SM&CR – reading the regulatory mind-set

By Gavin Stewart, Head of Strategy Execution of Financial Services Group, Grant Thornton

Published: 12 July 2017

Driving cultural change will require more collaboration between firms and the regulators due to the extension of the Senior Managers & Certification Regime (SM&CR)

We are approaching a decade since the markets froze in August 2007 and Northern Rock collapsed, signalling the start of the financial crisis. SM&CR, due to come into force in 2018, originates in these events.

Understanding this context, in particular its effect on the mind-set of regulators and of Parliament, will be critical to making a success of the new regime. The Parliamentary Commission on Banking Standards (PCBS) report was not subtitled “changing banking for good” by accident. Its core purpose was to change firms’ culture, and we should therefore view SM&CR as a means to that end.

In the first wave covering banks and insurers, both regulators and firms tended to focus on implementing the detail of the regime as an end in itself. This ensured accountability maps were clear and the rollout was as smooth as possible. However, this approach focussed too much on the implementation process, partially obscuring the outcome. The second wave, covering all remaining regulated firms – more than 50,000 - including hedge fund managers, alternative credit managers and funds of funds, is now looming, and regulators’ attention is starting to shift. Two forces are driving this – a year’s practical experience of the regime, and the much larger and more diverse nature of the second wave of firms.

Practical experience will drive behaviour

Unsurprisingly, operating the new regime on the ground is posing challenges to both firms and regulators. For firms, accountability maps, by their nature, are often too neat to represent accurately what happens in practice, particularly when there is a problem. For regulators, there will be some tension between recognising that each firm is different and the desire to compare different approaches.

The sheer spread of firms also makes the second wave of SM&CR a challenge. The new regime will encompass everything from large asset managers to dentists and therefore will demand a different approach, with far more proportionality built in.

The first time the regulator sets a precedent by taking action against a senior manager, a new tone will be set for what happens thereafter. Firms are already wary of this and regulators will likely feel under pressure to show the regime works as intended by holding individuals to account successfully. In addition, this will play out against the background of some senior managers retiring or moving role, and new ones being appointed and approved. This too will influence the future behaviour of both firms and regulators.

The framework for regulatory relationships

One school of thought is that SM&CR will have little effect on regulatory relationships and that, if it does, this will be confined to banking, its original focus. However, this ignores the fact that the regime will produce accountability maps that purport to cover the entire organisation, a significant departure from the Approved Persons regime it replaces. It also underestimates SM&CR’s symbolic importance, with the Prudential Regulation Authority, for example, already declaring its success as a key component of the revolution in regulation that has taken place since the crisis.

Given all this, the new regime will probably provide the de facto framework for the regulators’ relationships with firms. In particular, their perception of SM&CR is likely to shape how they make two of their key assessments of the inherent risk a firm poses, namely the firm’s openness with the regulator and the quality of its systems and controls.

If both these assessments are consistently high, regulators are likely to view firms much more positively, through thick and thin. Historically, many firms have struggled to understand what openness means in practice, and so have relied predominantly on their systems and controls. However, these can never be fool proof, which leaves firms exposed when a problem occurs. SM&CR creates a set of expectations around openness, perhaps for the first time, and so could lead to a better mutual understanding about what it means in practice.

Implementing for the long term

Changes in culture and in firms’ openness with its regulators will not happen overnight, but firms should still carefully consider them through their implementation of SM&CR. This is because, even if only sub-consciously, regulators will begin to look at firms through the lens of the new regime even as it is being put in place.

Business change, communications and the future measurement elements of these programmes are all therefore likely be more important than ever. Testing the new arrangements against potential adverse scenarios should also be a core part of the approach and their design should contain enough flexibility to allow firms to reflect how the regime works under the pressure of future events.

Risks and opportunities for firms

Firms can find the regulators, particularly the Financial Conduct Authority due to its wide remit and complex structure, quite siloed, and as a result can receive mixed messages. This is sometimes compounded by the fact that firms usually deal with regulators on a transactional basis, often reflecting their own silos. SM&CR will challenge this status quo on both sides by applying a single lens across firms’ management and governance.

This will put a premium on firms’ ability to build a consistent overall relationship that encompasses all their regulatory touchpoints. If firms continue with a transactional approach, they might therefore be running increased regulatory risk, particularly if they encounter a problem and SM&CR does not operate as intended.

However, building such a relationship will be a major challenge for most firms. Even where they have a single focus point for regulatory affairs, these departments can easily become overly defensive to regulators’ scrutiny. This can mean they try to present a shield to protect senior management from regulatory overload, while they often also find it hard to maintain their knowledge of the firm’s business and the risks it is running. These challenges are likely to be especially acute for small/medium sized firms providing alternative finance, who do not have a named FCA supervisor and so will have little continuity of experience with the regulator.

Firms should therefore consider carefully what sort of overall regulatory relationships they want to have in the longer term. For many firms, this is likely to involve a greater degree of internal coordination and forward thinking.

Contact the author:

Gavin Stewart, Head of Strategy Execution of Financial Services Group, Grant Thornton: