AR’s and Regulatory Hosts! Pirate Practice or Business Innovation?

The Appointed Representatives (“AR”) regime is long-standing feature of UK financial services regulation.  It permits a firm or person to perform regulated activities as an agent for a regulated firm, it’s Principal, without itself being authorised. Over time, the FCA has allowed the AR regime to evolve beyond the role of a distributor of products, as was originally envisaged, into a diverse range of business models, including regulatory hosting.

The ‘regulatory hosting’ model involves a “Principal” who oversees the use of its permissions by ARs rather than carrying on any substantive element of a regulated activity itself. FCA supervision work has identified that most issues arising from regulatory hosting arrangements are due to the Principal applying too little resources to oversight and a lack of skills and experience in the different markets in which the ARs operate. The FCA had concerns about the business model and then Greensill collapsed, which drew political and public attention to the practice.

The FCA’s December Consultation Paper CP21/34 “Improving the Appointed Representatives regime” (“the CP”) sets out a range of rule changes and policy options to address the FC’s concerns. “… On average principals generate 50 to 400% more complaints and supervisory cases…” while the Treasury Select Committee’s (TSC) recent “Lessons from Greensill Capital” report recommended that the FCA and Treasury consider reforms to reduce opportunities to abuse the system.

In a nutshell, the FCA wants to introduce additional information and notification requirements on ARs and Principals to improve its oversight of the sector and to clarify and strengthen the responsibilities and expectations the FCA has of Principals.

The use of the term “nutshell” is deliberately playful – the proposals are a sledgehammer of prescriptive and detail changes, which could leave the regulatory hosting model banned altogether or at least operating in a regulatory straight-jacket.

New information and notification requirements

The FCA wants to more information about ARs to help it identify risks and facilitate an interventionist approach.  Supplemental information requirements will cover the primary justification for appointing an AR, the AR’s business, including details of any non-regulated business, the financial arrangements between the Principal and the AR, anticipated revenue from regulated and non-regulated activities during the first year of appointment, the rationale for any seconded or contractual arrangements between the AR and the Principal and information on complaints.

A sub-set of these requirements will apply to Introducer ARs who can only undertake limited activities (effecting introductions and distributing financial promotions) on behalf of the Principal.

Clarifying existing responsibilities

The CP seeks to bolster the FCA’s guidance to Principal firms to clarify its expectations, to improve ARs existing oversight requirements and to require Principal firms to:

• review annually the AR’s senior management’s fitness, propriety, competencies and capability;
• review the ARs financial position;
• review the capability of the AR to deliver the regulated services;
• assess the adequacy of the firm’s controls and resources; and
• complete an annual self-assessment indicating compliance with FCA rules and guidance.

At a minimum, the FCA expects Principals to collect and scrutinise management information, analyse data relating to risks and issues, closely monitor service delivery, scrutinise directors, establish regular engagement, set clear expectations including service level agreements and identify and assess the types of harm that impact consumers or market integrity.

Potential areas for regulatory change

Inviting views to shape policy, Chapter 5 of the CP is the ‘elephant in the room’, big-enough, indeed, to smash that nutshell.  Although the FCA has authorised firms with the permission s that enable them to provide regulatory hosting services since the mid-noughties, in recent years the FCA has found that the number of regulatory hosts has grown significantly.

Views are invited on the harms and benefits of the regulatory hosting model, particularly in the investment management sector.  Of particular concern to the FCA is where secondment arrangements provide, in FCA’s view a potentially misleading impression that the AR is an investment manager or a broker.  Similarly, under fire, is the “host AIFM model”, where ARs market themselves as the fund manager, while legally the role is taken by another authorised firm.

The FCA also considers some ARs are disproportionately larger than the Principal firm itself, leading to the risk of the Principal’s overly reliance on the AR to sustain its business, which might undermine the independence and effectiveness of its oversight.

The CP moots a number of potential policy interventions to reduce harm. Each carries its own pitfalls (only some of the FCA’s options are referenced below). The most far-reaching is the option to ban regulatory hosting services. Under this option, ARs that operate as an independent, unconnected business to that of the Principal would not be allowed to conduct regulated activities as an AR; however, the FCA thinks this could require a significant implementation period and might have a negative impact on competition and economic growth.

The FCA could limit the size of the ARs; however, this would impact existing firms operating in this space and present challenges in determining what the cap size would be.

Specific regulatory consent to be an AR is another option both at the point of application and on an ongoing basis, allowing the FCA to scrutinise more effectively regulatory hosting services.

This might be implemented with another policy option, to calibrate these firms’ prudential standards to the level of harm their business model presents to consumers and markets. The CP invites views on which sectors or business model arrangements could benefit from new or enhanced prudential standards.

Next steps

These new requirements will bite hard on Principal firms providing products or services through an AR or a network of ARs, requiring Principal firms to pay more heed to the activities of their ARs and, perhaps, exercise more business and regulatory caution.

In parallel with the FCA’s Consultation Paper, the HM Treasury has issued a Call for Evidence on how market participants use the AR regime and possible future reforms.  To make significant changes, the FCA may need HM Treasury to introduce complementary legislative change.

We urge all firms who either have existing ARs or intend to appoint ARs in the future to participate in the discussion and take this opportunity to influence an important area of regulatory development.

Firms operating under regulatory hosting structure may have intended the arrangement to be temporary or may be considering if the model is still relevant for their clients, their investors and for themselves. Now could be the time to transition to a firm’s own FCA authorisation. It’s not expensive, it may reduce compliance costs and it will provide a compliance framework fit for the business activities of the firm, not the activities, the FCA permissions and increasing capital requirements that the Principal needs.

Engaging a trusted regulatory consultant like Ellis Wilson to help prepare and manage an FCA authorisation means working with experienced consultants who understand regulatory business models, can present them clearly and objectively to the FCA, ensure a smooth authorisation process and be a reliable compliance partner in the future.

To discuss the benefits of having your own FCA regulatory licence and how Ellis Wilson can help IN COMPLIANCE, or for more information on AR compliance and the FCA’s consultation, contact Ellis Wilson.

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