SMCR for Financial Market Infrastructures: HM Treasury Consultation

What is the SMCR?

The SMCR has been introduced in a phased implementation since 2016 for banks, insurers and other FSMA authorised persons. It aims to reduce harm to consumers and strengthen market integrity by changing behaviours and culture within firms. Applicable in a tiered way to staff at different levels, the SMCR encourages a culture where staff at most levels take personal responsibility for their actions and ensures that firms and staff clearly understand, and can demonstrate, where responsibility lies within the organisation. When something goes wrong, this in turn enables the regulator to identify individual culpability (and take action when appropriate).

Why is this happening?

HM Treasury notes that FMIs have performed effectively under recent stressed conditions. However, it is concerned that the existing regulatory regimes for FMIs make very limited provision for oversight of individual conduct within these entities as most supervisory and enforcement powers are focused on the legal entity. To resolve this gap, the Treasury intends to introduce an SMCR for FMIs.

This is not a development that has come out of the blue. In the July 2019 Financial Stability Report, the Financial Policy Committee at the BoE noted that there was a strong case for extending the SMCR to FMIs, commenting that “FMIs’ governance arrangements and risk culture should reflect fully the vital services they provide to the financial system and the economy”. The Treasury Select Committee made the same recommendation in its 2019 report into IT failures in the financial services sector. The Committee noted the potential impact on customers of an operational incident in an FMI, stating that it is “vital that senior management at FMI firms are accountable for their management of operational incidents. There does not appear to be any justification for keeping FMI outside of the Senior Managers Regime”.

The Treasury has also taken into consideration the positive feedback from the PRA and FCA reviews of their existing SMCR regimes.

By introducing an SMCR for FMIs, the Treasury aims to:

• encourage effective governance within FMIs;
• incentivise good behaviour;
• require employees in FMIs to give adequate oversight to the areas for which they are responsible;
• encourage employees in FMIs to identify gaps in responsibility within the FMI and to address them appropriately; and
• improve risk management at FMIs, and therefore their safety and soundness, in turn, supporting UK financial stability.

Which firms will the SMCR apply to?

The Treasury explains that, in practice, the relevant FMIs are:

• central counterparties (CCPs);
• central securities depositories (CSDs); and
• payment systems recognised under the Banking Act 2009 (recognised payment systems), and specified service providers to these recognised payment systems. Where recognised payment are embedded within a CCP or CSD, it is intended that the SMCR will be applied at the level of the CCP or CSD.

What is the SMCR framework?

The SMCR for FMIs would replicate the existing SMCR in Part 5 of the Financial Services and Markets Act 2000 in most respects – except the BoE would be granted new powers to implement, supervise and enforce the regime.
The regime will comprise:

• a “Senior Managers Regime” under which the BoE has the power to determine whether individuals who perform roles that pose a potential risk to financial stability or to the continuing functioning of the FMI (“Senior Management Functions”) have the appropriate competence, expertise and probity to carry out their roles. It would require firms to submit documentation to the BoE on the scope of these individuals’ responsibilities (a “Statement of Responsibilities”) and would establish a statutory requirement for senior managers to take reasonable steps to prevent and/or stop regulatory breaches in their areas of responsibility;
• a “Certification Regime” which would require firms to certify any individual who performs a “specified function” that could cause significant harm to the FMI or its users (“significant harm functions”) as fit and proper, both on recruitment and annually thereafter; and
• “Conduct Rules” for all employees, which set minimum, high-level requirements regarding the conduct of individuals where necessary or expedient for advancing the BoE’s financial stability objective.

In addition, the Treasury explains the extension of the BoE’s disciplinary powers under the SMCR and that the BoE would have the power to make prohibition orders if it appears to the BoE that an individual is not a fit and proper person to perform a function in relation to an activity carried out by an FMI.

Next steps

The Treasury seeks views on its overall intention to create an SMCR for FMIs, as well as how the SMCR may be appropriately and proportionately applied to FMIs.

The government intends to legislate for the new SMCR regime when parliamentary time allows. Under the new regime, the BoE would be given new rule-making powers to implement the regime. The BoE will consult on these new rules in advance of them coming into effect.

We have extensive experience advising financial services firms on implementing the SMCR. Please contact us if you would like to discuss responding to this consultation or the impact of this development on you and your business.

Authored by Yvonne Clapham