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Senior Managers' Regime

Posted on 18 March 2016

Senior Managers' Regime

The events of 2008 that caused significant damage to the British economy continues to have an enormous political impact on the UK.  There have been numerous official investigations into the causes of the banking crisis and how to prevent another one in the future. The initial focus of politicians and regulators was to ensure that bankers' bonuses were amended to reduce the incentives for wrongdoing.  With that in mind the Remuneration Code was introduced. This provided for executives' interests to be aligned with the longer term interests of the bank through the requirement that half the bonus be paid in stock. It also reduced the incentive to do short term deals with long term negative consequences by requiring banks to defer the release of bonuses for at least three years. 

However, despite these steps, there remained a view amongst many of the public that individual bankers, who are felt to have caused much of the crisis, had avoided justice.  Aside from reputational damage and loss of jobs, the most visible punishments handed out were the disqualification of Peter Cummings, formerly of HBOS, and former RBS executive Johnny Cameron's voluntary acceptance that he would never seek a senior management role within a Bank. 

The Senior Managers' Regime (SMR) - which will apply to all banks from March 2016 - has many elements to it, but at its core is a drive to ensure that if anything goes fundamentally wrong at a bank in the future, there will be a specific executive who is responsible for the area that failed.  The SMR achieves this by requiring all banks to create an organisational map of their risks and then to have named individual executives responsible for managing each of those risks.  Executives have to sign up to a Statement of Responsibilities and in the event that there is a failure in any particular area, the regulators will look to the individual who has responsibility for that area. 

To increase the prospect of holding individuals accountable, in the first draft of the SMR there was a reversal of the usual burden of proof, which meant that the executive was to be deemed liable unless they could prove they had done everything reasonably possible to avoid the failure.  That reversal of proof didn't survive into the final version of the rules (not least because of concerns that it represented a breach of the Human Rights Act).  What we now have in the SMR is a more traditional "duty" to take all reasonable steps, with the burden of proof falling on the regulator to prove the executive has failed to discharge that duty.

Executives remain exposed however, not least because – particularly in hindsight – it is often obvious what could have been done to avoid any particular failing.  To use the Libor example, it was clear from the individuals' emails, texts and other communications that the submissions that were being made were false.  However, in the investigations into the Libor scandal, the fact that any particular senior executive was unaware of the wrongdoing meant that they were not personally liable (although it didn't protect them from being dismissed, named and shamed and suffering the loss of deferred compensation).  Under the SMR the risk for executives in an equivalent situation will be that by failing to put systems and procedures in place to prevent wrongdoing the executive has failed to discharge their liability and therefore they are liable, notwithstanding the fact that they were wholly unaware of the wrongdoing. 

Each bank is taking a slightly different approach to the application of the SMR to their business, but we can begin to see some overarching themes.  Banks are seeking confirmation from each senior executive that they are aware of the obligations of the SMR and, in particular, that they accept that the organisation chart and Statement of Responsibilities that they are signing up for accurately reflects the business for which the executive is responsible. 

We are likely to see a real tension between banks and their executives when issues arise, or indeed, from the moment it starts to look like there may be an issue.  Given the risk of personal liability, it is possible that, down the line, executives will argue that they have fully discharged their obligations to the best of their ability but that they were hamstrung by the bank's failure to provide them with the resources to adequately discharge that responsibility.  Equally, we may see a significant increase in executives making use of their right to whistle blow directly to the regulators in order to give themselves additional protection in circumstances where they feel exposed.  Will executives in a bank that looks like it might run into trouble elect to resign if they cannot get comfortable with the bank's medium term business planning?

Whilst banks have traditionally chosen to engage with regulators by accepting wrongdoing and then working with the regulators to learn lessons (and reduce any fines payable), that approach may prove more problematic in situations where the interests of the bank and the executive diverge more than they did under the previous regime.    

The next few years look like continuing to be interesting times to be part of the management team of a major bank.

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