Regulatory references: latest tool to boost individual accountability will impact on employment relationship

Out-Law Analysis | 11 Dec 2015 | 5:02 pm | 4 min. read

FOCUS: The introduction of mandatory 'regulatory references' for a wider set of banking and insurance professionals moving to similar roles at new firms is a game-changer.

Under the current Approved Persons Regime, firms must  provide a reference for individuals in  'controlled functions'. But a joint consultation by the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) has proposed new and expanded rules for mandatory references, designed to "prevent banks and insurers recycling individuals with poor conduct records".

It has been obvious for some time that the new individual accountability regimes for the banking and insurance sectors would have considerable implications for non-executive directors (NEDs) and on the employment relationship between the affected individuals and their PRA- and FCA-regulated employers. But the proposed rules on 'regulatory references' will also impact on the individual and hiring firm prior to employment, during the employment relationship or directorship, and on how terminations of employment and non-executive directorships will work.

We suspect that the new rules will be enacted largely unchanged before the Senior Managers and Certification Regimes (SM&CR) for bankers and the Senior Insurance Managers Regime (SIMR) take effect next March, given that their objective is to ensure that regulated firms hire the right individuals and then hold them to the new conduct rules as part of the firms'  enhanced regulatory obligations under the new regimes.

Putting aside for now any concerns over contractual freedoms, senior managers should be asking who within their governance and competencies framework is best-placed to complete and oversee the provision of requests for these references. Should it be HR? Compliance? The Board or CEO? Probably all or a combination of them, subject to the seniority of the individual concerned and the sensitivities of the matter, given that the new regimes are also about governance and SMF 'prescribed responsibilities'. Responsibility for these regulatory references must be allocated to an SMF holder so he or she will be responsible for the provision and retention of references.  Systems and controls, policies and procedures for both requesting and providing these regulatory references will therefore need to be set and overseen at a senior level.

The proposed rules are based on the June 2015 recommendations of the Fair and Effective Markets Review (FEMR), and will apply to:

  • Senior Manager Functions (SMFs) and certified staff in the banking regime;
  • PRA Senior Insurance Manager Functions (SIMFs);
  • FCA insurance controlled functions;
  • 'notified' roles held by NEDs in banks, systemic - i.e. PRA-regulated – investment firms and 'Solvency II' firms;
  • NED roles in credit unions; and
  • 'key function holders' as defined by Solvency II, and notified NED roles, at insurers.

The rules requiring firms to seek and provide these references will also apply to incoming EEA branches in the same way as they do for other firms, although they are unlikely to apply to those firms benefiting under the Financial Services and Markets Act (FSMA) overseas person's exclusion.

It is not yet clear whether these references will be required for key staff when elements of the SM&CR are extended to non-systemic firms in 2018. We suspect that they may well be extended if individuals with poor conduct records have migrated to the wider firm population because they have been flushed out of the systemic population as being unfit. These individuals may well struggle to find employment with regulated firms.

What must regulatory references contain?

To give a sense of the detail, rules on these mandatory references will:

  • stipulate detailed minimum content for a firm when it acts as a provider of a reference in response to another firm's required request. This includes information about a finding by the provider firm that, in the preceding six years, the employee concerned was in breach of one or more of the relevant conduct rules, or that the firm found that an employee was not fit and proper following an annual (re)certification;
  • impose very specific record-keeping obligations on firms to maintain these references for a six-year period after an employee leaves the firm; and to maintain any documents relating to an employee created after she or he has left the firm for a six-year period;
  • prohibit firms from entering into any termination arrangements with individuals which could conflict with the new rules on regulatory references – for example, undertakings to suppress or omit relevant information as part of a negotiated settlement. This could result in the end of confidentiality clauses in separation agreements suppressing information about misconduct that would be relevant to a regulatory reference;
  • Provide a mandatory template to increase consistency of these references across the banking and insurance sectors.

If a firm proposes to hire an employee from an unregulated firm, it must make "reasonable efforts" to secure a reference as part of its fit and proper person assessment of prospective candidates. If the employee is hired, the firm must create the reference and the record-keeping obligations will be triggered. The new employee will then be within the reference system.

Given recent scandals such as the FX and LIBOR rate-fixing which occurred after the banking crisis, FEMR recommended that the SM&CR should be extended to fixed income, currency and commodities markets to ratchet up integrity standards in these markets too. So an individual, disqualified from acting in an SMF role by his or her involvement in these scandals and now employed by another regulated firm in what will be a non-SMF role, will be mistaken if he or she believes he or she has sidestepped the new regime. He or she will need to be certified annually as fit and proper in the new role, and comply with the new conduct standards.

Elizabeth Todd is a financial services regulation expert and Jon Fisher is a financial services employment expert at Pinsent Masons, the law firm behind