FCA has published the results of its review into how firms in the investment management sector that have Appointed Representatives comply with their regulatory obligations as principals. There are over 1000 ARs in the sector, and their activities include business for all client types, AIFs, wealth management, and fund advisory and arranging activities. FCA reviewed nearly 400 principals, who had varying numbers of ARs and carried out a detailed visit to 15 of them.
It drew some concerning conclusions.
- at the top level it found poor governance structures, with poor risk frameworks that meant the firms did not consider the risks their ARs’ activities exposed them to. The key consequence is that many principals may not be holding adequate financial resources both in terms of capital and liquid resources. FCA says firms must urgently assess their calculation of their Pillar 1 capital requirement;
- this also meant firms did not fully assess their ability to supervise their ARs when they onboarded them;
- failure to assess or understand ARs’ business models not only concerned FCA in terms of the due diligence principals carried out, but also several firms used a generic contract which meant ARs were permitted to undertake more regulated activities than was needed;
- most firms did not have product governance arrangements in place which meant they could not show that the products ARs offer had been designed in the best interests of consumers;
- the practice of seconding individuals to the regulated firm (which firms need to do for activities that cannot be carried on by ARs) often led to ARs marketing themselves as investment managers. The popular “host AIFM” model creates particular risks of conflict, which FCA saw little evidence that principals were properly managing;
- monitoring was generally poor and often not bespoke to the AR’s business;
- the business model includes inherent conflicts, which were often not recognised by principals who tended to view ARs as their clients rather than entities for which they were responsible;
- several principals had not expanded their resources to enable them properly to supervise the numbers and range of ARs they appointed; and
- there was a common theme of misunderstanding of the risks of market abuse, including failure to monitor trading of managed AIFs.
The review also covered ARs for CFDs. Here, FCA found many ARs owned by overseas shareholders, and in turn that linked overseas businesses were giving third country investors the impression that they, by reason of their associated AR, were contracting with an FCA-authorised firm. Monitoring by the principals had not picked this up.
FCA has already taken action against several firms, and has now written a Dear CEO letter to all relevant firms, explaining that it expects them to assess how they are meeting regulatory requirements and take steps to identify and address any failings they discover. FCA will be carrying out further work and will visit more firms – and will expect to see they have acted on the findings of the letter.