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Appointed representatives and their principals continue to attract attention from the FCA. Already this year, the regulator has asked principal firms how they assess and manage the prudential risks from ARs and how they are captured in ICAAPs. The FCA also issued alerts on the responsibilities of principal firms and related enforcement action. If you are a principal firm you need to be able to demonstrate proper oversight of your appointed representatives to avoid unwelcome scrutiny.
What is an appointed representative?
The appointed representative and tied agent regimes enable firms to carry on regulated activities under the supervision of a directly regulated ‘principal’ firm without the need to go through the costly and time consuming FCA authorisation process. Under a written agreement, the appointed representative – or AR – acts as the agent of the principal firm, which takes full responsibility for ensuring that its ARs comply with the FCA’s rules and is accountable for any infractions committed by the ARs to which it stands as principal.
AR arrangements are attractive to firms for a number of reasons. They can enable firms to test the market and build up a track record before FCA authorisation, or begin offering their services during the FCA authorisation process. When utilised in conjunction with AIFM hosting services, they can also enable fund sponsors to offload the burdensome obligations of AIFMD onto the AIFM host.
How do principal firms and appointed representatives work together?
The arrangements can be similarly lucrative for firms willing to take on the risks of acting as a principal. Typically the principal firm will charge its ARs a fee for the benefit of using its permissions and for its ongoing supervision. Indeed, there are some FCA regulated firms whose business model entirely consists in acting as principal to firms seeking an appointed representative arrangement. Such firms could oversee dozens of ARs, though in the advisory space this can run into the hundreds.
However, the FCA expects principal firms to effectively supervise their ARs. A 2016 thematic review into ARs in the insurance sector, unearthed a worrying absence of oversight on the part of many principal firms. Now the FCA appears to be turning its attention to appointed representative arrangements in the wider financial sector. The regulator recently issued a series of alerts on the responsibilities of principal firms (Considerations for principals who have appointed–representatives or introducer appointed representatives and Investment advisers’ and authorised firms’ responsibilities when accepting business from unauthorised introducers or lead generators. This was followed by enforcement action against a group of firms that provided AR and AIFM hosting services to a number of EIS and other alternative investment fund sponsors (Second Supervisory Notice to Stargate Capital Management Limited and Stargate Corporate Finance)
What do principle firms need to do to have adequate oversight of ARs
Given that principal firms are fully accountable for the conduct of their appointed representatives, inadequate oversight on the part of principals entails running an enormous compliance risk.
The FCA’s expectations of principal firms in relation to their ARs is in four areas: due diligence, ongoing monitoring, written agreements and regulatory capital.
Before appointing an AR, principal firms should be able to demonstrate that they have considered the risks associated with the activities undertaken by prospective ARs, and whether they have the necessary resources and expertise to oversee them effectively. The solvency of the AR and the fitness and propriety of its owners and senior managers must also be considered.
Principal firms should establish a tailored risk-based monitoring programme for each of their ARs and ensure that they have adequate resources to put these programmes into practice.
The written agreement a principal has with its ARs must follow prescriptive requirements set out in the FCA handbook. These should clearly set out the activities the AR is permitted to carry on and include other measures to enable the principal to exercise oversight and mitigate the risks the relationship poses.
The FCA’s recent questionnaire sent to principal firms makes clear that principals should consider the risks posed by their ARs as part of their Internal Capital Adequacy Assessment Process (ICAAP) and, if necessary, hold more capital against certain identifiable risks arising through the business of their ARs.
The FCA’s thematic review of principals and their ARs in the insurance sector found that in many of these areas, a large number of firms were not meeting the FCA’s minimum expectations. Firms that provide AR services related to investment business will face similar challenges, thought there are also sector-specific risks (such as ARs going beyond what is permitted under the AR regime by exercising discretion over client portfolios).
How can Bovill help?
We work with a number of principal firms to ensure that they are not exposed to excessive risk as a result of the conduct of their appointed representatives. Services we offer include:
- AR due diligence – Before you take on an AR, we can assess the risks that its business poses, the fitness and propriety of its senior directors and the level of ongoing oversight that is likely to be required.
- Compliance monitoring – We can undertake regular compliance monitoring of your ARs on your behalf or work with you and your ARs to prepare a risk-based monitoring and oversight programme
- AR control framework review – As well as looking at your ARs, we can review your own firm’s due diligence and oversight framework for your ARs to determine whether it meets the FCA’s standards and recommend improvements.
- ICAAP review – Our specialist prudential team can review your ICAAP to ensure that all of the risks that arise as a result of your AR relationships are captured. We can also advise on whether you should be holding any additional capital.
Get in touch to find out more.