Hot on the heels of our article on how long it takes to become FCA authorised, the FCA has publicised some of the common errors that it has encountered where an asset manager applies for authorisation.
1. Senior management lacking experience and qualifications
This is typically due to proposed senior managers either:
- Lacking the competence and expertise to undertake the functions for this they have applied; and/or
- Not holding an appropriate level of seniority in the firm.
This includes where proposed senior managers have not held roles requiring prior experience, or who lack relevant/suitable qualifications. When questioned by the FCA, applicants have been unable to explain, in sufficient detail, the regulatory framework that applies to their business or how their proposed business model will work.
RQC Group View:
The level of scrutiny applied when assessing senior managers has increased over time, and a senior manager's application might be unsuccessful if he or she cannot demonstrate competency, expertise and seniority.
Whilst a senior manager does not necessarily need to have held a senior management function (or equivalent) previously, it is imperative that they possess the necessary skill to act in this capacity. This means that an individual who has not held such a function but – for example – has worked at an overseas financial institution, an unregulated UK firm or a larger regulated firm in a managerial (but not a senior management) capacity can be a successful applicant.
At RQC Group, when project managing applications, we analyse an individual's work experience, qualifications and expertise and then help our clients form a view on whether they are a viable candidate for a senior management position.
There are two senior management functions that in our experience are a particular area of focus: SMF16 – Compliance oversight; and SMF17 – Money laundering reporting. It is possible that the FCA will quiz the candidate on compliance and financial crime topics such as client categorisation, the Senior Managers and Certification Regime, customer due diligence and reporting suspicious transactions, and the candidate will be expected to provide relevant and coherent answers.
2. Office locations outside the UK
One of the threshold conditions for becoming FCA authorised is 'Location of Offices'. This relates to the 'mind and management' of a firm, which must reside in the UK. It is not sufficient for a firm to only perform tasks such as compliance and administration in the UK, or to have the business decision makers based outside the UK and visiting the UK from time-to-time.
RQC Group View:
It is commonplace for an applicant firm to be a subsidiary of a non-UK firm and/or for certain individuals associated with the firm to be based outside of the UK.
However, despite this structure the FCA's "Location of Offices" requirement necessitates a UK focus for day-to-day management.
This does not necessarily mean that all senior managers must be permanently based in the UK. For example, the board could include a non-UK-based director or partner whose role is to align the UK firm's strategy and governance with that of the wider group, as long as the UK focus noted above is maintained.
3. Business models: exposing clients to risk
The FCA accepts that all business models pose risk. However, applicants often neither identify the risks that their business model poses nor adequately consider and evidence how they might remove or mitigate those risks.
RQC Group View:
There are various ways in which an applicant firm can demonstrate to the FCA that it will have appropriate systems and controls to identify and manage risks.
Certain asset managers are required to submit an Internal Capital Adequacy and Risk Assessment (ICARA) document to the FCA. Among other things, this document must set out how the firm's risk appetite aligns with its business model and strategy, identify the main 'harms' that may arise to the firm's operations, and outline mitigation plans to address them. Applicant firms also have the opportunity to articulate risks in other application materials, such as the 'regulatory business plan'.
4. Outsourcing: underestimating your accountability
The FCA has found that some applicants have not considered the
relevant rules, the firm's responsibilities, and the impact on
their business when outsourcing.
In particular, firms fail to appreciate that responsibility and
oversight for outsourced activities will sit with the firm
itself.
RQC Group View:
In the first instance, an applicant firm should consider the functions being outsourced, including whether they are 'critical or important' and therefore subject to additional requirements, and to whom the functions are outsourced, including whether to a group entity or a third-party.
Following from the previous point, firms should understand the risks of outsourcing, starting with the premise that the outsourcing of important operational functions should not impair materially the quality of the firm's internal control.
Among other things, this impacts the choice of outsourcing entity, the ability to monitor the entity's activities and the ability to terminate the relationship or otherwise make appropriate adjustments to the outsourcing relationship.
5. Conflicts of interest: failing to identify concerns
Managing and controlling third-party assets and money gives rise to potential conflicts between the interests of the client, the firm and related parties.
Some applicants fail to consider potential conflicts of interest adequately, or at all.
The FCA would raise concerns where it has identified conflicts that were not also identified by the applicant firm.
RQC Group View:
The identification and management of conflicts of interests is an essential component of a firm's systems and controls infrastructure. Potential conflicts cover a wide range of areas such as investment conflicts, personal conflicts and operational conflicts.
Similar to risk management, there is opportunity to articulate conflict management in the application materials. One option is to draft and provide the FCA with a conflicts of interest policy that identifies each relevant potential conflict and how this will be dealt with.
6. Redress: avoiding appropriate schemes that protect consumers
Some firms seek exemption from the Financial Ombudsman Service ("FOS") and the Financial Services Compensation Scheme ("FSCS") where this is not appropriate. This includes where firms assume that if they don't have retail clients then they are automatically out of scope, which is not the case.
RQC Group View:
This scenario might arise where a client or a fund investor is classified as a professional client and is also a high-net worth individual.
Prior to submitting an application to the FCA, a firm must be able to articulate its target market and its marketing plan.
This assessment should include an analysis of whether any clients or fund investors might fall into the remit of FOS and/or FSCS.
Typically, where FOS and/or FSCS applies, this affects the periodic fees that a firm pays to the FCA.
The applicability of FOS would also affect the content of a firm's complaints handling policy.
7. Unready, unwilling or unorganised
The FCA expects applicants to be ready, willing and organised to carry out the activities that they plan to undertake.
Examples of where this is not the case are where applications
are submitted without recruiting relevant senior managers or not
having arranged for sufficient capital to be in place.
The FCA understands that circumstances might change during the
lifecycle of an application. However, they are not willing to
either put applications on hold for extended periods or accept
significant changes to the proposed model.
If there are significant changes, the FCA advises that firms should withdraw the application and then re-apply at a later date.
RQC Group View:
The FCA's 'ready, willing and organised' principle is a cornerstone of its authorisation process, ensuring firms are equipped to handle the activities they propose. Being unready, unwilling or unorganised is likely to be the most common reason why an application is either voluntarily withdrawn by a firm or is rejected by the FCA. In the period April 2023 to April 2024, these comprised around 18% of applications.
Given the time that it takes for the FCA to process an application, demonstrating on day 1 that a firm is ready, willing and organised with respect to activities to commence a number of months in the future is often a tightrope act.
For example – the FCA requests that relevant senior managers are recruited. However, it might not be reasonable or practical for a start-up to make all recruitment decisions in advance.
For asset managers, other contentious items include the timing of fund structuring, formation and appointment of service providers, and the firm's ownership structure.
By publishing these common errors, the FCA will no doubt expect to see improvements in the quality of applications made by asset managers. The volume of applications that are withdrawn by firms or rejected by the FCA is high, and there might be some improvement in these figures.
Furthermore, the FCA application process is usually the first 'touch point' between the firm and the FCA, and it represents the groundwork for the future relationship. In other words, the mindset of firms should be to demonstrate to the FCA that it has a coherent business model and systems and controls framework for the longer term, as opposed to merely aspiring to do what needs to be done to get over the authorisation finishing line.
Publishing the common errors is helpful but properly addressing these is not always intuitive. Successfully navigating the FCA's authorisation requires thorough planning and a realistic understanding of the application approval process. Our FCA applications team has collective experience in managing and processing over 500 FCA applications, and we welcome the opportunity to assist our clients with their applications and make the process as painless as possible.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.