UK regulators are considering how they can strengthen the regime to enhance standards and reduce risk.
By Nicola Higgs and Charlotte Collins
On 3 December 2021, the FCA published a Consultation Paper (CP21/34) on changes to its rules regarding the Appointed Representatives (AR) regime. HM Treasury simultaneously published a Call for Evidence, seeking views on how market participants use the AR regime, how effectively the regime works in practice, potential challenges associated with the regime, and possible future legislative reforms.
The FCA’s proposed rule changes are wide-ranging and would significantly increase the compliance burden for firms that use ARs as part of their business model. Both papers will be of interest to businesses across all sectors that use, or may consider using, the AR framework.
What is the AR regime?
The AR regime has long been a feature of the UK regulatory landscape. Essentially, it permits businesses to carry on certain limited regulated activities (in the nature of advising and arranging) without requiring authorisation, on the basis that they are overseen by an authorised firm (known as their principal). The principal firm must have contractual arrangements in place with the AR to ensure that the AR complies with certain regulatory requirements, and the principal is ultimately responsible to the FCA for the AR’s compliance with those requirements. There is also a subset of the regime for Introducer ARs, which introduce customers to financial products via the principal firm. These are typically non-financial businesses that wish to refer their customers to financial products related to their own offering, for example relevant insurance.
Why is change needed?
Although the AR regime was originally introduced as a way for distributors of financial products to undertake some limited regulated activities without the burden of authorisation, its use has grown to encompass a wide range of business models such as regulatory hosting and AR networks. Both papers report that there are currently around 40,000 ARs operating under around 3,600 principal firms. While some principals only have a small number of ARs, others operate large networks of hundreds or even thousands of ARs.
Earlier this year, a Treasury Select Committee report concluded that firms may be using the AR regime for purposes well beyond those for which it was originally designed. The report recommended that the FCA and HM Treasury consider reforms to the regime, “with a view to limiting its scope and reducing opportunities for abuse”. The FCA has prioritised reform in this area, citing concerns about a wide range of harm across all the sectors in which firms have ARs.
According to the FCA, this harm often occurs because principals do not perform enough due diligence before appointing an AR, or because there is inadequate ongoing oversight and control after an AR has been appointed. The FCA explains that principal firms often do not understand their regulatory responsibilities in relation to their ARs, or they fail to do enough to ensure that their ARs are complying with the necessary regulatory requirements and remaining within scope of their appointments.
Data analysis indicates that firms with ARs cause 50-400% more supervisory cases than firms that do not use ARs, and they receive more complaints. The FCA has already stepped up its supervisory oversight of principal firms and introduced a new levy on firms that use ARs to help fund additional supervision in this area. However, in light of the Treasury Select Committee report, the FCA is now proposing to impose significant new regulatory and compliance obligations on principal firms.
What are the proposed changes?
The FCA is proposing change in two main areas:
- Information requirements: Requiring principals to provide more information on their ARs to the FCA, both prior to appointment and on an ongoing basis. This is intended to help the FCA identify risks more easily, and to better assess whether the principal has the expertise, systems, and controls to effectively oversee its ARs. The FCA proposes to apply more limited requirements in respect of Introducer ARs.
- Responsibilities of principals: Clarifying and strengthening the responsibilities and expectations of principals in FCA rules, and providing additional guidance for principals on their responsibilities and the FCA’s expectations as to how principals should oversee their ARs.
The FCA plans to require principals to provide information on an AR’s business, revenue, complaints, and regulated and non-regulated activities. Firms would need to notify the FCA of a proposed AR appointment, with detailed information about the AR and the appointment, at least 60 calendar days before the appointment takes effect. Firms proposing to provide regulatory hosting services (in which the principal firm undertakes little regulated activity itself, but acts as a host for its ARs) would need to make an additional notification within the same timeframe.
The FCA is proposing to require that firms with existing ARs notify any additional information required under the new rules in respect of their existing ARs. Principal firms would also need to report any significant changes concerning their ARs to the FCA. In particular, they would need to notify any planned changes to the AR’s name, or to the categories of regulated activities the principal allows the AR to use, at least 10 calendar days before the change takes effect. They would also need to notify certain other matters within 10 business days of the change being made. Principal firms would be required to check the accuracy of the details held by the FCA on their ARs on an annual basis and report any changes.
Additionally, the FCA proposes to include details on the Financial Services Register of the precise regulated activities the AR is appointed to carry on, to allow easier verification of which activities an AR is permitted to undertake. Principals would no longer be able to provide aggregated complaints and revenue data, and would need to provide this split out per AR using a new reporting form. Revenue data would also need to be broken down between regulated activities, non-regulated financial activity, and non-financial activity.
These information requirements represent a significant additional burden for principal firms and the FCA evidently considers that the current information it receives about ARs and their business is not adequate for its supervisory purposes.
Responsibilities of principals
The FCA is planning to add new guidance on:
- How principals should ensure that any functions delegated or outsourced to an AR have appropriate safeguards in place.
- How management at principal firms should review whether senior management at its ARs remain fit and proper to act in that capacity on an annual basis. As the Senior Managers and Certification Regime does not apply to ARs, this measure could arguably be perceived as the FCA trying to apply similar principles by the back door.
- What steps principal firms should take to ensure that their ARs act in scope of their appointment.
- What controls and resources a principal should have in place and how to assess whether these are appropriate to oversee their ARs effectively.
- When an AR’s growth should trigger a review by the principal of its oversight arrangements.
- The systems and controls a principal should have in place to enable it to effectively oversee financial services staff at ARs to a comparable standard, as if they were individuals directly employed by the principal and the AR’s activities were in-house at the principal. This level of oversight is likely to be greater than what many principal firms currently have in place.
- How and when a principal should terminate, or remediate issues with, an AR relationship. Further, the FCA is proposing to require that principals ensure their AR contracts allow for termination where a principal considers it can no longer adequately oversee the AR. Existing AR contracts would need to be amended to provide for this, but only at the next contractual renewal date or other revision point.
The FCA also proposes a new requirement for principals to ensure that an AR’s activities do not result in undue risk of harm to consumers or market integrity, and to require that principals carry out an annual review of their ARs covering specific areas (and this must be performed more frequently in certain circumstances). Finally, principals would need to complete an annual self-assessment document on how they are meeting their regulatory requirements in relation to ARs, which would need approval from the board. The assessment would need to be made available to the FCA on request.
Overall, these proposals could introduce some fairly onerous requirements for principal firms, and create many new avenues through which the FCA could take action against a principal firm and/or its senior managers for failings involving ARs. Not only is the FCA proposing to introduce much more robust standards at the appointment stage, it also expects principal firms to conduct various regular checks and reviews to ensure their ARs are meeting the expected standards. This will significantly increase the compliance burden of principal firms and such firms should begin to consider how they could meet the FCA’s heightened expectations.
Further areas for consideration
The FCA is also seeking views through a discussion chapter on the wider risk posed by some of the business models operated by principal firms, in particular regulatory hosting arrangements, business models in which ARs are large in size relative to the principal, and principals with overseas ARs. As the FCA has limited data on how such arrangements are being used and by whom, it will review the results of a firm survey to help understand the potential risks and determine next steps. The FCA presents a range of options for consideration, from limiting the maximum size of ARs before requiring them to become fully authorised in their own right, to limiting the number of ARs a firm can have. The FCA is further considering whether it should strengthen prudential requirements for firms with ARs.
As the AR regime is set out in legislation, HM Treasury’s Call for Evidence is considering whether any legislative changes are necessary in addition to the FCA’s proposed changes to its rules. Although HM Treasury is not making any proposals at this stage, it highlights that the sorts of changes that would need to be made via legislation, and that it might consider, could include changes to the scope of the regime (both in terms of the activities ARs may carry on and the conditions for using the regime), potentially introducing a regulatory gateway for principal firms to ensure they have the right capabilities before they can appoint any ARs, enhancing the FCA’s intervention powers regarding ARs, and placing more regulatory obligations on ARs directly (such as extending the Senior Managers and Certification Regime to them).
What are the next steps?
Both CP21/34 and the Call for Evidence close on 3 March 2022. The FCA plans to publish a Policy Statement and final rules in the first half of 2022. HM Treasury will consider the responses to the Call for Evidence and determine whether any legislative change is required. If so, it will consult on any proposals “in due course”, so any potential legislative change will not be immediately forthcoming.
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