The FCA has identified the AR regime as an area of compliance weakness. This comes after reviews of the general insurance and investment management sectors. The regulator also points to the lessons from the Greensill Capital report, noting that the level of oversight by the principal was insufficient and the activity undertaken by the firm was not the type of limited activities considered when the AR regime was established.
This has prompted supervisory bodies to look closer and consider reforms to the regime. The FCA has therefore put forward a consultation paper that looks at two areas; changes to the AR rules and discussing regulatory hosting – read the key points in this article.
In this piece, we look closer at the FCA’s approach to AR arrangement notifications and future annual reporting. The final set of rules is expected by the end of H1 2022, meaning firms must start to prepare now.
Proposed changes to notification process
The FCA is proposing to materially enhance the notification requirements by asking principals to notify the FCA of all new AR relationship prior to the arrangement taking effect and provide new information at the onset of a relationship.
Some AR relationships are already subject to notification to the FCA prior to the arrangement taking effect. This requirement is extended to all AR arrangements. The notification will have to take place at least 60 days prior to the arrangement coming into effect.
Firms will have to disclose why the principal is entering into an AR relationship and what regulated activity will be undertaken. This will require the principal to articulate how this appointment fits within their business model and how it will support its business model and strategy. Demonstrating that the principal has considered customer outcomes will be an important element of such explanation. The FCA is not asking for the disclosure of investment category or class of business to be undertaken, however including information on this may help the FCA to understand the risk associated to the proposed relationship.
The FCA wants to understand the risk associated to the AR business model, levels of non-regulated activity versus regulated activity, and if the AR is part of a group and how they are controlled. Part of this information is relatively granular, and it can be challenging for firms, as AR might find the information request quite intrusive especially for new ARs not used to dealing with financial services firms. In addition, some of this information will have to be reported on an annual basis during the entire AR relationship. This will bring challenges for firms to ensure that they receive all the information on time to meet their reporting timeframe.
Firms will have to provide information on financial arrangements between the two parties and any secondment to the principal from the AR. When considering these elements, principals should consider what impact these two elements would have on their management of conflicts of interest. Remuneration and secondment should not compromise the integrity and effectiveness of their oversight of ARs.
Information on non-regulated activity will be not required for introducer appointed representatives (IARs).
When will firms have to notify the FCA?
The notification will have to be submitted at least 60 days prior to the AR having started undertaking regulated activity rather than once the AR started carrying out regulated activities.
While firms should have considered the risk associated of appointing ARs to date, they might not have gathered the same level of information, and if they have, it is unlikely to be in a format that is easily reportable. The FCA proposes that principals provide them with the new data for all existing ARs within 60 days of the enhanced regime implementation date.
The provision of this information will inform the FCA of risk associated to existing ARs, this may lead to the FCA reaching out to firms to assess if appropriate oversight arrangements are in place. Therefore, principals should be ready to articulate how their oversight arrangements meet the new requirements at an AR relationship level, considering that oversight should be tailored to the level of risks associated to the AR relationship.
Obtaining this information from ARs can be challenging for firms, especially for existing relationships where further education will be required on why such information is required, and updates will be required too.
The FCA is also proposing for the principal to update information on the AR when significant changes are to take place or have taken place:
The regulator will require 10 calendar days notification prior to the implementation of change is applicable to AR’s name change and to the regulatory activities used by the AR.
It also needs a notification in 10 calendar days of the change being made, for activities such as:
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AR intending to begin or cease to conduct non-regulated activities
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change in the nature of non-regulated activities the AR conducts
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changes in relation to providing services to retail clients
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AR becoming, or ceasing, to be part of a group
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significant changes to the financial relationship.
Key notification challenges
These new requirements will be challenging for firms to implement for two key reasons.
Firstly, the FCA is expecting firms to report on their existing ARs. Principals should assess their data availability, completeness and format to identify potential gaps. Where gaps are identified, resolution action plans should be established and completed by the implementation date. Considerations should be given on systems implementation for larger firms to support accurate, complete and timely reporting.
Additionally, the FCA requirement for a 10-day reporting timeframe for changes feels tight to enable accurate, complete and timely reporting. This will be more challenging for larger organisations who have multi-layer escalation processes and significantly depends on the level of dependency on the AR providing this information.
Considering how the principal communicates with their ARs is a good way to seek regular updates to identify early circumstances that might need reporting to the regulator. Firms should consider reviewing their agreements with ARs to include additional reporting contractual obligation and engage early with their AR to ensure that they understand the requirements.
The FCA is not expecting principals to have updated their agreements by the implementation date, however firms are expected to consider amending arrangements at the next renewal or review date. For open-ended arrangements, consideration should be given on the need to bring forward such reviews. Amending contractual arrangements often take longer than expected because of their complexity and multi-layer sign-off requirements.
The FCA is not defining the materiality of change that would be reportable; therefore, principals should consider what they consider to be a notifiable change based on their AR portfolio. It should be noted that the notification is at individual AR level, therefore what might be a material change in the nature of their non-regulated activities for one AR might not be one for another.
Firms must understand each AR business model and risk profile to assess reportable changes.
Firms face several obstacles around annual reviews and reporting
Financial services register (FSR) review
Regulated activity information provided will be reflected in the FSR, the principal will be required to verify the accuracy of the register within 60 business days of their accounting reference date. Firms will have to ensure that appropriate checks are in place to ensure that its attestation on the accuracy of the register is correct. This is a material extension on the current annual attestation that the information of the register is correct.
Reviewing the FSR will be more challenging for principals with a portfolio of ARs. Centralised registers and oversight can support such reviews, as the FS register will include all regulated activities used by each AR. The FCA has highlighted the importance of holding and disclosing appropriately regulated activity undertaken by firms though their request for firms to review their regulatory permissions under the ‘use it or lose it’ approach. This is in line with the current area of focus.
Complaints reporting
The FCA currently receives information on complaints from regulated firms, however the data is aggregated, therefore they cannot identify potential issues associated to a particular party in the distribution chain.
To remedy this, the FCA is proposing that principals report annually on each AR. This means that firms will have to ensure that their complaints handling process adequately records what complaints relate to an AR business and which AR.
This can be challenging as complaints relating to an AR business do not systematically mean that the complaints are due to the AR’s actions or omissions. ARs often only take part of part of the product or service provision rather than the entire provision of product or services. Principals will have to ensure that their complaints’ root cause analysis adequately allocates complaints to an AR’s potential failings.
Firms must ensure that complaints handling guidance and systems support the above to accurately report to the FCA.
The complaints report will be due within 30 business days of the end of the relevant reporting period. To meet this requirement, principals should consider the complaints escalation process in the AR arrangements.
Reporting accurately to regulators is paramount. We've seen recent enforcement actions from the PRA and BoE on this. The FCA has a similar view on the accuracy and completeness of regulatory reporting and has taken actions in the past against regulated firms.
Revenue reporting
This is the most challenging reporting requirement from an operational perspective. On an annual basis the principal will have to report to the FCA for each AR on the AR-regulated revenue and financial activity, as well as non-financial activity and non-regulated revenue. The FCA has not defined non-regulated financial and non-financial activities. Firms will have to define these activities, and this may lead to inconsistent reporting to the FCA.
This return will have to be completed with 30 business days of the principal’s accounting reference date. The AR might have different accounting reference date than the principal, therefore the firm will have to be very clear when seeking the information from the AR, communicating which period the information request relates to and use the reporting period consistently year on year to avoid any gaps.
Having to report annually on non-regulated business is also likely to be challenging as ARs may object to provide information that they would consider confidential and sensitive. Early engagement and educating ARs will be vital to support this reporting requirement.
The firm should also consider how they can validate the accuracy of the data provided by the AR. The FCA is proposing a transition period for existing AR to enable principal to report for the first full year of data following the rules coming into effect.
The above new requirements will be challenging to implement for principals. Early gap assessments on principal control and system, understanding the level of data currently held and how it is held, training campaigns and early engagement with ARs will be key to timely compliance with these changes. Principals should also consider scenarios where they face difficulties in obtaining the required information.
The implementation of the above, and other requirements may lead firms to terminate some AR relationships, because of the compliance costs associated to using ARs, especially for small relationships. This could be detrimental to access to products and some customers’ needs not being met. Where principals are considering terminating AR relationships, they should assess the customer outcome impact of the decision and mitigate the risk of harm.
What can firms do to prepare?
Firms should consider all potential scenarios and act sooner rather than later. They must assess any gaps and think about how they will respond to new requirements.
While the principal is accountable to the FCA, it will be important for firms to engage with ARs and vice versa to streamline compliance. Governance and policies will have to be updated and embedded into the organisation. Additionally, agreements with ARs may need to be amended.
Contact Alex Ellerton or David Morrey to find out more about the appointed representative regime or for more information on our support for financial services compliance.
