Online Platforms: “Walking” the line between legal and financial services compliance (Part 2 of 5)

Regulatory permissions

Under the Financial Services and Markets Act 2000 (“FSMA”) a person cannot carry on any “regulated activities” unless they are authorised by the FCA, or unless it falls within an exemption or exclusion. Any contravention of this prohibition is a criminal offence.

A “regulated activity” must satisfy all of the following criteria:

• a person carries on a "specified activity" (e.g. arranging deals in investments);
• in relation to a "specified investment" (e.g. shares);
• by way of business (e.g. to make a profit); and
• in the UK.

For example, a UK-based person that is in the business of arranging deals in relation to shares would carry on a regulated activity and would need to be authorised by the FCA (unless an exclusion or exemption applies).

In addition, firms carrying out “regulated activities” under FSMA are also required to choose which of the following customer types they are aiming to provide services to:

• retail clients – any client not categorised as an eligible counterparty or professional client;
• professional clients – including “per se” professional clients (such as authorised or regulated financial institutions, collective investment schemes, and institutional investors) and “elective” professional clients which elect to be considered professional provided they satisfy a qualitative test and, for firms carrying out MiFID business, an additional quantitative test:
  • The “qualitative test” requires an adequate assessment of a client’s expertise, experience, and knowledge to give reasonable assurance that the client is capable of making his/her own investment decisions and understands the risks involved;
  • The “quantitative test” requires two of the following three criteria to be satisfied:
    • the client has carried out an average of 10 significant transactions per quarter over the previous four quarters;
    • the client holds over EUR 500,000 in its financial instrument portfolio; and/or
    • the client works or has worked in a professional financial sector position for at least one year requiring knowledge of transactions or services envisaged;
• eligible counterparties – including “per se” eligible counterparties (such as investment firms, credit institutions, and pension funds) and “elective” eligible counterparties which vary depending on whether a firm is carrying out MiFID business:
  • For a non-MiFID elective eligible counterparty:
    • The client is an undertaking (i.e. non-natural person);
    • The client is a per se professional client (other than an institutional investor) and is either:
      • A body corporate with called up share capital of at least £10m; or
      • Has two of the following:
        • a balance sheet of EUR 12,500,000;
        • a net turnover of EUR 25,000,000; and / or
        • at least 250 employees during the year; and
    • The client requests such categorisation.
  • For a MiFID elective eligible counterparty:
    • The client is an undertaking;
    • The client is a per se professional client (except for an institutional investor); and
    • The client requests such categorisation.

Operators of online platforms will usually carry on one or more of the following regulated activities depending on the type of platform:

• arranging (bringing about) deals in investments;
• making arrangements with a view to transactions in investments;advising on investments;
• dealing in investments as agent or principal;
• operating a multilateral trading facility (“MTF”) or an organised trading facility (“OTF”);
• issuing electronic money; and / or
• permissions relating to payment services.

The operator of an online platform would carry on the above activities in relation to certain client types and types of investment. Depending on the business model, an online platform may also decide to hold client money or client assets.

In this article we have considered two options available to firms operating online investment platforms:

• applying to the FCA to carry on regulated activities; or
• becoming an appointed representative of an FCA-authorised firm.

Apply to the FCA for authorisation

The FCA authorisation process will require the firm to provide considerable information to the FCA, which includes:

• a business plan;
• details of the firm’s regulatory capital requirements;
• details relating to the firm’s controllers; and
• details of persons carrying out regulated functions for the firm.

Operators of online platforms are then required to provide further information specific to their business model. For example, firms providing investment advice must outline their processes to ensure investments are suitable to customers.

Operators of online platforms creating a trading venue for investment products, including platforms creating a secondary market for customers to trade financial instruments, may face a more complex authorisation process. In this case, the additional information to be supplied to the FCA includes:

• a rulebook for the trading venue;
• an assessments of strategies and controls to prevent market abuse;
• details of trade recording;
• a detailed assessment of IT systems; and
• a detailed assessment of capital requirements.

An authorisation application to carry on financial services should be processed within six months for a complete application or 12 months for an incomplete application.

Become an appointed representative (“AR”)

Operators of online platforms carrying on certain types of regulated activities, such as arranging deals in investments, have the option to become an appointed representative. This involves entering into an agreement with an FCA-authorised firm that already has permission to carry on the relevant regulated activities. The operator of the online platform may then rely on the permission of the FCA-authorised firm to carry out certain regulated activities. ARs are often an effective solution to quickly get an online platform to market rather than going through the FCA authorisation process.

As published in Butterworths Journal of International Banking & Financial Law, June 2019.

Part 1 │ Part 2 │ Part 3 │ Part 4 │ Part 5