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Dear CEO | Release Date: 20th May 2019

To read a shorter summary of this Dear CEO letter, click here.

To access the original FCA document, click here.

Long Summary

The Financial Conduct Authority (FCA) has recently disseminated a comprehensive “Dear CEO” letter that outlines the key findings and subsequent expectations following a detailed multi-firm review. This review scrutinises how principal firms in the investment management sector are managing and supervising their appointed representatives (ARs). The sectors under review include the promotion and management of alternative investment funds, asset management, wealth management, contracts for difference providers, fund advisory, and arranging activities.

Detailed Findings of the FCA Review

Governance and Risk Management Deficiencies

The findings from the FCA reveal substantial weaknesses in governance among the principal firms. These firms displayed either weak or significantly underdeveloped risk management frameworks and internal controls. A major concern is that many firms lacked effective processes to evaluate whether they could oversee their ARs effectively. This includes assessing the suitability of the activities undertaken by ARs and whether the principal had the necessary expertise to manage these activities. This failure extends to inadequate preparation and resource allocation, which are crucial for accommodating the variety of business models their ARs operate under.

Oversight and Control Shortcomings

The review highlighted a pervasive lack of proper control frameworks necessary for continuous monitoring of ARs’ compliance with the regulatory requirements. Most principals had not established tailored monitoring practices that suit the diverse business models of their ARs. Instead, many relied excessively on high-level attestations from ARs, which are insufficient for comprehensive oversight. This oversight deficiency means potential non-compliance issues might go unnoticed and unaddressed, posing significant risks.

Financial Resource Assessment Failures

It was noted that a vast majority of principal firms did not properly evaluate the financial risks arising from their ARs’ activities. This includes a failure to maintain adequate financial resources to cover potential liabilities. In fact, over 90% of the firms reviewed had financial resource assessments that were considered not fit for purpose, highlighting a grave oversight in financial planning and risk management.

Conflict of Interest and Regulatory Compliance Issues

The FCA found that many principal firms did not adequately identify or manage conflicts of interest. Moreover, there was a failure to maintain proper conflict of interest registers, despite the evident presence of conflicts. Additionally, some principals inaccurately reported their ARs’ revenues, which are used to calculate their annual regulatory fees to the FCA. This misreporting resulted in these firms paying less than required, unfairly shifting the fee burden to other fee payers.

Responsibilities and Expectations of Principal Firms

Regulatory Obligations

According to the FCA Handbook, principal firms have clear responsibilities towards their ARs. These include ensuring ARs are fit and proper to interact with clients and that these clients receive the same level of protection as they would if they were dealing directly with the principal firm. This section of the handbook is crucial in setting a baseline of expectations for principal firms’ operations and their supervisory roles.

Liability and Compliance

The principle of liability is clear: principal firms are fully responsible for any actions taken by their ARs that might breach regulatory standards. This responsibility is absolute, meaning that any misconduct by an AR is treated as a misconduct by the principal firm itself. In cases of non-compliance or misconduct, principal firms are expected to take swift action to rectify the situation and ensure customer redress. They may recover costs from ARs, but such decisions are purely commercial and do not absolve the principal of its regulatory responsibilities.

Actions Required

Immediate Review and Compliance Assessment

The FCA mandates that principal firms must critically review and realign their governance structures and control frameworks with the stipulated regulatory requirements. This involves a thorough reassessment of their current practices around the supervision of ARs, identification of any gaps, and immediate rectification of these gaps.

Future Engagement and Monitoring

The letter clearly states the FCA’s intention to engage further with principal firms. This includes planned visits and reviews to ensure that firms have acted upon the findings of this letter. The FCA expects firms to be proactive in sharing this letter with their Boards and preparing for subsequent regulatory engagements.

Addressing Shortcomings

Principal firms are urged to address all the identified shortcomings, particularly those related to risk management, financial resource adequacy, and the management of conflicts of interest. The emphasis is on creating a robust framework that not only meets but exceeds the regulatory requirements to safeguard the interests of consumers.

Consideration of Relationship Termination

In instances where compliance cannot be assured post-remediation efforts, the FCA suggests that principal firms should consider terminating their relationships with non-compliant ARs. This drastic measure should be seen as a last resort but is essential for maintaining the integrity and compliance of the principal firm within the regulatory framework.

Conclusion and Takeaways

This expanded summary encapsulates the critical elements of the FCA’s “Dear CEO” letter, highlighting the urgent need for principal firms in the investment management sector to enhance their governance, risk management, and oversight capabilities. It stresses the importance of rigorous internal reviews, adherence to regulatory standards, and proactive engagement in rectifying any deficiencies. Principal firms must take decisive actions to align with FCA expectations to ensure the continued protection of consumer interests and the overall stability of the financial market.

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