Analysis of FCA proposals for stronger oversight of AR’s


INSIGHT
Published
Dec 10th '21
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On the 3rd of December, the Financial Conduct Authority (“FCA”) launched a consultation on how the regulator may utilise its resources to improve the appointed representatives (“AR”) regime. Currently the AR regime allows a third party to carry on regulated activity on behalf and under the responsibility of a directly authorised firm, known as a Principal. However, FCA data analysis has found that, on average, Principal firms and their ARs generate 50-400% more complaints and supervisory cases than non-Principals across all sectors where this model operates. Therefore, the FCA are seeking to improve the way in which Principals and ARs operate.

 

The Consultation Paper CP21/34: Improving the Appointed Representatives regime has been published and puts forward some of the potential measures the FCA will look to introduce to lessen consumer harm the AR regime causes.

 

Why are the FCA seeking to change the AR regime?

The original purpose of the AR regime was created to allow self-employed representatives to engage in regulated activities without having to be directly authorised by the FCA. However, legislative scope allowed this purpose to evolve to include a wider range of business models across a myriad of sectors. When appointing an AR, Principal firms become responsible for the regulated activities which its AR undertakes. The FCA carried out data analysis of potential harm across all sectors using AR models. This analysis showed that Principals and ARs accounted for 61% of claims made under the Financial Services Compensation Scheme (“FSCS”) between 2018 and 2019. The FSCS is the UK’s statutory deposit insurance and investors compensation scheme for customers of authorised financial services firms. This means that FSCS can pay compensation if a firm is unable, or likely to be unable, to pay claims against it. The FCA’s 243 page consultation paper along with HMT’s Call for Evidence into the AR regime sets out the data which the FCA have considered and wish to further gather to support the proposed changes to the AR regime aim the regulator is looking to introduce.

 

Additionally, through the ‘Lessons from Greensill Capital’ report, the Treasury Select Committee recommended that the FCA and Her Majesty’s Treasury (“HMT”) considered reforms to the AR regime to limit its scope and reduce the opportunities available to abuse the system. The FCA embraced this recommendation and committed to reviewing the use of the AR regime as a business priority.

 

What measures are the FCA consulting on?

The FCA is proposing a number of key enhancements to the AR regime which it considers will allow the regulator to advance its objectives; consumer protections, market integrity and competition.

 

These key enhancements include:

 

  • Changes to information and notification requirements.
  • Enhancement of responsibilities of principals and FCA expectations.
  • Changes to how Regulatory Hosting models operate and are regulated.

 

The FCA use data and technology to assist in delivering their objectives. Over recent years, the FCA has progressed its use of data and technology as set out in the Business Plan 2021/22. The FCA wish to increase the detail of information which Principal firms must provide to their ARs. This increase will see Principal firms providing information including:

 

  • An AR’s business
  • An AR’s revenue
  • Complaints against an AR
  • An AR’s regulated and non-regulated activities.

 

Currently Principal’s provide high-level information about their ARs. The regulator wishes to increase this across the life-cycle of an AR from appointment to on-going monitoring and wind down. The proposals would require Principals to provide:

 

  • An explanation of the primary reason for the Principal’s intention to appoint the AR.
  • The nature of the regulated activities the AR is to undertake.
  • Information about any non-regulated business the AR undertakes. This includes:
    • The nature of the non-regulated business.
    • The proportion of the non-regulated activities compared to the regulated activities in the first 12 months of the appointment of the AR.
  • Whether the AR will provide services to retail clients.
  • Whether the AR was previously an AR of a different Principal, and if so, why the AR is now intending to operate under a new Principal.
  • Details of any group the AR forms part of and details of parent companies and holding companies. This will also extend to the activities of any wider group and how this may affect the activities of the AR and the potential risks it may create.
  • Whether any individuals from the AR will be seconded or contracted to the Principal firm to carry on portfolio management and/or dealing activities, and if so explain the rationale for entering into such an arrangement.
  • Detailed information about the nature of the financial arrangements between the principal and the AR. This will include, whether the AR pays or will pay the principal commission, any flat fees, or any additional payments.
  • Projected revenue from regulated and non-regulated activity during the first year of appointment.

 

Principal firms which appoint Introducing Appointed Representatives (“IAR”), are not likely to be expected to provide information to the detail set above. IARs are firms which are permitted to conduct is limited to effecting introductions and distributing non-real time financial promotions. The FCA have set out the proposal to required information for IARs such as;

 

  • The nature of the regulated activities the Principal will permit the IAR to undertake.
  • Information about the nature of the financial arrangements between the Principal and the IAR. This will include, whether the AR pays or will pay the principal commission, any flat fees, or any additional payments.
  • Revenue from regulated activity (excluding non-regulated activity) during the first year of appointment.

 

The FCA is also proposing that notification of proposed AR appointments will need to be made by the Principal at least 60 calendar days before the appointment is due to take effect. This extension of the notification time frame is to allow the FCA to ascertain that the Principal firm has conducted appropriate due diligence and have sufficient oversight arrangements in place.

 

The FCA are proposing to expand the scope of reporting significant changes to details of ARs. Whilst Principle 11 requires firms to deal with the FCA in an open and cooperative way the proposals set out further clarification. Principal firms must:

 

  • Notify the FCA at least 10 calendar days prior to taking effect any name change of the AR
  • Notify the FCA at least 10 calendar days prior to taking effect any changes to the categories of regulated activities the Principal allows the AR to use.
  • Within 10 business days, notify the FCA if the AR intends to begin or to cease to conduct non-regulated activities.
  • Within 10 business days, notify the FCA of any changes to the nature of non-regulated activities the AR conducts.
  • Within 10 business days, notify the FCA of any changes in relation to providing services to retail clients
  • Within 10 business days, notify the FCA if the AR becomes or ceases to be part of a group
  • Within 10 business days, notify the FCA of any significant changes are made to the financial relationship between the Principal and its ARs.

 

These FCA expect these changes to be reported via Connect by using the ‘Appointed representative or tied agent – change details’ form.

 

The FCA are also intending to expand the firm attestation process to include ARs. Currently, directly authorised firms are required to check and confirm or report changes to the accuracy of their details on an annual basis within 60 business days of their Accounting Reference Date (ARD). The FCA propose that this will be extended to include responsibility of attesting firm details of ARs to the Principal. This will mean that Principal firms must also attest their ARs details every 12 months within 60 business days of their ARD. This will be accompanied by an extension to the information which the Financial Services Register (“FSR”) publicly details of Principals and their ARs. This includes:

 

  • Information about the nature of the regulated activities the AR undertakes
  • The regulated activities the Principal takes responsibility for.

 

The FCA are also proposing to collect further detailed information about complaints relating to ARs. Currently this information if obtained as an aggerate figure across all ARs which the Principal appoints. The regulator are seeking to request this information by each AR. This will be collected on an annual basis using a new AR reporting form. Much in the same way, the FCA are seeking to obtain revenue data by AR rather than as an aggerate figure. This will include both regulated and non-regulated revenue. For revenue from non-regulated activities, the FCA propose that this is split between revenue from non-regulated financial activity and non-financial activity. Data relating to the non-regulated activities of IARs will not be reported. The FCA have distinguished how propose to collect this information for existing ARs, which includes:

 

  • Principals provide this information annually within their 30 working days ARD.
  • Principals will report this using a new AR reporting form.

 

The FCA will seek to apply a transitional period for existing ARs, so that principals provide this information for the first full year of data following the rules coming into effect. However, for the appointments of new ARs, Principals must:

 

  • Where the data is available, the Principal to provide actual figures (for example, for non-regulated business, or if regulated business was conducted under a different principal).
  • If the data is not available, particularly when a new AR is set-up and there are no revenues yet, provide a projection of the annual income of the AR (both regulated and non-regulated) at the point of appointment.

 

This information relating to new ARs will be gathered through the amended ‘Add an appointed representative or tied agent form’.

 

Within the consultation, the FCA put forward concerns relating to the size of Principal firms and their relationships with ARs which are much larger organisations. The FCA are considering a number of potential policy options to address concerns which smaller Principal firms that appoint larger ARs may raise. These include:

 

  • Limit the maximum size of ARs before requiring them to become directly authorised. This would mean that only firms of up to a certain size could conduct regulated activities as an AR.
  • Require Principal firms to regularly review the relative size/scale of business carried on by their ARs and consider whether it remains appropriate. This assessment should consider the appropriateness in the context of existing systems and controls rules in SUP 12, and proactively assess and monitor the size and growth of a Principal firm against its ARs’ business.

 

Another area which the FCA have sought to investigate further is that of ‘Regulatory hosting’. The ‘regulatory hosting’ model differs from a traditional Principal/AR relationship and instead the Principal does not carry on any substantive element of regulated activity itself. This service is commonly provided by firms which offer compliance support services. The FCA have shown concerns over the regulatory hosting model as the Principal is often removed from its ARs activities and can in some cases operate in a variety of different markets where traditional AR/Principal relationships share a common commercial goal. The FCA are consulting on whether the use of such model should continue or whether it may be necessary for firms offering regulatory hosting relationships to seek specific FCA permission, create additional regulatory requirements or limit the range of scope of regulated activities and/or size of regulatory hosting models.

 

What expectations do the FCA have of Principal Firms?

The FCA recognise that their concerns also require a clarification of their expectations of Principal firms. The regulator aim to:

 

  • Clarify a Principal firm’s responsibilities for their ARs.
  • Improve existing oversight requirements.
  • Give Principal firms more detail on the circumstances in which it may be necessary to terminate an AR relationship, and if so, how Principals should ensure that the relationship is wound down in an orderly way.
  • Require Principal firms to annually review senior management at ARs and aspects of ARs’ business and activities.
  • Require Principal firms to complete an annual self-assessment of compliance with relevant rules and guidance for ARs.

 

Clarify Principal responsibilities

Where a Principal firm relies on its ARs to support aspects of their own operations, this can extend into oversight functions, such as risk and compliance. This could result in a conflict of interest of the Principal/AR relationship. Current guidance set out in SYSC 3.2.3G(1) on how certain firms should ensure appropriate safeguards are put in place where certain functions or tasks are delegated. To ensure this guidance applies to all Principal firms, the FCA proposes to create new guidance that will apply to Principal firms which delegate functions or tasks to an AR and should put appropriate safeguards in place. These include but are not limited to; ensuring that the delegation does not represent a conflict of interest and enhanced monitoring of the delegated task or function.

 

The FCA have further highlighted current guidance setting out expectations around areas such as; fitness and propriety and competence and capability. Firms should ensure to undertake necessary due diligence to ensure that ARs and senior managers are fit and proper prior to appointment. Principal firms should also ensure that they conduct a review annually to establish that ARs and senior managers continue to meet these standards. These requirements are currently set out in SUP 12. The FCA are also considering establishing enhanced guidance around Fit and Proper test for Employees and Senior Personnel (FIT). This will enable Principal firms to ensure that AR senior management are fully equipped to carry out their roles and responsibilities when carrying on activities or business within the scope of the Principal’s permissions. These include:

 

  • Whether the senior management at the AR are appropriately experienced and trained to be responsible for the activities and business they carry on.
  • Whether the senior management at the AR have the necessary time to perform the tasks and/or functions for which they are responsible.
  • Whether the senior management at the AR have the requisite knowledge and skills to undertake the tasks and/or functions for which they are responsible.

 

This guidance will also extend to how Principal firms should be conducting these assessments and the FCA’s expectations for appropriate oversight from senior management. Principal firms and their Senior Managers should understand their AR relationships and more specifically, how those ARs are fit and proper. This will extend the current guidance provided within SUP 12.6.7G and includes:

 

  • Principal firms ensuring and verify information provided by an AR, either at entity-level or about senior management individuals, is accurate, sufficiently detailed, and up to date.
  • Principal firm’s senior management discuss any omissions or concerns proactively with relevant persons within an AR.
  • Principal firm’s senior managers keep up to date with changes, such as to the AR’s senior management, which may affect the quality or integrity of the information provided.

 

The FCA isn’t currently looking to extend this guidance to IAR relationships.

 

Under SUP 12.6.6R, Principals must take ‘reasonable steps’ to ensure that their ARs act within the scope of their appointment. The FCA are seeking to set out high standards of oversight by providing practical steps within new guidance. This will prescribe the reasonable steps which a Principal firm must take to ensure that an AR does not undertake activities outside its scope unregulated.

 

Improve existing oversight requirements

Principal firms are required to establish and ensure that it has sufficient resource and adequate control to oversee its ARs on an on-going basis.  This includes risk, audit and compliance functions, organisational structures (such as reporting lines) and reporting. Resources refer to the processes, technology, facilities and information needed to oversee an AR’s activities. This includes, for example, having appropriately trained staff and up-to-date IT systems. The FCA wish to set out clearer guidance for Principals on how they can assess that they have adequate resources and controls. These include:

 

  • Ensuring that the Principal’s size and expertise is commensurate to the size of the AR’s business and the regulated activities it carries on, e.g. having appropriately trained staff with knowledge and expertise specific to the relevant activity/activities.
  • Enable a Principal firm to effectively manage conflicts of interest.
  • Allow a Principal firm to maintain effective oversight of the AR.
  • Enable a Principal firm to identify and resolve any issues arising from an AR.

 

Monitoring systems and controls

The FCA suggest Principal firms review the adequacy of their controls and resources at least annually. Principal firms should consider whether each element they are allows them to monitor and enforce compliance and oversee their ARs’ activities. Principals should also consider the proposed guidance at SUP 12.4.4GG on ensuring controls and resources are commensurate to the size of the AR’s business and its activities. Where a Principal firm reviews its controls and resources and determines that its controls and resources are inadequate, it should:

 

  • Remediate the identified issue with its controls and resources as a matter of urgency. If the problem is significant and ongoing, the firm should consider notifying the FCA under Principle 11 (Relations with regulators).
  • Where it has not yet appointed the AR, it should postpone doing so until the issue has been satisfactorily resolved.
  • If the problem cannot be remediated in a reasonable time period, the Principal should consider whether it needs to indefinitely postpone appointment of the AR, or, if it has already appointed the AR, terminate the relationship.

 

Similarly, the FCA propose enhanced guidance by setting out how firms should monitor the growth of the ARs which includes the size/volume of the AR’s regulated business increases significantly in a short period of time, the senior management turnover at the AR is unusually high and staff turnover at the AR, across all staff members involved in carrying on regulated activities. Under these proposals, Principal firms must also consider the contractual arrangement with its ARs and whether they can terminate such arrangements where it feels it can no longer adequately oversee ARs. The FCA have stated that they will allow firms to amend any existing contracts at the next contractual renewal/review point where the contracts do not provide adequate provision for the Principal to terminate.

 

Principal firms must ensure that the ARs which they appoint satisfy and continue to satisfy the FCA’s Threshold Conditions. The FCA will strengthen guidance around their expectations on the systems and controls which provide Principal firms with the tools to effectively oversee staff of their ARs. The FCA expect Principal firms to be able to oversee and ensure that the standards of an ARs staff are comparable standard as if they were individuals directly employed by the Principal. This would include:

 

  • Collecting, and scrutinising, management information.
  • Analysing data provided by the AR to identify risks and issues.
  • Monitoring the delivery of the AR’s activities and business.
  • Scrutinising directors (CF1s), as the senior responsible individual within the AR, to ensure they are appropriate for the role.
  • Regular engaging with their ARs, whether through in-person meetings, regular phone calls or emails.
  • Setting clear expectations around processes of escalation of issues, including service level agreements (SLAs) where necessary.
  • Taking a risk-based approach to oversight of the AR’s activities and business.

 

Termination of AR contracts and winding down

The FCA proposes to provide clearer guidance that will assist Principal firms in deciding how and when to terminate the appointment of an AR. The FCA propose to add guidance on the circumstances in which Principal firms should pursue termination. Circumstances include, but are not limited to:

 

  • Issues with ARs which have not been resolved satisfactorily or in a reasonable time period. An example the FCA have provided for this, where the AR has agreed to resolve known issues but it has not met the Principal firm’s standards or expectations for remediation, or where the Principal deems the proposed remediation risks breaching FCA rules or guidance.
  • If senior management turnover at the AR is high and the reason for this is unsatisfactory. For example, senior management departures are unexplained or the AR’s reasoning is insufficient or vague.
  • If the AR is found carrying on regulated activities which are not within the scope of its appointment.
  • If the AR is found to have intentionally misled its customers in any way.
  • If any of the AR’s senior management with responsibility for, or involvement in, activities carried on within the scope of the AR’s appointment are dismissed due to gross misconduct.

 

Self-assessment

The FCA propose to set out a requirements for self-assessment document for Principal firms. This document would ensure Principal firms are proactively assessing, monitoring and documenting the steps they take to comply. It will also ensure that a Principal firm’s governing bodies are appropriately sighted on AR relationships. Principal firms will be expected to be able to identify gaps or issues which may lead to harm. The FCA are proposing to require the governing body (i.e., the Board or managing body) to annually review and approve, a self-assessment document. The document would be a written record which demonstrates:

 

  • How an AR’s senior management meet the fit and proper expectations and the considerations the principal had in carrying out the assessment. This includes the ability of relevant persons at the AR to carry out regulated activities for which the firm has accepted responsibility.
  • An AR’s financial position.
  • How a Principal firm is monitoring oversight of its ARs and the outcome of the oversight appropriateness review.
  • A Principal firm’s assessment of its own controls and resources.
  • A Principal firm’s assessment of the risk of consumer/market harm arising from the AR’s activities/business.

 

Principal firms will also need to evidence in the self-assessment document methodologies used to carry out the activities required. Principal firms should use the previous year’s self-assessment form as a starting point for the following years self-assessment.

 

Next steps

Feedback of the consultation is due by 3rd of March 2022. Feedback can be provided by completing the online response form, emailing cp21-34@fca.org.uk or writing to Governance & Professionalism Policy, Financial Conduct Authority, 12 Endeavour Square, London E20 1JN.

 

We recommend Principal firms review their current arrangements and ensure that they have sufficiently detailed and robust written policies and procedures which relate specifically to the assessment and monitoring of their ARs. Principal firms should ensure that they have sufficient knowledge and resources to oversee their ARs. Principal firms shouldn’t have a ‘one-size fits all approach’ and should tailor their monitoring of ARs and AR senior managers to the risks which are inherit within business activities.

 

Related: Financial Promotion brief guide for Appointed Representatives

 

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