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With the publication of the Central Bank (Individual Accountability Framework) Bill 2022 in July this year (“the 2022 Bill”), and the increased focus of the Central Bank on institutional culture, the role of INEDs in providing oversight and challenge of firms and their boards will become even more critical, as the IAF seeks to drive cultural change in Regulated Financial Services Providers (“RFSPs”).

INEDs are Pre Approval Control Functions (“PCFs”) under the current Fitness and Probity Regime and will be brought into scope of the Senior Executive Accountability Regime (“SEAR”) as Senior Executive Functions (“SEFs”). This enhanced role brings both challenges and opportunities for INEDs.  First, they will be individually accountable for discharging a legal “duty of responsibility” to comply with the Conduct Standards under the IAF.  Second, INEDs will need to consider how they oversee and challenge RFSPs both during IAF implementation and in the business-as-usual environment.

The key points for INEDs to consider in the context of the IAF are described below.

1. Culture

The implementation of the Senior Manager and Certification Regime (“SMCR”) in the UK succeeded in driving cultural change in financial services institutions.  Both the Prudential Regulation Authority[1] and the Financial Conduct Authority[2] conducted surveys and reviews which stated that financial institutions had noted positive changes in behaviours and a cultural shift because of the SMCR.

The role of INEDs and Boards in driving a culture of integrity and openness is already captured in the UK Corporate Governance Code.  In addition, The Institute of Directors has also developed a Director Competency Framework which includes the high expectations of leaders to develop an organisational culture that is value based and aligned to the overall strategy of the organisation. 

INEDs should now be prepared to focus on fostering and encouraging a positive cultural agenda.  This includes driving the right “Tone from the Top”, promoting, and setting an example for diverse thinking and inclusive behaviours within the organisation and challenging those aspects that are not currently best practice.  This will then support successful implementation of the IAF, including the behavioural shift required.

[1] Prudential Regulation Authority, introduction to Supervisory Statement 5/16 “Corporate Governance: Board Responsibilities”, March 2016 [first published].

[2] Financial Conduct Authority, “Senior Managers and Certification Regime Banking Stocktake Report”, August 2019

2. Collective versus individual decision making

INEDs occupying the SEF roles under the SEAR will be individually accountable for the decisions that they make and therefore subject to the applicable sanction in the event of any regulatory breach.  However, the Central Bank has reinforced that the IAF does not seek to remove the framework of collective decision making.  The 2022 Bill clearly notes that, under the Common Conduct Standards (which will also apply to INEDs), in-scope individuals must act “with due skill, care and diligence, including […] acting appropriately in any decision-making, including collective decision making, ensuring decisions are properly informed and exercising sound judgement”.

Within the UK, the FCA has been explicit that an INED is neither required or expected to assume executive responsibilities and views the application of the SMCR as consistent with the principle of collective decision making. The PRA has also spoken directly to these concerns noting that the expectations of firms and individual requirements should be viewed as being “complementary”.[1]

The INED response will evolve as the legislation comes into effect., INEDs must be mindful of the potential consequences and the need for a robust “reasonable steps” framework to evidence how decisions are made and that the relevant Conduct Standards are being implemented.

[1] Prudential Regulation Authority, introduction to Supervisory Statement 5/16 “Corporate Governance:  Board Responsibilities”, March 2016 (first published)

3. Role of Chairs

INEDs occupying Chair roles on both Boards and Committees will face increased responsibilities and therefore will need to consider how this will affect the execution of the Chair role and running of the committees.

Key considerations for such INEDs therefore will include:

  • Ensuring that the Board or Committee meets with sufficient frequency
  • Ensuring that the Terms of Reference accurately reflect the functions of the Committee
  • Fostering open and inclusive discussion which challenges executives
  • Facilitating participation and contribution from all Board or Committee members
  • Ensuring that the forums and their members have the information necessary for their tasks
  • Reporting to the main Board on the Committees activities
  • Assessing the collective performance of the forum and/or the individual performance of its members
  • Safeguarding the independence of the committee, where appropriate
  • Facilitating the running of the Board or Committee, to assist it in providing oversight of the executive
  • Ensuring that the Board or Committee devotes sufficient time and attention on the matters within its remit

4. Role of the Board

IAF will require RFSPs to have a robust and clear Internal Control Framework (“ICF”) with accountabilities and responsibilities clearly defined. Boards must ensure that the ICF is robust by challenging the executive appropriately.  They are likely to require a clear combined assurance statement on the effectiveness of the ICF to satisfy themselves that internal controls are operating effectively, and ensuring that firms have established appropriate structures and resources to support this.

There is also a requirement for INEDs to challenge executives on the implementation of the IAF, ensuring that it both leverages the existing ICF and also incorporates any enhancements that may be required.

5. Director & Officers (“D&O”) Insurance & Indemnities

INEDs must consider how an ‘Insured Person’ is defined within current Directors’ and Officers’ (“D&O”) insurance policies to confirm their coverage. Additionally, the indemnities, financial thresholds and aggregate limits under the current D&O policies should also be reviewed as they may need to be revised. It is crucial that INEDs have a full understanding of what exactly is covered by the relevant policies and what is excluded in the event a claim is made.

Employment contracts may also need to be reviewed to include a personal indemnity for breach of conduct standards and this should dovetail with cover in the D&O policy to ensure there are no gaps in cover should a breach arise.

Finally, INEDs must determine whether there are there any gaps in cover between professional indemnity (“PI”) and D&O policies. To the extent that an investigation of those in SEF roles concerns the provision of professional services, this may be outside the scope of D&O and will need to be considered under Professional Indemnity policies.

6. Remuneration

The impact of the SEAR on remuneration has yet to be fully determined. In other jurisdictions, regulators have adjusted remuneration regimes to align to the individual accountability provisions to incentivise and encourage the required behaviours.

  • The UK approach to remuneration is codified in the FCA’s Remuneration Code which operates deferral and clawback mechanisms for Senior Managers and Certified functions under the SMCR
  • The Australian regulator has also focussed on remuneration when implementing its accountability provisions under the Banking Executive Accountability Regime (“BEAR”)

Therefore, in addition to any pre-existing regulatory requirements on remuneration, INEDs and firms should also be mindful of the potential impact of the IAF on remuneration.

How can INEDs challenge firms effectively?

INEDs must critically appraise their role as independent advisors in the context of the IAF implementation. Outlined below are the high-level themes on which INEDs should challenge their boards and senior executives to ensure effective implementation:

  • Driving the required cultural agenda
  • Ensuring that Governance Structures are appropriate and support SEFs under the SEAR
  • Defining responsibilities and accountabilities of Senior Executive Functions as well as associated Management Information and Reporting
  • Legal considerations such as indemnities, insurance and legal support for Senior Executive Functions and review of contracts to ensure compliance with the Conduct Standards.
  • Establishing a Certification Regime to annually assess the in-scope population as fit and proper and at certain trigger events and ensuring Human Resources engagement throughout
  • Aligning Performance, remuneration and breaches of Conduct Standards with the Certification Regime
  • Technology changes required to support ongoing compliance with the IAF
  • communication between all three line of defence functions throughout IAF implementation and beyond
  • Operating model changes and associated costs arising from the introduction of the legislation to ensure effective implementation in BAU

The IAF provides both challenges and opportunities for INEDs, both in respect of their individual accountabilities under the SEAR and their oversight and challenge of RFSPs.  INEDs should prepare now and consider the key themes identified above, to drive the required cultural changes and ensure successful transition of the IAF from implementation into the business-as-usual environment. 

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