Key factors to understand when investing in a regulated business
min read
If you are considering investing in a regulated financial services business, you already know the potential rewards - a resilient, growing sector that continues to attract private equity, banks and family offices alike. However, before committing your capital, it is essential to understand that these transactions come with unique considerations that go beyond a typical investment. Navigating the regulatory landscape is paramount, as missteps can have serious consequences. Whether you are looking to acquire a minority stake or take a controlling interest, getting to grips with these regulatory realities early on will help you avoid reputational risks, costly delays and ensure a smoother path to completion. In this article, we set out the top five areas that, in our experience, most commonly catch investors off guard, and explain how to get ahead of them:
- Assembling specialist advisors early to navigate both the commercial and regulatory landscape.
- Identifying FCA or PRA notifications and consents before they become a bottleneck to completion.
- Understanding whether you will be personally vetted by the regulator, and what that means for your timeline.
- Verifying the target's FCA permissions match what the business actually does in practice.
- Grasping the regulatory capital requirements and how they could affect your ability to exit the investment.
1. Why should you assemble your advisory team early?
Any successful investment starts with assembling the right team of advisors. We recommend engaging lawyers, accountants and corporate finance advisors early in the process to guide you through your legal, financial, tax and strategic considerations. It is particularly important to work with advisors who have a deep understanding of the financial services sector, including the regulatory landscape set by the Financial Conduct Authority (the FCA) - the UK's primary financial services regulator - and the Prudential Regulation Authority (the PRA), as well as current market trends and the unique challenges facing the business you are looking to invest in.
Expert advice is particularly important in regulated transactions, which require you to manage regulatory approvals and risk alongside the usual legal, commercial and financial due diligence. Your advisory team can help you understand the regulatory implications of different deal structures, spot red flags and help manage your relationship with the FCA. This early engagement with the right expert advice and guidance will make for a smoother transaction and avoid surprises or sanctions at a later date.
Your advisory team should be equipped to assist with:
- Legal due diligence - reviewing the target's corporate structure, contracts and regulatory status;
- Financial and tax analysis - assessing valuation, capital adequacy and tax-efficient structuring;
- Regulatory strategy - advising on FCA/PRA notifications, controller applications and the Senior Managers and Certification Regime; and
- Compliance review - spot-checking client files and operational practices against the firm's FCA permissions.
2. What FCA or PRA approvals could delay your deal?
Before you complete an investment in a firm that is authorised but the PRA/FCA, you must establish whether prior FCA or PRA approval is required, because completing without it can be a criminal offence and have other serious consequences.
The regulators focus on who controls authorised firms, whether directly or indirectly, and whether its 'controllers' are fit and proper. Ordinarily, a person who decides to become a controller – or increase their level of control through a 'controller band' – must obtain prior approval from the PRA/FCA.
Put simply (and depending on the nature of the relevant firm), if your investment takes you above 10%, 30%, or 50% of the shares or voting rights in the authorised firm, you will likely need regulatory approval before completing the investment.
If multiple investors are acting together, you may be treated as 'acting in concert', meaning the regulator(s) will assess your combined shareholding rather than each investor separately. This means co-investors who have agreed to exercise voting rights jointly could cross a controller threshold that neither would trigger alone.
Example of acting in concert: If a family office acquires a 25% stake in an FCA-authorised wealth management firm, and a co-investor separately acquires 10%, the FCA may treat the investors as "acting in concert" if they have agreed to exercise their voting rights together - meaning a combined 35% holding that crosses the 30% controller band and requires prior FCA approval.
Addressing any notification or consent requirements early on is important if you wish to avoid any delays to your investment. Regulated businesses that need investment urgently would be wise to ensure they don’t leave it to the last minute to seek any required consents, or at least have a “Plan B” to hand. In our experience, whilst regulated firms themselves often understand the importance of being prepared, investors may have their eye on speed or deal execution, and so it is important all parties are aligned on this part of the process.
3. Will the regulator(s) need to vet you personally?
A question that often surprises investors is whether they will need to be personally vetted by the PRA/FCA. The answer depends on how you invest, the size of your stake and the role you plan to play (if any) in the regulated business.
If you are acquiring a controlling stake, you will need to apply to the regulator(s) to be a ‘controller’. This involves submitting information about you, your background, finances, and intentions for the business. This can take several months, so factor it into your timeline.
Separately, if you plan to take a management role in the business – such as a director position or as an employee – you may need separate approval under the UK’s Senior Managers and Certification Regime (SMCR). This requires individuals in senior functions to evidence their training. propriety etc and be pre-approved as a senior manager by the FCA before starting that management role.
Be clear early on about what role you intend to play post-investment, and discuss with your advisors what personal approvals may be required to avoid unnecessary delays and regulatory breaches. This is particularly important when considering what rights the parties will have under the investment documentation, and so it should be considered at the outset rather than left until later in the process.
4. Does the business hold the regulatory permissions it needs?
It should not be taken for granted that what a firm does in practice and what it is authorised to do necessarily match up - a mismatch that can fundamentally alter the risk profile of your investment. Before investing, you should verify that the target business holds all the regulatory permissions it needs to carry out its current activities, as well as any activities you may wish it to undertake in the future.
A business’ regulatory permissions are essentially the licences that authorise the firm to conduct specific regulated activities, such as advising on investments, managing client money, or arranging deals.
Legal due diligence will typically include reviewing a business’s regulatory authorisations and permissions, but typically it is advisable to have a specialist regulatory consultant to review how a business operates in practice from a regulatory perspective, spot check client files and analyse regulatory compliance.
However, whilst some regulatory ‘gaps’ or misdemeanors identified in due diligence are capable of being remedied, whether pre- or post- your investment, where the regulatory concern identified has a likely reputational impact, whether to the firm itself, its clients or yourself, those types of risks are harder to mitigate or remedy. Making sure the business operates within its actual permissions is therefore essential (and indeed undertaking the necessary due diligence, rather than simply relying on contractual protections in the investment documentation, is advisable).
Checking the firm you are investing in has robust compliance and risk management is recommended – not just because it is importance from a governance perspective, but also because the FCA pays close attention to those areas. Dips in performance or regulatory issues can have the potential to materially impact the value of your investment.
5. How could regulatory capital requirements trap your investment?
If your equity investment counts towards a firm's regulatory capital, that capital may become "trapped" - restricting your ability to exit and recover your returns.
Financial services firms regulated by the PRA/FCA may be required to maintain a minimum level of regulatory capital at all times, depending on the regulated activities they undertake. Regulatory capital is money that the firm must hold to ensure it can meet its obligations to clients and withstand financial shocks. This is a technical area of regulation and, as an investor, it is essential to understand how this requirement may affect both the business itself, but also your own investment and any restrictions on getting your capital back.
Understanding the firm's current regulatory capital position – and whether it has adequate headroom above required capital adequacy requirements imposed by the regulators – is important. You will want to check the firm’s capital adequacy returns and calculations are accurate. If the business is operating close to its minimum capital levels, that may limit growth or indicate stress or an inability to absorb further losses.
Considering how your investment is structured from a regulatory capital perspective is essential. Equity typically counts towards regulatory capital, whereas debt may not, but it will depend upon the exact terms of your investment. If structured as regulatory capital, money you invest may become 'trapped' in the business until such time as it is replaced by another source or if you have the regulatory approval to withdraw your cash. This could have a significant effect on how you view the investment opportunity – especially if it is likely to stunt your ability to exit in line with expected timeframes.
Be aware also that capital requirements can change over time. If the regulator requires additional capital to be held, that may affect your ability to extract returns. You may even be required to contribute further capital.
What happens if you get it wrong and how can we help?
Investing in a regulated financial services business involves navigating multiple workstreams in parallel: ensuring the commercial and financial elements are right, whilst sequencing the regulatory steps sensibly. Whilst there are potential pitfalls, ultimately these can be navigated in a straightforward manner – and indeed it is important to get them right, especially given the potential regulatory consequences of getting things wrong. The FCA has a suite of tools it can deploy, even where no offence has been committed, including directing that shares be disposed of to a third party. Beyond formal action, there is reputational harm and damage to the firm and your own ongoing relationship with the regulator.
Our corporate and financial services regulatory teams work together to advise investors at every stage of these transactions - from structuring and due diligence through to regulatory engagement and completion. If you are considering an investment in a regulated business and would like to discuss any of the issues raised in this article, please get in touch.
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