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Regulatory Hosting v Direct FCA Authorisation

Start-up fund managers have a choice of how to start undertaking regulated activities, which typically is between obtaining direct authorisation with the FCA and utilising a regulatory hosting platform.

Which option is the right one? We investigate the pros and cons of each approach and hopefully make the subject a little clearer.

What Constitutes a Regulated Activity?

Most activities undertaken by an investment manager in the UK are classified as regulated activities, and many are central to the fund manager’s role, including dealing in investments, arranging deals in investments, managing investments, discretionary management of assets, establishing, operating or winding up a collective investment scheme, managing a UK UCITS and advising on investments.

Individuals or firms undertaking any of these regulated activities in the UK must be properly authorised by the Financial Conduct Authority (FCA) for the purpose, or they risk committing a criminal offence.

Direct Authorisation with the FCA

Gaining direct authorisation from the FCA to undertake regulated activities is one route that start-up firms can take.

Pros of Direct Authorisation

A firm that is authorised directly with the FCA can manage investments directly and benefits from having more control over their business. They make the decisions on the systems and processes the business uses and the direction they want to take it in. Institutional investors may also see direct authorisation as preferable to operating under a regulatory hosting umbrella, especially if the umbrella is not well known or not overly robust.

Cons of Direct Authorisation

There are two sides to every story of course and going down the direct authorisation route is no small undertaking.

Firstly, the process can be time consuming and cumbersome. It can take between 6 to 12 months to gain authorisation, depending on how quickly the firm submits all the necessary forms and documentation and on how many queries the FCA have regarding the application. This time delay should not be underestimated in its impact on the pathway to potential success.  This could be 6 months without management fees coming in – time really is money! 

The level of required documentation is quite extensive and includes a detailed business plan, opening balance sheet, financial projections, compliance procedures and details of the compliance monitoring programme, a disaster recovery plan, staff organisation chart, CVs and passports for all Approved Persons, client agreements, training and competence procedures, details of service providers and many others.

The onus is on the firm to prove to the FCA that it has the appropriate resources, both financial and non-financial, to undertake the regulated authority. It must also demonstrate suitability in the way it operates and in the way it is managed by those in charge. Under the Senior Managers Certification and Regime, direct authorised firms need to assess and appoint individuals to the roles of SMF16, Compliance Oversight, the person responsible for the compliance function in the firm and reporting to the governing body on this function and SMF17, the MLRO, or the person who has responsibility for overseeing the firm’s anti-money laundering systems and controls.  These functions will typically be held by the inhouse COO. 

This can impose a significant financial and compliance burden on smaller firms and is worth careful consideration.

Regulatory Hosting

A viable alternative to direct authorisation is to operate under a regulatory hosting umbrella. Firms become an appointed representative of the principal (the regulatory hosting platform provider). The principal is authorised by the FCA and provides the license, knowledge, compliance expertise, systems and procedures. The appointed representative can then run activities, acting as an ‘agent’ for the authorised principal.

Pros of Regulatory Hosting

By engaging the services of a regulatory hosting platform and becoming an appointed representative, firms can be up and running, carrying out regulated activities within weeks rather than months.  Therefore, able to start earning management fees straight away and reduce the impact on that precious starting capital.  The objective of most managers is to increase assets under management and one of the key requirements for investors is evidence of a track record – the sooner you can begin posting a track record within an audited fund structure the more likely you are to be in a position to attract capital.  This speed to market really can be the difference in achieving long term success.

The cost of becoming an appointed representative can  be much lower than direct authorisation, making it an appealing prospect for smaller firms.

The principal (the regulatory hosting platform provider) is responsible for the appointment of the senior managers that fulfil the SMF 16 and SMF 17 roles. These are difficult roles to recruit and because of this, the ongoing compliance burden is much lower when using a regulatory hosting platform, than with direct authorisation.

Appointed representatives do not have to maintain minimum regulatory capital requirements.

Cons of Regulatory Hosting

Appointed representatives still have to comply with many FCA rules, despite not being directly regulated.

The principal (regulatory hosting platform) needs access to the appointed representative’s staff, policies, procedures and records so that it can supervise and ensure compliance.

An appointed representative can not directly manage its own investments, that has to be done via the principal.

An AR can market its products and provide investment advice, but it is not permitted to manage investments.

However, there are a number of ways that firms can manage their own investments as an appointed representative.

Methods of Managing Investments as an Appointed Representative

As an investment advisor to the fund manager (principal)

If the principal is appointed as the fund manager and the appointed representative is the investment advisor to the principal, they can issue the instructions and make the decisions, while the principal carries them out.

Via secondment

Some appointed representatives may decide to second staff to the principal, where they conduct regulated activities for and on behalf of the principal. This does mean that staff may not be able to easily fulfil other roles for the appointed representative and can have IR35 implications for the individual and principal.

Via an investment committee

Some firms may decide to create an investment management committee within the principal to make decisions for the fund. The committee’s members would be drawn from both the appointed representative and the principal’s teams. This allows closer control of the investment process and provides full transparency to investors around the decision making team and process.

Regulatory Hosting Under the Microscope

Since 2019, the FCA has been scrutinising the operations of principal firms that offer regulatory hosting services to appointed representatives, so they in turn taking greater care when selecting appointed representatives. The process may therefore be more vigorous and will ensure that the principal firm has undertaken due diligence to assess the risks associated with a prospective appointed representative.

The growth in the number of Regulatory Hosting firms in the sector prompted the FCA’s review and it found significant risks to the business model, in having proper oversight and monitoring of the appointed representatives and in carrying enough capital and liquidity to mitigate financial risks.

Most of the firms surveyed by the FCA had weak governance arrangements in place, so it is advisable that as an appointed representative, you do your own due diligence into the regulatory hosting platform that you choose.

Choose a platform that offers:

  • Robust governance arrangements
  • A clear, organisational structure with well defined, transparent and consistent lines of responsibility
  • Effective processes to identify, manage and monitor the risks it may be exposed to
  • Internal control mechanisms, including sound administrative and accounting procedures and effective control and safeguard arrangements for information processing systems

In our view the key benefits of utilising a regulatory hosting platform means a start-up manager:

  • does not need to worry about regulatory capital
  • is not responsible for the SMF16 & SMF17 functions – therefore aligns well with utilising an outsourced COO
  • can deploy a lighter infrastructure footprint – thus reducing running costs and distractions so the manager can concentrate on implementing their investment strategy
  • can get started very quickly deploying capital and therefore can begin building a track record sooner and start accruing management fees from day one

Launching an asset management business is a daunting task and potentially a very expensive one.  Any way in which your starting capital can be used more efficiently buys you more time to build a positive track record which will ultimately enhance your chances of success.

We work with the most respected Regulatory Hosting platforms in the market, so can advise you on what to look out for or what might be the most appropriate path for you.

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