Key business impact

Statements of
responsibilities
Individual responsibility
and regulatory action for
misconduct

The new regulatory regime

for senior bankers in the UK

New criminal offence

Individual standards rules
to replace principles

Summary
Major changes are being made to the regulatory regime for senior bankers in the UK.
The intention is to make individual responsibility in banking a reality, in the words
of the report of the Parliamentary Commission on Banking Standards whose
recommendations form the basis of the new regime.
These changes apply in respect of UK-incorporated banks and investment banks, but the
Treasury may extend the application of most of these changes to non-UK-incorporated banks
and investment banks.
Further reforms are being made to set clearer expectations of the behaviour of both senior
and more junior bank employees and to replace the approved persons regime for more junior
employees with a licensing regime operated by the bank itself.
This briefing focuses on the new regime for senior bankers.
The PRA has said that it expects the new regime to come into force in 2015, but precise
timings are not known at this stage.

Key business impact

Regulators will more easily be able to apportion blame to individual senior bankers
if things go wrong, and therefore more easily take disciplinary action against them.
This comes on top of the FCAs increasing tendency to require individuals personally
to attest that required remedial action has been taken and that controls are fit for
purpose. It is clear that senior individuals are becoming much more exposed to the
risk of disciplinary action by the regulators.
These changes add to the burden of senior management responsibility and the
cumulative effect may be to dissuade some capable individuals from taking up
senior positions in banks.
The focus on individual accountability is likely to have important implications for
a banks governance structures. For example, tensions may arise in structures based
on collective decision-making at all levels up to and including the board of directors
itself. Individuals consciousness of their own personal responsibilities and potential
exposure could also make it harder to reach compromises in other contexts. And cases
may become more frequent in which a senior banker feels unable to comply with the
wishes of the board or other individuals to whom he reports.
Michael Raffan
T +44 20 7832 7102
E michael.raffan@freshfields.com
Simon Orton
T +44 20 7832 7671
E simon.orton@freshfields.com

The new statement of responsibilities will be a key document in defining the scope
of a senior persons responsibilities and therefore potential liability, especially in light
of the reversed burden of proof. A great deal of care will be needed in drawing these
up and maintaining them over time as management structures and businesses change.

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European bank recovery and resolution directive

February 2014

Introduction
The reforms to the regime for the regulation of senior bankers are contained in Part 4
of the Financial Services (Banking Reform) Act 2013 (the Act). They derive from the
recommendations of the Parliamentary Commission on Banking Standards which reported
in June 2013 and whose recommendations were largely endorsed by the government and
welcomed by the two UK regulators, the Prudential Regulation Authority (PRA) and the
Financial Conduct Authority (FCA).
For banks (as defined below), the current approved persons regime will be replaced with:
(1) a strengthened regime for the regulation of senior persons; and
(2)for more junior employees, a licensing regime under which the bank will itself
be responsible for certifying that the employee is a fit and proper person to carry
out his job.
In the light of these reforms the regulators are considering what changes they might make
to the approved persons regime for non-banks.
The Act received Royal Assent on 18 December 2013. Part 4 will come into force on a day
or days to be appointed by the Treasury. Both the PRA and FCA have said that they will
consult on implementation of the new regime in 2014. The PRA has gone further in saying
that it anticipates making the new rules in 2014, ready for implementation in 2015.

Scope of the new senior persons regime

The senior persons regime will apply in relation to senior persons in the following types
of firm (referred to in this briefing simply as banks):
(1) UK-incorporated banks, building societies and credit unions;
(2)UK-incorporated investment banks (ie investment firms that have regulatory permission
to deal in investments as principal and are regulated by the PRA); and
(3)if the Treasury makes an Order to this effect, any non-UK-incorporated banks or
investment firms of a kind specified in the Order.
The one exception is the new criminal offence, which has a slightly narrower scope: it will
not apply to senior persons in credit unions and the Treasury has no power to extend its
application to non-UK-incorporated firms.

Who is a senior person for this purpose?

A senior person is a person who carries out a designated senior management function
in a bank. These designations will be made by the regulators in due course. However,
the regulators may only designate functions that come within the broad definition
of senior management function contained in the Act. This is, broadly, a function that
carries responsibility for managing (or taking or participating in decisions concerning)
an aspect of a banks affairs that involves, or might involve, a risk of serious consequences
for the bank or for business or other interests in the UK.
Although the Acts definition of senior management function could be interpreted very
broadly, it is likely that the regulators will designate only a relatively narrow range
of functions. The FCA has spoken of only the most senior individuals in the bank
and the PRA has referred to those roles that can directly affect the firms safety
and soundness.

European bank recovery and resolution directive

February 2014

Statements of responsibilities
An application to perform a senior management function (SMF) in a bank will need to be
accompanied by a statement of responsibilities setting out the aspects of the banks affairs
that a senior person will be responsible for managing. The idea is to ensure that individuals
are aware of their responsibilities and have formally accepted them. The PRA has said that it
will require banks to assign the key activities they undertake and the key risks to which they
are exposed to particular individuals, including the CEO. It recognises, however, that it will
be appropriate for some matters to remain within the remit of the board as a whole rather
than a single individual.
If a senior persons responsibilities change at any time after the application has been granted,
a revised statement of responsibilities must be provided to the relevant regulator.

Handover certificates
Before a senior person relinquishes his responsibilities, he will be required to prepare
a handover certificate outlining how he has exercised his responsibilities and identifying
any issues which his successor should be made aware of. These certificates should be
held by the bank as a matter of record and made available to the regulator to help with,
among other things, the attribution of responsibility in the event of any future disciplinary
action. It is not hard to see that these could be dangerous documents in the hands of
a disgruntled leaver.

Individual responsibility and regulatory action for misconduct

The statement of responsibilities takes on a particular significance in the context of
the regulators new disciplinary powers. Until now, a regulatory breach by a firm has
not necessarily implied misconduct on the part of an individual unless the individual
was knowingly concerned in the contravention or was in breach of the statements of
principle for approved persons. This is now changing radically. In future, if a contravention
occurs in an area for which a particular senior person is responsible, that person will be
guilty of misconduct unless he can show he took reasonable steps to avoid the contravention
occurring (or continuing). The burden of proof will therefore fall on the senior person
to show his innocence. Moreover, merely showing that he was not knowingly concerned
will not be enough. He will need to show that he had taken such steps as a person in [his]
position could reasonably be expected to take to avoid the contravention occurring
(or continuing). These steps are likely to include, at the least, ensuring that appropriate
systems and controls were in place, including appropriate reporting lines and management
information arrangements.
Where a senior person is found to have committed misconduct, the disciplinary powers
available to the regulator include (as now) power to impose an unlimited fine and/or
to ban the person from performing particular types of function (or any function) in
a regulated firm.

Duty to notify regulator of disciplinary action

A firm must notify the relevant regulator if it takes disciplinary action against
a senior person, thereby enabling the regulator to decide whether it should itself
take any further action. Disciplinary action for this purpose means the issue of
a formal written warning, the suspension or dismissal of the person, or the reduction
or recovery of any of their remuneration.

Freshfields Bruckhaus Deringer LLP

European bank recovery and resolution directive

February 2014

Annual review
A bank will also now be required to review formally, at least once a year, whether there
are any grounds on which a regulator could withdraw its approval of a senior person.
If it believes that there are such grounds it must notify the regulator.

Extended time limit for disciplinary action by regulators

The limitation period for disciplinary action by a regulator where a person commits
misconduct or carries out his functions without having obtained a necessary approval
from the FCA or PRA has been extended from three to six years after the regulator first
knows of the misconduct (or the person began performing the relevant functions).

New criminal offence

The Act creates a new criminal offence of reckless misconduct leading to the insolvency
of a bank. A person guilty of the offence is liable to an unlimited fine and/or up to seven
years imprisonment.
Three elements must be present for the offence to be committed. The first is that a senior
person takes a decision (or agrees to it being taken or fails to do what he can to prevent it)
and that decision causes the insolvency of the bank or another financial institution in its
group. The second is that the senior person is aware at the time that the decision could cause
that insolvency. And finally, his conduct in relation to the decision must fall far below what
could reasonably be expected of a person in his position.
However, proving that a senior persons behaviour fell far below the expected standard is
likely to be a major hurdle for the prosecution in all but the most egregious cases. Similarly
it will often not be easy to prove that a particular decision was the cause of a banks
insolvency in many cases the insolvency will have been caused by the coincidence of a
number of different factors, none of which would have caused the insolvency on its own.
These difficulties contrast sharply with the considerably easier task faced by a regulator
in taking disciplinary action against a senior person. There, as discussed above, the burden
of proof falls on the senior person to show that he is not at fault for a failure (whether the
insolvency of the bank, or any other failure to meet regulatory requirements) occurring
within his area of responsibility. In practice, therefore, we expect disciplinary action
against senior persons to be much more common than criminal prosecution even in
cases of bank insolvency.

Individual standards rules to replace principles

At present, approved persons are required to comply with a regulators statements of
principle for approved persons and the accompanying code of practice. The Commission
found the principles and code to be incomplete and unclear in their application and they
will in future be replaced by a new set of individual standards rules applicable not only
to senior persons but to all banking employees within the scope of the licensing regime
(see below).
The regulators are expected to consult on the new individual standards rules in due course
and it is currently too early to say what this new rules-based regime will look like. However,
we can expect the regulators to take note of the Commissions findings in this area.
In particular, the Commission said that the current regime was overly complex and
legalistic. It also recommended that the rules should cover a number of issues not currently
covered in the statements of principle, including the management of conflicts of interest,
treating customers fairly and whistle-blowing to senior management and regulators.
Interestingly, a bank will be required to notify the regulator if it knows or suspects that
a person subject to these rules has failed to comply with any of them. There does not appear
to be any materiality threshold here. Reporting of employee regulatory breaches will
therefore be required in a broader range of circumstances than it is now.

European bank recovery and resolution directive

February 2014

Vetting of senior person candidates by the bank

The regulators have always expected firms to do their own vetting of candidates for senior
management positions, but there is now a formal legal requirement that a bank should do
this. A bank must satisfy itself that a candidate for approval by a regulator is a fit and proper
person to perform the function to which the application relates. In deciding that question,
the bank must have regard in particular to the same set of considerations as the regulator
will itself assess. These are whether the candidate, or anyone who may perform a function
on the candidates behalf, meets the requirements set out in the regulators rules in four
areas: qualifications, training, competence and personal characteristics.

Conditions and time limits on regulatory approvals

The regulators have a new power to grant approval subject to whatever conditions or for
whatever limited period they consider appropriate. The FCA gives as an example of a case
in which it might impose a condition a case in which it considers that a particular person
needs to acquire a specific skill in order to carry out a job well. Any conditions imposed may
subsequently be varied, removed or replaced with new conditions, either on the application
of the bank concerned or on the regulators own initiative. Powers to impose conditions or a
time limit are also available in respect of approvals originally granted without any such
conditions or limit. Each regulator must publish a statement of its policy regarding the
granting of conditional or time-limited approvals and regarding variation of approvals.

Information on the FCA register

A senior persons entry in the FCA Register, the online database searchable by the public,
will in future include information concerning any disciplinary action taken against him
by a regulator (once it has reached the stage of a final notice being issued).

Licensing regime for more junior bank employees

For bank employees other than senior persons, the bank itself will be responsible for
operating a licensing regime under which it will have to issue annual certificates for all
relevant employees, certifying that it considers them fit and proper persons to carry out
their jobs. This licensing regime will apply in respect of employees carrying on functions
designated for this purpose by a regulator. The regulators will make these designations in
due course. The designated functions can only cover those that the regulator considers may
involve the risk of significant harm to the bank or any of its customers.

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