Head of Investments, Azariah Nukajam discusses in this blog the Financial Conduct Authority’s improvements to the Appointed Representative regime and its key areas of focus.
In August 2022, the Financial Conduct Authority (FCA), released Policy Statement PS22/11, on ‘Improvements to the Appointed Representatives (AR) regime’, setting out the feedback and responses to the Consultation Paper CP21/34, along with the final rules.
The changes are due to take effect on 8 December 2022, following a four-month implementation period. The changes described in this article were brought about by the Regulator’s desire to reduce potential abuse of the regime and to minimise potential for consumer harm.
These new rules are applicable to all regulated firms that have Appointed or Introducer Appointed Representatives. They are also relevant to firms that propose to implement this model. It should be noted that the FCA has excluded firms in the Temporary Permissions Regime (TPR) and the Financial Services Contracts Regime (FSCR).
What is the Appointed Representatives regime?
The AR regime permits representatives known as ‘Appointed Representatives’, to utilise the regulatory permissions of authorised firms, known as ‘Principal’ firms, in order to engage in regulated activities without the need to be directly authorised themselves. This provides a quick and easy alternative route to market for firms wishing to offer their products and services, but who do not have the desire or capacity to meet the stringent requirements of regulatory authorisation (namely, Threshold Conditions).
Principal firms assume full regulatory responsibility and oversight of their Appointed Representatives under this model. Over the years, the regime has gained traction across the entire financial services industry and has expanded beyond the scope of sectors for which this model was historically geared towards – adviser, consumer lending and general insurance in the main.
This evolution and expansion has brought about an array of challenges for the FCA and in recent years, the FCA undertook two market reviews (in Investments and General Insurance), that led to material findings. The biggest concern for the Regulator relates to Principal oversight and their capacity to oversee AR arrangements. This was of particular concern with the regulatory hosting model.
This Policy Statement responds to feedback and discusses the next steps in the process of enhancement of the regime.
The FCA’s approach to remedying the issues identified is two-pronged:
- Collect additional information on ARs and strengthen reporting requirements for Principals.
- Clarify and strengthen the responsibilities of Principals.
The FCA identified harm ranging from mis-selling to fraud, in relation to the AR regime. From an analysis of the Financial Services Compensation Scheme (FSCS) complaints the FCA found that from 2018 to H1 2019, Principals and ARs accounted for 61% of total value in claims from the FSCS, representing approximately £671,000,000.
Further, on average, Principals cause between 50-400% more supervisory cases and complaints, than that of non-Principals. This is true when looking to the Financial Ombudsman Service (FOS) too, with FOS complaints and supervisory cases all being higher per pound of revenue for principal firms compared to those with no ARs. These are the metrics by which the FCA intend to evaluate the success of any changes made to the AR regime upcoming.
In a 2019 review of Principal firms in the investment management sector, the FCA also found that Principals lacked understanding of their regulatory responsibilities where it relates to ARs. Most principal firms reviewed had weak, or at least under-developed, governance arrangements in place.
The key areas of focus are:
- Notification and regulatory reporting
- Due Diligence and Oversight
- Regulatory hosting
Under the existing regime, Principal firms are required to notify the FCA prior to entering the AR-Principal relationship. However, depending on the financial services sector, sometimes firms may be allowed to notify the FCA after they have commenced the relationship with the AR.
Going forward, all sectors will have to notify the FCA prior to the relationship starting. This information will have to be provided for ARs and some for Introducer ARs. The pre-notification period for new AR appointments will be 30 days before the appointment is to take effect.
For existing ARs, the FCA will collect the data via a Section 165 data request. Principals will then have 60 days to submit the data on their ARs. Any ad hoc notifications, for example, changes of AR’s name and/or regulatory activities will need to be made at least 10 days before the changes take effect.
- The reason for AR appointment;
- Proposed regulated activities to be undertaken by the AR;
- Details relating to the provision of services to retail clients;
- If the AR was previously an AR of another Principal., If so, the reason for the new Principal arrangement;
- Whether the AR is part of a Group;
- Secondment from the AR to the Principal;
- Estimated revenue of regulated and non-regulated business (the FCA is introducing revenue bands for reporting anticipated revenue of the AR from regulated and non-regulated activity);
- Nature of financial agreements ( the FCA wants to see that firms have identified and put in place controls to manage any potential conflicts of interest that could arise with AR).
Under existing rules, once an AR is added to financial services register, no further notification is required. However, under the new regime, 3 further obligations will be extended to Principals:
- To verify AR details on the Financial Services register and attest as part of the FS register annual attestation that the AR information is correct – this is in keeping with the FCA’s permissions approach of “use it or lose it”;
- Provide complaints data for each AR on an annual basis (60 business days of the end of the relevant reporting period);
- Provide revenue information for each AR – this is in relation to regulated and non-regulated revenue (60 business days from the firm’s accounting reference date).
The FCA has also reminded Principal firms of their obligations under Principle 11 disclosures which provides that a firm must deal with the regulator in an open and co-operative way.
Due Diligence and Oversight requirements
Principal firms are already subject to the requirement to undertake due diligence prior to appointing an AR and to oversee them on an ongoing basis. However, persistent weaknesses have been identified in this area.
To remediate them, the FCA is proposing to include additional requirements and further develop the Handbook to clarify its expectations:
- Customer harm impact assessment: The FCA is seeking to plug the gaps that it perceives to see within SUP 12. Whilst the FCA expects that Principal firms are doing this anyway, the impact assessment will support the Firm with demonstrating customer harm impact in a structured and measurable way. Firms are required to understand their ARs customers, services and products, consider vulnerability and risks and to think about product governance and how that is reflected within the customer outcomes monitoring. Note that this should be aligned with the FCA’s new Consumer Duty rules.
- Annual compliance assessment of each AR: This is a formal assessment which the FCA expects should be documented. The FCA prescribed a variety of areas for review. For example, the financial position of ARs should be assessed to ensure ongoing solvency; the adequacy of the AR’s controls and resources and fitness and propriety of those running the business.
- Risk based approach review to be triggered by any material changes to the AR: Principals’ relationships with their ARs can evolve during the course of the relationship and therefore, it is important for Principals to assess the impact of those changes on the ARs, and also the impact of the changes on the Principal’s capacity to maintain adequate oversight of the ARs.
- Annual self-assessment approved by the Board: The FCA provides that the self-assessment should focus on how the Principal itself is meeting its responsibilities in relation to all of its ARs. This should help to focus the Board’s mind on the quality of oversight and also the risks posed by the relationship.
- Termination for lack of the principal oversight capacity: Principal firms should have a clear view of what should constitute breach of contract and areas where Principal firms would consider termination. Principal firms should have a documented policy with formal thresholds and escalation points. In practice, ARs should implement a formal governance process to assess whether termination needs to happen. Where termination is required, Principal firms should have a framework in place to support their ARs with the orderly termination; or to wind down in an orderly way to ensure minimisation of harm to customers and to the financial markets.
The FCA has redefined “regulatory host”, to include models whereby a regulated firm (host), agrees to appoint ARs as part of their commercial profit making strategy, and where, either:
- The host does not carry on any regulated activities other than through its ARs; or
- The regulated activities of the Principal are not connected to the regulated activities carried on by its ARs.
Whilst no further changes have been proposed as yet, the FCA reminds firms they must apply robust controls where offering regulatory hosting services, and ensure they comply with the new rules and guidance introduced by PS22/11. Firms are also required to notify the FCA of whether they provide currently, or intend to provide, regulatory hosting services.
Further development to the AR regime
The FCA has indicated that it will continue to work with HMT to consider potential ways of reforming the legislative framework for ARs. This work follows the discussion and options outlined in HMT’s call for evidence on the AR regime, which explored some more fundamental changes to the regime.
Proposed changes include:
- Changes to the scope of regulated activities which ARs can have access to;
- Introduction of a new permission for firms to act as a Principal;
- Extension of Financial Ombudsman Service (FOS) coverage to ARs;
- Extension of the Senior Managers & Certification Regime to the AR regime. ARs are currently subject to the Approved Persons Regime; and
Feedback on these proposals is still awaited, but in the Policy Statement the FCA outlines feedback from respondents on various other areas of potential policy change – which might be addressed with further change in the future.
The new rules will take effect on 8 December 2022 following a four-month implementation period. Transitional arrangements have been put in place to allow firms more time to comply with some of the new rules, particularly those requiring them to submit information on an ongoing basis and to review their ARs and self-assess annually.
To find out more about how FSCOM can be of support to your business, please contact Head of Investments, Azariah Nukajam at firstname.lastname@example.org