12/01/2023

FCA gives wholesale brokers six weeks to review regulatory compliance and culture

On 11th January, the Financial Conduct Authority (“FCA”) published a ‘Dear CEO’ letter letter setting out its supervisory focus for wholesale brokers over the next two years. In its letter, the FCA highlights what it believes are the four most pressing risks in the wholesale broker market. Importantly, the FCA expects firms to discuss these risks at board and/or director level, and to have agreed actions by the end of February this year. Charlotte Gregory and Oliver Wannell discuss.

Financial Resilience

According to the FCA’s letter, firms have failed to develop their own competence or recruit external expertise to adequately manage liquidity risk. Where firms have sufficient capital and liquidity, they are far less likely to cause market disruption. However the FCA is concerned that firms hold insufficient amount of liquidity to survive instantaneous shocks or periods of extended market volatility. This risks disorderly wind downs and raises the risk of contagion and widespread market disruption.

To improve financial resilience, the FCA has advised firms to review the level of liquidity that they hold under the new Investment Firm Prudential Regime (“IFPR”) and ensure that their assessment is comparable to the risk. The FCA will carry out targeted work in this space and take action, including business restrictions and Board effectiveness reviews, where material weaknesses are identified.

Remuneration Structures

The FCA is concerned that issues around weak incentive and reward structures highlighted in its 2019 ‘Dear CEO’ letter remain. In particular, the FCA considers low salaries and large bonuses based on the value and volume of trades results in a risk to client outcomes. In its view, this remuneration structure incentivises brokers to focus on short-term financial targets at the expense of client interests and has potential to encourage brokers to conclude trades by whatever means.

The FCA has affirmed that it expects firms to comply with the MiFIDPRU Remuneration Code (SYSC 19G), introduced in January 2022. Specifically: bonuses must be appropriately balanced with fixed salaries making up a sufficiently high proportion of total remuneration; performance must take account of financial and non-financial criteria including metrics on conduct; and firms must identify ‘Material Risk Takers’ who must be subject to more stringent remuneration requirements such as deferral, malus * and clawback * to help mitigate against short-term thinking and excessive risk taking.

Governance and Culture

The FCA has observed that poor decision making and failures in oversight have played a key role in exacerbating underlying issues or preventing them from being resolved sooner. The FCA considers that Boards with a suitable mix of skills and experience that provide effective challenge to the management are more likely to make better decisions, manage risks and succeed within the sector.

The FCA’s letter therefore encourages firms to continue to embrace the Senior Managers and Certification Regime (“SM&CR”) and to avoid conduct risk by properly taking into account regulatory references and considering risk mitigations where appropriate when hiring new certified staff. The FCA has warned that there will be little sympathy for firms that suffer the consequences of hiring individuals who have been disciplined elsewhere without ensuring additional control or oversight.

Control Functions

The FCA’s recent work has highlighted widespread deficiencies in wholesale brokers’ client onboarding processes to control financial crime and money laundering. The FCA will carry out further work in this area in the year ahead.

The FCA’s letter emphasises that firms are expected to comply with all relevant FCA rules, consider relevant guidance and have adequately resourced risk management and control functions. Beyond this, firms are expected to promote a culture that encourages adherence to the FCA’s rules as well as their own policies and procedures.

Next Steps

The FCA expects all CEOs to have discussed the letter with their fellow directors and/or Board and to have agreed actions or next steps by the end of February 2023.

If you have any questions, read more and get in touch with our Financial Services team here.

 

* Reducing or cancelling deferred incentive awards (i.e. bonuses) that have not yet vested if, for example, investments perform poorly. 

* Recouping incentive awards that are already vested.