UK: The Banking Reform Act | The Curtain Rises

Senior bank executives face the prospect of new burdens and heavier penalties when things go wrong, following the finalisation of the Banking Reform Act (née Bill) this week. Although the legislation will receive Royal Assent today, there is still a long way to go to make it a reality.

The Act began in 2013 as the Government's vehicle to implement the retail ring-fence, but has since developed into more of a catch-all for the broader financial services industry, and most notably, for the recommendations of the Parliamentary Commission on Banking Standards (PCBS). 

The retail ring-fence is by now familiar; completion of the law adds little to what we knew six months ago. Many of the most consequential details are yet to be finalised or indeed written. A workable ring-fence depends far more on these yet-to-come rules than the high-level Act.

The Act also introduces the bail-in tool, meaning that bail-in could be live in the UK before the EU's Recovery and Resolution Directive is even finalised. There are a host of other things included, not least of which is the creation of a new regulator for the payments system.

But banking standards are the real new meat: the overhaul of the Approved Persons regime, new rules of conduct, and the focus on holding individual decision makers accountable. These are the first steps of a journey the PCBS said may take a generation to complete, on which work will now start in earnest. There are new burdens which may sit uncomfortably with senior management, most notably a new criminal offence, and a presumption of guilt until proven innocent for some forms of misconduct.

Individuals on an even sharper hook

'Senior management functions' will be designated by the PRA and FCA, with 'management' defined broadly to include anyone involved in decision-taking, including non-executives and even potentially directors of parent companies. Regulatory approval of these roles will necessitate an explicit "statement of responsibilities" detailing the affairs which an individual will manage. We've already seen the regulators asking for signed attestations from senior individuals over the course of 2013 and this process of increased and more tightly specified accountability will continue.

The headline-grabber is the new criminal offence for senior managers, punishable by up to seven years in prison, for taking a decision which causes a financial institution to fail. Although prosecutions under this offence may seem a remote possibility – an institution has to actually fail, and its failure would have to be caused by a decision taken by an individual who was aware that failure might follow, in circumstances in which their conduct falls "far below" expectations – its existence will surely concentrate minds.

However, perhaps closer to home for most senior management in terms of the day-to-day running of a bank is the reversed burden of proof – senior managers will be presumed guilty of misconduct if their firm contravenes regulatory requirements for which they were responsible at the time, unless they can demonstrate that they took reasonable steps in order to prevent it happening. This reversal won't apply to criminal charges, but it does suggest that misconduct cases are likely to be brought against individuals more frequently and with a higher success rate.

Precisely what these changes will do to the pool of prospective senior bank executives is unclear, but it would surely be counterproductive if their cumulative effect was to deter well qualified candidates from putting themselves forward.

It's not just about senior management

The PRA and FCA will also write "rules of conduct" for a broader set of employees. The FCA has indicated that it may adapt existing standards for approved persons for this purpose, with the full range of enforcement powers to be at its disposal for misconduct, and an expectation that firms shoulder more of the responsibility than the regulator for the conduct of these staff.

Where does it leave us? – known unknowns

The Bill has been finalised, and will become an Act of Parliament today, but we are essentially left with a series of 'known unknowns'. We have a framework for ring-fencing, but no ring-fencing rules. We have a new regime for senior managers, but an as-yet-unwritten code of conduct to which they and others will have to adhere. We know there will be more prescription, but have scant indication of its form or content. By this time next year we should have more of these important details.

In the meantime, ring-fence planning will continue much as it has over the last six to 12 months. Banks need to engage with the secondary legislation (which remains in draft form) and with the PRA when it starts to consult on the ring-fence rules. They will also need to watch out for the European Commission's closely-guarded legislative proposal on bank ring-fencing, expected in January.

The proposals on banking standards, on the other hand, are themselves barely six months old, and more work is required to understand their full implications. This is part of the legacy of the PCBS which will really begin to make itself felt in 2014, as both the PRA and FCA consult on new rules, with a view to implementation in 2015.

This is not the end of the story – firms should watch the regulators' broader responses to the recommendations of the PCBS closely. In wider corporate governance terms we know that risk committees and the roles of the Chief Risk Officer, Head of Compliance, Head of Internal Audit, and non-executives in general, are likely to be the subject of further scrutiny in 2014. The curtain has been raised on this Act, but the reform narrative has some way to run yet.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.