How could the FCA's focus on ARs affect advisers?

In a speech delivered in May by Sheldon Mills at a British Insurance Brokers' Association conference, the executive director of consumers and competition said: “If you use appointed representatives in your business model, we expect you to have good oversight of them, to ensure that they are following our rules on product suitability and value.

“We have recently set up a new department to oversee the AR regime and will be supervising these firms more closely to deliver better outcomes.”

As well as establishing said department, in March the FCA closed a consultation on improving the AR regime, in which it set out proposals to require principals to:

• Provide the regulator with more information on their ARs and the business these ARs conduct;

• Report to the regulator specific information on the activities the ARs are permitted to undertake, for inclusion on the Financial Services Register; and

• Notify the FCA of an intention to begin providing regulatory hosting services before beginning to do so.

James Dingwall, chief executive of compliance consultancy Thistle Initiatives, says he is not surprised by the regulator’s recent focus on ARs. “It's pleasing that the FCA has now increased its supervision of the sector, but of course, this is after the damage has been done.”

How did we get here?

Analysis by the FCA found that principals generate between 50 per cent and 400 per cent more complaints and supervisory cases on average than non-principals, which the regulator said shows there are more issues arising from principals and ARs than from other directly authorised businesses.

Bovill consultant Jonathan Reid likewise says the FCA’s focus on ARs does not come as a surprise, given the collapse of Greensill Capital that made use of the AR regime.

The actual and potential consumer harm levels were simply too high for the FCA not to take wider action.Lindsay Lee, Brodies

A report called Lessons from Greensill Capital, published by the Treasury Committee in July, said it appears that the AR regime may be being used for purposes that are “well beyond” those for which it was originally designed.

Indeed, in its consultation paper the FCA notes how the regime was created primarily to allow self-employed representatives to engage in regulated activities without having to be authorised, but that over time, the regime has evolved to include a wider range of models such as regulatory hosting and networks.

Despite the common perception that Greensill Capital’s collapse led to the regulator’s review of the regime, Lindsay Lee, senior associate at law firm Brodies, says the FCA’s previous thematic reviews of the general insurance and investment management sectors had already exposed shortcomings in the AR model.

Lee adds that subsequent ‘Dear CEO’ letters and FCA analysis, which found that principals and ARs accounted for 61 per cent of the Financial Services Compensation Scheme
claims value between 2018 and 2019 H1, meant the actual and potential levels of consumer harm were “simply too high for the FCA not to take wider action”.

How could the proposed changes affect existing ARs?

It seems very likely that large networks with scale and systems already in place will be better able to handle the proposed new requirements, says David Morrey partner at Grant Thornton, especially where ARs have similar advice propositions that make it relatively easier for a principal to oversee.

“The biggest impacts will be felt by firms in smaller networks where they might have been given more flexibility over the systems they use, the types of advice and products they offer and the clients that they serve. Those firms might find their principals taking steps to limit their activity, or potentially to de-risk by severing ties completely.”

Additionally, Lee at Brodies predicts the proposed changes to the regime are very likely to make it more expensive for financial advice businesses to be an AR.

“Basic principles of economies of scale will undoubtedly apply, so ARs in larger networks will likely see the smallest changes in terms of costs, and also established networks with an already strong compliance structure will be least impacted by the changes,” Lee adds.

Jonny Williams, a partner at law firm Womble Bond Dickinson, agrees that larger networks may already have most of the resources they need to meet the proposed requirements. 

“If [larger networks] need to make less additional investment, then this may lead to less of an increase in fees they charge their ARs. But on the other hand, perhaps the smaller networks may have a more intimate supervisory model that means they will need to make fewer fundamental changes to the way they do business with their ARs. 

“I think principal firms will be left in no doubt that the FCA will be looking very closely indeed at firms with large networks. And as is often the case, some firms may have been conducting the bare minimum in terms of supervision, which will no longer be good enough and will find they need to inject much more resource in order to continue a compliant business model, which will make it more expensive for their ARs.”

Will joining a network become harder?

While many principal firms that run networks are very thorough and conscientious in their vetting and monitoring of their AR advisers, Williams says that some have been less attentive.

“The proposed additional requirements, as well as the messages the FCA has been putting out through industry communication and enforcement action, will make it more time-consuming and costly for firms to onboard ARs in the first place.”

Lee at Brodies likewise says the changes are unlikely to make joining a network notably more difficult at large, established networks that already maintain strong oversight of their ARs.

Principals with much smaller networks, on the other hand, may make strategic decisions to exit the market as a result of the changes, which could impact financial advice businesses seeking to join a network, she adds.

Ian Manson, a managing director in the financial services compliance and regulation practice at Kroll, says that weaker regulatory hosting service providers could be forced out of the market.

“On the one hand that raises standards and increases compliance oversight to ensure only adequately resourced firms offer regulatory hosting services, which is a clear positive. On the other hand, it’s yet another barrier to entry into the market and could reduce competition.

“A well-run regulatory hosting business model adds considerable competitive advantages to the UK’s financial services sector by providing a quicker, complementary alternative to direct FCA authorisation.”

Will direct authorisation become more favourable?

Morrey at Grant Thornton says he does not anticipate a major change in the appeal of being an AR, despite the potentially higher costs. “The new rules will impose extra costs on principals, mostly in the extra supervision they will need to carry out, but also in areas like higher fees for submitting an AR application.

“We would expect principals to pass some or all of these costs onto their ARs, which may make the AR route slightly less commercially attractive. But we don’t expect the AR route to be materially less attractive for advisers.”

Unless the volumes of business merit the initial and ongoing costs of direct authorisation, Williams at Womble Bond Dickinson agrees there will still be significant advantages to being an AR. “Even though principals will almost certainly increase their AR fees, becoming directly FCA-authorised is becoming increasingly time-consuming and difficult,” he adds.

Lee at Brodies likewise says for smaller ARs it is highly unlikely that the FCA’s proposed changes will reduce the appeal of being an AR as opposed to being directly authorised.

“The ongoing compliance costs of FCA authorisation are prohibitive. For much larger ARs, who are using the AR regime as a stepping stone to full authorisation, it is possible that the changes might accelerate that strategic decision,” she says.

Reid at Bovill agrees: “[An AR regime] enables smaller businesses to function without having all of the overheads around compliance, governance, insurance and sales.

“I still think [the AR regime is] viable in that field, because firms aren’t going to have to have all that function in-house, which is very expensive. So I don’t believe it’s necessarily going to reduce the appeal [of being an AR] in that type of scenario.”

Firms that are already quite sound around their governance arrangements won’t massively feel the pinch. It will be the ones where they haven’t.Jonathan Reid, Bovill

The FCA is yet to publish its policy statement following the consultation on improving the AR regime, and while the proposed changes will affect all principals and their agents, Williams predicts that some longstanding ARs may find it “annoying” to be subject to a more intrusive style of supervision than they are used to.

But he adds that those who are “properly customer-focused” should welcome measures that should result in less compliant principals and ARs potentially leaving the markets.

Reid likewise describes much of the battle as being around consistency. “Some firms... don’t have a massive amount of control on what the ARs are up to. So that’s going to be a big cultural shift for those sort of firms that just let the ARs get on with it.

“Firms that are already quite sound around their governance arrangements won’t massively feel the pinch. It will be the ones where they haven’t.”

Chloe Cheung is a senior features writer at FTAdviser