FCA publishes the results of its review of the Host AFM Market

On 30 June, the FCA published the findings of its review of the host AFM (or host ACD) market. The FCA have highlighted that while the findings focus on the conflicts specific to the host AFM model, there are useful lessons for all firms operating within a group structure. 

The FCA has high expectations for the conduct of host AFM firms, stating that those operating effectively “are prepared to make decisions in the interest of the schemes they operate and of investors, disregarding the impact on their business.” The findings of this review have not given them comfort that these expectations are being met. 

The findings are grouped into four key areas: 

• Due diligence of delegated investment managers and funds: The FCA found that some firms lacked a robust process around due diligence and therefore failed to gather sufficient information to understand the nature of the funds for which they would be responsible. There was no link between the questions asked during on-boarding and the subsequent oversight. Firms failed to ascertain whether model portfolios, distribution strategies, charges and performance worked in practice as described during on-boarding. 
  
  In our work with clients operating this business model, we have found that a detailed and flexible risk assessment undertaken at on-boarding stage can support more effective ongoing oversight. This assessment will enable the identification of relevant Key Performance Indicators and tailored critical limits and thresholds.
   
• Ongoing oversight: The review highlighted a concerning lack of in-depth knowledge, skills and experience amongst host AFM staff with responsibility for oversight of the delegated funds. 
  
  With respect to performance and risk oversight, the FCA expects to see a variety of key indicators and associated tolerance levels understood by monitoring staff. Risk metrics should be appropriate to the fund and the frequency of data should be consistent with the fund’s objectives. These metrics should be identified during on-boarding stage and periodically revisited by members of the oversight team and senior management in the context of the funds’ own performance, as well as broader macroeconomic and regulatory developments. For example, following the collapse of the Woodford fund in 2019 we saw many of our clients in the space reassessing the fund-level liquidity risk metrics in place. 
   
• Governance and oversight: Some firms reviewed failed to evidence robust governance procedures and the FCA saw a wide variance in the quality of NED contributions across the population. Conflicts of interest are an inherent risk to this business model and there should be regular Board discussion to ensure risks are being effectively managed. Potential conflicts can crystallise around fees in particular and firms should ensure that they are acting in the best interest of investors and preventing undue costs being charged to a fund or its investors. The FCA highlighted, for example, that most firms had not considered negotiating break points in the fees paid for asset management services, even when funds had grown significantly in size.
  
  With respect to the value assessments, some firms are misapplying the review considerations with some reviewing performance at fund level rather than share class level. 
  
  While PROD rules apply to AFMs as guidance, reviewing your systems and controls through the lens of these rules can provide a useful framework to ensure you are meeting your obligation to act in the best interest of investors.
  
  A basic point perhaps but a pitfall we have seen across this industry is a paucity of documentation and record-keeping. Host AFMs must be able to evidence how and when they challenged delegated IMs, and the outcome of that challenge. Minutes should be scrupulously kept to ensure that the contributions of senior management are reflected in official documentation. 
   
• Financial resources: The FCA’s findings suggest that some host AFMs may not be charging enough to execute their services effectively. Several firms are operating at relatively low operating margins and lack investment in systems, controls and people. Some firms rely on professional indemnity insurance (PII) and support from a parent firm to manage risks. 
  
  The FCA observed a lack of credible wind-down plans and noted errors in firms’ regulatory reporting, suggesting inadequacies in the firms’ risk management frameworks. 

The FCA have said that it will issue some s166 Skilled Persons reports to particularly poor performing firms. The findings of the review are significant and concerning and there is likely to be additional regulatory actions taken in the space in the coming years, perhaps even rule changes. 

BDO has a wealth of experience in supporting firms to improve their governance and oversight arrangements and remediate regulatory findings, with a particular focus on the Principal / AR and Host AFM business models. In recent years we have undertaken Skilled Person Reviews, assessed Board and senior management effectiveness, supported in the implementation of SM&CR, and overhauled control and oversight frameworks. We have extensive experience in this niche market and can undertake assurance work to ensure the adequacy of your governance and oversight framework as well as support you in remediating any gaps identified. 

If you have any queries relating to the information above, please get in touch with our team or speak to Richard Barnwell.