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Dear CEO | Release Date: 18th April 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 addressed a comprehensive letter to CEOs of brokerage firms operating in wholesale financial markets. This letter outlines the significant harms these firms may pose to clients and markets, along with FCA’s strategic plans to mitigate these risks. It is essential for management boards to deliberate on how these issues pertain to their operations and initiate necessary adjustments.

Overview of Wholesale Market Broking Firms

Brokers in wholesale markets are pivotal in sourcing liquidity, discovering prices, and connecting buyers and sellers. However, the broker-centric business model is fraught with risks, especially if brokers fail to align with an ethical culture and robust control environment. The sector is reportedly lagging in adopting a culture of good conduct compared to others, prompting an urgent need for regulatory attention.

Key Challenges Identified by the FCA

1. Compliance with Regulations

Despite the implementation of major regulatory reforms like MiFID II and MAR, which have heightened the standards for market participants, brokerage firms have been slow to adapt. Investments in compliance resources and systems have generally been reactive, spurred by supervisory interventions rather than proactive governance.

2. Harmful Remuneration Models

Compensation structures in brokerage firms often directly link broker earnings to the commissions they generate, neglecting non-financial performance metrics. This model not only fosters poor conduct but also discourages a long-term perspective on performance and accountability.

3. Inadequate Governance

Governance structures within many firms do not provide sufficient tools for oversight or clear accountability standards. This deficiency impedes the effective management of conduct and operational risks.

4. Conflicts of Interest and Capacity Issues

Firms frequently fail to recognise their operational capacity, leading to unmanaged conflicts of interest and non-compliance with regulatory obligations. This issue is compounded by inadequate systems to identify and safeguard against these risks.

5. Culture and Risk Management

There is a pervasive underestimation of the risks associated with market abuse and financial crimes. Many firms lack the necessary monitoring controls and training to mitigate these risks effectively.

FCA’s Supervision Strategy

The FCA’s supervision over the next two years will focus on addressing the above issues through various approaches:

Remuneration and Incentives: The FCA is currently reviewing market practices and plans to take a firm stance on remuneration models that contribute to misconduct.

Governance and Culture: With the upcoming Senior Managers and Certification Regime (SM&CR), the FCA aims to enhance the clarity of roles and responsibilities within firms, promoting a culture driven by effective governance.

Managing Conflicts of Interest: The FCA expects firms to establish robust systems to clearly identify their service capacities and manage associated conflicts of interest appropriately.

Controls Against Market Abuse and Financial Crime: Improved surveillance and proactive engagement in identifying risks are expected, with firms enhancing their focus on these areas.

Technology and Cybersecurity

The FCA has also highlighted the critical role of technology and the need for improved resilience against cyber threats. Firms are encouraged to prioritise investments in IT and ensure robust testing of their technological infrastructures.

Implications of EU Withdrawal

Firms must ensure that their Brexit contingency plans are robust and allow them to continue acting in their clients’ best interests under all potential scenarios. Proactive communication with the FCA regarding these plans is crucial.

Conclusion and Takeaways

Key Actions for Brokerage Firms:

Review and Adaptation: Firms must critically assess their practices and governance structures in light of the FCA’s letter and make necessary changes.

Enhance Compliance: There is an urgent need for firms to align their operations with regulatory expectations and to invest in compliance and technology.

Engagement with FCA: Firms should engage actively with the FCA through upcoming roundtables and supervisory interactions to ensure they are fully aligned with the expected standards.

Brokerage firms must take immediate action to address the deficiencies highlighted by the FCA. By fostering a culture of compliance, transparency, and accountability, firms can mitigate risks and contribute to the stability and integrity of financial markets.

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