On 20 May 2019, the FCA published a webpage setting out the findings of its supervisory review of principal firms in the investment management sector. The review was carried out following a similar review in the insurance sector which identified shortcomings in the control and oversight of appointed representatives (ARs) by their principal firms. More recent supervisory work within the investment management sector identified similar concerns, prompting this review.
The review included a survey of 338 principals, each with between one and 80 ARs, and a range of business models. The aim of the survey was to gain insight into principal and AR business models, the extent of monitoring of ARs undertaken by principals, client numbers and categorisation, product types, sales methods, revenues and prudential oversight.
Key findings of the review were, amongst other things:
- AR on-boarding process: when selecting ARs, the lack of effective risk frameworks meant that many principals failed to fully assess their ability to oversee prospective ARs effectively. This meant that, once on-boarded, some ARs could conduct activities outside their principals’ core areas of expertise;
- ongoing monitoring of ARs: in many cases, monitoring was not bespoke to the business model of the AR and the principal often relied on high-level attestations from the AR. Some principals did not challenge the information submitted or ask further questions. No principal firm reviewed was regularly reviewing their ARs’ websites. Some of these sites contained non-compliant financial promotions;
- capital and liquidity assessment: most principals were not assessing the risks to their firms arising from the activities of their ARs. Furthermore, some were not adequately assessing their risks across all risk types, including liquidity risk and their compliance with the overall liquidity adequacy rule where it applies. Where the FCA reviewed firms’ assessments of the adequacy of their financial resources (where required under the prudential regime), more than 90% of these failed the ‘use test’ and were not fit for purpose;
- alternative investment fund managers: the FCA noted that the ‘Host AIFM’ model has flaws. Under this model, a principal firm is appointed as the alternative investment fund manager (AIFM) to an alternative investment fund (AIF); the AR is usually appointed as an adviser to the AIF. People from the AR may be seconded to the principal, in which capacity they can undertake portfolio management activity. Amongst other issues, the Host AIFM model has inherent conflicts of interest where, for instance, employees of an AR are appointed to carry out controlled functions for the principal; and
- foreign-owned ARs of contracts for difference providers: the FCA found that several principals that act as contracts for difference providers had recently registered ARs. Most of these ARs were owned by shareholders based overseas. UK-based directors were usually hired by agents of the overseas shareholders and typically did not have any day-to-day involvement in the AR’s business. Third-country entities, with very similar names to the AR entities, were advertising their services overseas but referencing the FCA firm registration number of the AR, and more broadly FCA regulated status, on foreign websites. Third-country investors were given the impression they were contracting with an FCA-registered entity, when they were potentially contracting with an unregulated third-country entity.
As regards actions, the FCA intervened in relation to a number of principal firms in their sample due to identified shortcomings. The FCA expects principals to assess how they are meeting requirements in relation to their ARs, as set out in the Handbook; the FCA will continue to work with principal firms involved in the review. The FCA has published an accompanying Dear CEO letter setting out the findings of its review, and its expectations for firms.