FCA stronger requirement: oversight of Appointed Representatives (ARs)

What has happened?

In December 2021, the FCA announced a consultation paper, CP 21/34 on improving the appointed representatives (AR) regime and tackling consumer harm from this model. This CP is launched in the context of HM Treasury’s call for evidence on how market participants use the appointed representatives regime, how effectively the regime works in practice, potential challenges to the safe operation of the regime and possible future reforms.

The consultation will end on 3 March 2022. The FCA will review feedback and expects to publish a follow-up Policy Statement (PS) and final rules in H1 2022.

The Treasury Select Committee’s (TSC) July 2021 Lessons from Greensill Capital report found that the AR regime, as in the case of Greensill Capital Securities Ltd, an AR of Mirabella Advisers, may be being used for purposes which are well beyond those for which it was originally designed. The report recommended that the FCA and Treasury consider reforms to the AR regime, with the aim of limiting its scope and reducing opportunities for abuse of the system.

What may you need to do?

The FCA has pointed out that its data analysis has found that, on average, principals generate 50 to 400% more complaints and supervisory cases than non-principals across all sectors where this model operates, demonstrating that there are more issues arising from principals and ARs than from other directly authorised firms. The FCA sums the situation up by stating;

Where harm occurs, it is often because principals do not undertake adequate due diligence before appointing an AR, and from poor ongoing control and oversight. We consider there is now significant evidence of harm requiring regulatory intervention

This CP builds on the findings of the FCA’s previous thematic reviews of the general insurance sector in 2016 and the investment management sector in 2019. These reviews identified significant shortcomings in principals’ understanding of their regulatory responsibilities for their ARs. Failings included insufficient oversight of their ARs and inadequate controls over the regulated activities for which they had accepted responsibility.

The FCA has found that harm often occurs as a result of principals being unclear about their regulatory responsibilities for their ARs, insufficient oversight of ARs by principals and inadequate controls over the regulated activities for which they have accepted responsibility. This can result in a failure of principals to prevent practices, including:

• ARs providing information which is misleadingly presented or difficult for consumers to understand, hindering their ability to properly assess products or services,
• Products and services that are not fit for purpose in delivering the benefits that consumers reasonably expect, or are not appropriate for the consumers they are being targeted at and sold to,
• Harms not being identified or acted on,
• ARs acting outside the scope of their appointment. This can result in consumers not being able to access appropriate redress where only the regulated activities for which the principal has accepted responsibility are covered., and
• Other practices which hinder consumers’ ability to act, or which exploit information asymmetries

The FCA is consulting on two main areas of change. These are:

• Additional information on ARs and notification requirements for principals. This will allow the FCA to more easily identify potential risks within principals and ARs. It will also help assess whether the principal has the expertise, systems and controls to effectively oversee its ARs and to target supervisory interventions more effectively, and
  
  
• Clarifying and strengthening the responsibilities and expectations of principals in the rules and providing additional guidance for principals on their responsibilities, and the FCA’s expectations of how they should act and oversee their ARs

Details of the proposed changes - Additional information on ARs and notification requirements for principals

The FCA proposes to require principals to provide the following new items of information for each of their ARs;

• The primary reason for the principal’s intention to appoint the AR,
• The nature of the regulated activities the principal will permit the AR to undertake,
• The non-regulated business of the AR. This includes:
  • The nature of the non-regulated business (financial services products or services, non-financial products and services)
• The proportion of the non-regulated activities compared to the regulated activities in the first year following the appointment
• 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,
• Whether the AR is part of a group. If so, it must provide the name of the parent undertaking,
• 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,
• Information about the nature of the financial arrangements between the principal and the AR. For example, whether the AR pays or will pay the principal commission, any flat fees, or any additional payments,
• Anticipated revenue from regulated and non-regulated activity during the first year of appointment.

The scope of the activities IARs are permitted to conduct is limited to effecting introductions and distributing non-real time financial promotions (SUP 12.2.8G). As such, the potential harm arising from their activities is relatively low. The FCA therefore proposes to require principals to provide less information on IAR appointments compared to AR appointments. It is proposing to require the following information for each IAR appointment:

• 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,
• Revenue from regulated activity (but not from non-regulated activity) during the first year of appointment

The FCA proposes to require notification of these additional items of information in respect of existing ARs as well as those appointed after the proposed rules come into force. It proposes to amend the ‘Add an appointed representative or tied agent form’, and to require firms to submit this information for all their existing ARs, as well as for new appointments

The FCA is proposing to require that a principal notifies it of a proposed AR appointment at least 60 calendar days before the appointment takes effect.

The FCA proposes to require principals to report to it 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. It is proposing that changes to the following information provided in the ‘Add AR form’ are reported within 10 business days of the change being made, as per the existing rule in SUP 12.7.7R:

• changes to the categories of regulated activities the principal allows the AR to use,
• if the AR intends to begin or to cease to conduct non-regulated activities,
• changes to the nature of non-regulated activities the AR conducts,
• changes in relation to providing services to retail clients,
• if the AR becomes or ceases to be part of a group,
• if significant changes are made to the financial relationship between the principal and its ARs

These changes would be reported using the ‘Appointed representative or tied agent - change details’ form on Connect.

All FCA-authorised firms are required to check the accuracy of their details on an annual basis, confirm where details remain accurate and report changes (see SUP 16.10). The FCA is proposing to extend this requirement to cover the details of firms’ ARs, including the activities the principal permits them to conduct, with any changes notified using the appropriate form set out in SUP 12 and in accordance with SUP 16.10.4R.

It is further proposed that the information about the nature of the regulated activities the AR carries on, for which the principal takes responsibility, is included in the Register.

The FCA proposes to require principals to submit complaints data by AR. Firms would be required to submit data on complaints against their ARs on an annual basis, using a new AR reporting form.

The FCA proposes to require principals to submit revenue data for each of their ARs, from both regulated and non-regulated activities. For revenue from non-regulated activities, this would split between revenue from non-regulated financial activity and non-financial activity.

For existing ARs, it is proposed that:

• Principals provide this information annually based on their Accounting Reference Date (ARD), with 30 working days in which to submit the return,
• Principals will report this using a new AR reporting form (SUP 12 Annex 6R),
• A transitional period would apply for existing ARs, so that principals provide this information for the first full year of data following the rules coming into effect.

For appointments of new ARs, it is proposed that:

• Where the data is available, the FCA would require 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, the principal would provide a projection of the annual income of the AR (both regulated and non-regulated) at the point of appointment,
• It is proposed that for new appointments this information is provided using the amended ‘Add an appointed representative or tied agent form’.

It is proposed to require principals to notify the FCA of an intention to begin providing regulatory hosting services and to require existing principal firms to notify the FCA if they already provide regulatory hosting services. The principal would make this notification at least 60 calendar days before starting to provide regulatory hosting services.

Details of the proposed changes - Clarifying and strengthening the responsibilities and expectations of principals

To ensure this guidance in SYSC 3.2.3G(1) applies to all principals for their ARs and tied agents, and to give more detail on what these appropriate safeguards might be, the FCA proposes to add new guidance at SUP 12.6.5BG. Principals, where they delegate functions or tasks to an AR or tied agent, 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 managing body at the principal will be required to review whether senior management at its ARs remain fit and proper to act in that capacity, on an annual basis. Guidance will be included on the considerations principals should have in assessing the competence and capability of individuals at ARs. 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 behalf of the principal,
• have the necessary time to perform the tasks and/or functions for which they are responsible, and
• have the requisite knowledge and skills to undertake the tasks and/or functions for which they are responsible

Guidance will also be included on the practical considerations that senior management at principals should use to conduct these assessments effectively. These include:

• ensuring and verifying that information provided by the AR, either at entity-level or about senior management individuals, is accurate, sufficiently detailed and up to date,
• discussing any omissions or concerns proactively with relevant persons at the AR, and
• keeping up to date with changes, such as to the AR’s senior management, which may affect the quality or integrity of the information provided

Currently, under SUP 12.6.6R, principals must take ‘reasonable steps’ to ensure that ARs act within the scope of their appointment. To reduce the potential for this situation to arise, the FCA is proposing to add some guidance setting out what it expects ‘reasonable steps’ to be.

The FCA already requires a principal, before it appoints an AR and on an ongoing basis, to establish on reasonable grounds that the principal has ‘adequate’ controls over the AR’s intended activities, and resources to monitor and enforce an AR’s compliance with the relevant requirements that apply to its regulated activities. Guidance would set out that ‘adequate’ means controls and resources which:

• are 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 the principal to effectively manage conflicts of interest,
• allow the principal to maintain effective oversight of the AR, and
• enable the principal to identify and resolve any issues arising from the AR

Principals should review the adequacy of their controls and resources to oversee ARs at least annually.

The FCA considers it would be beneficial for principals to have some clarity on the specific circumstances in which an AR’s growth should trigger a review of oversight appropriateness. By oversight appropriateness, it means a review to determine whether the resources and systems and controls the principal employs to monitor the AR’s activities and business are appropriate. It is therefore proposing to include guidance at SUP 12.4.4FG on these specific circumstances. These include, but are not limited to, if:

• 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,
• staff turnover at the AR, across all staff members involved in carrying on regulated activities for which the principal is ultimately responsible, is unusually high

It is also proposed that principals are required to ensure that their contractual arrangement with an AR allows for termination where a principal considers it can no longer adequately oversee the AR.

The FCA proposes to introduce new guidance on its expectations at SUP 12.4.4BG. This would clarify that principals should have systems and controls in place which enable them 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 would include expectations that principals should:

• Collect, and scrutinise, management information. Principals should work with ARs to agree how and when management information should be provided, the format it should take and the data it should capture,
• Analyse data provided by the AR to identify risks and issues. The FCA expects principals should scrutinise entity-level data provided by their ARs. For example, where principals analyse complaints data, they should look at the volume of complaints but also at other data and trends to identify the root cause of any issues,
• Closely monitor the delivery of the AR’s activities and business, within the scope of its appointment. For example, this could take the form of reviewing call scripts or other materials provided by the AR and organising regular check-ins with them,
• Closely scrutinise directors (CF1s), as the senior responsible individual within the AR, to ensure they are appropriate for the role,
• Have regular engagement with their ARs, whether through in-person meetings, regular phone calls or emails,
• Set clear expectations around processes for escalation of issues, including service level agreements (SLAs) where necessary. This could include, for example, grading of issue severity based on impact and potential harm to the ARs’ customers and processes for remediation timeframes. Where appropriate, such expectations should be included in the contract between the principal and the AR. The FCA does not propose that contracts be amended to include these considerations, but suggests that they are incorporated, if necessary, at the first contract revision/renewal point,
• Take a risk-based approach to oversight of the AR’s activities and business, within the scope of its appointment. For example, this could include the principal setting out different expectations and management information requirements where a particular activity carried on by the AR is, in the principal’s view, risky.

The FCA proposes to require principals to ensure that an AR’s activities do not result in undue risk of harm to consumers or market integrity.

The FCA proposes to include a new rule at SUP 12.6A.2R requiring principals, on an annual basis, to review (for each AR they have a contractual arrangement with):

• The fitness and propriety of senior management at the AR, considering existing guidance at SUP 12.4.4G(2) and the proposed competence & capability guidance at SUP 12.4.4G (3).
• The AR’s financial position, considering existing guidance at SUP 12 Annex 1G.
• Spans of control, i.e. the ability of relevant persons at the AR to carry out regulated activities for which the firm has accepted responsibility.
• The adequacy of the firm’s controls and resources for the purposes of SUP 12.4.2R(3)(a) and (b).

It also proposes to require principals to carry out the annual review more regularly in certain circumstances. These include if:

• the AR changes its business model, or
• the scope of the AR’s appointment changes (for example, it begins conducting a new activity within the scope of the principal’s permission), or
• if the AR changes any of its senior management responsible for, or involved with, the activities being carried on within the scope of its appointment more than once in a calendar year, or
• if the AR enters into a new contractual arrangement with another principal

The FCA proposes to add guidance at SUP 12.6.1-AG on the circumstances in which principals should pursue termination to give them some clarity. Circumstances include, but are not limited to:

• Issues with the AR which have not been resolved satisfactorily or in a reasonable time period. For example, where the AR has agreed to resolve known issues, but it has not met the principal’s standards or expectations for remediation, or where the principal deems the proposed remediation risks it 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. For example, by including a misleading status disclosure on its website, other communications or financial promotion materials.
• If any of the AR’s senior management with responsibility for, or involvement in, activities carried on within the scope of the appointed representative's appointment are dismissed due to gross misconduct.
• Where principals decide termination is appropriate, the FCA considers it the principal’s responsibility for ensuring the AR relationship is wound down in an orderly way. So, the FCA proposes to include a new rule at SUP 12.8.3R. This requires principals to ensure that they terminate a relationship with an AR in an orderly way

The FCA is proposing to require the governing body (i.e. the Board or equivalent managing body) to annually review and approve, a self-assessment document. The document would contain, among other things, a written record of:

• How the 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.
• The AR’s financial position.
• How the principal is monitoring oversight of its ARs and the outcome of the oversight appropriateness review.
• The principal’s assessment of its own controls and resources.
• The principal’s assessment of the risk of consumer/market harm arising from the AR’s activities/business.

Principals will also need to evidence in the self-assessment document methodologies used to carry out the activities required. By methodologies the FCA means the approaches, techniques and systems used to inform their assessment process. To produce the self-assessment annually, principals may be able to use the previous year’s self-assessment document as a starting point. The FCA does not expect principals to produce the document from scratch on an annual basis if this is not necessary. It is expected that principals with multiple ARs should produce a single self-assessment document covering all the required information, rather than 1 document per AR

The FCA is also seeking views, in a discussion chapter (Chapter 5 of the CP), on the risk from regulatory hosting arrangements and business models where ARs are large in size relative to the principal. It also wants views on whether it should introduce or strengthen prudential standards to reflect the harm posed to consumers and markets by firms with business models that include ARs.

The FCA has identified issues and potential harm arising from regulatory hosts. Supervision work has identified that most issues arising from regulatory hosting arrangements are due to the principal applying too little resource to overseeing ARs, lack of skills and experience in the different markets in which the ARs operate and lack of appropriate systems and controls in place to enable principals to effectively oversee their ARs (see SUP 12).

Experience suggests to the FCA that regulatory hosts often take a more distanced ‘light-touch’ approach to their ARs than other principals. Many of them have a wide range of permissions and ARs conducting a broad range of business models. This makes it inherently more difficult for principals to have the requisite scale, knowledge, expertise and systems and controls to effectively oversee the ARs. Where principals are more reliant on income from their ARs to sustain their business model, this could also create a conflict of interest where a principal may be less able or willing to effectively oversee its ARs or take swift action to address harm when needed.

The FCA’s multi-firm review of principals and ARs in the investment management sector in 2019 found that regulatory hosts might permit people at ARs to be seconded to the principal. These individuals then undertake regulated activities, such as dealing in investments as agent and managing investments for which ARs cannot be exempt (Handbook SUP 12 and SUP 12.2.7G). This secondment arrangement has led to the emergence of ARs marketing themselves as, for example, investment managers, wealth managers and stockbrokers. These descriptions give the impression that these ARs can carry on a wider range of regulated activities than those for which a principal can lawfully accept responsibility.

The vast majority of ARs are relatively small firms that operate on behalf of their principal. There are also relatively small principals which are responsible for overseeing ARs of significant size. Where an AR – or the group in which they operate - is disproportionately large relative to the principal, we are concerned this could lead to harm. For example, where a principal becomes overly reliant on the AR to sustain its business, this might undermine the independence and effectiveness of its oversight.

Most ARs and principals are located in the UK. But recently some principals, particularly in the general insurance, consumer investments and wholesale markets sectors, have been appointing or looking to appoint, overseas ARs, that is firms or persons which have their head office outside the UK. The FCA is concerned this practice may be used, by some ARs or potential ARs, as a way to access UK markets instead of seeking Part 4A permission to carry on regulated activities in the UK.

Potential policy options being considered are;

• prohibiting the engagement of ARs which operate businesses which are materially distinct from that of the principal,
• limiting the maximum size of ARs before requiring them to become fully authorised in their own right,
• requiring specific FCA consent to provide regulatory hosting services or to have larger ARs 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,
• requiring principals that provide these services to meet additional requirements to those that apply to other principals.
• relying on changes already in this CP, including requiring firms that want to provide regulatory hosting services to notify the FCA of this intention before beginning to provide these services
• requiring principals to regularly review the relative size/scale of business carried on by their ARs and consider whether it remains appropriate.

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