Government takes the reins on regulation of governance at FS firms - reverse burden of proof for senior managers scrapped and Approved Person regime replaced

In the clearest signal yet to bankers that the tide has turned and the Government wants to agree a "new settlement" with the industry, it published on October 15 2015 two announcements that go to the heart of how financial services firms are governed.

a. Reverse burden of proof scrapped and extension of duty of responsibility to managers of all authorised firms

One of the most controversial topics for senior managers in the new accountability regime was the reverse burden of proof.

Under the senior manager and certification regime (SMCR) rules, it was proposed that senior managers would be guilty of misconduct if there was a breach of a regulatory requirement by the firm for which they were the senior manager responsible (as set out in their statements of responsibility, for example). It would be up to the senior manager to satisfy the FCA or PRA that they were not guilty because they took such steps that a person in their position could reasonably be expected to take to avoid the breach occurring or continuing.

In essence, the individual would have been guilty until they could prove their innocence, a theory at odds with some of the fundamental tenets of our legal regime. In their consultations, the PRA and FCA gave some exhaustive examples of what reasonable steps a manager would need to take to prove his or her innocence.

This principle has been scrapped in the Bank of England and Financial Services Bill which had its first reading in the House of Lords on October 14 2015. Instead, there is a "duty of responsibility" which requires management to take appropriate steps to prevent a regulatory breach from occurring. In the explanatory notes to the Bill, the Government notes that: "no senior manager will be guilty of misconduct unless the regulators can prove that the senior manager did not take reasonable steps to avoid the breach happening. As amended, this ground of misconduct will also apply to senior managers at all authorised persons, and not just those in banks or other relevant authorised persons".

The key point to note is that the change from a reverse burden of proof to a duty of responsibility will make little difference to what senior managers are expected to do in practice. Pre-emptive actions to prevent a breach occurring, initial reviews of the business prior to taking up senior manager position, implementing, policing and reviewing appropriate policies, and awareness of relevant requirements and regulatory standards, are all good practice to show that the manager is fulfilling his or her duty of responsibility, just as they were examples of what steps a manager should take to rebut the presumption.

However, the softening of the language signals a clear change in the relationship between the Government and senior industry figures, which was heralded in George Osborne's Mansion House speech earlier this year.

Final guidance on the presumption of responsibility and other enforcement-related matters was delayed, probably as a result of behind-the-scenes discussions on this u-turn. We now expect further information from the regulators on how they foresee the duty of responsibility working in practice, particularly with the extension of its scope described below.

b. Approved persons regime to be replaced by SMCR for all firms

Hand in hand with the announcement that the reverse burden of proof is to be scrapped is the Government's proposal for an extension of the SMCR to all authorised firms, to replace the current Approved Persons regime.

This was something that had been mooted following the Fair and Effective Markets Review recommendations earlier this year, although potentially in stages with asset managers and broker-dealers being dealt with first. The Government has, however, decided to extend in a single step. In its proposals, the Government notes that it expects the number of roles that require regulatory approval to drop (with the senior manager population smaller than the approved person population), most current approved persons to be caught by the certification regime, and some costs to be incurred by firms as a result of the change. Nevertheless, the Government thinks that it is an appropriate time to extend the regime which will create "a more rigorous, comprehensive and consistent approach across the financial services industry".

The Government intends that implementation of the newly extended regime should come into operation during 2018. This is no mean feat for firms and, indeed, the regulators. We expect further information on these proposals from the regulators shortly.

If you have any questions, please contact your usual Ashurst contacts.