SMCR – When are ‘reasonable steps’ reasonable?
1. Introduction – What are reasonable steps?
Senior Managers within financial services firms now need to comply with the Senior Managers & Certification Regime (SMCR). This means they have a duty of responsibility to prevent, stop and remedy regulatory breaches within their areas of responsibility and need to take ‘reasonable steps’ to discharge their accountabilities and evidence that they have done so. Which begs the question – when are ‘reasonable steps’, well, reasonable?
Reasonableness is a subjective test by the regulators based on a comparison of what a manager actually did, with the actions that would have been carried out by a competent individual in the same situation. Guidance on meeting these requirements has understandably remained scarce, with firms left to their own devices in navigating the complexities of defining what is ‘reasonable’ and what could be used as appropriate evidence. Four years on from the initial implementation of the SMCR in the banking sector, there continues to be significant ambiguity around the concept of reasonable steps.
In our view, a Senior Manager’s reasonable steps are the sum of all of their actions in running their area of the business effectively, from making decisions, managing employees, delegating activities, documenting key information, pursuing effective and robust governance arrangements, embedding adequate risk management and control frameworks through to the nurturing of a good culture and good conduct practices.
In the event of a regulatory breach, Senior Managers should be able to articulate a clear narrative explaining how they identified, stopped and remedied the breach, in addition to how they will prevent this from happening again. Any actions taken should be evidenced by data made available from relevant reports, management information, escalation from delegates and systems and controls within the area of the business for which they are responsible.
2. Why are they important?
The introduction of reasonable steps under the SMCR is driven by the regulators’ desire to focus accountability on a narrow set of senior individuals. They believe that holding executives to account for their actions leads to better outcomes for the firm’s customers and the overall performance of the financial system. The Senior Manager Conduct Rules is the mechanism through which the regulators can take enforcement action against those accountable individuals.
It is clear that regulators view ‘reasonable steps’ to be a very broad topic which incorporates most of the actions taken by a Senior Manager in managing their area of the firm. Having worked with many firms and seen different approaches to reasonable steps, we think that firms can greatly improve the guidance and direction provided to Senior Managers by outlining a clear set of standards to help them understand this concept and follow it in a consistent manner. Providing this guidance mitigates the risks arising from individuals defining their own standards and limits the resulting divergence between the approaches taken and evidence retained by each Senior Manager. Ultimately, a lack of centrally provided direction on what is reasonable will unintentionally expose certain individuals or the firm itself to regulatory scrutiny in the event of a significant issue.
The current COVID-19 pandemic provides an excellent example of why Senior Managers need to be able to evidence that they have taken reasonable steps in a robust and consistent manner.
Under normal circumstances, firms will usually take adequate time and care to ensure that any changes (to processes, governance, controls) are appropriately considered and tested to ensure the best outcome for the firm and its customers. In a crisis, the same amount of time may not be available and rapid decision making, often based on minimal information, becomes critical. For example, what guidance and equipment did managers provide to their staff with regards to effective home working? How did they ensure that the usual risk management controls continued to operate effectively? How were products and services adapted to address the needs of customers? Have they maintained the timeliness and integrity of regulatory reporting?
Once the crisis has passed, it is very likely that the regulators will look back at the decisions made and actions taken to determine whether they were ‘reasonable’. Additional scrutiny may be applied if financial markets, the firm or its customers have been negatively impacted or government expectations with regards to emergency loans, small business lending or insurance claim pay outs have not been sufficiently met.
3. Why getting this right is important for firms and Senior Managers?
Since the regime first went live in 2016, the FCA has continually increased their investigation and enforcement activity, with a growing number of enforcement cases being opened year-on-year. The number of investigations into specific Senior Managers is also rising, with recent high-profile cases demonstrating that the FCA is taking investigation and enforcement activity seriously.
As a result of the SMCR, the FCA and PRA have unparalleled clarity on who the key accountable individuals are within the firms they regulate. There are also fewer individuals directly accountable for the key activities of the firm compared to the earlier Approved Persons Regime, meaning that productive dialogue between the regulators and these relevant individuals is more consistent and therefore strengthened.
4. So how can we help?
Our experience of working with firms across all aspects of the financial services industry, lawyers and ex-SMCR policymakers has helped us to define a Reasonable Steps Framework which incorporates the key activities a Senior Manager should be performing when discharging their accountabilities. Within this framework, we define eight different categories which cover existing business practices which, if business areas or functions are ran effectively today, should be in place and can be evidenced.
Senior Managers should consider the activities they perform and how their business area works in practice, documenting supporting information throughout their decision-making and thereby providing tangible evidence to the regulators should this ever be requested. The categories of our Reasonable Steps Framework include:
Often Senior Managers and Compliance departments believe ‘reasonable steps’ to be a new concept which requires them to create volumes of new documentation, change how they perform their role and create layers of governance or introduce new MI and reporting to detail every aspect of the business. In our view that would be unreasonable.
The BCS framework provides a pragmatic and holistic approach to consistently define reasonable steps. This framework has been embraced by many of our clients, bringing greater comfort and confidence as they explain how they run their area of the business. In many cases, they realise that the majority of what they already do demonstrates that they are taking ‘reasonable steps’, but the framework also helps them identify any gaps or blind spots in their arrangements which must be resolved. To us, and to many of our clients, that sounds very reasonable.