Conduct and Pay in the Financial Services Industry

The regulation of individuals

Thomas Ogg, Richard Leiper QC, Thomas Ogg, Richard Leiper QC

• Publisher: Informa Law from Routledge
• Year: 2017
• Print ISBN: 9781138680876
• eBook ISBN: 9781317189923
• Edition: 1
• Topic: Law
• Subtopic: Corporate Law
• Index: Law

Since the financial crisis, one of the key priorities of the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) has been individual accountability. This book addresses the regulatory and employment law challenges that arise from the FCA's and PRA's requirements.

The expert team of writers examine in depth the provisions of the Financial Services and Markets Act 2000 which relate to individuals, and the associated requirements of the PRA and FCA. The topics addressed include:

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• The Senior Manager, Certification and Approved Person Regimes

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• Regulatory references and whistleblowing

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• Disciplinary investigations, enforcement and sanctions

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• Notifications, 'Form C', and fitness & propriety

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• Bonus disputes and the Remuneration Code

Conduct and Pay in the Financial Services Industry considers the full extent of an individual's employment, from pre-contractual discussions to the post-termination clawback of remuneration. It is a vital reference for lawyers and human resources professionals working within the financial services industry, both in-house and in private practice. It will also be of interest to all academics, regulators and policy-makers involved in this sector.

Chapter 1
Introduction

Thomas Ogg and Richard Leiper QC

The development of the new regime

1.1 It is now nearly a decade since the most serious financial crisis since the Great Depression. In September 2007, the first run on a UK bank since 1866 began against Northern Rock, and in 2008 it was nationalised. By 2009, four further UK banks were wholly or partly in public ownership, and dozens of financial institutions worldwide had either merged or failed. The UK regulator, the Financial Services Authority (“FSA”), was abolished by the Financial Services Act 2012 and replaced with effect from 1 April 2013 by the Prudential Regulation Authority (“PRA”) and the Financial Conduct Authority (“FCA”).

1.2 In late June 2012, the FSA published the Final Notice to Barclays Bank Plc in relation to the attempted manipulation of the London Interbank Offered Rate (“LIBOR”). The Chancellor of the Exchequer noted in the House of Commons that “the public are very angry about what happened”, in something of an understatement.¹ The public perception was that the LIBOR scandal showed that the conduct of bankers in the lead-up to the financial crisis was not merely negligent, it was dishonest. The £59.5m financial penalty imposed on Barclays was, at the time, the largest fine ever imposed by the FSA, although the subsequent fines arising from the LIBOR, and other benchmark fixing scandals that followed, made that sum seem almost modest.

1.3 In July 2012, the Parliamentary Commission on Banking Standards (“PCBS”) was created to examine the “professional standards and culture of the UK banking sector” in the light of the LIBOR scandal, and to report on the lessons to be learned. Many of the new concepts discussed in this book, such as certification, have their origins in the PCBS’s final report, Changing Banking for Good (19 June 2013). The PCBS wrote that “The problem” was:

“Too many bankers, especially at the most senior levels, have operated in an environment with insufficient personal responsibility. Top bankers dodged accountability for failings on their watch by claiming ignorance or hiding behind collective decision-making. They then faced little realistic prospect of financial penalties or more serious sanctions commensurate with the severity of the failures with which they were associated. Individual incentives have not been consistent with high collective standards, often the opposite.”

1.4 In relation to the then current regime for individuals, the Approved Persons Regime, the PCBS found that it “has created a largely illusory impression of regulatory control over individuals, while meaningful responsibilities were not in practice attributed to anyone. As a result, there was little realistic prospect of effective enforcement action, even in many of the most flagrant cases of failure.” Its key recommendations to resolve those problems were that:

• the regulators should take additional stringent steps to require banks to clearly allocate senior management responsibility, so as to enable the regulators to penetrate the “accountability firewall” they had encountered in previous enforcement investigations. This was to be part of what was called a “Senior Persons” regime, which subsequently became the “Senior Managers Regime”;
• the banks should take responsibility for assessing the fitness and propriety of their mid-level employees. The PCBS described this as a “licensing” regime, which subsequently became the “Certification Regime”; and,
• the Statements of Principle for Approved Persons should be replaced with a clearer, more comprehensive set of “Banking Standards Rules” of general application, which subsequently became the “Conduct Rules”.

1.5 Those recommendations were legislated for by the government, initially only for banks, in the Financial Services (Banking Reform) Act 2013 (the “Banking Reform Act”), which came into effect on 7 March 2016. The Banking Reform Act was primarily intended to implement the recommendations of the Independent Commission on Banking, chaired by Sir John Vickers, including that retail banking should be separated from investment banking by means of “ring-fencing”. The PCBS’s recommendation that there should be a specific criminal offence relating to bank failure was enacted in section 36 of the Banking Reform Act. The government also took forward (only later to revise hastily) a proposal for a “reverse burden of proof” for senior managers as regards their responsibility for regulatory failures occurring in their area of responsibility. The “reverse burden” became a statutory “duty of responsibility” as a result of the Bank of England and Financial Services Act 2016.

1.6 The PCBS’s recommendations as regards remuneration were no less sweeping, and have now largely been implemented. The PCBS recommended that variable remuneration should be subject to significant deferral periods of up to ten years (at the time, the standard deferral period was three years). Deferrals of that length were required so as to allow for the possibility that unvested (ie unpaid but owing) remuneration could be reduced by means of “malus”. The PCBS also emphasised that “clawback” (the recovery of remuneration already paid) should be more widely utilised, particularly where fines for misconduct were imposed, so that the downside risks of misconduct could bear some remote comparison to the upside rewards during the good times. It also recommended that the regulators should bring forward proposals for mechanisms to allow for the performance adjustment of buy-out awards provided by new employers, which as presently operated were “tantamount to wiping the slate clean”. In late 2016, the PRA’s final rules on buy-outs were published as PS27/16.

1.7 The PCBS recommended the creation of a professional standards body, which is now the Banking Standards Board, an industry-funded body tasked with raising conduct standards across the industry. The PCBS placed emphasis on the mechanisms the regulators provided for whistleblowing, and its proposals led to separate reviews by the regulators and the Department for Business, Innovation and Skills on, amongst other things, financial incentives for whistleblowers (which were rejected). The PCBS also made detailed recommendations relating to the conduct of the regulators in supervising and taking enforcement action against banks. History is likely to judge the PCBS to be one of the most impressive, effective and sweeping of the many reviews that followed the financial crisis.

1.8 Whilst the significant reforms in banking were being developed, for insurers, the long-planned “Solvency II” directive (2009/138/EC) also required a number of regulatory changes in the field of conduct. Together with the changes to Part V of the Financial Services and Markets Act 2000 (“FSMA”) arising from the Banking Reform Act, the PRA took the opportunity to introduce a Senior Insurance Managers Regime, which mirrored a number of the changes for banks. The FCA followed suit by making a number of similar changes to the Approved Persons Regime as it applied to insurers. The Senior Insurance Managers Regime and associated changes applied from 7 March 2016, with certain changes brought into effect on 1 January 2016 to coincide with Solvency II.

1.9 Another response to LIBOR was the Fair and Effective Markets Review (“FEMR”), a collaboration between the Treasury, the Bank of England and the FCA, which was announced in June 2014 by the Chancellor of the Exchequer. The focus of FEMR was on the Fixed Income, Currency and Commodities (“FICC”) markets in the wholesale sector. Its terms of reference concerned trading practices as a matter of market standards, and it was asked to consider how regulation could rebuild trust in FICC markets following the benchmark scandals. Its final report, published on 10 June 2015, contained wide-ranging recommendations for the operation of FICC markets, including what led to the creation of the FICC Market Standards Board, whose role was to develop standards of good market practice for particular types of trading on the FICC markets.

1.10 Significantly, the FEMR recommended that many of the main elements of the Senior Managers Regime should be applied to all other firms operating in the FICC markets. FEMR also recommended a requirement that regulatory references should be made on a standard industry template, so as to stop the “rolling bad apples” (employees with poor conduct records) moving between firms. FEMR recommended that the regulatory reference proposals should be brought into effect on 7 March 2016. In the event, after consulting on ambitious proposals on references, only interim rules were made by the regulators to apply by 7 March 2016. The final rules were published on 28 September 2016 as PRA PS27/16 and FCA PS16/22.

1.11 Another loop in the roller-coaster of reviews, reports and commissions described above is the proposal, published by HM Treasury on 15 October 2015, for the Senior Managers and Certification Regimes (“SMCR”) to be applied to all financial services firms.² Whilst we may later regret this prediction, it may be that this latest reform signals the “beginning of the end” of major changes to the regulation of individuals, at least in the short term. The last significant change to the regulation of individuals was the introduction of the Approved Persons Regime in 2001, upon the coming into effect of FSMA. Whilst the temptation to tinker with the new regime will doubtless be irresistible for the regulators and the Treasury, given the scale of the reforms undertaken so far, it may well be that the SMCR will remain in place for at least a similar period of time to the Approved Persons Regime.

1.12 The flurry of consultations and policy statements from the regulators will, however, continue for the foreseeable future as they seek to implement the Treasury’s 15 October 2015 proposal, which entered the statute book as part of the Bank of England and Financial Services Act 2016. The stated aim in the 15 October 2015 announcement was for the SMCR to apply to all FSMA-authorised firms by 2018, and that it should be implemented “proportionately”, given the diversity of financial services firms. At the time of writing, the details of how the extended regime will be tailored have yet to be considered by the regulators, let alone consulted upon.³

1.13 There is no doubt that individual accountability will continue to be an important theme in enforcement action taken by, and policy proposals from, the regulators in the years ahead. As the FCA stated in its Annual Report for 2016: “Future confidence in financial services will depend on senior individuals in positions of responsibility taking personal accountability for how their firms operate and the consequences of misconduct.”

Brexit and the European Union

1.14 At the time of writing, the shock of the United Kingdom’s vote to leave the European Union on 23 June 2016 remains fresh. The ultimate effect of “Brexit” remains wholly unclear, either in its impact on the regulatory regime or upon the UK (and London in particular) as a global centre for financial services.

1.15 It is often said that EU law has had a profound effect on the development of financial regulation in the UK. Its impact is certainly evident as regards the regulation of individuals. This is perhaps most obvious in relation to pay: the bonus cap, for example, is wholly a creature of EU law. However, many of the requirements of the conduct regime are also underpinned by EU law. The requirement for individuals to be “fit and proper”, now so central to the UK regulatory regime, is also a requirement of EU law: for example, article 9(1) of Mifid⁴ requires that “persons who effectively direct the business of an investment firm to be of sufficiently good repute and sufficiently experienced as to ensure the sound and prudent management of the investment firm”.⁵

1.16 However, whilst EU law generated and structured a great deal of the legal architecture for financial regulation in the UK, in many cases it has served only as a baseline. Decisions in the UK have repeatedly “gold-plated” and extended regulatory requirements beyond any baseline set by EU law. For example, the significant periods of deferral of variable remuneration in the UK apply as the result of a domestic policy process (described above), as does the significant extension of the requirement to be “fit and proper” across a very wide range of roles in the industry. In fact, the PCBS was concerned that the increasing tendency of EU law towards harmonisation would limit the scope for the UK to take action unilaterally, causing the UK to move “at the speed of the slowest ship in the convoy”. There would therefore seem to be considerable force in the view expressed by Andrew Bailey (previously the CEO of the PRA, and now CEO of the FCA) that there will be “no great bonfire of regulation” once Brexit finally comes to pass.⁶

1.17 At the time of writing, even the UK government does not know what its policy will be on its post-Brexit relationship with the EU. It is therefore simply too early to say whether the “hard Brexit” currently being discussed will transpire, or whether the negotiations will result in the UK continuing to implement some aspects of EU law as the price of access to the Single Market (by means of passporting, or otherwise). Query, then, whether prime candidates for the legal dustbin post-Brexit, such as the bonus cap, may survive yet.

This book

1.18 The focus of this book is the regulatory and employment law problems that arise in relation to individuals working in the UK financial services industry. As the book’s title suggests, it does so in two parts. Part I concerns conduct-related issues, including regulatory control of who may perform particular functions in financial services firms, and individual accountability for misconduct. Part II concerns remuneration, from both a ...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• SUMMARY CONTENTS
• DETAILED CONTENTS
• List of contributors
• Table of cases
• Table of legislation
• Table A and Table B
• Table of final notices
• Table of abbreviations
• Table of statutory instruments
• CHAPTER 1 INTRODUCTION
• PART I CONDUCT
• PART II PAY
• Index