Travers Smith's Alternative Insights: Regulatory hosting under scrutiny in the UK

Travers Smith's Alternative Insights: Regulatory hosting under scrutiny in the UK

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Overview

A regular briefing for the alternative asset management industry. 

For many private fund managers – especially a new firm, a spin out from a larger business, or a firm that manages a relatively small pool of capital – the UK regulatory requirements can be daunting. Getting the necessary regulatory permissions is an expensive and time-consuming business, especially if there is no certainty that the fundraise will be successful, or if the fee structure leaves little headroom for advisory costs or compliance staff. The barriers to entry may even be so high that they stifle competition and innovation.

In this scenario, many firms turn to regulatory hosting services. These are well-established and enable a fund sponsor to enlist a regulated service provider to provide licensing cover for the firm's activities, together with compliance support and oversight. These arrangements are often temporary – to allow a sponsor time to establish its own regulated entity – but can be permanent, especially for smaller fund sponsors. 

There are various permutations of the model, many of which rely to some extent on the UK's "appointed representative" (AR) regime.  Under that regime, a regulated firm (the "principal") takes regulatory responsibility for certain types of lower risk regulated business carried on by its appointed representative, under the oversight and supervision of the principal. 

(In fact, the appointed representative regime has many other uses – notably by larger asset managers who use it to help companies in their group to launch new products quickly, subject to a robust group-wide compliance framework.  It also plays an important role in reducing pressure on the FCA, the relevant regulator, whose response times in various contexts are under significant pressure.)

However, the regime is under scrutiny.  The latest developments came earlier this month, when the FCA and the government launched a consultation and call for evidence respectively.

This attention is neither new nor surprising. In 2019, the FCA completed a review of principal firms in the investment sector and "identified significant shortcomings in principals' understanding of their regulatory responsibility for their ARs". Among other things, the FCA found that principals did not exercise sufficient oversight over their ARs and did not have sufficient control over the business for which they had accepted responsibility. More recently, an influential UK parliamentary committee published a report on the failure of Greensill Capital (itself an appointed representative) which recommended (among other things) that the FCA and the government should consider reforms to the regime, noting that it was being used for purposes way beyond those envisaged when it was established in 1986 "for self-employed salespeople".

...the FCA is convinced that changes are needed: there is, it says, "significant evidence of harm" and corner-cutting...

For its part, the FCA is convinced that changes are needed: there is, it says, "significant evidence of harm" and corner-cutting. The consultation seems likely, therefore, to lead to changes to the rulebook. These will clarify the expectations of principals, in particular to ensure that they properly monitor and supervise their appointed representatives on an ongoing basis. Probable changes (among many others) include increased obligations for principals to report to the FCA, and a requirement to assess, on an annual basis, whether the senior management of its appointed representatives remain fit and proper. 

Well-run firms will have little to fear from these proposed changes, even if they do impose some additional compliance burdens and, potentially, costs. In fact, if they help to improve standards across the board, they will be welcomed.

However, the review does not only look at the appointed representative framework itself; it also extends to the potential harms and benefits of the regulatory hosting model more generally. The FCA is particularly focussed on hosting models where individuals are seconded into the hosting platform, enabling them to undertake potentially higher risk activities like discretionary portfolio management or dealing. The FCA has mooted a range of possible options, from imposing additional obligations on regulatory hosting platforms (such as increased substance or capital requirements), limiting the scope of activities that can be undertaken under a regulatory hosting model, or even an outright ban.  While some of the options on the table would level up standards for hosting providers – something which is perhaps overdue – other changes under consideration are more fundamental, and could be damaging to a structure that is important for the alternative asset management sector.

At this stage, the FCA is just looking for evidence to inform its policy approach to regulatory hosting providers. The regulator itself acknowledges that the regime has many benefits, including fostering competition and innovation, recognising that a ban could have a negative impact on economic growth. However, it is important that the private funds industry makes the case that these arrangements are not damaging when operated properly and in accordance with FCA rules and, indeed, the resources and expertise of the principal firms can help to incubate and underpin the compliance function of the hosted firm. At the same time, the case for appointed representative arrangements within a group context also needs to be made. 

Whilst effective supervision of hosting platforms is, of course, essential, significant restriction of access to regulatory hosting would be a retrograde step.

 

Alternative Insights will take a break and return in January. We wish all our readers a happy and relaxing holiday season.

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TRAVERS SMITH'S ALTERNATIVE ASSET MANAGEMENT & SUSTAINABILITY INSIGHTS

A series of regular briefings for the alternative asset management industry.