Smaller and newer fund managers often find it easier to sign on with a regulatory incubator or umbrella as an Appointed Representative (AR), rather than become FCA-authorised in their own right.
The authorisation requirement
Most of the financial and investment services undertaken by fund managers constitute “regulated activities” in the UK. This includes activities that are central to the fund manager’s role, such as:
- Dealing in investments
- Arranging deals in investments
- Discretionary management of assets
- Operating a collective investment scheme
- Advising on investments
Individuals and firms undertaking any of these “regulated activities” in the UK must be properly authorised by the Financial Conduct Authority (FCA) for the purpose. If not, they are committing a criminal offence, and will also find that they cannot enforce their agreements with investors and other counterparties.
There are some drawbacks to obtaining direct authorisation from the FCA to undertake such regulated activities:
- The application process takes time (typically six months, occasionally longer)
- It imposes a significant ongoing cost and compliance burden – which can be difficult for relatively new or small fund managers to meet if they have limited cash and staff resources.
An increasingly popular alternative to direct authorisation, especially for emerging managers, is to become an Appointed Representative (AR) of another firm (the principal) which is itself authorised by the FCA. There are a number of authorised firms who “host” or “incubate” multiple ARs on a commercial basis for a fee, and a sizeable proportion of start-up managers opt to sign up with them.
Advantages of AR status
- The arrangement allows the AR to carry out regulated activities by ‘borrowing’ some of the principal’s permissions as an authorised firm
- The AR application process is relatively straightforward and can be completed quickly: typically a matter of weeks, rather than months
- For the AR it is quicker and cheaper than direct authorisation
- The regulatory compliance burden is, in effect, shared between the AR and the principal
- The principal can spread its compliance costs across a base of several AR clients
- ARs do not have to comply with certain FCA requirements such as minimum regulatory capital requirements.
Disadvantages of AR status
- Although ARs are not directly regulated by the FCA, they still have to comply with most FCA rules.
- The principal is required by the FCA to supervise the AR’s compliance and is responsible to the FCA for it.
- The AR will be obliged to give the principal access to its staff, premises and confidential records, so that the principal can supervise the AR effectively.
- An AR can market its products and provide investment advice, but it is not permitted to manage investments.
The prohibition on an Appointed Representative managing investments is typically an issue for fund managers, most of whom would want to do precisely that. But only a fully authorised firm with appropriate regulatory permission is allowed to manage investments in the UK. Therefore, unless a fund manager applies to become FCA-authorised in its own right, it will need to find other mechanisms of operating its funds. We consider the pros and cons of three common solutions below.
The advisory solution
A popular mechanism is for the AR to have its principal appointed as the manager of the fund; the AR in turn is appointed as the principal’s investment adviser. The manager has the technical authority to make decisions for the fund, but it does so on the AR’s advice.
One drawback of the advisory solution is that the AR does not have direct control over the fund’s assets and cannot contractually compel the principal (or any manager) to implement its advice. Of course, the principal is unlikely to act against the AR’s advice, partly because it is the AR (rather than the principal) that has people with the requisite technical expertise to invest the fund, but also because the AR will typically be able to replace the principal as manager.
But if the manager has neither the capacity nor willingness to challenge or review the AR’s advice, the arrangement could be open to attack, with serious legal and financial repercussions for the AR if it is deemed to be managing investments unauthorised.
The optics for investors are also quite different: the fund offering documents would show only the principal as fund manager, with the AR executives having the ability to provide advice, but they would not be named as the fund’s management team.
The secondment solution
An alternative is to second AR staff to the principal, where they conduct regulated activities for and on behalf of the principal.
The FCA acknowledges the validity of secondment arrangements between AR and principal, if structured properly. But there are some drawbacks:
- “Seconding” technically means “transferring” staff, whereas the AR may not really want to transfer the relevant people, as it wants them to operate in the AR’s name for other purposes, e.g. investor marketing
- IR35 (i.e. the intermediaries tax legislation) may come into play. It can result in PAYE/NI tax charges payable by the principal as intermediary. The principal would thus require the AR to indemnify it for tax liabilities.
The investment committee solution
A more sophisticated model is to create an investment management committee within the principal to take decisions for the fund. The committee’s members would be drawn from both the Appointed Representative’s investment executives and the principal’s own staff.
This allows the AR to influence and control the principal’s investment management activities more closely. The AR remains an adviser to the principal, in which capacity it can undertake supporting research and investment diligence, and formulate investment advice. Importantly, the fund offering documents of the fund can then show the AR executives as part of the investment manager (by virtue of their membership of the investment committee).
Most fund managers, once they reach a certain size and maturity, become FCA-regulated in their own right. Direct authorisation can be better optically (particularly to institutional investor clients) and being able to take investment management decisions yourself, rather than handing the power over to a third party, is both less risky and less cumbersome to operate.