Clifford Chance

The Financial Conduct Authority (FCA) has signalled a hardening in its supervisory approach to Appointed Representatives (ARs) in its Business Plan for 2024/25 (Commitment 13). This intensified scrutiny arises from FCA concerns over inadequate supervision by principal firms, which they say has led to consumer harm and a significant strain on the Financial Services Compensation Scheme (FSCS), with AR-related claims accounting for 61% of the compensation paid out in 2018/2019. In a move to mitigate these risks, the FCA established a dedicated AR department and introduced stringent new rules for principal firms in December 2022. This article examines the practical implications of the FCA's rules on principal firms and their ARs and provides insights on best practices for compliance given the regulator's increased focus in this area.

The AR Regime

The AR regime allows certain entities to provide financial services or products without direct authorisation from the FCA. Under Section 39 of the Financial Services and Markets Act 2000 (FSMA), a UK-regulated insurer, reinsurer, or insurance intermediary can enter an "appointed representative agreement" with another party to allow that party to carry out insurance-related activities. This agreement, which has certain prescribed terms, places the responsibility for the AR's actions on the principal firm. The principal firm is responsible for ensuring the appointed representative is fit and proper, complies with FCA rules, and operates within the scope of their appointment.

The FCA concern relates primarily to the general insurance sector, which hosts a substantial number of ARs. ARs have proven to be a popular route for connecting consumers with insurance providers, particularly for introducer ARs, which primarily introduce clients to the principal firm, and full ARs, which may provide a broader range of services under the principal's supervision. These AR models can be advantageous for insurance businesses starting out, as they allow for accelerated market entry without the time, resources, and costs associated with full authorisation. Additionally, leveraging the AR model can provide access to specialised advice and the extensive contact networks of insurance intermediaries and brokers, enhancing the business's market reach and expertise. However, the FCA has identified risks with this model, including the potential for mis-selling and the erosion of market integrity due to ARs operating beyond their authorised remit.

FCA Strategy – Consumer Protection

The FCA's heightened focus on ARs aligns with its broader three-year strategy (2022-2025) to improve outcomes for consumers and financial markets. This strategy involves increased use of data and analytical tools for targeted supervision of principal firms across the financial services sector. It also includes greater scrutiny of firms applying for authorisation and appointing ARs. The FCA is concerned that principal firms often lack the resources and expertise to properly oversee their ARs, putting consumers at risk of being misled or mis-sold, and undermining the integrity of the financial sector.

To address these risks, the FCA published new rules and guidance that took effect on 8 December 2022. The key requirements for principal firms include:

• Enhancing oversight of their ARs, ensuring they have adequate systems, controls, and resources,
• Assessing and monitoring the risks their ARs pose to consumers and markets, providing similar oversight as for their own business,
• Reviewing information on their ARs' activities, business, and senior management annually,
• Clearly defining the circumstances for terminating an AR relationship,
• Notifying the FCA 30 days before appointing a new AR, and
• Providing the FCA with annual complaints and revenue data for each of their ARs.

In September 2023, the FCA detailed plans to further strengthen the AR regime through more comprehensive data analytics. This initiative is closely tied to the Consumer Duty, which became effective on 31 July 2023 for both new and existing products and services and for closed book products and services, the Duty will take effect on 31 July 2024. Principal firms must now supervise their ARs' compliance with the Duty, and the FCA will consider the conduct of ARs when evaluating a principal firm's adherence to the Duty. If an AR fails to comply, the principal will also be deemed in breach.

The FCA also warned that an AR disproportionately large compared to the principal firm could cause harm in several ways. For instance, if the AR becomes overly relied upon to sustain the principal's business, it could undermine the principal's independent oversight and effectiveness. Similarly, if the AR is much larger or more complex than the principal, the principal may lack the skills and resources to effectively oversee the AR. Additionally, the principal firm may lack the financial resources to address the failure of a significantly larger AR or provide adequate redress to affected consumers. Furthermore, the FCA's rules require principals to annually report revenue information for each of their ARs. This leaves principal firms with no excuse for not tracking AR revenue as part of their ongoing assessment of their oversight arrangements.

Despite the new rules and guidance, the FCA remains concerned that authorised firms are not adequately supervising their ARs. To address this, the FCA has pledged in its 2024/25 Business Plan to:

• Conduct deeper analysis of existing data and utilise improved data sources, including updated Gateway forms, new regulatory returns, and a comprehensive AR dataset.
• Strengthen its scrutiny and engagement with principal firms as they appoint new ARs.
• Provide assertive supervision of high-risk principals through regulatory tools and appropriate enforcement action.

Next steps

Insurers that rely on appointed ARs should review their current AR oversight procedures both contractually and in practice to ensure they remain appropriate for the volume and size of their AR business. This review should involve open communication with ARs to confirm they understand and comply with FCA rules, including those outlined in the August 2022 Policy Statement.

Principals must be prepared to demonstrate to the FCA that they have a structured plan, robust procedures, and adequate designated resources for overseeing ARs. This is crucial to ensure their ARs do not act outside of their limited activities and do not stray into unauthorised AR business. Principals should also be aware of the Consumer Duty Finalised Guidance and communicate this to ARs where appropriate, which reinforces key FCA rules. Importantly, principals must ensure they have adequate professional indemnity insurance (PII) cover for current and former ARs, as they are responsible for the conduct of all their ARs. Even if ARs hold their own PII, principals face greater claims risk if they have not complied with the new oversight rules. Principals should also make certain their ARs maintain adequate PII cover, as policy exclusions or limitations are only permitted by the FCA in limited circumstances.

Overall, insurers relying on the AR model must adapt to the FCA's recent regulatory changes. A thorough review of AR oversight, open communication, and adherence to the new rules and guidance are crucial. While the number of ARs has decreased by around 19% since 2020, it remains to be seen whether the FCA's renewed focus on principal oversight will further diminish the use of ARs in the insurance sector.