Written by Emma Mifsud
Senior Consultant
In this article, our Senior Consultant Emma Mifsud reviews the FCA’s latest ‘Dear CEO’ letter for asset managers, and analyses regulatory trends and priorities for the sector.
As part of its supervisory strategy, the FCA regularly reviews sectors or ‘portfolios’ of firms with similar business models and regulatory permissions to maintain transparency within the industry regarding its focus areas. On March 1, 2024, the FCA released an interim update to the portfolio letters issued in August 2022 and February 2023 concerning its Asset Management & Alternatives Supervisory Strategy. The firms addressed in this letter include FCA authorised firms primarily managing alternative investment vehicles (e.g., hedge funds or private equity funds) or directly managing and advising alternative assets; as well as more traditional asset managers.
The objective of these letters is to outline the FCA’s updated supervisory strategy and priorities for portfolio firms, as well as to highlight areas where improvements can be made. Firms are urged to assess whether the risks of harm outlined within the letters are present within their organizations and to adopt strategies for mitigating them. These risks and mitigation strategies should be presented to governing bodies and senior managers to demonstrate their efforts in ensuring adequate protection for consumers and markets.
In this article, we focus on the highlighted risks to provide an overview of the areas where firms may fall short. The FCA acknowledges the challenges faced by asset managers in 2023 due to heightened uncertainty and market shocks, resulting in difficulties in raising and maintaining assets. The FCA identifies ineffective governance as a root cause of some asset managers’ failure to mitigate risks or deliver better outcomes for customers.
It appears the FCA will continue to emphasize measuring the effectiveness of firms’ governance arrangements in assigning senior accountability and overseeing risks, especially during periods of uncertainty and change. The FCA aims to ensure that governance bodies of portfolio firms prioritise investors’ interests, particularly during market disruptions and consolidations.
Looking through the letters we can see the evolution of the Consumer Duty initiative in the making. Initially the focus was on ensuring investment strategies do not carry inappropriate levels of risk for their target client. Firms that onboard retail or elective professional customers were reminded to review their processes to ensure they are effective. Subsequently, the emphasis was on the risk that the quality and value of product offerings, or the quality of communications with customers, did not deliver good outcomes for consumers or meet their needs. Now the FCA’s Consumer Duty focus is on how asset managers consider price and value of products and services.
The FCA last year conducted a multi-firm review of authorised fund managers’[1] assessments of value (AoV), confirming progress in implementing improved practices. This year, it will assess, under the Consumer Duty, how asset managers have considered the price and value of products and services provided to unit-linked funds. Firms with a material impact on price and value are encouraged to review their processes to ensure the best outcomes for consumers.
External events like the COVID-19 pandemic, Brexit, and the cessation of LIBOR, significantly impacted the asset management industry, necessitating the redirection of resources to address these challenges. These events highlighted the harm to consumers and market integrity that can be caused by operational disruption at firms. The FCA informs firms that they will be evaluated on their governance and resourcing of change programs, considering potential harms to investors and markets.
As part of the FCA’s commitment to strengthen market integrity, the FCA expects firms to ensure their risk management systems, controls and resources are fit for purpose. Building on the work the FCA completed on liquidity management, it will be conducting a multi-firm review examining valuation practices for private assets, including personal accountabilities for valuation practices in firms, the governance of valuation committees, the information reported to boards about valuations and the oversight by relevant boards of those practices. In addition, it will continue to work to strengthen resilience of money market funds, funds with significant liquidity mismatches, and to address vulnerabilities to market stress.
Another key harm that has been consistent throughout the three communications has been ESG (Environmental, Social, and Governance) Investments. In 2023, the FCA assessed how well firms had embedded the Guiding Principles for ESG and sustainable investment funds. It found that while much progress has been made, many firms still have further work to do, particularly around the disclosure and clarity of information being given to retail investors and consumers. It is important to note that where firms promote their ESG credentials, their boards and other governance bodies should be appropriately structured to oversee and review management information about these activities, the third-party ESG information providers used and the claims made by their firms. The FCA will be concerned if firms make exaggerated or misleading sustainability-related claims, including about their investment products.
The 2024 letter indicates that the FCA will strengthen horizon scanning for emerging risks, monitor firms with significant market impact and urge firms to ensure systems and controls are in place to prevent financial crime.
The letter informs the industry that the FCA is:
1. Working with the Bank of England on the ongoing System-Wide Exploratory Scenario being conducted to improve understanding of the behaviours of banks and non-bank financial institutions during stressed financial market conditions and how those behaviours might interact to amplify shocks in UK financial markets that are core to UK financial stability.
2. Working with the Technology Working Group, which sits under the Treasury’s Asset Management Taskforce, on the recently published blueprint for fund tokenisation.
3. Continuing to support the Asset Management Taskforce to identify and harness potentially innovative new technologies for the UK asset management industry. With Project Guardian, the FCA is collaborating with regulators across the world to explore fund and asset tokenisation use cases.
4. Undertaking work to implement the government’s Smarter Regulatory Framework (SRF) with a focus on MiFID, AIFMD and UCITS.
5. In the process to ‘lift and drop’ significant parts of existing regulation, but will take the opportunity to make changes to progress the three main priorities for reform identified through feedback: making the regime for alternative fund managers more proportionate; updating the regime for retail funds and supporting technological innovation.
6. Currently in the process of transferring EU requirements for Money Market Funds into its Handbook, and at the same time consulting on standards to enhance resilience of such funds.
7. Building on work done over the last year to strengthen horizon scanning for emerging risks, making sure firms in their portfolio meet threshold conditions, closely monitoring those firms with significant market impact, that present idiosyncratic risks to the system or are identified as outliers.
To summarise, the FCA emphasises the importance of:
A. Effective Governance
Firms should ensure they have robust governance structures in place to identify, assess, and mitigate risks effectively, particularly during periods of uncertainty, market disruptions, and significant regulatory changes. The governance structures should consider all potential harms to the firm, including all areas highlighted in the letter to the industry.
B. Consumer Protection
Firms should have processes in place that prioritise investors’ interests. The processes should ensure that firms deliver good outcomes for consumers, through assessments of value, compliance with the Consumer Duty, and transparency in ESG and sustainable investment practices.
C. Market Integrity and Resilience
To assist in strengthening market integrity and resilience, firms should assess their risk management, operational resilience and liquidity and valuation practices to prevent serious harm to investors and markets.
The key themes across all three portfolio letters highlight the importance of effective governance, consumer protection, and market integrity and resilience. Firms are urged to ensure robust governance structures are in place to identify and mitigate risks effectively, especially during periods of disruption.
As the industry continues to evolve amidst external events and technological advancements, the FCA remains proactive in its efforts to strengthen market integrity, support innovation, and promote positive change. Collaboration with industry stakeholders and ongoing engagement will be essential in achieving these objectives and ensuring a resilient and well-functioning asset management ecosystem.
Overall, the FCA’s supervisory strategy emphasises the importance of fostering a culture of accountability, transparency, and consumer-centricity within the asset management and alternatives sector, ultimately striving to safeguard the interests of investors and maintain the integrity of financial markets. In response, Firms should assess the effectiveness of their governance arrangements by assigning senior accountability for the risks identified, ensuring oversight by governance bodies, and using appropriate management information about those risks to support good decision making.
[1] An authorised corporate director, an authorised scheme manager or an authorised unit trust manager
