Compliance Easy Rider? - Why being an Appointed Representative should not mean easy compliance

September 2016

Here's the latest blog from Sandra Quinn - my fellow Director at The Compliance Foundation.  Well worth the read if you are a FinTech Startup.

At TCF we are asked regularly by would-be financial services firms and tech start-ups, who are keen to get set up and operating at speed, about becoming an Appointed Representative as an alternative to Full Authorisation by the Financial Conduct Authority.  We always say that it can be an attractive option, that can help you get up and running quickly, but that it does come with its own responsibilities and risks, that are not always obvious to the would be Appointed Representative and that the arrangement is not failsafe and can still lead firms into hot water with the FCA. 

The FCA themselves also appear to be refocusing regulatory attention on the operation of Appointed Representatives having just published a report on Principals and their Appointed Representatives in the General Insurance sector,

https://www.fca.org.uk/news/tr16-06-principals-appointed-representatives-general-insurance-sector. This report has lessons for anyone setting up a financial services business and thinking of doing so using an Appointed Representative status.   Below is our TCF “in a nutshell” view on the option.

Providing financial services in the UK requires authorisation by the relevant regulator – often the FCA.  An alternative to Full Authorisation, for certain types of service, can be, usually for a fee, to seek to become an “Appointed Representative” of an already ‘Fully’ authorised financial services firm known as the “Principal”.  To do this the Principal will need to have the regulatory permissions required to sell and operate the Appointed Representative’s proposed service or product.  Under the arrangement the Principal will take responsibility for ensuring that the compliance arrangements and performance of the Appointed Representative are at the standard specified by the FCA and to do this they are required to make regular compliance checks to satisfy themselves about the Appointed Representative’s conduct and performance.

Some firms sensibly enter into an Appointed Representative/Principal relationship because of the nature of the business they plan to carry out, e.g. to be able to sell and distribute a product provided by the Principal.  Where this symbiosis exists it can be a sensible plan and the level of compliance support and engagement can often be at a suitable level as it is clearly in the interests of the Principal to maintain a high level or risk their own business and/or reputation.

However, some Principals, have built their business models around the successful taking on and managing of multiple Appointed Representatives from whom they generate fees.  Other Principals have business models that provide an initial bed and breakfast arrangement, to enable firms to get off the ground, on the proviso that they pay fees and/or purchase business consultancy services to help them get fully authorised.   Our experience suggests that when firms look to become Appointed Representatives in these situations they need to proceed carefully as all that glisters is often not gold and can be toxic.   The lure of the promise of easy compliance and a platform to operate are a heady mixture.

Some firms tell us about Principals who have assured them that “compliance will be easy” and have left them to “get on with it”, developing a reactive rather than properly proactive relationship with them.  This has left them very vulnerable to FCA investigation as per below.

While the FCA’s report applies to general insurers, it draws conclusions which anyone considering seeking Appointed Representative status should consider as it highlights failings in a number of areas in the firms they reviewed which are potential risks in any Principal/Appointed Representative relationship and which show the potential consequences, including:

• Lack of control and oversight from the Principal with some of the Principals reviewed not appearing to have understood the full extent of their obligations for ensuring their Appointed Representatives complied with regulatory requirements.
• Over half of the 15 Principal firms in the FCA’s sample could not consistently demonstrate that they had effective risk management and control frameworks to identify and manage the risks arising from the activities of their Appointed Representatives.
• Failure to understand the nature, scale and complexity of the risks arising from their Appointed Representatives’ activities and in particular the risk to customers with almost half of the Principal firms unable to demonstrate that they had understood.
• Examples of potential miss selling and customer detriment as a result of Appointed Representatives’ actions at a third of the Principal firms included in the review, with most of these issues not previously identified by the Principals.  These cases included customers buying products they may not need, products they may not be eligible to claim under or customers not being provided with enough information to make an informed decision.  In one case the FCA was satisfied that at the Appointed Representatives of one Principal firm there was significant evidence of miss selling leading to actual customer detriment.

As a result of these findings the FCA is taking action including:

• Calling in Skilled Persons (essentially commissioning professional services firms) to review two firms – very expensive.
• Requiring two firms to stop selling services and or products – terminal.
• In effect prohibiting five firms from taking on new Appointed Representative.
• Considering the need for customer redress and compensation and whether further regulatory action in relation to the issues identified is required – also very expensive.

Our advice is always, that for anyone considering becoming an Appointed Representative, that firstly they ensure, that they themselves, have enough regulatory understanding and compliance capability to keep their business secure and compliant.  In addition, getting effective and compliant processes and policies in to a business at an early stage can save huge amounts of money, time and energy at a later date as they won’t need to be reengineered.

Secondly ensure that they contract with a Principal that’s capable of providing the right compliance support, because, while the Principal might take an umbrella regulatory responsibility for a business, it’s still the businesses own customers, reputation and future that need to be protected.   The compliance regime offered by a Principal should be disciplined and demanding – its in an Appointed Representative’s best interests.

Thirdly ensure that the Principal’s business ambitions and reputation align with that of the Appointed representative.   What affects you can affect a Principal and what affects a Principal can affect you.  This is particularly important for anyone considering being an Appointed Representative before seeking full authorisation.  Reputations matter with the FCA.

In practice we often find ourselves helping clients to redesign and ‘upgrade’ their business and compliance arrangements to be able to apply for full authorisation.  Some of this is inevitable because an Appointed Representative can no longer rely on a Principal to provide compliance services and the general responsibilities are more extensive. But, while upgrading arrangements is entirely doable, we recognise that the more a firm can use their existing arrangements as a foundation, the more effective and the cheaper it can be.

In summary we believe that the old addage about there being “no such thing as a free lunch” applies to Principals and Appointed Representatives.  Good compliance standards and a demanding Principal who understands their responsibilities and applies them to a conscientious Appointed Representative is good for both the businesses and the regulators.

Reputations, customers and your business are all your own.