HM Treasury and Financial Conduct Authority consult on Appointed Representatives

Introduction

Both the Financial Conduct Authority and HM Treasury published papers concerning the Appointed Representative regime on 3 December 2021. Each paper is open for comment until 3 March 2022.

An Appointed Representative (AR) is a firm (or person) who carries on a regulated activity (or activities) under the responsibility of an FCA authorised financial services firm. An authorised firm which appoints representatives in this way is referred to as a "principal". A key feature of the AR regime is that an AR does not need to seek authorisation from the FCA to carry on its regulated activities. Instead, in appointing an AR, the principal assumes responsibility for the regulated activities carried on by the AR that have been agreed with the AR in a written contract. The principal firm is responsible for ensuring the AR complies with FCA rules.

The publications (issued in parallel) follow regulatory, and well publicised, concerns connected with the AR regime (most notably the case of Greensill Capital). HMT's Call for Evidence (CFE) focuses on the broad AR framework and seeks information to help HMT (and the Government) assess challenges to the safe operation of the AR regime and consider possible future reforms that might be needed to address those challenges. 

The FCA's Consultation Paper 21/34 (CP) has a more focused remit. Given the FCA makes and enforces rules within the existing legislative framework, the FCA is not consulting on whether the AR regime needs changes at a fundamental level. Rather, the FCA is consulting on proposals to address harm caused as a result of the current AR regime to the extent possible within their existing rule making powers.

Background

Whilst this document is intended to be accessible and does not necessitate the reading of the CFE or the CP in advance, this document is neither a summary of nor substitute for reading the publications. Readers are encouraged to read both the CFE and the CP in addition to this document and to form their own views and opinions. The purpose of this document is to draws attention to certain aspects of the CFE and/or the CP for market participants and those who may be affected by these publications with the aim of stimulating discussion, fostering cooperation and raising the possibility of joined up responses to both publications. In short, we'd love to talk to you about these publications and compare notes ahead of submitting responses to HMT and the FCA.

The CFE and the CP

Given their different remits, the two publications have different tones and approaches. And it is useful to bear these in mind when considering each, as these impact on the language used and approach taken in each.

The CFE is a consideration of the AR regime as a whole. It is (perhaps surprisingly) constructive and positive toward the AR regime as a concept. The CFE explains how the AR regime evolved and this self-awareness of its place in the entire landscape means that the CFE comes across as grounded and part of a bigger whole. The CFE makes an interesting, and occasionally insightful, read. It gives useful structure and analysis to the AR market as a whole and should be the starting point for considering these publications.

If the CFE is akin to a profit and loss account, the CP is more like a balance sheet offering a snapshot. Whilst the CFE seems to indicate a concern for how we have arrived at where we are and where the market heads in the future, the CP is in the now.

Given these differences, it is not surprising that the CFE and the CP seem to advocate divergent positions. For example, the CFE seems broadly comfortable with the idea that larger non-financial  businesses (e.g. retail stores) who might introduce customers to a third party financial service provider as a consequence of its business would be an AR of a principal which is in the financial sector but considerably smaller than the AR. However, the CP sees ARs who are larger than their principals as a risk to be eliminated.

A brief history of ARs

The regulatory concept of ARs was introduced by the Financial Services Act 1986. The purpose was to enable unauthorised persons to distribute products to consumers under the responsibility of the principal which they represented without themselves requiring authorisation. The policy aim was to ensure that consumers who purchased financial services products through representatives were protected by regulation in the same way as they would be if they had purchased products directly from an authorised firm. The 1986 Act was intended to make an authorised financial institution responsible for its self-employed representatives to the same extent as if they were employees of the firm.

The year 2000 brought "N2" and the Financial Services and Markets Act 2000 (FSMA). FSMA brought together the various regulatory regimes for UK financial services into one overarching regulatory framework to be operationalised by one statutory regulator: the Financial Services Authority. Much of the regulatory approach established by the 1986 Act was preserved in FSMA but applied to financial services activity more generally. This included the AR provisions. 

Thus, whilst FSMA preserved the overall approach of the AR exemption, it created some important differences from the previous regime, most notably: (i) ARs can carry out their activities independently of their principal, rather than having to be connected in some way beyond being an AR; and (ii) ARs can carry on an expanded the range of activities under a principal, which expanded the scope of the entire regime.

FSMA also granted the regulator (then the Financial Services Authority, now the FCA) powers to make rules and regulations in respect of authorised firms, which includes principals, to ensure that ARs were used appropriately.

HMT points out in the CFE that the task of setting (and monitoring) the detailed requirements to ensure that the AR regime operates safely and effectively falls to the FCA. When allied to HMT's position in the CFE that is broadly positive toward the benefits provided by the AR it is hard to read this as a criticism of the effectiveness of the FCA's rules around ARs and principals. In a similar vein, by taking a more critical view of the AR regime as a whole in the CP, the FCA can be seen as taking the view that whilst it is doing what it can to operate and oversee the AR regime, the entire framework (which is HMT's territory) is undesirable in the first place given the harm it causes. This tension between HMT and the FCA is key and can be seen in various elements of the CFE and the CP. It matters because depending on which entity comes out on top, we could see different outcomes to the entire AR regime once the comment periods end.

The AR landscape now

The CP sets out the FCA's position that where harm occurs, it is often because principals do not undertake adequate due diligence before appointing an AR and from poor ongoing control and oversight. To that end, the CP proposing two main areas of change: (i) additional information on ARs and notification requirements for principals; and (ii) clarifying and strengthening the responsibilities and expectations of principals and providing additional guidance for principals on their responsibilities, and the FCA's expectations of how they should act and oversee their ARs.

The CFE sets out four broad categories of ARs, which help set the scene:

• Introducer Appointed Representatives (IARs) – where small, often independent, traders carry on activities solely for the purpose of promoting, and introducing consumers to, their principal (or other members of the principal's group). For example, a dentist may act as an IAR to inform a customer about dental insurance options offered by an authorised insurance firm. HMT is positive toward IARs and indicates it would like them to be allowed to continue to operate.

• Smaller ARs – this refers to ARs who are small, often independent, traders whose primary business involves regulated activity. This type of use as closest to the original intention of the AR regime. Again, HMT is positive toward this version of ARs generally. The FCA has issues with the ability of principals to supervise their ARs, no matter their size or complexity.

• Larger ARs – where larger businesses, often involved in multiple markets, act as ARs to offer additional products or access new markets. These firms often operate similarly to smaller ARs, in that they sell on financial services products designed and administered by an authorised firm. For example, a department store chain may become an AR to introduce a customer to credit offered by an authorised lender to support the purchase of their household products. Whilst HMT sees the benefits to this approach, there is a concern that where principals are smaller than their ARs (and may have several ARs) there is an inherent risk in the structure which could risk the collapse of the entire structure. The FCA also has issues with the ability of principals to supervise their ARs, no matter their size or complexity.

• Regulatory hosting – this is where a principal makes its permissions available for use by its ARs. These types of principal often have many AR relationships, and this service to the ARs is commonly marketed as an additional service alongside other compliance support services. The principal's ARs may be independent, unconnected businesses, operating in different markets. Or the ARs and principal may share a common commercial objective and operate in a particular sector. Regulatory hosting has been a growth business in recent times, especially in wholesale capital markets, where ARs can "dip their toe in the water" through this model ahead of deciding whether to be directly authorised and regulated by the FCA in their own right. This model also offers a cost-effective and potentially rapid route to market for firms looking to commence operations and for whom the burden and slowness of FCA infrastructure and application is a barrier to entry. Whilst HMT in the CFE accepts that this model fosters innovation and has allowed the UK to become a leader in the global financial services market, the FCA in the CP focuses on the harms arising from this model. This negativity is in no small part driven by the complaint figures presented in the CP, and by the fact that Greensill Capital was on a regulatory hosting platform. (Given the political toxicity of Greensill, the logic is clear.) 

Supervision of the AR by the principal

In many ways, the fundamental underlying question in both the CFE and the CP is how can a principal effectively supervise an AR? This is especially an issue when considering a principal with a large number of ARs, or where the AR's regulated activities are independent of the principal, or where an AR is larger and more complex that its principal.

Frustratingly, whist both the CFE and the CP acknowledge that further clarification is needed from the FCA as to their supervision expectations in this regard, neither the CFE nor the CP gives substantive detail on this point. Past experience of dealing with the FCA would indicate that their expectation is they expect a senior member of the principal's personnel to be onsite and overseeing every aspect of regulated business undertaken by an AR, with no allowance made for size, complexity of proportionality. But this is not spelled out in CP. Possibly because the FCA is considering its position. Possibly because such a level of supervision will be a death knell to the entire AR regime. Or possibly, more cynically, it may that the FCA would prefer to not to clearly set down its expectation in this regard on record so that it can take action against misfeasance rather than preventing the harm in the first place. Time will tell if any of these analyses are correct.

Suitability of a principal

Currently, the FCA is not able to scrutinise the suitability of a principal firm to act as a principal. Instead both the FCA and HMT propose that the FCA introduce a process where the FCA needs to expressly authorise a firm to act as a principal before it can do so. (Such a move is analogous to the FCA's recent proposals requiring firms to seek specific authorisation before approving financial communications under section 21 of FSMA for unauthorised persons.

The data gap

The FCA is not currently able to scrutinise AR's directly. This means that there is a "black hole" of data which the FCA and HMT crave and do not have access to in connection with the activities of ARs. The solution suggested, in part, is to introduce reporting requirements for ARs and principals, so that the FCA is provided with large amounts of data. This should help the FCA understand the AR market in a way which is clearly lacking as things stand.

Contract shortcomings

The appointment of an AR must be based on a contractual agreement which sets out the regulated activities the AR is permitted to carry on and for which the principal assumes regulatory responsibility. Any regulated activity carried on by the AR which falls outside of this agreement will not be exempt and will likely breach the "general prohibition" set out in section 19 of FSMA. But FSMA only holds the principal responsible for that business for which it has accepted responsibility in its agreement with the AR. Thus, if an AR carries on a regulated activity outside of the scope of its AR agreement with the principal, the principal is not responsible for that business. And since the exemption from the general prohibition for ARs is established by reference to the existence of a contract between principal and AR which meets prescribed requirements, the liability of a principal also has the potential to fall away if there is a technical fault in the contract.

In addition, the AR will be carrying on that regulated activity in breach of FSMA, which can lead to civil and criminal proceedings.

Any customer complaint arising from out of scope activities will not be caught by the Financial Ombudsman Service (FOS). And this aspect has been identified as a consumer harm but is also arguably a political harm since if consumers have been harmed and the FOS will not apply, recent cases have shown that the Government has taught the market it will step in and underwrite matters.

The solution proposed here is that the contents of AR agreement will have to be expanded. 

What does this mean for the AR regime? 

Whilst the measures touched on above to strengthen the AR regime seem logical, reasonable and uncontroversial in their own rights, taken together, they give seed to the question of whether the AR regime would remain meaningfully differentiated from the direct FCA authorisation regime to which the AR regime is supposed to present a counterpoint. If, in order to make the AR regime fit for purpose, the AR regime becomes administratively onerous and requires time for completion of applications, allocation of a case officer, processing an application and allowances for periods of heavy workload, will there still be any benefit to going down the AR route? And where will that leave the UK as a competitive financial services marketplace?

What the future might hold

In terms of the broader AR regime the CFE seeks industry views on four potential areas of change to the regime (and legislation):

• Overall scope of the AR regime – Only certain regulated activities can take place inside the AR regime, and (for example) investment management is not permitted within an AR framework. If there is evidence to suggest that use of the AR regime to carry on a particular regulated activity was generating an unacceptable level of risk for consumers or market integrity, the Government could consider prohibiting ARs from carrying on that activity. This would not be a straight forward measure, as the market impact of such a change would also need to be carefully assessed before any proposal was taken forward. Alternatively, the AR regime could be amended to  specify conditions to be met in order for the AR regime to be allowed to apply to an AR or a principal. For example, a size limit for ARs (which could involve absolute limits or limits in relation to the size of the principal) could be introduced or a requirement for the principal to be carrying on the same regulated activities as its ARs (such a condition would be aimed at ensuring the principal has sufficient expertise in the activities of its AR in order to provide adequate oversight and would be in line with the original AR concept from the 1986 Act as seen above). 
• Empowering the FCA – As discussed above, any authorised firm is permitted to appoint ARs, with no further permission or approval needed from the FCA. This could be addressed by introducing a "principal permission" gateway whereby authorised firms must gain a specific permission from the FCA before appointing ARs. This concept is echoed in the CP too.
• Placing obligations on ARs – As discussed above, there is currently no "line of sight" between the FCA and ARs. (This is an outlier given the advent of the FCA's Senior Manager & Certification Regime (SMCR) to the bulk of the FCA regulated firms (but currently excluding the AR regime) which is all about giving the FCA direct access to almost all personnel at all FCA regulated firms.) Placing regulatory obligations directly on ARs could both give the FCA more power to supervise the sector and drive ARs to better  understand and comply with regulatory rules that serve to protect consumers and markets (for example, SMCR). But, where would such an approach leave the AR regime? Would it cease to be attractive?
• Extending the remit of the FOS to cover complaints toward ARs – As discussed above, the FOS currently has limited scope to cover complaints toward ARs from customers. HMT is inviting comments on whether this should be changed. But this proposal assumes that customers are unaware of the principal's involvement. A simpler solution would be to underline the requirement that ARs prominently draw customers' attention to the existence of a principal. 

What about everyone else? 

Finally, amongst the questions HMT asks in the CFE, the most interesting one is "For multinational firms that use the [AR] regime to access UK financial services markets – how do you access these markets in other countries?" This indicates that HMT is not looking at the AR regime in a vacuum and is keen to seek to ensure that the UK retained its preeminent position in the sector even if changes are made to the AR regime. If it manages is to be seen.