Posted: 25th May 2017

The upcoming extension of the Senior Managers and Certification Regime (SM&CR) to all regulated financial services firms in 2018 will mean that firms within all sectors such as Wealth Management and Consumer Credit need to assess the impact of the new accountability and responsibility rules.

Senior managers within these firms will have greater personal accountability for any failings which happen within their designated areas of responsibility.

But what does this mean for private equity firms?

There are two distinct ways private equity firms could be impacted; the first lies in the internal governance arrangements of those firms which are authorised in their own right and the second is dependent on whether a firm has invested directly into other authorised financial services firms. The latter element has the potential to pose some fairly significant challenges for firms, especially in relation to gaining assurance over the ‘business as usual’ activities of the firm that has been acquired or invested into and whether it has suitable and sustainable strategies for delivering good outcomes for customers.

So, what should private equity firms and their senior management teams be thinking about ahead of the extension of the regime?

Thoughts for Authorised private equity firms

If you fall into this category, your firm will already be well versed in FCA’s current approved person’s regime (APER), which captures both the appointment and ongoing conduct of key individuals; however, the imminent extension of SM&CR will see the APER fall away.

SM&CR is an altogether different prospect from APER and, to ensure compliance moving forwards, private equity firms will need to consider changes in relation to governance and responsibility mapping while they make the transition from Controlled Functions under APER to senior manager function (SMF) roles under SM&CR.

Thoughts around Authorised financial services acquisitions

The precise impact of the extension of SM&CR on authorised financial services acquisitions will in part depend on the sector and risk profile of the firm being acquired or receiving investment.

In addition to the internal governance changes and responsibility mapping, individuals from private equity firms who acquire or invest in authorised firms will need to ensure they are clear of their individual responsibilities and understand what they are accountable for in the new firm. Those individuals who join the executive team or operate as Non-Executive Directors and have a significant degree of control over the activities of an authorised firm will need to understand and be prepared for the extended SM&CR regime.

Practical steps for consideration

Private equity firms should be thinking about SM&CR, its impact on them and the practical steps that can be taken to set up for success once the final details of the extended regime are released. To guide this thinking and to ensure successful, compliant acquisitions, firms can consider:

1. Initial and ongoing due diligence in relation to the investment

Although private equity firms are well versed in the importance of initial due diligence activity prior to any potential acquisition, the ability to provide assurance to the regulator that ongoing due diligence is being conducted on “live” investments is equally as important. This evidence should consider both commercial and customer angles to ensure there is no bias on commercial return over the best interests of customers.

2. Responsibility allocation and mapping – within the firm and the investment

Private equity firms which are directly regulated will be required to allocate specific responsibilities (some prescribed by the regulator, others defined by a firm as appropriate) to relevant members of senior management and produce a ‘responsibilities map’ so that, if a failing does occur, the FCA can now hold one person individually responsible and take consequent action as it sees fit.

Early preparatory work in relation to responsibility mapping is likely to be beneficial in the long term, both at private equity firm level and the level of the regulated financial services investment. Private equity firms should have a clear understanding of which members of the team are responsible for individual regulated investments.

To support and evidence this, firms need to ensure they have reviewed and, where evident or appropriate, enhance the policies that support the monitoring and control over the regulated financial services businesses in which the firm has invested. Private equity firms will also need to develop their training approach for the new regime and conduct rules. Given the differences in the operation and risks inherent in the various business areas for which senior managers are responsible, training may need to be tailored in order to be effective.

3. Governance – within the firm and the investment

All of the requirements brought about by SM&CR naturally prompt questions over whether an authorised firm is set up in the right way, and many have seen it as an opportunity to assess the makeup of business areas and management functions and establish whether changes are appropriate. Private equity firms investing in authorised firms should bear this in mind and understand that authorised firms will be at differing stages of this journey. This may lead to varying levels of risk to the firm, and in many ways requires extra vigilance.

In relation to the makeup of boards, the FCA announced late in 2016 that it planned to extend the application of the Code of Conduct Sourcebook (also referred to as COCON) to all Non-Executive Directors in banks and insurers. The extension of the existing regime to all NEDs will directly capture individuals within private equity firms who sit on the board as non-executives of existing investments. It remains likely that the application of the rules to all non-executives will also be part of the extended SM&CR.

The FCA has made it clear that it expects the changes to “increase the standards of conduct for these individuals…to reduce the risk of future misconduct and mis-selling.”

The regulator has also expressed reservations historically where the board may be unduly influenced by members of the private equity firm who sit on the board and have not always balanced commercial and customer considerations. As part of COCON, NEDs from private equity firms will also have to "pay due regard to the interests of customers and treat them fairly".  This is a significant divergence from the previous APER regime.

Acting now

As we move into a world of personal accountability at senior level, individuals at private equity firms who have joined the board of regulated firms need to consider how they are impacted and ensure they have clear sight of their specific accountabilities.

Are you ready for the challenge of a specific responsibility rather than being one of many CF1s with group responsibility for compliance tasks? The FCA will expect clarity on how individuals with the potential to inflict significant harm on customers ensure and demonstrate the compliance of their assigned functions.

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