The City regulator, the Financial Conduct Authority (FCA), is making changes to improve the appointed representatives (AR) regime, taking effect on 8 December 2022. In this article, Financial Services solicitor Simon Deane-Johns of Keystone Law outlines these changes as well as issues that the Treasury and FCA are considering as part of a wider review. Separately, principals and ARs should also consider how the new Consumer Duty applies to them and their activities and target market.
What is the AR regime?
The AR regime was intended to enable self-employed individuals to offer certain regulated financial services without needing their own authorisation but was used by firms much more broadly and with varying degrees of due diligence and supervision.
The FCA has seen up to four times the number of cases arising from principals than firms that do not have ARs (‘non-principal’ firms) across the board.
Key problems that the FCA is keen to resolve include:
- ARs providing misleading or unclear information (or engaging in other practices) hindering customers’ ability to properly assess products or services.
- ARs offering products and services that are not fit for purpose or inappropriate for the target consumers.
- Principals and ARs not identifying or acting where harm is being caused.
- ARs conducting unregulated activity by acting outside the scope of their appointment and the scope of the principal’s permissions, meaning redress is unavailable.
The FCA has seen the need to: enhance the responsibilities of principals; require principals to provide additional information on their ARs and how they are supervised; ensure an orderly termination and wind-down of an AR’s activities; and simplify the structure of its rules and guidance relating to ARs.
The FCA expects the rule changes to reduce the number of ARs by about 10%.
It is also working with the Treasury on a call for evidence to inform other potential changes that may require expanded regulatory powers in 2023.
Principals will receive a ‘section 165 data request’ that firms have 60 days to complete and submit to the FCA (firms could start preparing to do that now). That information involves:
- Explaining the primary reason for appointing the AR;
- Describing any financial non-regulated activities the AR carries on; and
- Indicating whether the AR has had a different principal and the reason for the change.
In addition, principals will need to annually:
- Notify the FCA of future AR appointments 30 calendar days before the appointment takes effect.
- Verify the details of an AR and that it is only carrying on activities permitted by the principal; and report changes to the FCA (the “annual review” – but there are other circumstances when a review should also be carried out).
- Conduct a self-assessment of their ARs.
- Provide complaints data and revenue information for each AR.
Regulatory hosting services
“Regulatory hosting” is where the principal firm (often a compliance consultancy/platform) mainly oversees ARs, rather than carrying on any substantive regulated activity itself. The host firm’s ARs are generally independent, unconnected businesses and the ARs may not have any relationship with the principal’s products or services. That differs from the network model, where the ARs and principal typically focus on a common commercial objective and sector.
Regulatory hosts tend to generate more – and more severe – supervisory cases than other principals, mainly because of the host:
- Applied too few resources to overseeing its ARs.
- Lacked the skills and experience in the different markets in which its ARs operate.
- Lacked appropriate systems and controls to effectively oversee its ARs.
From 8 December 2022, principals must notify the FCA of an intention to begin providing regulatory hosting services at least 60 calendar days before starting; and declare such services in response to a section 165 request.
The FCA may then:
- Check the principal’s due diligence, oversight arrangements and actions to address any concerns about the AR.
- Require firms to have prior FCA consent to provide regulatory hosting services.
- Limit the range or scope of regulated activities that regulatory hosts can oversee or the number of ARs they can have, or both.
- Require principals to meet additional requirements to those that apply to other principals.
- Ban the “host alternative investment fund manager (AIFM) model” (where the principal is the AIFM to an alternative investment fund (AIF) and the AR is usually appointed as an adviser to the AIF, so the AR, rather than the AIFM, claims to be the fund manager when marketing AIFs, but legally this role is taken by the principal as the AIFM).
Enhancing principals’ supervisory responsibilities
- Ensuring delegated functions or tasks do not represent a conflict of interests and are subject to enhanced monitoring.
- Annual fit and proper test for senior management of ARs (except IARs).
- Competence and capability assessments for AR’s senior management to check whether they are:
- appropriately experienced and trained to be responsible for the AR’s activities and business;
- have the necessary time; and
- have the requisite knowledge and skills.
- New guidance on the need for principals to take “reasonable steps” to ensure that ARs act within the scope of their appointment.
- Principals must have adequate controls over the AR’s intended activities and the resources to monitor and enforce an AR’s compliance with the requirements that apply to its regulated activities, considering whether the firm has resources that:
- can effectively manage conflicts of interest;
- enable it to identify and remediate any issues arising at the AR; and
- are commensurate to the size or potential size of the AR and the nature of the regulated activities for which the firm is responsible.
Where controls and resources are inadequate, principals should consider notifying the FCA; and, if the issue cannot be resolved, should postpone or cancel the AR’s appointment or terminate an existing AR relationship. There are certain triggers for reassessing these controls and resources.
- A principal must ensure that:
- its contract with an AR allows for termination if it can no longer adequately oversee the AR.
- the appointment will not prevent the principal from meeting its threshold conditions for authorisation.
- it has systems and controls in place enabling it to effectively oversee financial services staff at its ARs, as if they were individuals directly employed by the principal.
- its AR’s activities do not result in undue risk of harm to consumers or market integrity.
Terminating an AR’s contract and winding-down
There will be new FCA guidance to give principals a clearer idea on how and when they should terminate, or remediate issues with, an AR relationship. The guidance also sets out how the FCA expects principals to wind down a relationship, where they decide this is the right course of action, in an orderly way.
Principals should pursue termination in the following circumstances:
- Issues with the AR have not been resolved satisfactorily or in a reasonable time period.
- Senior management turnover at the AR is high and the reason for this is unsatisfactory.
- The AR is carrying on regulated activities which are not within the scope of its appointment.
- The AR has intentionally misled its customers in any way (misleading status disclosure on its website or app, or in other communications or financial promotions).
Annual self-assessment of ARs
This single board-level document (available for inspection by the FCA) must contain a written record covering all ARs of:
- How the AR’s senior management meet the fit and proper requirements.
- The AR’s financial position.
- How the principal is monitoring oversight of its ARs and the outcome of the oversight appropriateness review (see above).
- The principal’s assessment of its own controls and resources.
- The principal’s assessment of the risk of consumer and market harm arising from the AR’s activities and business.
Where an AR has several principals, each should conduct its own self-assessment as the assessment but the various principals may wish to discuss effective information sharing.
Smaller principals with large ARs
Where an AR is disproportionately large relative to the principal, the smaller principal may have insufficient skills and resource to effectively oversee the AR, or insufficient financial resources to deal with the AR’s failure or pay appropriate redress to consumers.
Policy options include:
- Limiting the size of ARs relative to the size of the principal.
- Requiring principals to regularly review the relative size and scale of business carried on by their ARs and consider whether it remains appropriate.
- Imposing restrictions on large ARs, such as requiring prior consent to have larger ARs than the principal.
Prudential standards for principals (capital requirements)
The FCA is considering whether prudential standards should be introduced or enhanced to reflect the harm posed by firms with ARs.
Potential legislative changes
HM Treasury identified four key elements to the regulatory approach to ARs that may mean changes to legislation:
- Changing the scope of the AR regime, including the regulated activities that ARs are allowed to carry on or introducing conditions, such as:
- introducing a size limit for ARs; and/or
- requiring principals to carry on the same regulated activities as its ARs.
- Extending the role of the FCA to deal with ARs:
- introducing a “principal permission” gateway, whereby firms must gain specific permission from the FCA before appointing ARs. The FCA can then scrutinise the principal’s process.
- allowing the FCA to vary or withdraw a principal’s permission to appoint ARs.
- enabling the FCA to intervene more directly in relation to the AR.
- Placing more regulatory obligations on ARs, such as extending the Senior Managers and Certification Regime (SM&CR) to certain functions within ARs.
- Extending the ability of the Financial Ombudsman Service (FOS) to investigate complaints involving the activities of ARs.
- Extending FOS’s remit in relation to ARs remit – the FOS can generally only consider consumer complaints about regulated activity undertaken by an AR included in the AR’s agreement with its principal, even where the agreement was defective in failing to include an activity. The law could be changed so that a principal is responsible for all of an AR’s regulated activities, even if the appointment is invalid. An objective remit would be easier for all to understand and result in better outcomes for consumers.
With the 8 December fast approaching, firms should consider the steps they’ll need to take, including information to be provided to the FCA regarding their AR regime.
This article was first published on the Keystone Law website on 17 October 2022