The proposals in summary
FSA proposes to:
- extend the definition of the existing CF1 (director) and CF2 (non-executive director) controlled functions to include individuals exercising significant influence on a regulated firm from a parent undertaking or holding company unregulated by FSA or an EU financial services regulator.
- Clarify the role of non-executive directors;
- Extend the definition of the CF29 controlled function to include all proprietary traders. Recent events suggest that the risks of proprietary trading in firms and the current market situation now warrant review of the position of all proprietary traders in relation to the approved persons regime. FSA considers the ability to take enforcement action may assist in deterring both senior and junior proprietary traders from undertaking activity for short term advantage that is either unauthorised, exposes the firm to risk of financial failure or jeopardises confidence in UK markets. (CP08/25 para 5.3)
- Amend the application of the approved persons regime to UK branches of third country firms so that all the controlled functions may apply. Currently only certain controlled functions apply to UK branches of third country firms and CF1 and CF2 do not apply. FSA now wants to change this to reflect current corporate governance arrangements and to ensure regulatory consistency between third country firms who form subsidiaries in the UK and third country firms that branch into the UK.
- Extend the rule obliging firms to provide references to all controlled functions.
FSA has already decided to:
- Hold individuals exercising significant influence over authorised firms accountable for poor conduct at those firms with regard to regulated activities. FSA has to date focussed on cases of dishonesty or lack of integrity. In the future, FSA will now investigate more individuals and alsoreview the competence of significant influence function holders. Comment: this is not, in practice, a distinction that FSA currently draws. FSA has taken action against senior management for failings in their firms, but only where it can demonstrate a close link between the manager and the misconduct – which is generally only possible in the smallest firms.
- Interview more applicants for significant influence functions at the largest firms. FSA supervisors will seek assurance that they can rely on those holding significant influence functions to make more principles based regulation a reality at their firms. Comment: this practice commenced some months back, starting with appointees to troubled firms and entrants from outside the industry. The interviews may be conducted by a “grey panther” – a retired industry figure – together with Supervision. The aim of the interview is to check the applicant’s understanding of FSA’s regulatory requirements and to enable FSA to understand his or her plans for the firm.
- Change Form A (Application for a controlled function) to require firms to provide supplementary information about the competence and capability of the candidate. (CP08/25 para 2.2)
FSA’s proposals for non-executive directors
FSA considers that firms must have high quality non-executive directors committed to ensuring that their firms are run effectively, and views the duties of a non-executive to cover the following responsibilities:
- Assisting executive colleagues within the firm’s governing body in setting and monitoring the firm’s strategy
- Providing an independent perspective to the overall running of the business, scrutinising the approach of executive management, the firm’s performance and standards of conduct
- Carrying out other responsibilities as assigned by the board, for example as a member of a board committee, such as an audit or remuneration committee. (CP08/25 para 4.2)
FSA recognises the valuable role of the non-executive director within regulated firms, and expects them toask challenging questions will hold non-executive directors accountablein order to understand (and if necessary, positively influence) the business model and inherent risks within the regulated firm. FSA is proposing changes to the APER Code of Practice to better reflect the duties of non-executive directors. FSA states that it , as well as the firm and its executives, if there is evidence to suggest that they have failed to fulfil their duties with competence and/or integrity. (CP08/25 para 2.4)
The draft rules for non-executive directors will require a non-executive director to discharge three functions:
- Provide an independent perspective, and constructively challenge and help develop proposals on strategy.
- Scrutinise the performance and approach of senior managers in meeting agreed goals, objectives, and standards of conduct.
- Establish and continually maintain his confidence in the:
(a) Conduct of the firm;
(b) Performance of senior management;
(c) Development of the firm’s business strategy;
(d) Adequacy of financial controls;
(e) Risk management;
(f) Appropriateness of remuneration;
(g) Appointment and replacement of key personnel; and
(h) Plans for management development and succession.
: while these draft rules record the duties normally expected of a non-executive director, they are significant for two reasons. First, they effectively codify FSA’s requirements and thus indicate the areas that an NED should cover. This in turn raises the expectation that an NED will keep records to indicate how he or she has performed the role – what they have read, what questions they have asked, and what action they have instigated. Second, it presages enforcement action – this is FSA making it clear that, when misconduct occurs, it will scrutinise the acts and omissions of the firm’s NEDs and act against those that were ineffectual.
FSA’s plan to extend controlled functions to holding companies
FSA considers that the current regime for individual approval captures individuals in matrix management structures if there has been a significant delegation of authority for management decisions by the governing body of an authorised firm (by CF29). However, the regime does not necessarily reflect the increasing significant influence exerted on an authorised firm by individuals based in parent undertakings or holding companies to which the authorised firm is accountable. (CP08/25 para 3.3)
FSA therefore proposes to apply the extended CF1 and CF2 to individuals in the following types of company exercising a significant influence over an FSA authorised firm:
- Regulated and unregulated UK parent undertakings and holding companies;
- Regulated and unregulated third country parent undertakings and holding companies; and
- EEA unregulated parent undertakings and holding companies. But not UK branches of an EEA regulated company, nor UK incorporated authorised firms with an EEA regulated parent company. (CP08/25 paras 3.10, 11)
FSA proposes to extend the definitions of both CF1 and CF2 to include individuals, such as directors, non-executive directors or senior managers, employed by a parent undertaking or holding company whose decisions, opinions or actions are regularly taken into account by the governing body of the authorised firm and therefore likely to have a significant influence on the conduct of an authorised firm’s affairs.
this is akin to the Companies Act definition of a “shadow director” and contains the two elements of authority and regularity. In other words, a parent’s director or senior manager may fall within the extended CF1/2 definition if (i) his or her decisions, opinions or actions are authoritative and thus considered by the FSA regulated firm before reaching a decision, and (ii) this is a frequent occurrence. (CP08/25 para 3.7)
Not every parent/subsidiary relationship will result in the parent’s senior managers exercising significant influence over the UK subsidiary – the issue will in each case be a matter of fact. If the governing body of an authorised firm is sufficiently robust and autonomous then FSA would not expect individuals in any company to which the firm is accountable to need approval.
But if governance arrangements in the authorised firm rely heavily on the governing bodies or other individuals within another group company then the extended controlled functions are likely to apply. FSA gives the following examples:
For the extended CF1 role
- The chairman of a group audit committee.
- A senior manager working for the holding company who is involved in taking decisions for or influencing the UK firm, or who has significant influence in setting the objectives for, and remuneration of, the UK directors.
For the extended CF 2 role
- A non executive director of the group holding company who is a member of the group audit committee
- Or who sets and monitors business strategy for, or who has oversight over management performance in, the UK subsidiary. (CP08/25 paras 3.8, 13; draft rules)
Who must identify affected individuals?
The firms themselves – FSA believes that robust corporate governance arrangements should identify where individuals in parent undertakings and holding companies are exercising a significant influence on the authorised firm. FSA will be looking closely at corporate governance arrangements to see if they sufficiently identify where significant influence lies. (CP08/25 para 3.12)
If this proposal is implemented, it will extend FSA regulation to senior managers of unregulated firms who are not otherwise subject to UK regulation and who have no direct responsibility for the management of those firms. The obligations arising from individual FSA approval as a person holding a significant influence position do not correspond to the role performed by a manager working for an unregulated firm who may influence, but holds no office in, a UK regulated subsidiary.
In particular, FSA may find it difficult to assess the fitness and properness of such an individual who does not, and otherwise has no requirement to, operate in the regulated environment. Furthermore, it is inappropriate to require an unregulated individual to fulfil the requirements of APER 5 – 7. These statements of principle for approved persons in essence require an individual registered as CF 1 or 2 to ensure that the firm is being run compliantly. It is impracticable for FSA to impose this requirement on an individual who has no executive role in a regulated firm.
Firms should challenge FSA over the justification for these steps. The cost benefit analysis is weak, and there is no identification of any regulatory failure. Furthermore, the imposition of APER 5 – 7 appears to be disproportionate and impracticable.
If FSA does proceed with this proposal, then unregulated holding companies would be well advised to reconsider their method of operating, possibly changing the roles of individuals working in holding companies so that they plainly fall outwith FSA’s definitions. This would be a regrettable step to have to take, because it would deprive the regulated firm of the benefit of group oversight that has so far proved beneficial and in respect of which FSA has no sound objections.