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Reforming the Appointed Representative regime – a spotlight on Principal and hosting firms

The FCA recently published Consultation Paper 21/34 (CP21/34) aimed at improving the Appointed Representative (AR) regime. This follows evidence from the FCA relating to a ‘range of harms’ across all of the sectors where firms have ARs and high-profile failings such as the collapse of Greensill Capital.

Our previous blog (Raising standards in the Appointed Representative Regime) highlighted key regulatory concerns relating to the Principal / AR relationship highlighting key areas of regulatory concern covering; significant shortcomings in Principals’ understanding of their regulatory responsibilities for their ARs, inadequate due diligence before appointing an AR, and from poor ongoing control and oversight.

For this article, we highlight the key messages from CP21/34 and outline the steps that firms should be considering to best prepare for the forthcoming changes that will impact commercial and risk management thinking.

Background and highlights from CP21/34

Last year the FCA published a ‘Call for Input’ which asked for views on how the AR regime is working in practice in the investment sector. As part of this exercise, the FCA received a range of views, many of which raised concerns. Some respondents argued that ARs drove significant consumer harm and the regulatory disparity between authorised firms and ARs was a source of confusion and harm for consumers.

The Treasury Select Committee (TSC) recent report (Lessons from Greensill Capital) also found that the AR regime may be being used for purposes that are well beyond those for which it was originally designed. To add further fuel to the fire, the FCA has also specifically highlighted the growing number of failings identified through their supervisory and enforcement work across all sectors with ARs. Many of the issues cited were not a surprise, for example:

  • Firms having too few resources to adequately oversight their AR network

  • A lack of skills and experience in the different markets in which the ARs operate

  • Inadequate systems and controls in place to enable Principals to effectively oversee their ARs

It was also noted that AR’s:

  • Generate significantly more complaints than direct regulated firms

  • Have a higher claims rate to the Financial Services Compensation Scheme, and

  • Generate significantly higher supervisory cases

The FCA is thus consulting on two main areas of change.

Firstly, and aligned to their data-led strategy, the regulator is looking to improve and enhance the information they hold on ARs and impose more onerous notification requirements for Principals. This includes additional questions on ARs’ revenue, business models, activities, complaints against the AR and the AR’s regulated and non-regulated activities, whether the AR provides services to retail clients, company and corporate status, revenue and fee structures etc.

This will allow the FCA to more easily identify potential risks within Principals and ARs. It will also help the regulator to better assess whether the Principal has the expertise, systems and controls to effectively oversee its ARs and to target their supervisory interventions more effectively.

Secondly, the CP seeks to clarify and strengthen the responsibilities and expectations of Principals in the handbook, providing additional guidance for Principals on their responsibilities, and expectations of how they should act and oversee their ARs. Key areas of focus include:

  • Clarifying Principals responsibility for their ARs and enhancing existing oversight requirements. The Principal must effectively oversee the ARs and must ensure that it has the appropriate governance arrangements, effective risk frameworks, internal controls and adequate resources (people, process, technology, facilities and information, which are necessary to oversee the AR)

  • Giving Principals more specific detail on the circumstances in which termination of an AR relationship may be necessary, and how, if termination is necessary, they should ensure that the relationship is wound down in an orderly way

  • Requiring Principals to annually review the fitness and property of the senior managers within their AR’s and the adequacy of their oversight arrangements and controls

Aligning reforms to SM&CR

The FCA’s proposals seek to place greater responsibility on Principal firms’ senior management to ensure the ongoing fitness and propriety of senior management at ARs with a specific requirement for a Principal’s governing body to review and approve an annual self-assessment of each AR.

This is a significant raising of the bar for many Principal firms and will require a new approach to risk management and oversight of ARs. This will include greater data analytics and behavioural monitoring to form a clear view of key risks based on a comprehensive data suite. The assessment requires not just an assessment of the risk of consumer and market harm arising from the AR’s business activities, but also an assessment of the adequacy of its oversight, controls and resources.

What should firms be doing ahead of the planned changes?

Reporting requirements for all firms is proving more onerous and challenging, and this will certainly be the case for Principal firms with extensive data submissions before any appointment of an AR, plus more onerous ongoing reporting requirements. Some Principal firms will already have this level of information and knowledge of the business of their ARs. For others, however, it will require an overhaul of their business model, their contractual and commercial relationship with their ARs.

Firms should actively consider:

  • The adequacy of existing governance arrangements against the proposed new rules

  • Whether data and MI requirements are comprehensive. What additional data above that prescribed by the FCA would support better quality monitoring and oversight?

  • The role of technology in supporting risk management

  • The methodology for risk identification, including the right blend of desk-based and ‘on-site inspections’

  • Changes to business models, commercial arrangements and contracts

  • Changes to risk appetite in light of the new rules

  • Appropriately skilled resources are in place to support the transition to, and compliance with, the requirements of the new regime

  • Whether staff have the necessary skills and capability to cover the breadth of activities and business models within their AR population, including deep dives on key regulatory initiatives

It is hard to disagree with the proposed changes and it will likely create challenges for firms to ensure compliance with the outcomes sought by the FCA. The unintended consequences however also cannot be overlooked. It will place even greater pressure on the profitability of the Principal firm and may drive ARs into the directly authorised space (unlikely to be something the FCA would welcome) and potentially further limit access to PI cover.

The FCA expect to publish a follow-up Policy Statement and final rules in H1 2022.

The Solution – About Square 4

Square 4 was founded with the vision to support people and businesses to grow and thrive. Across the team, we have extensive experience incorporating the ‘big four’ professional services firms, industry regulators, leadership roles within Global Systemically Important Financial Institutions (G-SIFIs) and other outsourced learning, resourcing and consultancy providers. We combine this expertise with best-in-class technology across an evolving spectrum of conduct, financial crime and operational risk.

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