Regulatory risk alert

04 June 2021

By Gareth Johnson, Strategic Compliance Director Signature 

 

Principal firms and Appointed Representatives with seconded discretionary investment management staff

As the saying goes, forewarned is forearmed: in this document, we raise a regulatory risk warning to all Principal firms and Appointed Representatives who have arrangements involving seconded AR discretionary investment management staff. This document is also relevant to members of the discretionary investment management community contemplating striking out independently. 

We see clear warnings of a significant change in this area, and the Signature regulatory barometer needle is firmly pointing to ‘Stormy Weather.’ All affected firms should be adding this issue to their senior management / board meetings as standing agenda items and seeking advice to prepare for what may lie ahead.

 

Background

To recap the regulatory position: it is generally illegal to carry out a regulated financial services activity in the United Kingdom without being directly authorised by the regulator. This is known as the ‘general prohibition.’ Limited and specific exemptions to the general prohibition are allowed by the Appointed Representatives (‘AR’) regime. 

Typically, we think of ARs carrying out activities such as giving financial advice, but to remind the reader, the AR regime does not extend to:

  • Acting as a discretionary investment manager

 

  • Dealing as agent

 

  • Acting as an Alternative Investment Fund Manager

 

Why not? Simply put, because HMG / Treasury / FCA does not find the ‘parental-responsibility’ model of Principal + AR sufficiently protective of consumers and the systemic integrity of UK financial services for such serious endeavours as having investment management control of consumer monies. Such roles are only permitted to be performed by directly authorised and regulated firms.

 

Current market practice: AR staff fulfilling discretionary investment management roles

 

The reality is that by 2019 there were already, according to the FCA at that time, at least 1,000 ARs carrying out discretionary investment management roles by a mechanism of being seconded into their Principal’s temporary employment. Although the numbers are not centrally recorded, we are led to believe this number may have grown to as many as 3,000+ such ARs as of Spring 2021. 

We call such firms Discretionary-Seconding ARs (‘DS-AR’s’) to distinguish true AR activities such as advice from non-AR activities such as discretionary investment management.

There should be no issue to proponents of the mechanism: the Principal is required by law to take full responsibility for all its employees; the staff being seconded-in are appropriately qualified and experienced; the regulatory capital is posted. 

To critics, the objection is clear: regulatory hosting of unauthorised DS-AR investment management firms is ‘AR through the backdoor.’ In explicitly not creating an AR exemption for the activity, the requirement for direct authorisation was clear. Some DS-ARs market their businesses so that it appears to all intents and purposes that they are discretionary investment managers of fact and act as ARs when they do so.

 

 

The warning signs

An FCA review[1] and Dear CEO letter[2] in 2019 reported major shortcomings in Principal supervision of DS-ARs. The regulator detailed repeat control and oversight problems, lack of regulatory protection for end-investors, real cases of financial detriment, and ‘significant risk of potential harm to investors and the market.’ Action was taken directly against some firms at the time, and the FCA stated that it would do more work in the space. 

Since then, the lull in action is explained largely by the pandemic: when having to deal with the critical, the important has to wait. However, it would be wrong to have taken comfort from this enforced lull in the proceedings. The issue hasn’t gone away at all, and for those of us who watch out for these things, recent signs are that it is coming back to bite and soon.

 

Back on the agenda

Readers will probably be aware that the FCA recently announced a £250 levy on all ARs. In part, the funds raised will pay for a review into the phenomena we are discussing in this article which has also been explicitly referred to in the recent annual FCA fee review communications. 

Real consumer confusion in this area is understandable since multiple DS-ARs include the words ‘Investment Management’ or ‘Asset Management’ in their company name and advertise what appear to all intents and purposes to be their discretionary services on their websites. With real detriment and lack of regulatory protection already identified, we think it is highly unlikely that the new review will result in the status quo being allowed to perpetuate. Firms need to start contingency planning now.

 

What next? Enforcement and probable change

Firstly, we think it is inevitable that there will be further action against firms who have contravened the financial promotions rule and/or failed to supervise the investment management of consumer portfolios adequately. Firms who have any concerns or at a minimum want to achieve comfort in this area should seek independent review and assistance immediately. 

Secondly, will strong enforcement in this area be enough on its own? Perhaps, but our feeling is it may well be too late for this to be considered enough. If the modern marketplace practices that have evolved out of using this secondment mechanism are felt to be an unacceptable contravention of the spirit and/or the letter of the general prohibition and the explicitly limited AR exemptions, there is a serious chance the practice will be ruled offside for good.

We believe every firm affected by this issue needs to start actively planning for the possibility of a future move away from the status quo. Future states broadly revolve around direct authorisation, sale or a merger with an authorised firm, or for some, exit.

 

Next steps for Principals and DS-ARs

All readers are invited to email info@signature-support.co.uk to register interest for one of Signature’s upcoming webinar briefings that will be held over the forthcoming weeks and to receive future updates. 

For Signature members, please contact your Signature team for assistance. For non-Signature members, if you would like to have an initial confidential conversation and learn more about the support services we are putting in place for Principals and DS-ARs, including a fully independent ‘health check’ assessment specially designed for this issue, please email us at info@signature-support.co.uk or call us on 01484 443 431 and a member of our team will be in touch.

 

 


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