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Robust governance can build regulatory hosting back stronger than ever

07 Apr 2022

Nearly three years ago, the Financial Conduct Authority (FCA) issued a Dear CEO letter scolding regulatory hosting firms for “significant shortcomings in the control and oversight of ARs.” This year, it seems appropriate to mark the occasion by reflecting on what it means to be a responsible regulatory host—and how improved governance can build back an industry that is critical to UK finance.

When the FCA’s letter was written, the regulatory hosting industry had a fatal flaw: “a rapid growth in numbers of ARs without associated enhancements to governance and risk frameworks”. This resulted in a number of scandals culminating with Greensill, which brought the Appointed Representative (AR) regime under a political microscope.

While the FCA raised legitimate criticisms in 2019, the regulatory hosting landscape looks much improved today—particularly amongst large principal firms with the resources to bolster their governance. But principal firms are back in the FCA spotlight, with Consultation Paper CP21/34 suggesting reform for principal firms and standardised compliance practices industry-wide.

We must build regulatory hosting back after this period of intense regulatory scrutiny—particularly in the wake of Brexit. IQ-EQ is leading the industry by investing heavily in our people and enhancing our systems to provide more robust compliance support to alternative funds than ever before.

Keeping asset owners’ eyes on London

In many ways, regulatory hosting is an integral part of ensuring London’s relevance in alternative asset markets.

It has helped maintain London’s status as a primary financial centre post-Brexit, enabling U.S. and other overseas fund managers to manage and advise funds from the UK investing in European, Middle Eastern and African (EMEA) markets. It has also provided a base to market to European investors using sub-delegation from EU managers or private placement regimes, despite the loss of passporting.

International managers looking to launch funds quickly and bring them to market in Europe often cannot wait the 9-12 months it currently takes to get direct approval from the FCA. Whether long-term hosting or incubation services are required, regulatory hosts provide an essential route to launching funds and bringing them to market within 6-8 weeks. The third-party alternative investment fund manager (AIFM) services offered by those hosts tick another box when speed is key.

When executed responsibly, this speed to market keeps London relevant as a financial centre. Also, it allows for innovation within the industry, extending inroads for ESG and sustainable funds that would otherwise remain out of reach for UK and European investors.

What is the responsibility of regulatory hosts?

While some see dark clouds on the regulatory horizon, we see an opportunity. Principal firms modelling industry best practices will secure a future for the hosting industry by building regulatory hosting back stronger than ever.

At IQ-EQ, we believe that better governance is the rising tide that lifts all boats. To ensure the future of regulatory hosting in the UK, principal firms must provide sufficient oversight—and that means wider reporting and documentation requirements.

So far, the FCA has only required high-level reporting on AR activity. As a result, there has been limited insight into the activities carried out by host firms and ARs. While specifics are still under debate, the FCA’s focus is evident: stricter reporting requirements and more robust monitoring by host firms of their ARs.

Well-governed regulatory host firms able to provide evidence of proper controls can lead the industry toward a sustainable future and maintain London’s position in world markets. But regulatory hosts must improve their operations and oversight if we are to achieve that aim.

Why the AR regime and associated compliance are so important

The UK Treasury has openly stated its intention to maintain London as a leading financial centre post-Brexit with nimbler rule-making and more tailored regulation. Proposed reforms to the EU’s MiFID regulations will bring tangible benefits and improve the competitiveness of UK financial markets.

However, a ban on regulatory hosting would completely undermine that hard-won progress. The sector plays a critical role in incubating funds and fostering innovation.

Regulatory hosting has helped bolster the UK’s position in world finance post-Brexit by serving as a bridge for innovative ESG and other sustainable funds hoping to tap into British and European markets.

As an asset management superpower, the U.S. currently relies on the AR regime to launch within weeks rather than waiting a year or more for a direct FCA licence. Even funds that do apply directly with the FCA can benefit from a “regulatory incubator” to help bridge the gap.

In many cases, start-up funds are brought to market with stronger oversight by a principal firm than if they had sought direct FCA authorisation at the fund’s inception. Regulatory incubation services help new managers navigate unknown regulatory environments before applying directly.

It is up to principal firms to ensure the longevity of the regulatory hosting industry by bolstering controls and supervisory standards. They must invest heavily in expert people and technology to enhance governance, risk management, onboarding due diligence and ongoing monitoring.

IQ-EQ is proud to be named one of the top regulatory hosting firms, due in large part to our expertise in hosting U.S.-based funds, along with our range of AIFM platforms in the key European jurisdictions. Contact our team today to learn how we can support your fund.

Working with IQ-EQ has been seamless – you and your team understand our business, advise us appropriately, and handle your side of our collective partnership so that we can focus on making good investment decisions. Evan Gibson SVP, Merchants Capital

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