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Dear CEO: Principal Firms in the Investment Management Sector

Dear CEO: Principal Firms in the Investment Management Sector

20th June 2019

Last month the FCA published their findings on their supervisory work looking into how principal firms in the investment management sector understood and complied with their regulatory responsibilities in respect of their appointed representatives (ARs).

It seems that the regulator’s review identified a number of significant shortcomings in principal firms and of their understanding of their regulatory responsibilities for their Appointed Representatives, resulting in the FCA issuing a Dear CEO letter to Principal Firms in the Investment Management Sector.

Those firms with the following business models will find the findings of this review particularly relevant:

- asset management;

- promotion and management of alternative investment funds (AIFs),

- wealth management activity,

- contracts for difference providers,

- fund advisory and arranging activities.

This Review followed a previous alert issued by the FCA in 2017 to all Principals who have Appointed Representatives s or introducer ARs, where the regulator highlighted the risks to Principals of not having adequate oversight of its ARs and also reminded Principals of their responsibility for the regulated activities of their ARs. 

FCA’s Review of Principal Firms:

Within the Investment Management sector, the FCA advises that Principal Firms have appointed and accepted regulatory responsibility for over 1000 Appointed Representatives. The FCA’s review included undertaking a survey of 338 Principal Firms, each with between one and 80 Appointed Representatives and a diverse range of business models. In addition 15 of these Principal Firms were visited and had a more detailed review undertaken.

In particular, the FCA looked whether Principal Firms understood and complied with their regulatory responsibilities relating to business risk models, oversight and ongoing monitoring and financial resources.

Findings from the review identified that most principal firms reviewed had either weak or under-developed governance arrangements in place including:

- Lack of effective risk frameworks;

- Lack of internal controls; and

- Lack of resources

Whilst Principals are responsible for the activities of their Appointed Representatives, most Principals were not assessing the risks these activities posed to their firms. As a result, some principals may not have been holding adequate financial resources for both liquidity and capital.

Furthermore, many Principals did not identify any conflicts of interest inherent in this business model or make any attempts to manage these conflicts.

The deficient risk-management frameworks found by the regulator at Principal firms meant that directors were unable to adequately discharge their responsibilities of providing oversight and direction.

As a result the FCA concluded that there is “a significant risk of harm to consumers and to the market arising from the activities of ARs operating in this sector.”

CFD Providers & Foreign-owned Appointed Representatives

Of note within the FCA’s report were findings that several Principal Firms acting as Contracts for Difference Providers had recently registered Appointed Representatives. The majority of these ARs were owned by shareholders based overseas. UK-based directors invariably had been hired by agents of the overseas shareholders yet they typically did not have any day-to-day involvement with the AR’s business and in addition, in most cases the AR was inactive whilst continuing to pay relatively high fees to its Principal.

As it transpired, similar named entities to the overseas Appointed Representatives had been set up in third countries and were “advertising their services overseas but referencing the FCA firm registration number of the AR, and more broadly FCA regulated status, on foreign websites.” This gave investors the impression they were dealing with an FCA-regulated entity when in fact they were not.

Based on the FCA’s findings, they have high concerns that principals in the contracts for difference sector have insufficient systems and controls in place to monitor their ARs and will continue to monitor.

Dear CEO Letter: Principal Firms

Given the level of concern, the FCA’ issued a Dear CEO Letter to Principal Firms in the Investment Management Sector on 20 May 2019 that sets out their expectations.

Principal Firms should now ensure that they identify and address any shortcomings in their firm’s risk management frameworks, process and practices, and where these cannot be addressed sufficiently to comply, consider ending their relationship with any Appointed Representative.

The FCA has stated that they will be conducting further work in this area, including undertaking visits to Principal Firms and will expect to see that firms have acted upon the findings of their Dear CEO Letter. If firms have failed to act, then the FCA has warned they will take appropriate action.

It should be noted that whilst the FCA’s review focused upon the investment management sector, their findings may also be applicable to Principals and Appointed Representatives operating in other sectors of the UK financial services industry.

Compliance Support:

If you would like to discuss any aspect of having Appointed Representatives or would like to enquire about undertaking a compliance health check in this regard, please call our experienced compliance consultants who would be happy to help.

You may also be interest in:

• Appointed Representative Pitfalls: Principal Firms Take Note!
• Appointed Representatives: Principal Firm Responsibilities
• Direct Authorisation or Appointed Representative?

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