Dealing with the Regulators: FCA Authorization or Hosting Solution? Compliance

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Dealing with the Regulators: FCA Authorization or Hosting Solution?

Dealing with the Regulators: FCA Authorization or Hosting Solution?

Before an investment manager can operate in the UK it will need to secure authorization from the Financial Conduct Authority (FCA), or seek regulation via a hosting solution, as described below. This must be done ‘up front’, i.e. before a fund begins carrying out any regulated activities. Firms must meet certain standards with regards to their legal structure, location, available resources and any links they might have with certain firms or individuals. The extent to which any of these factors might prevent effective supervision is a key consideration for the FCA.

In their contribution, the Duff & Phelps team offer valuable insight into the FCA authorization process, together with a detailed account of how firms can meet the challenges of ongoing compliance.

Smaller or start- up managers in the fund management business may use a hosting solution to leverage the authorizations held by another regulated entity, commonly referred to as a regulatory ‘umbrella’, rather than becoming directly authorized by the FCA.


A Brief Introduction: Who Needs Authorization?

Anyone carrying out a ‘regulated activity’ will need to either secure FCA authorisation or an exemption from the authorization requirement. The list of activities which are deemed ‘regulated activities’ is set out in the (Regulated Activities) Order 2001 (the RAO). Fund managers will be carrying out the regulated activity of managing an Alternative Investment Fund (AIF). Investment managers will be carrying out the regulated activities of managing investments and advising on investments. As such, it will be necessary to secure appropriate FCA authorization or a hosting solution in all cases.

Part 4A of the Financial Services and Markets Act (FMSA) establishes the FCA’s authorization powers. As a result, the authorization is often referred to as ‘Part 4A permission’. A firm’s Part 4A permission will specify the nature of the regulated activities that a firm is permitted to carry out, which investments those activities relate to, which types of customer (retail, professional, eligible counterparty) those activities may be carried out with and any special conditions or additional requirements which must be met. Once a firm receives Part 4A permission it will become an ‘authorized person’ and may carry out the specified regulated activities.


FCA Authorization and Ongoing Compliance

Where an investment manager chooses to be directly authorized by the FCA, it must demonstrate to the FCA that it meets appropriate standards at the point of authorization and can maintain those standards on an ongoing basis by implementing an appropriate compliance framework.

The first thing to consider is what type of regulatory permission is required from the FCA. Some managers will be appointed as the Alternative Investment Fund Manager (AIFM) and hence require permission to manage an alternative investment fund. (For more information on the intricacies of the AIFM regime please turn to Section 3: Understanding the Alternative Investment Fund Managers Directive.)

Other managers will only act as delegated portfolio managers, hence require permission to manage investments under the Markets in Financial Instruments Directive. Different regulatory obligations will apply to different types of firms, for example around transaction reporting, valuation and risk management.

The FCA application, to be submitted online, involves the collation of key information about a firm’s business proposal including:

  • relevant FCA application forms
  • business plan covering information about:


    • governance arrangements
    • systems and controls
    • IT and Outsourcing
    • marketing activities and target markets
    • fees to be charged to the funds/clients
    • conflicts of interest
  • details of Senior Managers and individuals performing Certification Functions
  • staff organizational chart
  • details of group and ownership structure (covering controllers and close links)
  • financial projections demonstrating capital adequacy – investment management agreements
  • where applicable, information about the fund (including Private Placement Memorandum and other relevant fund documents), depositary, custodian, prime broker, fund administrator
  • firm’s compliance monitoring program

Applicant firms must also pay the FCA an authorization fee which varies depending on the complexity of the application.

Once the application is submitted it will be reviewed by an FCA case officer who will engage with the applicant firm to address any questions and areas where clarifications may be required. The FCA can take up to six months to assess complete applications, but the process may take longer if the quality of the application does not meet expected standards.


FCA ‘Asset Management Authorization Hub’

In order to streamline the authorization process for eligible new asset managers, the FCA launched the ‘Asset Management Authorization Hub’ at the end of 2017. The main aims of this initiative are to:

  • clarify what the FCA expects from applicant firms
  • foster better engagement between the FCA and applicant firms
  • provide support to start- up firms

Importantly, proposed new managers are also able to book a pre- application meeting with the FCA. This ensures that a case officer is assigned at that point and allows start- up firms to discuss their plans, timescales and any potential regulatory issues with the FCA in advance of submitting an application. This gives firms an opportunity to gather early feedback from the regulator, better understand the FCA’s expectations, and avoid surprises during the application process. By using the Authorization Hub, firms have better chances of submitting good quality and complete applications. This can help significantly reduce the FCA decision- making timescales for new asset manager applications.


Maintaining an Appropriate Ongoing Compliance Framework

Once an asset manager is authorized, it must maintain an appropriate compliance framework to ensure ongoing compliance with applicable rules, regulations and market standards.

Both investors and regulatory expectations of compliance have increased over the past decade, with the demands of compliance sometimes felt the hardest by smaller asset management firms. From the requirements of the AIFM Directive to the more recent Senior Managers & Certification Regime (SM&CR), there has been a recent steady expansion of the compliance expectations of all firms, including hedge funds.

The FCA requires that an individual within the firm take responsibility for compliance oversight. In smaller start- ups this responsibility is likely to fall on individuals who may already be responsible for other key areas of the business (e.g. Chief Operating Officer, General Counsel, or Chief Risk Officer). It is important that the person who is appointed to oversee the compliance function has the required time, resources and expertise to take on that responsibility.

The compliance function must ensure that:

  • they remain independent from the trading and portfolio management functions they oversee
  • the firm implements a risk- based monitoring program to evaluate whether:


    • the firm’s business is conducted in compliance with its obligations
    • its internal policies and procedures, organization and control measures remain effective
    • internal policies and procedures are appropriate to ensure that compliance risk is comprehensively monitored

Firms must also document the ongoing compliance monitoring work completed to assist the firm’s senior managers evidence the reasonable measures they are taking under the SM&CR to ensure their business is compliant. Regular reporting on the outcome of the monitoring activity to the firm’s governing body can also provide comfort to a firm’s senior management on the adequacy of its compliance arrangements.

The FCA expects firms to have adequate policies and procedures in place and to ensure that the relevant compliance obligations are communicated appropriately to staff. Firms must also ensure that their policies and procedures remain up to date with evolving regulatory requirements and that members of staff receive appropriate assistance from the compliance function on the effective application of those policies and procedures. Effective compliance training programs should be implemented to ensure staff fully understand the regulatory obligations applicable to them.

Firms must also comply with ongoing FCA reporting obligations and ensure that they have appropriate processes, systems and procedures to provide accurate and timely information to the regulator. The regulatory information to be provided includes, for example, financial information about the firm, transaction reports, and extensive information around the funds’ strategies, exposures, leverage and investors.

Market abuse and financial crime also remain key areas of focus for the FCA. It is important that firms carry out thorough risk assessments to identify key risks that are relevant to their business models and strategies and that appropriate and effective procedures are implemented and monitoring undertaken. Measures would include pre- and 
post- trade controls, controls around receipt, identification and use of inside information, monitoring of expert network usage, robust anti- money laundering and anti-bribery procedures.


How Can a Compliance Consultant Help?

A compliance consultant can help a firm prepare a high-quality application, guide applicants through the various stages of the FCA authorization process, and assist the firm with establishing an appropriate compliance framework, manual, policies and procedures. Once the firm is authorized, engaging an external compliance consultant will help maintain and improve internal compliance standards, reduce overheads and mitigate compliance risks within the firm. This allows management to focus on its core business of delivering positive investment outcomes for its clients.

An external compliance consultant is well placed to:

  • provide the required level of independent challenge through an ongoing compliance monitoring or a mock- exam compliance review
  • bring a fresh perspective on possible improvements to the established compliance practices of firms
  • advise on compliance issues and the firm’s relationship with the FCA
  • support resourcing needs, for example by managing a firm’s regulatory projects or providing interim compliance resources via secondments
  • assist firms with their reporting requirements to ensure that all regulatory filings are made on a timely basis and perform assurance reviews
  • advise on regulatory changes in a timely fashion, so that the firm is well prepared to implement the requirements of the change from a systems and policy perspective.

The FCA firm authorization process and the ongoing compliance obligations on firms can be challenging. However, by engaging a reputable and well- resourced compliance consultancy, an asset manager can receive experienced compliance support throughout all phases of its regulated life which makes the regulatory burden manageable.

This article is from the Hedge Fund Launch Guide from Eversheds Sutherlands.

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