Out-Law News | 06 Jul 2021 | 2:09 pm | 2 min. read
All UK authorised funds are required to appoint an AFM, who is responsible for ensuring that the fund complies with FCA rules. Host AFMs, who could be authorised corporate directors or authorised unit trust managers, are those that delegate investment management to third party managers outside of their corporate group, although the FCA said that some of the findings of its review were also applicable to in-house AFMs.
The FCA said that it would provide written feedback to all firms in the review, while a small number will be required to undertake section 166 ‘skilled person’ reports to improve compliance or to hold additional capital against the risks that they are exposed to. It will review the progress each firm has made in 12-18 months and may propose changes to the regulatory framework, including rule changes, should this be necessary.
Financial services regulation expert Elizabeth Budd of Pinsent Masons, the law firm behind Out-Law, said that the FCA had had concerns over compliance at some host AFMs “for some time”.
“These latest findings are the strongest indication yet that host AFMs must up their game and take strong regulatory control of their funds or the FCA will actively intervene – whether by rule change or disciplinary action,” she said.
“The reality is that in a hosting model, the investment manager usually holds the commercial and economic power in the relationship. This is at odds with where the regulatory obligations require the power to be. These findings show that that balance of power needs to shift,” she said.
These latest findings are the strongest indication yet that host AFMs must up their game and take strong regulatory control of their funds or the FCA will actively intervene.
The FCA expects host AFMs to be well-capitalised and well-resourced, with senior management in place who recognise and control the conflicts of interest inherent in the business model. While some of the firms reviewed by the FCA were operating well, the regulator found weaknesses in governance structures, conflicts of interest controls and operational controls at others.
Some of the firms reviewed were found by the FCA to be referring to funds as if they were solely operated by the third party investment manager or fund sponsor; while others lacked sufficient focus on controlling the risk of harm to investors from being exposed to inappropriate or poor value products.
The FCA was also concerned about the ‘onboarding’ process for investment managers, noting that in some cases there was no obvious link between questions asked and the outcomes to be tracked. While some host AFMs followed a set process, others relied on more informal conversations to assess and understand proposals and did not always gather the detailed knowledge required about the funds for which they would have responsibility. Host AFMs often submitted fund applications to the FCA that required material changes before approval, and often had to refer questions raised by the FCA back to the third party investment manager.
A number of firms displayed poor oversight of the delegated investment manager; while others were unable to provide evidence of robust governance procedures and effective challenge by independent non-executive directors. While most firms had a framework in place for managing conflicts of interest, not all appeared effective, with several firms in the review unable to provide evidence that they had identified even obvious relevant conflicts of interest.
The FCA was also concerned about the relatively low operating margins demonstrated by several of the firms in its review. In some cases, firms relied heavily on the support of a parent firm to maintain capital adequacy, or used professional indemnity insurance as their main risk mitigation tool.
Sheldon Mills, the FCA’s executive director of consumers and competition, said: “Our review indicates that some firms are not sufficiently meeting FCA standards and we want to see significant improvements in this area”.
“Our focus on this sector will aim to ensure that the regulatory framework is in the right place to provide good value for investors balanced by appropriate protections, and we will consider whether we need to make changes to rules to supplement the work of this review and its findings,” he said.
17 Jan 2020