RegulationSep 29 2020

How to regulate management functions during a pandemic

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How to regulate management functions during a pandemic

It may come as a relief to senior managers within financial institutions to learn that there is no required senior management function specifically to deal with the challenges of the coronavirus. 

Indeed, given the risk that such a person could suddenly become absent, it makes more sense for such responsibilities to be spread.

While working remotely presents a considerable challenge to any business, by comparison with most, keeping control over large financial institutions with sizeable trading floors and activities running into hundreds of millions, if not billions, of pounds without an office represents a very considerable challenge indeed.

The Financial Conduct Authority and Prudential Regulation Authority set out their expectations of regulated companies in a joint statement, dated April 3 2020. 

Both regulators recognise that there may be a need for regulated companies to reorganise and redeploy staff in order to cover for furloughed managers, making this a challenging time for such businesses. However, they both require that existing responsibilities remain in place, albeit subject to some practical changes.

Temporary measures

In particular, the FCA recognises that companies may need to make temporary arrangements in order to cover absences.

While it is unlikely that large regulated companies, such as banks, will furlough anyone undertaking a senior manager role, this is not the case for smaller businesses, which were brought under the auspices of a reduced Senior Managers and Certification Regime last year. 

Dual v solo-regulated companies

While the SMCR has been in place for dual-regulated companies (FCA and PRA), that is, banks since 2016, the regime was expanded and adapted to cover solo-regulated companies (FCA only) from 2019. 

While banks are generally large and well resourced, this is not always the case for smaller solo-regulated businesses such as IFAs, fund managers and boutique advisers, where they will draw upon a smaller pool of talent, with the result that the FCA and PRA have flexed their requirements slightly for solo-regulated companies.

By way of example, dual-regulated companies are required to continue to the annual certification of certified employees (below the rank of SMFs).

Key Points

  • Existing responsibilities must stay in place for furloughed senior managers
  • Dual-regulated companies must have an individual performing CFO and CEO functions
  • Any furloughed senior manager will effectively become dormant

Dual-regulated companies are required to have an individual performing the chief executive officer (SMF1) function and chief financial officer (SMF2) function at all times. UK branches of overseas banks must always retain a head of that branch. 

In general, the FCA has indicated that it expects certain key SMFs (that is, compliance officer (SMF16), money laundering reporting officer (SMF17) or in the case of a limited scope companies, the SMF29) only to be furloughed as a very last resort.

This makes sense as the regulator will want consistency in terms of their dealings with a company. If an individual performing one of these functions becomes absent (that is, through sickness) the company must appoint another individual to continue to undertake these core and essential legal functions.

The FCA understands a company may furlough a non-mandatory function (that is, a chief operating officer SMF24). Nonetheless, the FCA and PRA encourage companies not to do so, as this could cause intrinsic operational risk.

Twelve-week rule

The FCA’s and PRA’s rules allow individuals to perform SMFs without approval for up to 12 weeks in a consecutive one-year period if their company experiences an SMF vacancy that is (a) temporary; and/or (b) reasonably unforeseen. This is generally referred to as the ‘12-week rule’.

In the current circumstances, the FCA has agreed to a temporary arrangement under which the 12-week rule can be extended to up to 36 weeks for solo-regulated companies). They are still considering their position for dual-regulated companies, ie, banks. The FCA is offering this change because it understands that in the current circumstances, the movement of people and governance arrangements will be need to kept under constant review.

Reallocating responsibilities

Both regulators understand that companies will sometimes need to reallocate prescribed responsibilities to an individual who is standing in for a senior manager, absent on furlough.

The FCA and PRA have indicated that their preference is for companies to reallocate a furloughed SMF’s responsibilities to an existing and already approved SMF.

This reduces the need for a regulator to get to know a new manager at a time when no doubt their own resources are also stretched thin.  

The preference of both regulators is for companies to appoint the most senior person available.

Nonetheless, both regulators have indicated a level of flexibility and accept that it may be necessary for an untested and unapproved manager to step up. By way of example, if the SMF responsible for risk management is furloughed it may make more sense to appoint that person’s deputy than to ask the compliance officer to spread themselves more thinly by taking over responsibility for an area with which they are less familiar.

Statements of responsibility

Where a senior manager is absent (presumably on furlough), a regulated company needs to update its statements of responsibilities and its responsibilities map to the extent applicable.The FCA has made some temporary arrangements in order to make this process easier during the current exceptional circumstances.

In order to minimise the burden on companies, the FCA has indicated it does not expect regulated companies to submit updated statements of responsibility in respect of the absent senior manager for the new person taking on their role. However, companies should update and document any changes internally.

Any furloughed senior manager will effectively become dormant. Unless they are permanently leaving their post, they will remain approved by the FCA even during their absence and will not need to be reapproved upon their return. Nonetheless, the regulated company remains responsible for ensuring that senior manager is a fit and proper person. As a result the company will not need to file a form C (where a SMF leaves their post permanently) or form J (long-term leave).

In these uncertain times, our regulators have attempted to steer a middle path between accepting companies may have to substitute SMFs for reasons of financial or physical health, while wishing to ensure that a control structure remains in place under which there are no blurred lines of responsibility.This is particularly so at a time when material risk takers are no longer physically in the office under the watchful eye of managers who may pick up on eccentric behaviour, prior to the effects of such behaviour on the regulated company’s financial performance. 

Depending on how long the crisis continues we may expect to see further updates.

Nigel Brahams is a partner at Collyer Bristow