Putting people first

Ensuring success in financial services deals

Transactions – M&A, outsourcing or insourcing – are core to many businesses in the financial sector. While key commercial heads of terms are generally hammered out early on, essential people issues are often overlooked. Ensuring that you get this right is fundamental to the success of a transaction. It is particularly important in the financial services sector to join up the legal, regulatory and HR teams from the outset to avoid any unintended regulatory consequences in relation to people management.

Employment contracts

Any due diligence process should include a review of employment contracts from an employment law and regulatory perspective. In a financial services context, any regulatory obligations on employees, such as compliance with regulatory rules, require particular attention. Senior Managers’ contracts are particularly relevant. If these do not adequately protect an employer from a regulatory perspective, the new employer should consider entering into new employment contracts as a condition of completion. There are some risks associated with this in the context of a transfer under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”).

Regulatory assessments and approvals

Buyers and new service providers should consider at an early stage whether fresh regulatory assessments and approvals are required for regulated employees following a transaction. This is particularly relevant in the context of a transfer under TUPE, since the employees will transfer to a new employer.

The new employer should request a regulatory reference from the former employer.

Regulatory approvals

Where the new employer is authorised and regulated by the Financial Conduct Authority (FCA) and/or the Prudential Regulation Authority (PRA), it must apply to the FCA and/or PRA as appropriate if the intention is that any transferring employees will perform a senior management function (SMF) on behalf of the new employer. The new employer (as the authorised firm) must ensure that an individual obtains regulatory approval before taking up their position as an SMF. However, both the firm and the individual could be the subject of regulatory action for a failure to obtain approval.

Fit and proper

Before making an application for approval to perform an SMF, the new employer must be satisfied that the SMF candidate is fit and proper (“F&P”). The FCA will consider whether the candidate is F&P before granting approval. Regulatory references should also be obtained by the new employer from the former employer. In respect of certified staff, the new employer will need to carry out a fresh F&P assessment even if the previous employer certified the employee as F&P within the preceding 12 months. 

A new employer may place some reliance on the checks performed by the former employer but will still need to perform its own checks to certify that each employee is F&P to perform a certification function. This could involve the new employer satisfying itself that the former employer had robust certification processes and ensuring that adequate records are provided by the former employer. The new employer should also request a regulatory reference from the former employer as part of the certification process.

Exiting employees

It is common for senior management to be exited as part of a business sale, usually under the terms of a settlement agreement. Where those managers are regulated, additional factors must be considered, including:

• The regulatory definition of “variable pay” is far-reaching and includes termination payments. Firms should assess whether any elements of a settlement package should be subject to deferral and malus, clawback provisions, and whether it should avoid payments that could be viewed as rewarding poor behaviour or performance.
• Any agreed reference should be indicative only and subject always to a firm’s regulatory reference responsibilities, and this should be reflected in the settlement agreement. 
• The settlement agreement should make it clear that it does not prevent an employee from making a protected disclosure (i.e., blowing the whistle) and should not require warranties from the employee in this regard.

Operational resilience

In 2021 the FCA, PRA and the Bank of England issued new rules and guidance for dual-regulated and enhanced Senior Managers & Certification Regime (“SMCR”) firms’ operational resilience. These require firms to take certain steps to ensure that they can prevent, adapt, respond to, and learn from operational disruptions, thereby mitigating the risk to clients. These rules are particularly relevant when it comes to outsourcing. Regulators make it clear that staff play a key role in ensuring operational resilience and overall compliance with the rules, and that responsibility continues to sit with the regulated entity.

Staff play a key role in ensuring operational resilience.

Outsourcing

Firms must carefully consider how to protect employees’ valuable know-how when important business services are outsourced. Although agreeing commercially that employees will not TUPE transfer may be commercially advantageous, it might also be unhelpful for a firm’s operational resilience obligations.

Offshoring

A similar issue is likely to arise where firms “offshore” services to a location where TUPE does not apply. In these circumstances, firms may need to make provision for the outgoing service provider to facilitate offers of employment from the new service provider or enter into a commercial agreement for the temporary provision of staff during the transition period. It is vital that consideration is given to this provision at the time the initial contract is drafted, as service providers are unlikely to show much goodwill once they have been advised that their services are no longer required or if they become insolvent. 

Firms are required to consider the operational resilience requirements in respect of any outsourcing arrangements entered into on or after 31 March 2022 and remediate existing outsourcings by no later than 31 March 2025.

A version of this article was published by Thomson Reuters on 23 November 2022.