Amid all of the regulatory upheaval arising from Brexit, margin reform, MiFID2, Solvency II and a swathe of other regulations and directives, financial institutions and in particular individuals, defined as ‘senior managers’, who fall under the senior managers and certification regime (SMR), have another date to prepare for. The end of October marks the first annual submission for notifying breaches of the Conduct Rules of staff both within and outside of the SMR.
But as the critical date fast approaches, there remains a lack of clarity and debate over who falls under SMR – particularly in relation to the in-house legal function. So what are some of the nuances and is it not time for in-house legal teams to accept their role in ensuring accountability?
SMR – increased scrutiny, transparency and accountability
As described by Paul Fisher of the Bank of England, the purpose of the SMR is “to make it clear who is accountable for what within a firm. The foremost objective of that is not so we know who to punish when things go wrong. It is to make sure someone is taking full responsibility for the right outcomes so misbehaviour becomes very much rarer”.
So there is now a requirement for banks to map out the roles of their senior managers and to allocate responsibilities to them in order for there to be accountability on an individual level. Understanding who is responsible for which function and supported by a clear individual statement of responsibilities reduces the time required by regulators to identify who is responsible for each of the key activities, business areas and management functions of a bank. This will likely lead to more specific supervision and enforcement, focused on the individual and not the bank as a whole. The days of a collective management function without clear accountability are seemingly over.
A ‘duty of responsibility’ is also introduced, which means that senior managers are required to take the steps that it is reasonable for a person in that position to take, to prevent a regulatory breach from occurring.
This level of increased scrutiny, transparency and accountability is surely welcomed by the public, shareholders and regulators as a way of improving confidence in a robust and well-run banking system providing orderly conduct of its affairs. However, as always, the devil is in the detail: exactly where should (and is it reasonable to) draw the line on individual accountability?
Clarity of responsibility
Such is the regulators’ desire to ensure that clarity of responsibility is crystal clear, they have laid out senior manager functions with prescribed responsibilities for relevant UK banks, from, for example, the CEO, chief risk and chief finance officer to the head of internal audit, compliance oversight and money laundering reporting.
While the SMF descriptions are clear, broader catch-all categories at SMF18 and SMF22 (other overall responsibility and other local responsibility functions, respectively), should be of concern to individuals in banks that manage functions, such as legal (including general counsel), technology and HR.
The legal profession has raised significant concerns over the inclusion of the legal function in the SMR, and, in fact, whether they were included; a point that required clarification by the FCA in a statement made in January 2017.
Is it right to include the legal function?
There are already too many shades of grey, even for functions clearly within the SMR. Despite some example scenarios being provided by the FCA, the reality is that we are awaiting real commercial examples of the expectations regarding accountability – which will be after action is taken against individuals under this new regime. That clearly results in caution, a trait the legal function in particular is trained to excel at.
Take the case of a lawyer in an investment bank. In most cases, lawyers are advisers who provide a range of options and outcomes to executives on a range of issues from structuring to trading to litigation. Many will be keen to say they are, therefore, not part of the C-level suite that makes the final decisions around strategic direction or financial matters, and should not face more regulation.
However, the counter argument is that while the provision of legal advice does not constitute ‘management’, it is the management of a ‘legal function activity’ that brings a general counsel or head of legal within the scope of the senior manager’s regime.
Over the last few years, many in-house legal teams have continued their drive to become more integrated with their companies’ business activities, evolving away from solely an internal law firm providing legal advice only. The credit crisis and the increased emphasis on compliance have put in-house legal teams centre stage for many financial firms thanks to the re-engineering of their role. This legal function now has to actively contribute to the bottom line and can be seen as an engine or at the very least a facilitator of economic value. In fact, the legal function can be seen as the ‘connective tissue’ that underpins a financial firm, interacting with every part of the business, from the core management, corporate functions like HR or finance, and front-line business units.
One of the reasons given for inclusion of the in-house legal function in SMR is the acknowledgement of its wider impact. The FCA notes in its discussion paper on the overall responsibility of the legal function that “systemic failings in the management of the legal function, as well as in other internal functions… could create risks that can in turn impact the wider business and result in a failing within the firm”.
In the years leading up to the crisis, the complexity of the documentation being put in place was all too clear to the legal department, with ever increasing signs of businesses failing to understand the financial instruments being constructed. Very few legal departments, however, were able to stand up to their business and detail the risks, when documentation processes were not fully followed or completed and lack of investment in legal contract data systems. The knock-on issues included, among others, not giving effect to client assets and money provisions that had been contractually agreed. The senior manager role enables the legal function to sound the alarm and be listened to.
The in-house legal counter argument
The legal fraternity has been vocal in the potential of the SMR, if applicable to the legal function, to further erode into the important role played by lawyer – (internal business) client privilege, where the internal client can be therefore more open and honest without fear of others being able to pry into the conversations where genuine legal assistance is required.
Moreover, there is the potential conflict with other regulations. If the head of a legal function is a solicitor, then they will also be regulated by the Solicitors Regulation Authority (SRA) or Bar Standards Board. These bodies have their own regulatory regimes that impose ethical and conduct obligations, and, as such, there is the potential for overlapping or conflicting regulation. This, however, is a fairly technical argument, bearing little merit in terms of substance. The approaches of these regulators and desired outcomes are unsurprisingly consistent. Other professions, such as accountants and actuaries, seem to have been able to clear this hurdle without significant issue.
Ultimately, this comes down to the legal function starting to recognise their role as managers who have an important – arguably critical – role to play in ensuring accountability for the areas they oversee and can impact. It is often said that lawyers make bad managers, however given the increasingly complex regulatory environment, it is a challenge the legal function really does need to respond to, for the sake of a safe, efficient and robust financial industry.