UK: How Might The Proposed New Senior Managers And Certification Regime For Individuals Have Affected Accountability For Foreign Exchange Manipulation?

Last Updated: 9 December 2014
Article by Richard Caird, Alexandra Doucas and Katharine Harle

Shakespeare's often misquoted suggestion, "first kill all the lawyers", still sells very successfully on mugs and T-shirts. It is likely that had he referred to bankers instead, merchandise sales would currently be at least as successful. The recent fine levied on five banks in respect of manipulation of spot FX rates has added fuel to the fire of public disapproval of banks and some of their behaviour. One of the most commonly perceived inadequacies of the authorities' response to this and other similar scandals has been a lack of individual accountability for the wrongdoing reported.

The notion of individual accountability covers a number of possibilities. It might refer to the accountability of the individual traders involved, or of their superiors who took no action to curb their activities. It could refer to criminal liability or to accountability to the regulator.

The FCA's and PRA's joint Consultation Paper "Strengthening accountability in banking: a new framework for individuals" states that public confidence in the banking system has been undermined by unclear or confused individual accountability. The new regime it proposes is designed to ensure greater accountability of individuals not only to the regulators but to their firms.

The new regime (yet to be announced in final form) is, of course, too late to affect FX manipulation. However, the issues surrounding the foreign exchange market may provide a useful prism through which to view the proposed new senior managers regime and accompanying changes.

In a subsequent article, we will consider how changes to the regulation of the market, rather than of the individuals who operate in it, might affect the type of behaviour identified by the FCA.

Foreign exchange manipulation - how was it done?

The spot rates investigated by regulators were those for the so-called G10 currencies as published by the European Central Bank (ECB) and WM Reuters at 13:15 and 16:00 respectively. The objective of the traders manipulating the "fix" was to ensure that the spot rate at which their banks would buy or sell currency to customers pursuant to existing orders was either higher or lower than the average at which the bank had bought or sold that day. The example given by the FCA in its Final Notices is that if the bank had net orders to sell currency to its customers, it would profit if the spot rate at which it did so was higher than the rate at which it had bought currency in the market that day.

This was achieved by traders forming groups in chat rooms in order to share information about their net positions (and occasionally confidential information about orders placed by specific clients), and then manoeuvring the individual positions of those within the group. So, for example, all the net buy orders within the group might be consolidated in the hands of just one trader who would execute a succession of large buys at just over the best available rate in the run-up to the fix, with the result that the spot price for that currency (which would determine the rate at which the bank then sold to its customers) would be artificially high.

The regulatory response

The fines levied by the FCA were for breaches of Principle 3 which requires firms to "take reasonable care to organise and control [their] affairs responsibly and effectively, with adequate risk management systems." The foreign exchange market is, of course, largely currently unregulated, and there were therefore no rules specific to the type of behaviour which had occurred.

The Final Notices published by the FCA are strikingly similar in content as regards the risk management model in place at the five banks, and its failure. All of them operated a "three lines of defence" model: the relevant business area's management being the first line of defence, with support from control functions such as Compliance, Risk and Legal (the second line of defence) and Internal Audit (the third line of defence).

The common criticisms made of the banks include:

  1. too much oversight being placed in the hands of the relevant business area's management, in the front office;
  2. that the banks had high-level policies in place which covered the sort of behaviour concerned, but did not deal specifically with the risks associated with G10 currency trading;
  3. that the right values and culture were not embedded within the front office teams;
  4. that those managing the front office were sometimes either aware of or complicit in the traders' activities;
  5. failure to implement properly general policies regarding confidentiality, conflicts of interest and trading conduct in the relevant teams;
  6. failure properly to monitor use of chat rooms;
  7. failure by the second and third "lines of defence" to challenge the front office appropriately.

The behaviour complained of, in an unregulated market, is unlikely to amount to market abuse under existing legislation. There was no requirement that traders be approved, so it is likely to be the case that many of those involved are not subject to the FCA's existing Approved Persons (APER) principles.

The new regime

The new rules on which the FCA and PRA are consulting fall into three categories:

  1. the Senior Managers regime;
  2. the certification regime; and
  3. conduct rules.

They represent the regulators' intended way of implementing the changes recommended in the report of the Parliamentary Commission on Banking Standards and the statutory reforms of the Financial Services (Banking Reform) Act 2013 (the 2013 Act).

The Senior Managers Regime

The stated aims of the PRA and FCA in their Senior Manager proposals are to focus on a smaller group of "key decision makers, responsible for the firm's main activities", and to ensure a "clearer allocation of responsibilities to key individuals, which minimises the potential for overlaps and underlaps in accountability", when compared to the existing Significant Influence Function (SIF) and APER regime.

There are perhaps two key features of the proposed new rules. The first is that individuals performing Senior Management Functions (SMFs) as designated by the regulators will require pre-approval before they are appointed. Applications must be accompanied by a Statement of Responsibilities which must be updated whenever an individual's duties change, and approvals granted can be limited by time or by conditions. Firms will also be required to maintain a Responsibilities Map describing the firm's management and governance arrangements. The regulators intend the changes to promote "clearer internal governance" as well as assisting supervision and enforcement.

The second key feature is the "Presumption of Responsibility" created by the new regime, whereby the Senior Manager responsible for an area where a contravention occurs can be held accountable for it unless he or she can show that they have taken reasonable steps to prevent it. Unlike the requirement for pre-approval, this aspect of the rule changes is directed at ensuring accountability for problems which arise, rather than giving regulatory oversight of the identity of individuals with key responsibilities.

The PRA and FCA have produced a combined list of 18 SMFs, which might conveniently be thought of as a list of job titles, the usual duties of which would make the holder a Senior Manager. Underlying this is a combined list of responsibilities which the regulators will require firms to allocate to an individual.

The recommendation which the regulators are trying to put into effect (while allowing firms some flexibility of structure) is that anyone at board or executive committee level should be caught by the new regime. The PRA also proposes to introduce a concept of Group Entity Senior Manager to capture those outside the authorised firm but within its wider group who might exercise significant influence. The FCA proposes a designation of Significant Responsibility SMF, an individual who is not a member of the board or executive committee, but who has overall responsibility for a particular function and is primarily responsible for reporting to the board about it.

Scanning the list of responsibilities which the PRA and FCA will require to be allocated to a Senior Manager is an interesting exercise in the context of the issues surrounding FX manipulation. On the PRA's list for example is: "embedding the firm's culture and standards in relation to the carrying on of its business and the behaviours of its staff in the day-to-day management of the firm".

Referring back to the common criticisms made of the firms fined by the FCA, how would they fit in? Assuming that the banks retained their "three lines of defence" model, it is clear that those who have ultimate responsibility for the second and third lines (including Compliance, Risk and Internal Audit functions) will require approval as Senior Managers under the new regime, and therefore in the future would be held accountable for their failings.

The first line of defence in relation to FX manipulation (and the one primarily responsible for not catching the problematic behaviour) was, of course, the front office. What exactly the "front office" is for these purposes will depend on the structure of the bank in question. The position held by the person ultimately responsible for a business area within a bank is to be an SMF, but the definition of SMF is itself tied to regulated activity (which currency trading currently is not). Will it therefore be the case that an individual responsible for an unregulated area of the bank's business will be a Senior Manager? The answer may well be no. In this regard it should be noted that although reforms to regulation of FX are proposed, there is at present no plan to make spot FX a regulated activity.

If that is the case, then the result may be that those responsible for the failure to detect improper behaviour (including Compliance, Risk, Internal Audit, and the individual responsible for embedding the appropriate values and culture within the firm) will be held accountable under the new regime, whereas those ultimately responsible for the trading desk itself would not.

The certification regime

The certification regime aims to extend the "fit and proper person" test more widely than its current application. Crucially firms (rather than the regulators) will be responsible for certifying that each employee meeting specific criteria is fit and proper to hold their position, and to renew such certification annually at least, and on any change in role.

In order to require certification, an individual must perform a "significant harm function" (i.e. one capable of causing significant harm to the firm or its customers in relation to any regulated activity). The PRA bases its criteria on the definition of "material risk taker" in the Capital Requirements Directive and the FCA/PRA joint consultation on remuneration. The FCA has adopted a similar approach but has included: anyone performing a function which is a SIF under the existing regime, but which will not be a SMF; anyone with a customer-facing role which is subject to qualification requirement; and anyone supervising or managing a certified person.

It is unlikely that this aspect of the proposed rule changes would have had much effect on the FX manipulation scenario. The certification regime does not apply to unregulated activities, nor does it seem likely to have much effect on holding individuals to account for misdemeanours, as opposed to trying to ensure that those likely to commit them are not appointed in the first place. Rather, since responsibility for certifying individuals will rest with the bank as opposed to the regulator, it seems likely to provide a further avenue in respect of which the regulators can hold firms to account and, if misconduct is discovered, levy large fines. Going forward of course, depending on the extent to which the FX market becomes regulated in the UK following on from the Fair and Effective Markets Review and similar initiatives, the position regarding individuals may well be different.

The Conduct Rules

It is the final part of the proposed new regime, the introduction of individual conduct rules, which may well be the most apt to deal with a situation like FX manipulation or any other misdemeanour concerning individuals who are not subject to the Senior Managers or certification regimes. The conduct rules are, in essence, nine high-level rules which will be applied by the FCA to a wide body of people. Unlike the SMF and certification regimes, they are not specific to regulated activities.

The proposed conduct rules are:

Rule 1: You must act with integrity.

Rule 2: You must act with due skill, care and diligence.

Rule 3: You must be open and cooperative with the FCA, the PRA and other regulators.

Rule 4: You must pay due regard to the interests of customers and treat them fairly (FCA only).

Rule 5: You must observe proper standards of market conduct (FCA only).

SM1: You must take reasonable steps to ensure that the business of the firm for which you are responsible is controlled effectively.

SM2: You must take reasonable steps to ensure that the business of the firm for which you are responsible complies with the relevant requirements and standards of the regulatory system.

SM3: You must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversee the discharge of the delegated responsibility effectively.

SM4: You must disclose appropriately any information of which the FCA or PRA would reasonably expect notice.

The rules with the prefix SM will apply to Senior Managers only. The remaining rules will be applied by the FCA to all employees of relevant firms with the exception of 20 specified categories comprising ancillary staff whose role is not specific to the financial services business of the firm (e.g. receptionists, security guards, IT helpdesk and HR administrators). It is interesting to note that in-house lawyers who are already subject to professional regulation will, under this regime, find themselves dually regulated in relation to their work.

It seems clear that much of the activity complained of by regulators in relation to FX manipulation would fall foul of Rules 1, 4, 5, SM1, SM2 and SM4.

Firms will be required to notify the FCA of any suspected breaches of the conduct rules and disciplinary action taken, within seven days in the case of Senior Managers, and in a quarterly compendious report for others. The FCA will be able to impose penalties (such as a fine, publication of the individual's wrongdoing, or suspension/removal of approval) in respect of any breach and the firm's reporting will, of course, make the regulator's job in identifying misconduct easier.

There does not at present seem to be any proposal in the rules to the effect that breach of a conduct rule will not give rise to a right of action by anyone affected. Breaches of FCA rules give rise to such rights unless specified otherwise. Section 64 of FSMA (repealed by the 2013 Act) allowed the FCA to create codes of conduct for approved persons, but specified that breaches of such rules would not give rise to a right to damages or render affected transactions unenforceable. Neither protection appears in the new statutory provisions inserted by the 2013 Act. Breach of the FCA's Principles for Business (on which the new conduct rules are expressly based) also does not give rise to a claim by those affected.

The proposed C-CON sourcebook (which will contain the individual conduct rules) does not currently contain any proposal that breach of the new conduct rules will not be actionable. It is likely that such a provision will appear in C-CON in due course. If it does not, it would have the odd (and unjust) result that individual bank staff, who might be very junior, could be sued for breaches of high-level rules in circumstances where their employer could not. It seems unlikely that this can be the intended result.


The new regime for individual accountability which has been proposed is lengthy, complex, and still in the process of finalisation.

It was (quite justifiably) reactive to the scandals which had engulfed the banking industry at the time when it was formulated, but there must be questions as to whether the new Senior Managers regime will be enough in itself to address public concerns about lack of accountability in the wake of the FX scandal, unless it is accompanied by significant regulation of the foreign exchange market and not just in the UK.

It may also prove to be a weakness of the new Senior Managers regime that its effectiveness is dependent on being able to identify an individual who is responsible within the organisation for every failing. It is rare, however, that problems fit neatly into particular boxes (particularly where they occur in what is currently an unregulated market), and it remains to be seen whether the regulators succeed in removing the "overlap and underlap" which they say has undermined the principle of individual accountability. It may turn out to be the case that without regulating the market, it proves difficult to hold senior personnel to account.

Those who will obviously be in the firing line for this type of behaviour going forward are those responsible for functions such as Compliance, Risk and Internal Audit. Given the criticisms which appear in the FX Final Notices (not for the first time) that these functions were not strong enough to curb poor behaviour, it remains to be seen whether the new regime will assist in strengthening them within their organisations or whether high quality individuals in these areas will be deterred from continuing in these roles for fear of personal liability. It may well be a legitimate regulatory strategy to go after those individuals, but it is likely that the heads which the public may (metaphorically one hopes) wish to see on pikes are those of the individuals responsible for the trading desks where mistakes (and possible profits) were made.

The aspect of the proposed rule changes which seems particularly applicable to FX manipulation is the introduction of individual conduct rules. These seem likely to capture the behaviour complained of, and provide a means of holding individual traders to account.  For those individuals, it is likely that the prospect of regulatory action would be considered preferable to the current situation where the SFO has been given "a blank cheque" by George Osborne to pursue criminal wrongdoing in the FX market.

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.

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