The half-way point in the FCA’s two-year supervision strategy for wholesale market broking firms
In April 2019, the Financial Conduct Authority (FCA) sent a Dear CEO Letter to wholesale market broking firms. In that letter, the FCA committed to taking a “tough stance” with wholesale market brokers in pursuit of “necessary and urgent” changes.
The Dear CEO Letter set out the FCA’s supervision strategy in relation to four key concerns. That strategy covered the period between April 2019 and March 2021. We have, therefore, just passed the half-way point. As such, it is time for firms to reflect on the progress that they have made so far – and to consider what steps they still need to take.
Firms should not expect the FCA to abandon its focus on these issues as a result of Covid-19. Just as firms are striving to maintain “business as usual” so the FCA is continuing to concentrate on its top priorities.
One such priority is the question of culture at wholesale market broking firms.
Key “drivers of harm”
The Dear CEO Letter listed the following four key “drivers of harm”:
- Compensation arrangements which link broker remuneration directly to business volume without giving sufficient recognition to long-term or non-financial indicators of performance;
- Governance arrangements under which boards and senior managers lack the necessary tools with which to oversee their staff and business;
- Workflows which fail to recognise that a broker may perform different regulated activities (and/or act in different capacities) at different times; and
- A culture and mindset which underestimates the risk of brokers committing/facilitating market abuse and financial crime.
What progress will the FCA expect to see?
Compensation and incentives
The FCA was particularly concerned by the traditional remuneration model under which firms make cash payments to individual brokers based on the revenue which those brokers have generated.
A year on, the FCA will not expect firms to be using a simple “eat what you kill” model without significant modification. The FCA expects firms to ensure that their remuneration models take a longer term view of performance and take account of non-financial performance. Relevant non-financial performance will include training, compliance and general contribution to a positive culture at the firm.
Given the level of concern expressed by the FCA at what might be called a fairly industry-standard approach to remuneration, firms should consider how they will be able to demonstrate that they can justify their particular approach to remuneration.
Governance and culture
The Dear CEO Letter also referred to that fact that brokers, who are often the principal revenue earners in their firms, have significant negotiating power. The FCA was concerned that boards may not always be able to stand up to brokers.
Given that firms have had a year to work on this and that the Senior Managers and Certification Regime has been rolled out to wholesale broking firms since the Dear CEO Letter, it is likely that the FCA will be expecting firms to have made significant improvements in this regard.
Importantly, many brokers will fall within in the Certification Regime. As such, it will be firms themselves which have responsibility for assessing brokers’ fitness and propriety. The FCA will want firms to be able to show that this assessment is a robust and evidence-based process rather than simply a “tick box” exercise.
More generally, the FCA will want to see that directors have appropriate mandates and are operating effectively.
Capacity and conflicts of interest
Firms will be well aware that this has been an area of particular focus. The Dear CEO Letter pulled no punches in this regard and said that the wholesale broking sector is “generally weak in identifying the particular capacity it is acting in for a given transaction”. This raises concerns regarding conflicts of interest.
More specifically, the Dear CEO Letter said that the FCA continued to be concerned about brokers “inappropriately charging commission to liquidity providers from whom they source liquidity” (known as “payment for order flow” or PFOF).
Given the emphasis that the FCA has placed on PFOF over a number of years, firms should consider whether they still need to improve the quality of the practices, policies, systems and controls that they have in place to ensure compliance with PFOF obligations and conflicts of interest obligations more generally.
Market abuse and financial crime controls
The Dear CEO Letter said that “firms are generally complacent about their responsibilities to monitor for and mitigate market abuse and financial crime risk”.
The FCA will want firms to have improved their surveillance arrangements (including the way in which they monitor communications) and to have increased the amount of resource devoted to this issue. Additionally the FCA will expect senior management to be more engaged in the process of identifying market abuse and financial crime risks.
The Dear CEO Letter specifically referred to “serious deficiencies in resilience and readiness to combat cyber-crime” and added “if firms fail to prioritise investment in IT this can cause serious harm to the firm, their clients and the market”.
The FCA will expect to see evidence that firms are testing their IT controls thoroughly and are making any necessary improvements. It is also likely that the FCA will expect firms to have increased the level of resource in this area.
Next steps
While firms are understandably diverting attention to coping with the impact of Covid-19, the FCA will still expect wholesale brokers to be addressing the issues set out in the Dear CEO Letter.
The half-way point in this two-year supervision strategy is a good time to take stock and to consider next steps. Firms would be well-advised to tackle these issues proactively rather than to wait for any follow up contact by the FCA or, even worse, enforcement action.
For more information please contact William Garner, or Richard Ellis.
Our thinking
Simon Green
International Bar Association quote Simon Green on the future of the legal sector in Hong Kong
International Bar Association quote Simon Green on the future of Hong Kong's legal sector
Bart Peerless
The Lawyer reports on the Firm's promotion announcement
The Lawyer reports on the Firm's promotion announcement
Bart Peerless
Charles Russell Speechlys promotes six to Partner
Charles Russell Speechlys promotes six to Partner
Jamie Cartwright
Jamie Cartwright comments on the potential impact of the plastic packaging tax
Jamie Cartwright comments on the potential impact of the plastic packaging tax
Tobias Niehl
Luxembourg Client Briefing: Circular CSSF 21/790 – self-assessment for UCITS, part II funds, SIFs and SICARs; management letter; separate audit report
The Circular defines three supervisory tools.
Tobias Niehl
Luxembourg Client briefing: Circular CSSF 21/789 – Fund manager self-assessment, management letter, separate audit report
The content of the SAQ depends on the scope of licence of the Addressee.
Matthew Blakebrough
Is Buy Now, Pay Later creating a new debt crisis?
BNPL providers are quick to claim that their services are offered with “no interest and no fees”, but is this really the case?
David Hicks
Diversity and Inclusion: Clear transparency?
This article focuses on the published its Consultation Paper on diversity and inclusion on company boards and executive committees in July.
David Hicks
Charles Russell Speechlys advises FairXchange on investment from United Fintech
FairXchange was founded in 2016, to bring clarity and transparency to execution performance through the provision of independent data.
Jodie Dennis
Mandatory climate-related disclosures coming soon
On 28 October 2021, the government published its response to its consultation on mandatory climate-related disclosures.
Matthew Blakebrough
Will JP Morgan’s digital only Chase launch shake up the UK retail banking sector?
Chase is JP Morgan’s consumer brand and is one of the largest retail banks in the United States with over 4,700 branches.
Matthew Blakebrough
Who? Where? What on earth is an “NFT”!?
An NFT is a “Non-Replaceable Token” meaning only one of its type can ever be created and recorded on the blockchain it is connected to.
Richard Ellis
How does the FCA Cryptoasset AML/CTF Regime affect UK cryptoasset businesses?
With the notable exception of security tokens, the majority of cryptoassets remain unregulated in the United Kingdom.
Adrian Mayer
Charles Russell Speechlys wins best Legal Services: Private Equity at the Africa Global Funds Awards 2021
We are delighted to announce we have been awarded the Legal Services: Private Equity award at the AGF Service Providers Awards 2021.
Jon Bond
Charles Russell Speechlys advises Silbury Finance on a £55m facility to a Jersey unit trust
Silbury provides real estate development finance for professional developers seeking to acquire and build in the UK.
Victoria Younghusband
The role of IFCs in the post-Brexit environment
International Financial Centres (“IFCs”), are now on a level playing field with the UK when approaching the EU market.
Helen Coward
Taxation of asset holding companies in alternative fund structures - draft legislation published
The draft legislation is in respect of the much anticipated new regime for asset holding companies.
Victoria Younghusband
Africa Global Funds Webinar: Due Diligence for PE Funds in Africa
Victoria Younghusband joined the panel discussing the challenges around due diligence for funds in Africa.
Edyta Brozyniak
Charles Russell Speechlys bolsters funds capabilities with the hire of Edyta Brozyniak as Partner
Edyta advises on fund formation of private equity and venture capital funds, co-investments, and investor negotiations.
Victoria Younghusband
Charles Russell Speechlys Africa Team advises Ascent Rift Valley Fund II
ARVF II will invest equity in leading small and medium-sized enterprises (SMEs) in Eastern Africa.