Appointed Representatives reforms - 'strengthening' of existing regime for now but more fundamental changes likely

For some time now, the FCA has been concerned by the potential harm to consumers and markets that it considers can be caused by the use of the appointed representatives (AR) regime. This is a model used by around 3,600 principals and 40,000 ARs across a wide range of financial services markets. On 3 December 2021, the FCA published proposed changes to the AR regime (CP21/34) and HM Treasury (HMT) published a call for evidence (CfE).

Key takeaways for firms and their ARs

• The current proposals focus on clarifying and strengthening existing arrangements rather than bringing wholesale change. More change must, however, be expected as both the FCA and HMT develop their thinking in this area. Firms with ARs should also expect to review and adjust their processes and contractual arrangements in the light of the FCA's changes.
• All firms with AR arrangements should consider how the proposals will affect them, but the changes will be felt most keenly by principals with large numbers of ARs. These firms in particular should start their planning now.
• Firms considering entering into new AR arrangements should bear in mind the prospect of future change, including that the AR model is likely to become more restricted over time. Small principals with larger ARs, overseas ARs and regulatory hosting arrangements are expected to be most affected by any future tightening of the regime.
• The proposals in CP21/34 form part of a wider intervention to tackle issues identified by the FCA. As set out in its 2021/22 Business Plan and 2020/21 Perimeter Report, the FCA is targeting supervisory action to ensure principals and ARs are financially stable and competent. Firms should already be seeing increased scrutiny of existing and proposed AR arrangements by the FCA, both in its supervisory and authorisation work. To fund this work, the FCA has introduced a new fee for principals with ARs.
• Principals should also consider how the new Consumer Duty, expected to apply from April 2023, would apply to their AR arrangements. Will their AR arrangements allow them to deliver good outcomes for retail consumers? (See our recent blog post on the new Consumer Duty here.)

The response date for both CP21/34 and HMT's CfE is 3 March 2022. The FCA plans to publish a policy statement and final rules in H1 2022, so it is possible that the FCA will expect the new rules to start applying sometime in H2 2022. HMT will decide whether amendments to the Financial Services and Markets Act 2000 (FSMA) is required once it has considered responses to its CfE.

Why is the AR regime being reformed?

First introduced in the 1980s, the AR regime was primarily created to allow self-employed sales representatives to engage in regulated activities without having to be authorised, in particular to allow insurers and other product providers to distribute products through ARs. Since then, novel and 'riskier' business models, such as regulatory hosting arrangements, have developed. The AR model is also being used in more diverse sectors, including asset management and wholesale activities.

Through its earlier work - including thematic reviews in the general insurance and investment management sectors in 2016 and 2019, respectively, and a call for input on the consumer investments market in 2020 - and ongoing supervisory and enforcement work, the FCA has found that:

• principals do not always understand their regulatory responsibilities for their ARs; and
• many principals do not provide sufficient oversight of their ARs or adequate controls over the regulated activities for which they have accepted responsibility.

The Treasury Select Committee recommended in the Lessons from Greensill Capital report that the FCA and HMT consider reforms to the AR regime, with the aim of limiting its scope and 'reducing opportunities for abuse of the system'.

What are the proposed changes to the FCA rules?

The proposals focus on clarifying existing requirements rather than introducing new rules. The FCA is consulting on two changes to its rules:

• Requiring additional information on ARs and notification requirements for principals:
  • Enhanced information gathering: Currently, principals only provide the FCA with high-level information on the market in which the AR operates. The FCA is proposing to require principals to provide additional details on the business each of their ARs will conduct both when an AR is appointed and on an ongoing basis, including when these details change over time (e.g. revenue, number of customers and complaints).
  • Notifications: The principal will be required to notify the FCA of a proposed AR appointment at least 60 calendar days before the appointment takes effect. This is much longer than the current requirements, which only apply for certain categories of AR.
  • Significant changes reporting: Principals will be required to report to the FCA 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.
  • Financial Services Register: Information about the nature of the regulated activities the AR carries on, for which the principal takes responsibility, is to be included in the Register. These are not currently shown at all on the Register.
• Clarifying and strengthening responsibilities of principals in the FCA rules and additional guidance on the FCA's expectations in the following areas:
  • Principals’ responsibilities for their ARs
    • Principals, where they 'delegate functions or tasks' to an AR or tied agent, to put appropriate safeguards in place
    • Principals to assess AR senior management's fitness and propriety, competence and capability
    • Principals to take 'reasonable steps' ('reasonable steps' not currently defined, but CP21/34 proposes guidance on what reasonable steps may include) to ensure their ARs act within the scope of their appointment
  • Overseeing ARs effectively
    • Principals to assess the adequacy of their controls and resources to oversee ARs annually
    • Principals to complete an ‘oversight appropriateness’ review when triggered by certain circumstances (e.g. significant growth of AR)
    • Principals to have systems and controls in place which anticipate the oversight of ARs to a comparable standard as if they were an individual directly employed by the principal and the activities being undertaken by the AR were in-house at the principal
    • Principals to ensure, when appointing an AR and on ongoing basis while in a contractual arrangement with an AR, that the activities the AR carries on do not, or would not, result in 'an undue risk of harm to consumers or market integrity'
    • Principals to review fitness and propriety of senior management at ARs and 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) annually
    • Principals to arrange ongoing oversight of their ARs
  • Termination of AR contracts and winding down
    • Principals to have clarity on the circumstances in which they should terminate an AR relationship
    • Principals to ensure, when terminating a relationship with an AR, that they do this in an orderly way
  • Self-assessment
    • Principals to prepare an annual self-assessment document, which will be reviewed and approved by the governing body, demonstrating their compliance with aspects of the policy and methodologies used to complete the assessment

What about Introducer Appointed Representatives (IARs)?

The FCA considers how its proposals will apply to IARs throughout CP21/34. The proposed requirements relating to assessment of AR senior management will not apply for IARs (see table at para 4.80).

What do the changes mean in practice?

Although the proposals focus on clarifying and strengthening existing arrangements, firms with ARs should consider whether they need to make changes to their processes and contractual arrangements. For example:

• Are there adequate processes in place to ensure that senior management and boards take responsibility for signing off the firm's self-assessment documents or to ensure that an oversight appropriateness review takes place once it has been triggered by events?
• Are IT systems changes required to ensure appropriate notifications are made to the FCA, correct data is collected (e.g. data which allows monitoring of increases in the size/volume of an AR's regulated business in a short timeframe or unusually high staff/senior manager turnover)?
• Is the principal firm able to terminate an AR arrangement where the principal considers it can no longer adequately oversee the AR (although contracts will not need to be amended immediately as this requirement will only kick in from the next contractual renewal date/revision point)?
• Are there enough appropriately experienced and trained staff responsible for overseeing and monitoring ARs, taking into account the extra responsibilities? Training will also need to be refreshed to take account of the new proposals.

Are these reforms the first steps towards banning AR arrangements?

A full ban on ARs seems unlikely. The FCA and HMT both acknowledge that the AR regime serves an important function which can benefit consumers when it works properly. The AR regime provides a cost-effective way to comply with regulation. By enabling more diverse types of participants to enter the market without an authorisation and allowing firms to trial new services and propositions without first applying for authorisation, the AR model can encourage competition and innovation. The AR regime is also an important mechanism enabling providers of all kinds of non-financial services to help customers access financial services.

The aim of the current proposals is to remove harms from the AR regime but keep the benefits by strengthening the FCA's rules.

What other potential reforms might we see in this area?

FCA Rules

The FCA is also asking for views on the following high-level issues in a discussion chapter within CP21/34:

• Prudential standards: The FCA will consider whether to introduce or strengthen prudential standards to reflect the harm posed to consumers and markets by firms with business models that include ARs.
• Regulatory hosting arrangements: The FCA has found that principals providing regulatory hosting services tend to take a more distanced 'light-touch' approach to their ARs than other principals and conflicts of interest may also exist where principals are more reliant on income from ARs to sustain their business model. The FCA is therefore seeking views on whether regulatory hosts can exercise adequate oversight over their ARs and remain commercially viable. The FCA refers in particular to the potential harm caused by 'Host AIFM' models. Such models have formed an important part of the funds and asset management infrastructure in the UK.
• Smaller principals with larger ARs: Where an AR or the group in which it operates is disproportionately large relative to the principal, the FCA is concerned this could lead to harm. Where a principal becomes overly reliant on the AR to sustain its business, this might undermine the independence and effectiveness of its oversight. The principal may also not have the skills and resource to oversee the larger AR. A principal may not have the financial resources to deal with the failure of a materially larger AR or pay appropriate redress to consumers.
• Overseas ARs: The FCA has noticed recently that some principals, particularly in the general insurance, consumer investments and wholesale markets sectors, have been appointing or looking to appoint, overseas ARs (i.e firms or persons which have their head office outside the UK). The FCA is keen to ensure that these ARs do not use this as a way to access UK markets instead of seeking authorisation. This is particularly the case for firms which had been in the Temporary Permissions Regime and which had not been successful in their application for authorisation.
• Potential policy options: To address the issues identified above, the FCA is asking for views on the following potential options:
  • ban the use of regulatory hosting services
  • require the FCA's specific consent to provide regulatory hosting services or to have larger ARs than the principal
  • limit the range or scope of regulated activities that regulatory hosts can oversee and/or the number of ARs they can have
  • require principals that provide these services to meet additional requirements to those that apply to other principals
  • rely on changes already in CP21/34, including requiring firms that want to provide regulatory hosting services to notify the FCA of this intention before beginning to provide these services
  • require principals to regularly review the relative size/scale of business carried on by their ARs and consider whether it remains appropriate
  • prohibit the engagement of ARs which operate businesses which are materially distinct from that of the principal
  • limit the maximum size of ARs before requiring them to become fully authorised in their own right

Each of these options brings its own difficulties.  For example, how big is too big if limits are to be placed on the size of an AR and would imposing a ban on "regulatory hosting" lead to reduced competition in some markets to the detriment of consumers?

Legislative changes

In its CfE, HMT stresses that the government has not yet reached any conclusion on whether the regime needs reform beyond the regulatory rule changes that the FCA proposes in CP21/34. However, depending on responses to its CfE, the government may consider the following legislative changes:

• The scope of s.39 FSMA could be altered, for example:
  • ARs can be prohibited from carrying on certain activities or certain activities may be restricted to less complex business models or less risky products;
  • new conditions (e.g. a size limit may be introduced for ARs) may need to be met in order for the exemption to apply; or
  • a requirement for the principal to be carrying on the same regulated activities as its ARs may be introduced.
• FCA's role may be enhanced, for example, by introducing a principal permission gateway or extending FCA's information gathering/investigation powers to apply directly to ARs;
• More regulatory obligations could be placed directly on the AR to strengthen the incentives for ARs to understand and comply with regulatory rules; and
• The Financial Ombudsman Service's ability to investigate complaints involving the activity of ARs could be extended (e.g. to include complaints where the AR has undertaken regulated activities outside the scope of the AR agreement).