The intensive Supervisory Model
FSA is adopting a more direct and intrusive approach to supervision. The most important aspect of which is moving away from ensuring that the appropriate systems and controls are in place and relying on management to make the right judgements to a model where it will “seek to make judgements on the judgements of senior management”. As FSA has said, this means regulation based on judgements about the future.
As part of this new approach, FSA is also switching its resources to focus on outcomes testing. It has said that, for example, on conduct issues a better use of resources is 'mystery shopping' and 'branch visits' rather than detailed reviews of high-level management information.
To achieve this end and ensure the resource is of a higher quality than in the past, FSA intends to hire an extra 280 specialist and supervisory staff, a 30% increase in its supervisory capacity, and has introduced a new Training & Competence scheme, which involves a regulatory testing regime for existing supervisors.
These changes are significant, FSA has termed it a “supervisory revolution”. Firms will therefore see a much more hands on and intrusive style of supervision from FSA and need to be prepared to deal with this and be able to demonstrate the quality of their decision making and risk management.
The competence of senior management and non-executive directors (“NEDs”)
Ensuring that senior management and non-executive directors are competent to carry out their roles is a critical part of this approach. FSA has concluded that it is not the governance structure which needs to be overhauled but the attitude and competencies of the individuals responsible for governance.
FSA Interviews for key management roles
As part of its significant influence function (“SIF”) review, FSA announced in its consultation paper in December 2008 the introduction of interviews for candidates for key functions. The presumption is that for high impact firms the Chair, the CEO, Finance Director and Risk Director will be interviewed and FSA supervisors may interview others if they consider it appropriate. In the first six months of this new policy being operative 51 have been interviewed and in a number of cases the applications have been withdrawn following the interview. FSA intends to publish a further statement on the proposed SIF changes it outlined in its December consultation paper alongside Sir David Walker’s review on governance.
Firms need to be aware that part of the assessment of a firm’s management and governance will include a review of the competence of SIFs looking at knowledge, skills, behaviour and expertise.
In his recent speech on 7 May 2009, Hector Sants placed considerable emphasis on the role of NEDs. FSA regards ensuring NEDs have the relevant and diverse expertise and willingness to challenge the board as a crucial aspect of its enhanced supervisory approach. In Mr Sants’ words: “This will mean a different calibre of NED, with a different mindset.”
NEDs will need to improve their technical skills particularly in the areas of risk management, regulatory understanding and the business model of the firm. It is envisaged that this will lead to “provisional” NEDs to allow time for current NEDs to acquire the necessary expertise. It will also mean that NEDs will be more full-time and can therefore expect the compensation they receive to reflect that.
FSA is also expecting a greater level of direct communication between NEDs and the FSA and greater use by NEDs of independent advisers. FSA has been careful to stress that it is not seeking to encourage conflict, with the NEDs competing against the executive, but merely to create a culture of challenge, allowing independent views to be expressed without undermining the unitary board model.
FSA has stressed the importance of having effective risk management function with clear independent reporting lines to the Risk Committee. FSA has emphasised the key role of risk officers, which should be recognised by firms by ensuring that the risk officer has the same stature as a unit head. Indeed, FSA expects to see an executive director solely responsible for risk on the main board.
Executives must be able to understand the circumstances in which their firm would fail and what plans have been put in place to mitigate these risks.
Enforcement and the Credible Deterrent
As Hector Sants said back in March 2009: “There is a view that people are not frightened of the FSA. I can assure you that this is a view I am determined to correct. People should be very frightened of the FSA.” Margaret Cole, FSA’s Director of Enforcement, in her speech of 27 April 2009 on delivering credible deterrence at the Annual Financial Crime Conference echoed this sentiment and made it clear she shared Mr Sants’ determination in this regard. She emphasised that credible deterrent meant delivering results that “make people sit up and take notice” and that FSA’s enforcement work would be complemented by the new intrusive supervisory strategy.
FSA‘s determination has been demonstrated by the first use of its criminal prosecution powers (and the promise of more to come), albeit that it has still to convict any high profile scalps; the increasing use of its civil market abuse powers; and in the action it has been taking against individuals, particularly those with senior management responsibility. Last year it imposed a record amount in financial penalties - over £27 million - and prohibited a record number of individuals. FSA now seems to be more willing to bring difficult cases which take longer and are more difficult to prove. Significantly, FSA has said the number of individuals with significant influence functions under investigation has increased threefold in the past 12 months.
It is important the firms’ senior management and NEDs take note of the points made by FSA in these recent speeches, particularly with regard to risk management and effective governance. In future, FSA will be assessing the quality of management’s judgements. FSA is sending out a clear warning that it will take action against individuals where failings or incompetence are found and this might mean significant personal fines, prohibition and certainly unwelcome publicity.
We have significant experience of advising firms on governance and risk management arrangements as well as acting for both firms and individuals involved in FSA investigations and enforcement action and we would be pleased to discuss further or assist in helping you deal with these issues. For further details on how to deal with FSA investigations and the way in which we could help please click here for our guide.