Overview 

On 2 June 2020, the FCA published Policy Statement PS 20/5, setting out final rules and guidance following its Consultation CP 19/31 on extending the Senior Managers Regime (SMR) to benchmark administrators (‘BA firms’). The final rules will apply to BA firms authorised in the UK, which do not undertake any other regulated activities [1], on 7 December 2020.

You can view some of Deloitte’s previous reports on SMCR here and hereand on the Benchmark Regulation (BMR) here and here.

The Certification Regime, which usually goes hand in hand with the SMR, and requires firms to assess the fitness and propriety of certain individuals, will not apply to BA firms. This is because BA Firms are already subject to the Benchmarks Regulation (BMR) which is intended to achieve the same outcome as the Certification Regime. However, BA firms will be required to confirm annually that their Senior Managers are fit and proper and will be required to undertake criminal record checks when appointing Senior Managers and Non-Executive Directors.

Conduct Rules, which form a fundamental part of the SMR and include different tiers of rules which apply to all staff and to Senior Managers respectively, will also begin to apply to BA firms from 7 Dec 2020.

Scope 

The rules will only apply to BA firms that are authorised in the UK and do not undertake any other regulated activities. They will also apply to exempt persons (including those operating a Recognised Investment Exchange) if they have a Part 4A permission for administering benchmarks.

Third country BA firms and their UK-based legal representatives will not be required to comply.

It should be noted that where firms have outsourced regulated activities, they remain accountable for their regulatory obligations; regulatory obligations under SMR cannot be outsourced.

Categorising BA firms under SMR

The SMR categorises firms as ‘Core’, ‘Limited Scope’ or ‘Enhanced’. This categorisation determines the extent to which certain obligations under SMR will apply to the firm. Core firms are required to apply all the basic obligations under SMR which are referred to later in this blog, Limited Scope firms have relatively fewer obligations and Enhanced firms have extra obligations over and above those for Core firms.

The FCA considers BA firms to be of significance to the financial markets and real economy, as the benchmarks that they produce can significantly affect its ability to discharge its objectives. As a result, all BA firms in the scope of SMR will initially be categorised as Core firms by default, however an option will be available for firms to move to Limited Scope using the existing waiver process under SMR. The FCA has stated that it does not expect any BA firms (who do not undertake any other regulated activities) to fall within the Enhanced category.

The FCA acknowledges that the Core regime may not be appropriate for all BA firms, hence the waiver process will provide the option for some to move to Limited Scope if appropriate.

The main requirements of the SMR i.e. FCA approval of Senior Managers, Duty of Responsibility and Conduct Rules will apply equally to Core and Limited Scope firms. The Limited Scope regime will offer a different model of accountability, without making firms and individuals subject to it ‘less accountable’ for their regulated activities.

The process for moving to Limited Scope categorisation will remain as consulted on in CP 19/31. BA firms will be required to demonstrate that complying with the Core regime would be unduly burdensome or would otherwise not achieve the rules’ purpose. The FCA has provided criteria for assessing this which include:

  • whether regulated activities form a small part of the firm’s activities; and
  • the importance of the benchmark administered to UK-based markets.

It is important to note that the SMR applies at a legal entity level, which means that the same group of firms could have individual entities within it that are categorised differently as Core or Limited Scope as per the FCA criteria.

The following table provides a general overview of obligations for Core and Limited Scope firms. 

SMR Obligation 

Core Firms

Limited Scope Firms

Designating Senior Management Functions

Applies

Applies

Seeking FCA approval prior to allocation of Senior Management Functions to individuals

Applies

Applies

Duty of Responsibility

Applies

Applies

Statement of Responsibilities

Applies

Applies

Prescribed Responsibilities

Applies 

Does Not Apply

 Senior Management Functions and Prescribed Responsibilities 

Core BA firms will be required to apply four Governing Senior Management Functions:  Chair; Partner; CEO; and Executive Director. These four functions will only apply if the BA firm already has someone fulfilling these roles. For Limited Scope BA firms, only one Senior Management Function would be required – SMF29 (Limited Scope Function).

Core BA firms will be required to allocate three Prescribed Responsibilities to the most senior personnel in respective areas:

  • performance by the firm of its obligations under the SMR, including implementation and oversight;
  • performance by the firm of its obligations in respect of notifications and training of the Conduct Rules; and
  • responsibility for the firm’s policies and procedures for countering the risk that the firm might be used to further financial crime.

Applying the Conduct Rules 

Due to the significance of BA firms to financial markets, the FCA will require the Conduct Rules to apply to all employees in BA firms that undertake both regulated and unregulated financial services activities. This would not include ancillary staff, such as cleaning staff.

Note, if a BA firm outsources regulated benchmark activities under the outsourcing provisions within BMR (e.g. to another group entity), the BA firm should ensure, via contractual arrangements, that the entity carrying out the outsourcing activities is appropriately applying the conduct rules. For example, the BA firm could receive periodic reporting on compliance with conduct rules (for presentation and discussion at the Oversight Group or equivalent governance group). Notably, and if a breach of the conduct rules were to occur, responsibility to inform the FCA lies with the BA Firm.   

The FCA has stated that how BA firms source and use information, and how this process is overseen, are fundamental to ensuring that the benchmarks are robust, and restricting the Conduct Rules to only a few specific individuals would not allow it to deliver its market integrity and consumer protection objectives. However, the Conduct Rules are not intended to, and should not, prevent employees from undertaking both regulated and journalistic activities, where the BA firm also produces news commentary.With regards to Annex II firms[2], the FCA has tailored the application of the Conduct Rules in line with how its Principles for Businesses (PRIN) are applied to these firms. Under this approach, all the individual conduct rules, and the Senior Manager Conduct Rule requiring disclosure of information to authorities will be restricted to Annex II firms’ regulated benchmark activities only. The other Senior Manager Conduct Rules will apply both to these activities and also to any activities that might reasonably be regarded as having a negative effect on the integrity of the UK financial system or a firm’s financial resources. 

The FCA acknowledged certain Annex II firms’ concerns that this narrower approach may only be available to Annex II firms that administer only Annex II benchmarks.  The firms were concerned that this would place administrators that provide both financial and Annex II benchmarks at a commercial disadvantage. The FCA has clarified that the tailoring of the Conduct Rules for Annex II firms will only apply to any individuals contributing to Annex II benchmarks. This will ensure that employees within ‘mixed model’ firms that provide both Annex II and non-Annex II benchmarks receive the same treatment, and is intended to create a level playing field amongst firms administering Annex II benchmarks.

Applying the Individual Conduct Rules

BA firms will be required to apply the five Individual Conduct Rules and the four Senior Manager Conduct Rules to all employees working on regulated and unregulated financial services activities. With regards to Annex II firms, the tailored approach set out above will apply.

During the consultation process, some stakeholders were concerned about the practical application of Individual Conduct Rules 3, 4 and 5 and the FCA has addressed the concerns as follows.

With regards to Individual Conduct Rule 4 (you must pay due regard to the interests of customers and treat them fairly), certain stakeholders stated that this may introduce a conflict of interest, by obliging BA firms to pay regard to the commercial interests of users of benchmarks. They were concerned that this could compromise integrity as employees may feel incentivised to manipulate the benchmark in the interest of customers; crucially, the definition of ‘customer’ in the context of BA firms’ activities was called into question. The FCA clarified that manipulation of benchmarks is clearly prohibited. It stated that ‘customers’ in this context are users of the benchmark, except where the user neither requires a licence to use it nor has made an agreement with the BA firm.

 Stakeholders were also unclear on how to interpret Individual Conduct Rule 5 (you must observe proper standards of market conduct) in the context of benchmark administration – they stated that they do not participate in any market. The FCA clarified that this obligation can be met through compliance with existing obligations under the BMR and other relevant legislation.

The FCA will publish guidance in due course on interpreting Individual Conduct Rules 4 and 5 in the context of BA firms which will formalise the abovementioned clarifications.

Some stakeholders were concerned that Individual Conduct Rule 3 (you must be open and cooperative with the FCA, PRA and other regulators) created a conflict with freedom of expression. They stated that sometimes journalists working at Annex II BA firms must protect confidential sources and other proprietary information, and that this rule should not be applied to them. The FCA explained that it had considered the case for exempting journalists working within Annex II BA firms from Individual Conduct Rule 3, but had concluded that this would compromise its ability to request information and would not meet the objectives of the Conduct Rules. The FCA has stated, however that, it respects the rights afforded to journalists under UK and EU law and would not expect journalists to disclose information when this was not legally permissible.

The FCA has proposed that BA firms should have 12 months to train staff that are not Senior Managers on applying the Conduct Rules – it has underlined the need for BA firms to tailor their application of the Conduct Rules to their business models.

Next Steps…

BA firms that have not already begun implementing these rules should now accelerate the process, engaging with the FCA as needed. Since the objective of the SMR is to enhance overall accountability and conduct for Senior Managers and for the general staff in the firm, it would be short-sighted to approach implementation as a ‘tick box’ exercise, when in some cases a medium‑term programme of cultural shift may be required to sufficiently move the dial on SMR compliance. Some key steps include:

  • Scope: determining whether your BA firm meets the threshold for Limited Scope Firms;
  • Role determination: considering which existing roles can be mapped onto Senior Management Functions - it is important to note that the SMR does not require firms to create Senior Management Functions where equivalent functions did not already exist in the firm, unless the functions are 'Required Functions'[3] as per the FCA Handbook;
  • Clarity on responsibilities: ensure that any Prescribed Responsibilities applicable to the firm have been allocated to Senior Managers and that they have bee included in their Statement of Responsibilities;
  • Legal entity coverage: for group structures, determine which of the legal entities in the group falls under the scope of these new rules;
  • Training & awareness: ensure that Compliance and Risk functions are well versed in not only the overall expectations under the SMR but also in the relevant administrative processes i.e. the different forms required to be submitted for FCA approval etc.; and
  • Embed the control framework: it is also key for control functions across the first and second lines of defence to create adequate monitoring programmes and relevant policies and procedures to ensure that the obligations are met on a continuing basis, and that breaches are recorded and reported where needed. Furthermore, since the SMR focuses heavily on individual behaviour, extensive and ongoing training for Senior Managers and general staff could prove useful in embedding the new standard of behaviour expected.

 

[1] Regulated activities are specific activities carried out with regard to specific investments see https://www.handbook.fca.org.uk/handbook/PERG/8/23.html

[2] BA firms that produce certain commodity benchmarks which are subject to the requirements under Annex II of the EU Benchmark Regulation (https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R1011&from=EN)

[3] Required Functions are certain roles which the FCA requires certain firms to perform on a mandatory basis – see https://www.handbook.fca.org.uk/handbook/SUP/10A/7.html?date=2018-09-29