With so much bandwidth being absorbed by the gravitational pull of Brexit, hedge fund managers could be forgiven for paying short shrift to the Senior Managers and Certification Regime (SM&CR), which formally comes into effect on 9 December 2019.
Set to replace the existing UK Approved Persons Regime (APR), it is a relatively straightforward regulation, intellectually speaking, and nowhere near as daunting as the 7,000 page tome of MiFID II, but even so managers are advised not to leave it too late to ensure senior managers have been properly trained and made aware of their roles and responsibilities.
A recent survey by ACA Compliance Group found that 60 per cent of firms surveyed are one-third, or less, of the way through their SM&CR projects. It found that more than 25 per cent of firms admitted that outside of their compliance teams, there was a lack of awareness. As was reported on 2 September, less than 2 per cent of firms’ employees have a good awareness of the new rules and their implications across the organisation, with the majority having not yet codified the Prescribed Responsibilities to senior managers.
Part of this lack of urgency could be that as most average UK hedge funds are medium-sized businesses (both in terms of staff and AUM numbers) they will be treated as Core Firms, not Enhanced Firms, which will require firms to apply the same thresholds or levels of compliance as bank institutions. Depending on the number of individuals who will be treated as Senior Managers or Certified Staff, hedge fund managers might not feel they have as big a workload as larger institutions, ahead of the December implementation deadline.
Even so, this is not something that can be left to the last minute.
“The SM&CR is really designed with the stability of the financial system in mind,” comments Andrew Henderson, Partner, Financial Regulation, Eversheds-Sutherland. “Our view is that SM&CR ought not to be overly onerous. Firstly, all of those individuals who are Approved Persons performing governance functions and so on, will be transferred to the new regime without the need for the firm to make a fresh application to the FCA. That removes some of the administrative burden.”
Secondly, with respect to certification staff, the ability to identify risk takers in the business shouldn’t be difficult. As far as ensuring that all staff are trained on and understand conduct rules, in terms of monitoring their behaviour, the level of difficulty (in terms of Senior Manager oversight) will depend on the size of the manager, in absolute terms.
To clarify, the Certification Regime (the second pillar of SM&CR) applies to anyone within a financial institution who is not a Senior Manager but whose role could cause significant harm to the firm and/or its investors; i.e. anyone who undertakes a material risk-taking role.
At its heart, the SM&CR aims to reduce harm to consumers and strengthen market integrity by creating a system that enables firms and regulators to hold people to account. As part of this, the SM&CR aims to:
• encourage staff to take personal responsibility for their actions
• improve conduct at all levels
• make sure firms and staff clearly understand and can show who does what
“Senior Managers will still have to prepare statements of responsibility, which will set out how they are expected to oversee the part of the firm for which they are accountable. However, unlike banks, which are multi-faceted businesses, hedge funds are inherently straightforward businesses in terms of applying oversight to those managing investors’ capital, and ensuring that investment guidelines are adhered to,” explains Henderson.
“There may be a higher degree of complexity when it comes to the use of technology and certain interactions with service providers but relative to most other financial institutions, be they banks or broker/dealers, the business of a hedge fund manager is a straightforward one.”
SM&CR has been designed to secure a higher degree of personal accountability. One of the leading complaints coming out of the financial crisis was that there weren’t enough, if any, individuals (that is, senior managers) who were held to account, says Henderson.
“Institutions were, but not individual executives. So the core premise of the SM&CR is the personal responsibility statement that individuals will have to prepare and sign up to. Individuals in a firm are identified and their specific responsibilities must be clearly laid out, and that there will be an individual ultimately responsible for specific and identified parts of the firm.”
As such, the legislation has identified a more clearly articulated standard of personal accountability. The question as to whether a Senior Manager’s conduct has been reasonable would be judged on whether they complied with what was in their statement of personal responsibility, which is really a subjective subject.
But there is also an objective standard, which would seek to judge the standard of an individual relative to the standard of other Senior Managers in the hedge fund space, and ask whether that standard fell below what was expected.
Running throughout all of this are specific conduct rules. In 2016, the FCA specifically highlighted financial crime as an area where senior management functions and prescribed responsibilities were not always assigned to sufficiently senior individuals.
Hedge fund managers should also think about their internal culture under SM&CR, not just about the level of compliance and governance being applied to their business activities to uphold the best interests of their end investors. Diversity and inclusion considerations should also be part of hedge funds’ conduct rules, and how they apply to individual staff members. Any breach of these conduct rules will have to be reported to the FCA.
“When it comes to issues around gender discrimination, the FCA have been very vocal on this. It’s not just a case of a hedge fund manager upholding their clients’ interests but also applying standards of personal conduct and behaviour within their own firm,” says Henderson.
He concludes with the following observation: “The personal accountability regime is central to the FCA’s regulatory agenda. A failure to take that central pillar of the FCA’s regime seriously would be viewed negatively, particularly if something were to go wrong at the firm.”
