A Brief Introduction: Who Needs Authorization?
Anyone carrying out a “regulated activity” will need to either secure FCA authorization or an exemption from the authorization requirement. The list of activities deemed as regulated activities is set out in the Regulated Activities Order 2001 (the RAO). The discretionary management of funds or individual segregated portfolios would generally amount to regulated activities and, as such, would require appropriate FCA authorization.
Part 4A of the Financial Services and Markets Act (FSMA) 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 that 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 the FCA requires. Some managers will be appointed as the Alternative Investment Fund Manager (AIFM) and hence require permission to manage an alternative investment fund. Other managers will only act as delegated portfolio managers and require permission to manage investments under the Markets in Financial Instruments Directive (MiFID). Different regulatory obligations will apply to different types of firms, for example around transaction reporting, valuation and risk management.
The FCA application 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 and/or fund administrator
- The firm’s compliance monitoring program
Applicants 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 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 startup 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 startup firms to discuss their plans, timescales and any potential regulatory issues with the FCA in advance of applying. 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 startups 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 ongoing compliance monitoring work in order to help the firm’s senior managers evidence the reasonable measures taken 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 communicate relevant compliance obligations to staff. Firms must also ensure that their policies and procedures remain up to date with evolving regulatory requirements and that staff members receive appropriate assistance from the compliance function on the application of those policies and procedures. 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 to their business models and strategies and that effective procedures and monitoring are implemented. Measures would include pre- and post-trade controls, controls around receipt, identification and use of inside information, monitoring of expert network usage, and 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 with establishing an appropriate compliance framework, manual, policies and procedures. Once a firm is authorized, engaging an external compliance consultant will help maintain and improve internal compliance standards, reduce overheads and mitigate compliance risks. This allows management to focus on its core business of delivering positive investment outcomes for 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 firm’s established compliance practices
- Advise on compliance issues and 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 with 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 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.