Financial firms should monitor FCA's AR consultation ‘carefully’

ARs are individuals or firms that carry out regulated activity on behalf of – or under the supervision of – an FCA-authorised firm, known as the AR’s ‘principal’. The principal takes responsibility for the regulated activities of its ARs. The AR regime allows organisations or individuals to engage in regulated activities without having to be directly authorised by the FCA. There are currently around 40,000 ARs in the UK, with around 16,000 ARs operating in the retail lending industry, and around 12,000 in general insurance and protection.

The regulator launched a consultation (132 pages / 1.75MB) on proposals to improve the regime after it uncovered evidence that some ARs were acting beyond the scope of the regulated activity for which their principal had agreed to take responsibility. The FCA also found that some principals were not preventing ARs from sending misleading information to consumers – or preventing them from targeting consumers with inappropriate products and services.

Elizabeth Budd, financial regulation expert at Pinsent Masons, said: “When ARs act outside of their scope of appointment, consumers’ redress is constrained as consumers can only access redress if their principal accepted responsibility for the regulated activity that caused the harm. A further risk is where the principal has a wide network of ARs or the ARs are significantly larger than the principal. Either of these could expose customers to the risk that the principal may be unable to pay the redress required.”

The FCA said lack of clarity around principals’ regulatory responsibility for their ARs as well as failure to complete due diligence checks before appointing ARs were two root causes of harms it has seen in the market. It also pointed to inadequate oversight of ARs by their principals once they had been appointed. The regulator said that, on average, principals account for 50% to 400% more supervisory cases than non-principals across all parts of the financial services sector where the AR model is used.

Budd warned that the FCA had placed principals “under a spotlight” and that changes to the AR regime “now seem inevitable”. She told firms to “monitor the outcome of the regulator’s consultation carefully”, and ensure they have the “expertise, as well as the systems and controls necessary to provide proper oversight and control over their ARs.”

In its consultation, which closed on 3 March, the FCA set out proposals that included new expectations for principals to undertake increased due diligence before appointing an AR. New guidance is proposed for principals to assess senior management and key personal at the AR for fitness and proprietary as well as the competence and capabilities of senior individuals managing the AR. During the due diligence stage, ARs will need to provide evidence of fitness and proprietary, financial stability, and an understanding of the scope of their appointment. Principals will expect ARs to demonstrate an alignment of the proposed products and services with consumer needs.

In order to improve transparency, additional information about the AR will be provided to the FCA by the principal, to be included on the publicly accessible Financial Services Register. The FCA said the additional disclosure on the register would help consumers understand the business ARs are permitted to undertake and for which their principal takes responsibility. Principals will also have to collect detailed information about their ARs’ business, such as financial arrangements, corporate structure, anticipated revenue and unregulated activities undertaken by the AR throughout the lifespan of the appointment.

Under the proposals, principals would also have to submit data on regulated activities carried out for principals and non-aggregated complaints data for each AR. The FCA said this could provide a clearer picture of which ARs are breaking rules - and enable earlier identification and remediation of issues. Principals’ governing bodies would also have to complete an annual self-assessment including how  its ARs comply with fitness and propriety  expectations, if the FCA’s proposals are taken forward.

Budd said: “The FCA’s proposals aim to strengthen the oversight of ARs by requiring principals demonstrate sufficient internal resources, systems, and controls to monitor activities of the AR. A practical change currently proposed is for principals’ contractual arrangements with their ARs to allow the principal to exit the relationship if adequate oversight is not possible. A failure to monitor an AR or its staff turnover effectively could itself trigger an ‘oversight appropriateness’ review of the principal by the FCA.”

Budd added: “The increased reporting obligations proposed for principals will directly influence the internal management of information by ARs. Their internal systems and controls must be sufficient to provide comprehensive information, on an ongoing basis, to their principal in a timely manner, so the principal can then meet its disclosure requirements. Regular reporting on the nature of regulated activities, complaints data, and revenue data will be expected by ARs. The FCA views the collection of revenue data as an effective tool to monitor an AR’s business, the impact risk it may have on consumers and the ability of the principal to pay any redress for harm.”

She said: “ARs will have to work closely with principals to ensure the scope of the regulated activities they can carry out under their agreement with their principal is understood by both parties to the arrangement. They will also need to understand how the proposed new reporting and oversight by principals impacts on them and the consequent information flows needed and the management time and input this will require.”

“Principals will be looking to spot potential risks within ARs and the regulator expects its proposals for greater information flow will  enable it better to identify and stem risks, at both the level of the AR and the principal,. Ultimately, this potential for greater regulatory scrutiny could lead to enforcement action from the regulator which, given the nature of the principal-AR relationship, would be brought against the principal as the authorised firm,” Budd added.

Additional reporting by Lindsay Woods of Pinsent Masons.