercises. “I will not name names, but some firms will have to have a complete culture change. Serious hedge fund managers anyway know there is an appropriate governance framework for growing assets and must do this in order to attract institutional tickets,” points out Quinn.
Yet a diverse range of governance models will continue. The FCA has prescribed a minimum number of independent directors for the boards of regulated UK funds but, “SMCR does not stipulate any requirements for board independence, though one senior management function is chair of the board – where there is one. Not all firms have a chair of the board,” explains Quinn.
Management information and systems may also need to be upgraded to meet the needs for data and record keeping. “How can a senior manager show they have taken reasonable steps if they do not know what is going on?” declares Quinn. He is working with an investment bank that has one full time person whose job is to show that 800 employees have been properly supervised. “Real time management information might reasonably be expected for, say, the head of a trading desk,” he adds.
SMCR responsibilities are dictated by the FCA according to its definition rather than seniority in any generic sense. Seniority per se does not explain why the Head of Legal is not now expected to be an SMF. The FCA’s September 2016 Discussion Paper had proposed it should be an SMF, but its February 2019 discussion paper proposes excluding it. Several arguments were advanced by The Law Society, and various law firms, in their responses to the FCA. “The issue here is that, although the Head of Legal is an in-house function, attorney client privilege applies just as it would if advice was sought from external counsel,” says Quinn. Therefore, to include Head of Legal in SMR could give rise to a potential conflict of interest, for instance if a Head of Legal waived privilege in order to demonstrate that “reasonable steps” had been taken in appropriately fulfilling their SMR responsibilities. Additionally, the SMR imperative to alert the FCA to anything it would reasonably require notice of, could conflict with a Solicitor’s Regulatory Authority (SRA) principle of acting in the best interest of clients. Moreover, the SMCR regulation could duplicate SRA regulation, throwing up more conflicts. A further nuance here is that SMR might apply to some forms of advice from the Head of Legal – in relation to control functions – but not others. And where Head of Legal is also CCO (which seems to be reasonably common) then advice in their capacity as CCO could be covered. It remains to be seen if any other functions might need to be carved out of SMR for conflict-related reasons.
Quinn has worked in London since 2006 and set up RQC in 2008 because he felt, “a need for a consultancy focused on cross-border regulatory advice, considering the UK, the US and Europe, offering advice in an integrated and fluent way, not in a vacuum”.
RQC has a New York office. SMCR can to some degree be seen as comparable to the FINRA framework of series 24 principles, which Quinn became familiar with in his early career as a US lawyer. But, “apart from the FINRA broker/dealer regime, US regulators do not have anything analogous to SMCR. The SEC and CFTC do not specifically assign personal responsibilities as will be the case here,” Quinn observes. “The style of supervision is different: US regulators do carry out more frequent and more intrusive examinations, which will ultimately hold owners and principals responsible.”
In broad terms Quinn expects, “some firms may rethink their global structure and division of responsibilities in the context of SMCR. Many hedge fund managers in London have headquarters elsewhere such as in the US. There is a spectrum of outcomes: they may adjust to the UK regime, or may try to avoid SMCR by making all decisions in the US. They also need to determine the balance between senior managers and certified staff in each jurisdiction”.
But he argues that SMCR need not be too onerous if managers are prepared, have allocated time to this and have a plan in place. “Firms need only show that senior managers took reasonable steps to comply. Additionally firms will need to provide conduct rules training annually.”
Extraterritoriality is not new: in 2012, Greenlight’s David Einhorn – a US manager based in the US – fell foul of the UK but not the US insider trading rules in relation to trading a UK listed stock, and currently Quinn observes that certain overseas staff spending more than 30 days a year in the UK can be covered by FCA rules. SMCR does potentially expand the FCA’s extraterritorial reach however. Greater numbers of overseas firms’ UK staff and UK firms’ overseas staff, could be covered by FCA rules. SMR functions are potentially covered if carried out overseas, whereas the CR is only expected to apply beyond the UK for Material Risk Takers or those dealing with UK clients.
FCA rules could differ from overseas rules: “when designing global compliance programs, RQC has generally taken a conservative approach of using the strictest standard where standards differ,” Quinn says. Incidentally, the CFA Institute code of ethics, which applies to many people in the industry, also recommends a “highest common denominator” approach of observing the strictest standard where there are differences.
As SMCR applies to 60,000 regulated UK firms, which may have operations in over 100 countries, it could become complicated. The FCA has recently announced a number of Memorandums of Understanding (MoU) with regulators in various European countries, designed to ensure continuity under a hard Brexit. It is not clear whether the FCA has MoU with all regulators that could be relevant under SMCR, or whether these MoU provide for all eventualities that may arise where FCA rules differ from those overseas.
One scenario is that an FCA sanction could sometimes lead other regulators to follow suit: “I do not expect that the SEC would object to any FCA actions taken against certified employees, and even think that the SEC might then take other actions against senior managers who were supervising them,” Quinn says.
RQC’s online package, which includes some input from law firms, is intended to offer a transparent roadmap at an inexpensive cost (single digit thousands of pounds overall) which provides a foundation to build on. In some cases, it might be close to a complete solution. “The amount of work involved depends on the size and complexity of the firm. It remains to be seen how many clients will follow a pure DIY approach, and how many will need additional support,” he says. Quinn’s base case expectation is that, “some firms may implement it themselves, but some will need extra help after a certain stage. We are agnostic about whether they use one or more of a regulatory compliance consultant; a law firm; an accountancy firm; a human resources firm, or others, because every firm has their own advisers who may be appropriate”.
Broadly, Quinn expects the first year of SMCR will be the worst, as firms work through any teething troubles, paving the way for smoother routines in future years.