Reforms to banking regulation that are meant to remedy the world's continuing financial crisis are coming into force, bringing with them significant changes. These include greater individual accountability at regulated firms in the UK.

Supervision is to become stricter as a result of the findings of the Parliamentary Commission on Banking Standards. Regulators will remain responsible for approving the occupants of only the highest positions of responsibility at firms, the 'senior managers’ functions'. Firms themselves will be turned into ‘mini-regulators’ and senior managers will become ultimately responsible for all other employees who work in financial services.

The new regulatory regime is to introduce a two-tiered governance structure made up of a Senior Managers’ Regime, which builds on the outgoing Approved Persons Regime, and a Certification Regime.

While the regulators finalise the Senior Managers’ Regime, firms should be getting to grips with its precepts and laying the groundwork for a smooth transition when it finally arrives.

How will the new regime look?

The Senior Managers’ Regime has been designed collaboratively by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). Although there is a large degree of overlap, each regulator has its own specified 'key' areas of responsibility for various components of the senior managers’ functions. Every firm will have to account for each senior manager's function in its 'governance structure,' as the FCA puts it.

There will be a transition period during which the Senior Managers’ Regime will only apply to new applicants. Firms will have to tell the FCA about all current 'significant influence functionaries', along with the equivalent senior managers' jobs that they will be taking on under the Senior Managers’ Regime, and certify their 'fitness and propriety' in relation to their work.

The Certification Regime will require firms to certify that certain employees are fit to perform specific functions and 'proper' to boot. The regulators describe these as 'significant harm' functions; jobs that relate to aspects of a firm's affairs (as far as they relate to a regulated activity that the firm performs) that might involve significant harm to the firm or any of its customers.

How to prepare for the changes

Firms should begin preparing for the new regime by mapping out the organisational structure for regulated activities, a part of the Senior Managers’ Regime known as the Management Responsibility Map.

The first stage of this process is to take the existing management structure chart, which lists all the current approved persons, and adapt it for the transitional period. This exercise should involve discussions with approved persons and other senior managers to determine the boundaries of responsibilities during the transitional period and identify those employees who are part of the Certification Regime.

The second stage will involve the drawing-up of the Management Responsibility Map, setting out the senior management and 'governance structure' that will obtain once the new regime is fully embedded. The act of drafting this in advance of the transitional period should help the compliance office in question to identify any gaps in accountability in the current or proposed structure. This will allow the firm to negotiate changes to existing senior management jobs or the recruitment of suitably qualified individuals to plug those gaps.

SORs

Firms can also begin to draft 'statements of responsibilities' (SORs) for the senior managers’ functions. The regulators will require firms to submit SORs when applying for approval for individuals to perform senior managers’ functions and whenever there is a significant change in a senior manager's responsibilities.

Collectively, the SORs will have to cover all areas of responsibility identified by the FCA and PRA, but should not necessarily be limited to those responsibilities and key business functions. They should also highlight any additional responsibilities specific to senior managers that may have been introduced at the firm's own initiative (e.g. succession planning).

When firms are drafting SORs, there is a danger that a conflict of interest might arise between the senior managers-to-be and the firm. Given the importance of and the risks associated with becoming a senior manager, people who agree to taking on 'senior managers’ functions' will want to limit their responsibilities and exposure, while the firm will want to ensure that there are no gaps between people's responsibilities. In the light of this conflict, firms may wish to seek legal advice when preparing their SORs, even in some cases arranging for the senior managers-to-be to have access to independent advice.

Firms should also be aware that the drafting of an SOR is not a one-off job. Although the bulk of the work has happen at the beginning, each SOR must be the subject of constant review and adjustment where appropriate, particularly in the early stages of the regime when both firms and senior managers are finding their way.

Certification

In relation to the Certification Regime, each firm will have to draw up lists of people to be certified and will then have twelve months to issue an annual compliance certificate, which should allow for different appraisal cycles.

The PRA proposes that the Certification Regime should apply according to the criteria used to define 'material risk takers' for remuneration purposes, as defined in the European Union's Capital Requirements Directive. The FCA states that 'material risk taker' and 'significant harm function' are effectively synonymous for prudential purposes. The FCA regime also captures:

• anyone in a job that is currently classified as a Significant Influence Function, who will not otherwise become a senior manager;

• anyone who works in a customer-facing role that requires a qualification, such as a mortgage advisor; and

• anyone who supervises a certified person who is not a senior manager.

The regulators have noted from responses to their consultation papers on the Senior Managers’ Regime that a significant number of firms are planning to build the annual certification process into existing performance management processes. Although this is not an issue per se, if an individual moves between certified roles or adds a new function to his role between appraisals (and re-certification), the firm must assess him against the relevant criteria for 'fitness and propriety' at the point the change is made and not wait until the annual certification.

Finally, a new set of conduct rules will replace existing rules and guidance set out in the FCA's APER Sourcebook. The FCA has indicated that the new rules will be broadly similar to the existing rules.

However, the application of the new conduct rules is far broader than under the existing regime. The PRA rules will apply to all individuals who are performing a senior management function or 'certified function' specified by the PRA. The FCA rules will apply to:

• all individuals approved by the FCA or PRA as senior managers;

• all individuals covered by the FCA or PRA's certification regime; and

• all other employees other than those ancillary staff who do jobs that are not specific to the financial service business of the firm.

This is likely to inflate the number of employees subject to conduct standards. Given that the rules will be substantially similar to the existing ones, firms should take the opportunity now to identify all staff who will be subject to the new conduct standards and provide them with training about the existing standards and the implications of failing to comply, the better to ensure a smooth transition to the new conduct regime.

How will the changes affect boards and the directors who sit on them?

The Senior Managers’ Regime will capture a relatively small group of individuals at the top of each organisation. In most cases this will comprise the board and the executive committee, the top two tiers of governance.

After analysing feedback from its original proposals for the Senior Managers’ Regime, the FCA says that it does not intend to include 'standard non-executive directors' [NEDs] in the regime. This might be because they are not very involved in the running of businesses. However, NEDs with specific mandates, including all chairmen, all committee chairmen and all senior independent directors, will be subject to the regime.

The regulators expect SORs to be less extensive for NEDs who are subject to the Senior Managers’ Regime than for executive board members, as NEDs do not run firms.

If the board of a firm has delegated overall responsibility for a particular function to someone and he is primarily responsible for reporting to the board in respect of that function, it should 'approve' him as a senior management functionary.

In practice, all executive members of the board ought to become senior managers and it is likely that at least some of them will have responsibility for more than one function. If the firm allocates responsibilities on a shared or collective basis, perhaps as part of a job-share, each senior manager will be jointly accountable for those responsibilities.

Severe punishments for failure

Senior managers will be held accountable for failings in their areas if they are unable to satisfy the FCA and/or PRA that they have taken reasonable steps to prevent those failures. The sanctions for failing to take reasonable steps are likely to be severe. In particular, the Senior Managers’ Regime is to introduce a new criminal offence of taking a reckless decision that causes a financial institution to fail.

Directors should, therefore, have a clear understanding of the responsibilities they have been allocated and the standards expected of them by both their firms and the regulators. Boards, and the directors that sit on them, should ensure that reporting lines throughout their 'governance structures' are simple, clear and adequately understood by those who manage. They must also ensure that there is the right degree of oversight in each of the key areas that make up the new regime.

How compliance and HR departments can help each other

Human Resources (HR) departments will have a crucial part to play in attuning their firms to both the new Senior Managers’ Regime and the Certification Regime, working closely with senior managers, particularly those on the board, and compliance departments. They must help to evolve a well-organised and well-managed process for the appointment and support of senior managers and 'certified persons.' This will help their firms attract and retain talent at the highest level.

At this stage, firms should be ensuring that the individuals earmarked for senior managers’ functions and 'certified' jobs have the necessary qualifications and skills, while also collating and storing the evidence required for both senior managers’ functions and certified jobs.

Detailed, specialised training is necessary for people who are to perform senior managers’ functions. HR and compliance departments must work co-ordinate this together. If gaps are identified, candidates will have to be given additional, specialised training and support now. HR and compliance departments will have to co-operate during this process, sharing expertise and know-how.

HR and compliance departments should also work together to train people about responsibilities and conduct standards, while appraising all staff members who are to labour under the new regime, especially the senior managers.

The regulator's nark

Together, they will have to design an efficient process for dealing with people who break the rules and fail in other ways. They will have to tell the regulators about senior managers who break the rules within seven days, which means that their firms will have to be able to investigate problems extremely quickly – a significant challenge.

When 'certified persons' break the rules, their sins will be included in quarterly reports. This means that firms will have to deal directly with any breaches of the rules by anyone other than the senior managers. It will be crucial for them to deal with such instances consistently. This will require detailed policies and a suitable mixture of HR and compliance personnel. It would also be wise for them to identify trends in non-compliance, highlighting areas where additional support or supervision is required.

The Senior Managers’ Regime will require firms to beef up their systems and controls. It will broaden the scope of the existing conduct regime and firms face a gruelling uphill slog to conform to it. The good news is that it is not, at this stage, threatening to bring with it a slew of changes to the existing rules and standards. It is crucial that HR departments, compliance departments and senior managers co-ordinate their efforts to guide their firms through this time of trial.

* Emily Benson is a partner and the head of financial services regulation at the City law firm of TLT. She can be reached on +44 (0)333 006 1471 or at emily.benson@TLTsolicitors.com