HMT’s call for evidence
HMT has overall responsibility for the legislative framework for the regulation of ARs. The FCA is responsible for the regulation and supervision of principal firms. HMT has not yet reached a conclusion on whether reform is necessary, this is only a call for evidence. If HMT concludes that reform is needed, it will consult on proposals.
HMT is asking for comments on these potential reforms:
(1) Changing the scope of the AR regime:
- If there is strong evidence to suggest a regulated activity is generating an unacceptable level of risk for consumers or market integrity, the government would consider prohibiting ARs from carrying on that activity or restrict the activity to less complex business models or less risky products.
- Alternatively, a size limit on ARs could be imposed or principals could be required to carry on the same regulated activities as their ARs.
(2) Enhancing the role of the FCA:
- A ‘principal permission’ gateway could be introduced to require firms to gain permission from the FCA before appointing ARs. This would also allow the FCA to vary or withdraw a principal’s permission to appoint ARs.
- The FCA’s information gathering and investigation powers could be extended to apply directly to ARs. This would allow the FCA to carry out prompt investigations into ARs, resulting in quicker supervisory action.
(3) Placing further obligations on ARs:
- The Senior Managers & Certification Regime (SM&CR) does not currently apply to individuals in ARs. SM&CR conduct rules could be applied to ARs, with their principals obliged to ensure those rules are complied with, or the FCA could be given responsibility for directly enforcing compliance in AR firms.
(4) Extending the ability of the FOS to investigate complaints involving ARs:
- The AR exemption could be amended so that a principal is responsible for all an AR’s regulated activities, even if the appointment is invalid or the AR carries on activities outside the scope of its appointment. This change would allow the FOS to investigate complaints and provide redress against the principal regardless of whether the AR’s activity is covered in its agreement with the principal.
FCA’s consultation paper
The FCA’s proposals fall into three categories: (1) areas of potential policy change; (2) additional information and notification requirements for principals; and (3) increasing the responsibilities of principals. The majority, but not all, of the proposals in (2) and (3) also apply to Introducer Appointed Representatives (IARs).
(1) Areas of potential policy change
(a) Regulatory hosting
The ‘regulatory hosting’ model is where, rather than carrying on any substantive regulated activities itself, an authorised firm oversees the use of its permissions by ARs. These principals often have many AR relationships and this service is commonly in addition to other compliance support services. This model differs from a ‘network’ in that the ARs are generally all independent, unconnected businesses and in some cases they are operating in different markets. In the more traditional AR ‘network model’, ARs and principals typically share a common commercial objective and operate within a particular sector. In recent years, the number of firms providing regulatory hosting services has grown significantly. In the FCA’s view, most issues arising from regulatory hosting arrangements are due to the principal applying inadequate resources to overseeing its ARs, having a lack of skills and experience in the different markets in which its ARs operate and having inadequate systems and controls to effectively oversee its ARs. The FCA’s analysis shows that regulatory hosts have, on average, more complaints against them compared to other principals and create more supervisory cases, which are often more severe. The FCA does acknowledge that the data it has on regulatory hosts is limited and that it needs more information on the benefits and harms of the regulatory hosting model before deciding whether to make any policy changes. FCA is specifically requesting views on potential harms from these business models in the investment management sector and on its draft definition of ‘regulatory host’.
(b) Smaller principals with larger ARs and overseas ARs
The FCA is concerned that: (i) overseas ARs are seeking AR appointments as a way of gaining access to UK markets instead of seeking a Part 4A permission; and (ii) some ARs are disproportionately large relative to their principal. However, it acknowledges that it does not have enough information at this stage to assess the harm arising from these arrangements and is conducting a firm survey to further inform its approach.
(c) Policy options under consideration for (a) and (b)
To tackle harm arising from the business models described in (a) and (b) above, the FCA is considering the following policy options:
- Prohibiting the appointment of ARs which operate businesses which are materially distinct from that of the principal;
- Limiting the maximum size of ARs before requiring them to be authorised in their own right;
- Requiring specific consent to provide regulatory hosting services or to have ARs larger than the principal;
- Limiting the range or scope of regulated activities that regulatory hosts can oversee and/or the number of ARs they can have and introducing additional requirements to those that apply to other principals;
- Requiring principals to regularly review the relative size/scale of an AR’s business and consider whether it remains appropriate; or
- Relying on changes proposed in the CP, including requiring firms that want to provide regulatory hosting services to make a notification before beginning to provide hosting services.
(d) Prudential standards
The FCA intends to update prudential standards so that the metrics determining firms’ prudential requirements better reflect the harm they may cause to consumers and markets. It wants to hear views on which sectors or business model arrangements with ARs could benefit from new or enhanced prudential standards.
(2) Additional information and notification requirements for principals
Proposals include putting additional information about an AR’s activities on the FCA Register and requiring principals to:
- provide more information on their ARs (e.g. business, revenue, complaints data and regulated and non-regulated activities);
- notify their intention to begin providing regulatory hosting services at least 60 calendar days in advance; and
- verify annually AR details.
(3) Strengthening the responsibilities of principals
Proposals include requiring principals to:
- Ensure that any delegation of functions/tasks to ARs do not represent a conflict of interest.
- Carry out an annual review of an AR’s fitness and propriety. This will not apply to IARs.
- Carry out assessments of an AR’s competence and capability. This will not apply to IARs.
- Identify when an AR is acting outside the scope of its appointment.
- Oversee ARs effectively and ensure the principal’s resources are adequate and, if they are not, remediate or terminate the relationship. A review should be conducted at least annually.
- Monitor an appointed representative’s growth and respond to review triggers.
- Terminate the contract if a principal can no longer adequately oversee the AR or concerns arise and then wind down the relationship in an orderly way.
- Effectively recognise, and limit, the risk of harm to consumers or market integrity.
- Carry out an annual review of an AR’s activities and business. The frequency of this review should be matched to the nature and level of risk of the AR’s business and activities. A more frequent review should be carried out in certain circumstances. This will not apply to IARs.
- Create a self-assessment compliance document which the governing body approves annually.
Both papers close to comments on 3 March 2022.
This article was first published in Thomson Reuters on Thursday 9 December 2021.