On 20 May 2019 the FCA released its findings of the thematic review it carried out from 2017 onwards with regards to regulatory hosting platforms which host Appointed Representatives. This included a summary called a Dear CEO letter addressed to the sector.
The FCA undertook the review because it was concerned about firms acting as ‘regulatory hosts’ or Principals, without being fully aware of their obligations notably stated in the FCA Handbook under SUP12. As such, there were concerns of risks for the market where Principals might not be undertaking the necessary due diligence, monitoring and risk assessment appropriate for their appointed representatives.
According to the report, the FCA reviewed 338 Principals, carrying out only 15 visits. Laven was privileged to be included in the visits. We assume this was due to our prominence as well as the fact that we hosted some less common wholesale activities. The visit was long and included 3 parts and various questions which altogether lasted over a year. It sometimes felt that the overview was unduly delayed due to lack of resources or technical know-how, but there was a good effort to understand a complex part of the industry, and in the end the findings disclosed publicly were valid and we agreed with them. We understand that peers of equal prominence went through a similar process.
In many respects the visit was a learning exercise for the FCA. The truth is that if the FCA even hints at something being wrong, any business will be immediately concerned with failure. This has happened a few times over the last decade even when there is no enforcement. Therefore, engagement with the FCA causes a fair amount of stress and business disruption. It is also not done on an equal footing which means that even with the best intention the FCA is not used to being treated as an institution that needs to learn. This was also evident when it missed the crisis of 2008, so it is nothing new. We do wish that the FCA would learn however from past lack of communication with its own market, be more British in its pragmatism and less continental in its approach to dealing with facts with no or little room for nuance. We want to be frank about this as otherwise we as a regulated entity promoting the best of compliance, would have nothing to say and one of our core value, to ‘Improve the industry by sharing knowledge’ would evaporate.
We contributed all we could to this FCA effort, as we believe it will enhance the industry. In the course of the review the FCA did ask some firms to stop their hosting business, temporarily or permanently, so it had an impact for the better. Of course, any such review may lead to debate and different consideration of various points, and we know that some firms did use the opportunity to challenge the FCA’s understanding of the industry. Our own aim was not only to demonstrate our compliance efforts, but to avoid the FCA being put off by parts of the industry it is less familiar with. For example, the FCA does not want regulated firms to approve section 21 disclosures as allowed by the law. The FCA also does not appreciate the limits of Principals’ duties of oversight, when a regulated firm hosts another, the duties of the Principal are to review that hosted company. The FCA is of the view, erroneously according to some practitioners and experts, that the clients of the hosted business should also be brought under the oversight of the Principal, even where those firms are independently authorised and supervised by the FCA.
Following the conclusion of our own review there was no official remedial steps taken, which we believe to be a testament to the strength of Laven’s corporate governance, compliance oversight and risk controls. Since the visit, Laven has nevertheless looked to improve and strengthen its compliance oversight and governance of Appointed Representatives and we took on board recommendations made by the FCA.
As our clients know we work closely with our Appointed Representatives in an effort to deliver an effective service, allowing them to focus on their core business whilst adhering to the highest regulatory standards. We appreciate that sometimes we are a bit demanding and some of our requests can be initially a bit hard to get used to, but they all pertain to meeting the FCA’s requirements as that also evolves.
In the Dear CEO letter, the FCA highlighted key issues that were linked to Principal firms having ‘weak or under-developed governance arrangements in place, including a lack of effective risk frameworks, internal controls and sufficient resources.’ Those issues related to the following areas:
1) Lack of effective risk frameworks and due diligence from principal firms when on-boarding Appointed Representatives. It was noted that Principals fail to assess risk, lack an understanding of the business model, and lack product governance arrangements.
2) Lack of appropriate control frameworks for the ongoing monitoring of Appointed Representatives. It was noted that Principals due to a generic, ‘one size fits all approach’ failed to diligently review Appointed Representatives or indeed had a conflict as a fear of losing an Appointed Representative, was seen to lead some Principals to be lax when it came to doing compliance reviews.
3) Incorrect capital adequacy assessment of the Principal. The FCA concluded that due to lack of proper accounting for the risk posed by their Appointed Representatives Principals did not hold the appropriate Pillar 1 capital and this also included making errors in reporting regulatory revenue of Appointed Representatives.
4) AIFM platforms do not monitor the activities of seconded employees in enough detail. With regards to asset management the FCA felt that more monitoring may be needed so as to better prevent the possibility of market abuse.
5) The FCA wants Principals to demonstrate a good understanding of the Appointed Representative’s business. The further conclusion overall was that many Principals failed to adequately show their understanding of how each Appointed Representative impacts the Principal’s risk and thus to ensure the systems and controls are in place to limit any such risk.
6) The FCA wants Principals to carry out fuller assessments prior to onboarding Appointed Representatives. It was felt that more questions could be asked by some Principals and that too little diligence lead to risk exposure that was not factored in by management.
Laven met all the main standards that the FCA raised however due to the enhancement of our RegTech for client onboarding and monitoring we added new controls and further utilised technology to help review the actions of our Appointed Representatives and asset managers. For example, we are now adding a new MLRO report software module and a SM&CR fully functioning module to meet new regulations by December.
Laven also added a new software module on top of client onboarding from its operational due diligence and investment due diligence department that allows the hosting platform to provide the best analysis of potential risks before onboarding a client and during the life of the client’s time with Laven which tends to be for many years. So far new clients have been so happy that they have asked us for actual copies of our reports to use to improve their internal processes or controls!
Our process remains anchored in ensuring thorough initial conversations about the past and present business activities, strategies, corporate structure and the individuals behind the Appointed Representative, prior to pricing or progressing to contractual stage. This gives us a very good understanding of the potential risks associated from the outset. In a second phase when we proceed to onboarding (which is carried out using our proprietary software called the KYC Assistant – a client onboarding portal designed as an automated system to reduce human error, creating automated reports which link directly to both regulatory and best practice standards) we look for potential issues concerned with breaches of best practice or law. This enables our onboarding team to escalate any potential problems, or unforeseen risk, prior to onboarding and registering the Appointed Representative with the FCA. Our reports are always reviewed by a consultant and vetted by a member of senior management so as to work alongside the system to ensure the nature and structure of the Appointed Representative suits Laven’s permissions and acceptance of risk profile. It also sets the tone as to the frequency, extent and questions we would typically ask during our continued monitoring.
We hope the above gives a good insight into how Laven operates its regulatory hosting platform and how we dealt with the FCA review. We maintain an institutional level of regulatory oversight through our consultant’s expertise. Our regulatory technology supports and thus enables our Appointed Representatives and asset managers to carry out their activities effectively and in compliance with all the relevant rules and regulations in real time. As the markets evolve and as compliance becomes more intrusive we hope to maintain the right balance between doing business and protecting customers.
If you have any questions regarding Laven please do not hesitate to get in touch.
We are always happy to discuss and share ideas at Laven!
