Sotiris Kanaris examines the way that the commercial finance market operates has undergone changes through the new rules set by the Financial Conduct Authority
Thousands of commercial finance brokers have been invited to convert their ‘interim permission’ into full FCA authorisation. The ones wishing to be considered for authorisation were given a particular application period or ‘landing slot’, a three-month period between October 2014 and the end of March 2016.
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By obtaining full authorisation, a broker is allowed to engage in business activities and transactions classified as ‘regulated’ by the FCA. However, there’s a wide range of requirements which need to be met, often requiring changes in the business structure.
Carl D’Ammassa, group managing director – business finance at Aldermore, believes that the standards set by the regulator are "challenging".
"There’s no doubt the bar has been significantly raised and the disciplines everyone in the origination chain needs to demonstrate are more challenging in their nature. It’s far from a ‘business as usual’ approach," D’Ammassa says.
Brokers unwilling or unable to meet the FCA’s requirements to gain full authorisation have two options – to gain appointed representative (AR) status, or engage solely in unregulated activities.
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By GlobalDataThe FCA defines an appointed representative as a "business which is not authorised, but which has a contract with a firm – called ‘the principal’ – that allows it to carry on certain activities under the permission of the principal."
A principal is a full FCA authorised firm, which has met all of the regulator’s requirements.
"Under the terms of the contract, the principal will take responsibility for the actions of the credit broker in carrying on the regulated credit broking activities," says Nikki Worden, partner at international law firm Addleshaw Goddard.
Despite the fact that ARs are not fully authorised by the FCA, they have some direct responsibilities in the new regulatory environment as they need to understand and comply with the regulatory requirements relating to the business. Commercial finance brokers aiming to become appointed representatives need to notify the FCA of their intention.
How appealing is the appointed representative route?
The process of becoming fully authorised by the FCA can incur costs to brokers in terms of money and time.
Simon Walker, partner at KPMG says: "The costs to smaller firms of dealing with regulatory issues entirely in-house are going to be relatively high as a percentage of their turnover. There are not just the direct financial costs of regulation but also the drag on senior management time."
Large brokers who gained authorisation have to invest in people and resources in order to make sure that they are fully complaint.
"Super brokers or ‘principals’ have made significant investment in people, processes and technology to ensure a robust and compliant regime is in-force, not only among their own employees, but also across any appointed representatives’ businesses," says D’Ammassa.
Small businesses aiming to get authorisation will either need to employ compliance officers or allocate different roles to existing employees, which could stir changes in their business structure.
"Small businesses will have to work out who is going to deal with anti-money laundering, who is going to take care of other compliance functions, and who is going to deal with the annual returns to the FCA," says Walker.
He adds that potential increases in the costs of professional indemnity insurance could trigger more small brokers to consider becoming ARs.
Another challenge for these firms when seeking authorisation is that the senior management team has to gain extensive knowledge on regulation within a very short time frame.
"Having gone through the process of becoming regulated ourselves, we know just how steep the lending curve is for a business looking to gain FCA approval," says Callum Stevenson, head of broker relations at LDF.
On the other hand, becoming an AR is not cost-free, as brokers will have to give away a portion of their income to the principal, as well as allow the principal to access business records.
"Becoming an AR has the benefit that someone else is picking up all the paperwork, but you could give away anything between 8% and 15% of your income every month to remain as an appointed representative," says Adam Tyler, chief executive at the National Association of Commercial Finance Brokers.
The appointed representative should allow the principal access to its staff, premises and records in order to fulfil regulatory responsibilities.
Commenting on the decision that brokers have to make between following the full authorisation route or gaining an AR status, Tyler says: "Either you pay an upfront cost and get directly authorised, or you’re prepared to pay an amount on a regular basis to a larger body."
Walker believes there will be a high number of brokers becoming ARs, as was witnessed in other industries.
"If you look at what happened to mortgage brokers and insurance brokers after they became regulated, there’s been a clear shift towards the appointed representative model," says Walker.
Tyler doesn’t expect the proportion of commercial finance brokers becoming ARs to reach the high levels experienced in IFA markets, but anticipates a "sensible" growth in the next 18 months. In addition, he expects there will be a gentle switch between ARs and directly authorised brokers.
"What you’re going to see over the next 18 months is brokers who wanted to get authorised, deciding to ‘make their life easier’ and become appointed representatives. On the other hand, some appointed representatives will think that it’s not hard to gain authorisation and follow that route," Tyler says.
Tyler also highlights that many principals will quickly reach the limit on the number of ARs they can be responsible for.
"It is a whole new process and it has to be done in stages; you can’t go from five ARs to 500 overnight, because you need the infrastructure to do it," he says.
