Dear Chief Executive | Release Date: 4th August 2023
To read a shorter summary of this Dear Chief Executive letter, click here.
To access the original FCA document, click here.
Long Summary
The Financial Conduct Authority (FCA) has introduced its supervisory strategy for Principal Trading Firms (PTFs), aligning with its new regulatory framework under the combined Supervision, Policy, and Competition departments. This letter outlines the key risks, regulatory expectations, and the focus of supervision for the next two years aimed at firms classified under the PTF category.
Strategic Importance of PTFs
Principal Trading Firms predominantly generate revenue through principal trading activities such as algorithmic trading, including high-frequency operations, and market making. PTFs are integral to the liquidity and price formation in the financial markets both in the UK and internationally. They are often pioneers in technological advancements, driving market efficiency and innovation. As market makers, they ensure the stability of financial markets, especially under stressed conditions.
Current External Challenges
The strategy acknowledges several external factors impacting PTFs, including geopolitical tensions, economic uncertainties from the UK’s exit from the EU, and the ongoing repercussions of the COVID-19 pandemic. Specific incidents like the cyber-attack on ION Markets and the FTX collapse underline the critical need for robust risk management systems and operational resilience.
Risk Factors and Harm Drivers
A primary concern for PTFs is market abuse, where inadequate controls can lead to manipulation and disruption. The reliance on advanced technology further amplifies operational risks, necessitating superior cyber-security measures and operational controls to prevent systemic disruptions.
Supervisory Focus Areas
The FCA’s supervisory strategy for PTFs over the next two years will concentrate on the following key areas:
Algorithmic Trading Controls:
Given the inherent risks in algorithmic trading, the FCA emphasises the necessity for stringent controls and effective oversight. This includes managing the risks associated with artificial intelligence and other technological advancements. PTFs are expected to ensure that their trading activities do not adversely affect market integrity.
Financial Resilience:
PTFs must maintain sufficient financial resources to manage potential market stresses or facilitate an orderly wind-down. The FCA intends to conduct reviews under the new Investment Firm Prudential Regime (IFPR) to ensure firms have appropriate financial safeguards in place.
Market Conduct and Commodity Trading Volatility:
The strategy highlights the need for robust management of risks associated with market volatility, particularly for firms trading in commodity markets. The FCA plans enhanced monitoring and engagement with these firms to manage potential impacts on the financial markets.
Operational Resilience:
Operational resilience is crucial for PTFs, given their high dependency on technology. Firms are required to comply with the FCA’s Operational Resilience policy and ensure they can continue to operate within their impact tolerances by March 2025.
Brexit Implications:
Post-Brexit changes require PTFs to possibly adjust their operational structures to ensure compliance with UK regulations. Firms are urged to communicate any significant changes that might affect their operations or regulatory status.
Compliance and Enforcement
PTFs are expected to actively engage with the contents of this strategy, discussing implications and required actions with their Boards. The FCA underscores the responsibility of CEOs and senior management to ensure adherence to the supervisory expectations and regulatory standards. The authority will monitor compliance and is prepared to take action against firms that fail to meet these standards, ensuring the integrity and stability of the financial markets.
Conclusion
The FCA’s strategy for PTFs is designed to enhance the resilience and compliance of firms engaged in principal trading. By addressing algorithmic trading controls, financial resilience, market conduct, operational resilience, and the impacts of Brexit, the FCA aims to uphold the integrity of the UK’s financial markets and protect the broader economic landscape. This strategic approach not only mitigates potential risks but also supports the ongoing development and stability of the financial sector.