The FCA recently released its Sector Views report, a summary of its findings on each sector covering areas of investor harm, drivers of change and how each sector is changing. It provides an insight into areas of concern for the regulator and consequently, where new regulations and/or supervision work may be issued and undertaken.
Below, we summarise the FCAs comments into the investment management sector which covers asset and wealth managers. A number of the themes in the report are mirrored in the Dear CEO letters sent by the FCA last month.
Principal areas of concern
1. Pricing and Quality of Investment products
The FCA have identified concerns with a number of investors holding investments that either no longer meet their investment objectives, or which they are overpaying for. The causes of these outcomes are diverse but primarily result from unclear or complex product information, and poor governance practices at asset management firms. The FCA identified, in their Asset management Market Study, that there was weak price competition in several areas of the industry, an unclear relationship between charges on products and the performance of those products; and unclear or insufficient information on product pricing and quality. It is clear from the direction of travel by the FCA that there is a push for firms in the sector to improve the clarity, accuracy and timeliness of disclosures by firms.
2. Operational resilience
With many more interdependencies in the sector, the FCA is concerned that firms may not have robust enough assessments of their distribution and value chains to ensure continuity in the event of a business disruption. Harm to investors or market integrity could result following cybercrime, technology, or non-technology incidents. The FCA expects firms have contingency plans, and proper governance arrangements and oversight over all aspects of their operations.
3. High-risk or illiquid securities and their capacity to lead to disorderly markets
Recent headlines about ‘liquid’ vehicles unable to deal with redemptions have caused understandable concern to the regulator about how effectively the sector manages liquidity risk. There have been product interventions and new regulations to enhance and standardise liquidity risk management arrangements across Europe. We can expect this focus to only be strengthened throughout the year.
4. LIBOR Transition
By the end of 2021, LIBOR will no longer be an available rate. Given the use of these rates as benchmarks for performance measurement, and contracts, the cessation of these rates will lead to widespread changes in the sector. The FCA is working with a Working Group to come up with alternative risk free rates with the Sterling Overnight Index Average (SONIA) being currently preferred. Failure to plan effectively for the transition from LIBOR could lead to disorderly markets in the investment management sector.
5. Market Abuse
Market Abuse remains a source of concern at firms, particularly at smaller investment management firms whose market abuse systems and controls may not be robust enough. Performance linked remuneration provides a natural incentive to commit market abuse.
6. Pricing and quality of institutional intermediary and advice services
Investment consultants are currently out of scope of FCA regulation. However, given the scale of these entities’ influence- the FCA estimates that they and fiduciary managers provide services to pension schemes with assets of c.£1.6trillion- it is possible that these entities will be brought into regulation. Improving competition in this sector is an outcome the FCA is looking to achieve.
Future proofing your business
A number of changes are taking place in the sector, not least the raft of new rules that have been introduced in the last two years, including MIFID II, PRIIPs, SRD II and the AMMS. Other changes impacting the sector include the growth of passive investments as a percentage of total AUM, focus on ESG considerations, and impact of technology. In our view, Managers and intermediaries should be putting in place and/or enhancing the following.
1. Product Governance
The requirements under MIFID II for product governance were strengthened. Firms- manufacturers and distributors- are expected to take steps to satisfy themselves that products are going to the right target market, that the negative target market for each product is clearly defined. A periodic review is recommended, and steps taken to remedy any management information that indicates a change in distribution strategy or product details may be required. Financial promotions controls must also be strengthened with ongoing training provided to individuals responsible for the production and distribution of these materials.
2. Market abuse prevention
Systems and controls to prevent market abuse must be regularly reviewed and enhanced as typologies evolve. A number of system solutions exist to support firms in this regard however the use of these systems must also be regularly evaluated to ensure existing and emerging operational risks are effectively mitigated.
3. LIBOR transition
With less than two years to go before this rate ceases to be available, managers with contracts or benchmarks reliant on LIBOR must be reviewed in a timely manner. An assessment of the impact of the transition needs to be made and work began to ensure an orderly transition.
4. Operational resilience
Firms should review their business continuity arrangements and make enhancements as necessary. Inter-dependencies should be clearly understood and reasonable steps taken to manage the risks arising from those relationships.
5. Treating Customers Fairly
The FCA is a conduct regulator and it is imperative that firms’ systems and process can demonstrate putting the best interests of clients at its heart. Governance and Compliance monitoring processes should incorporate periodic reviews of products and services to ensure compliance with existing rules, particularly on disclosure, and principles for fair treatment of customers.
In the coming months and years, investment management firms can expect more scrutiny and regulations that the regulators hope will lead to better outcomes. By taking a focussed, informed and proportionate approach, firms can rest confident that they are on the right side of the rules and principles.
Compliancy Services is a specialist consultancy focussed primarily on UK regulation. We support hundreds of firms on a daily basis with meeting their day-to-day compliance obligations. These include assurance reviews on the overall compliance framework and deep dives into specific areas.
Related resourcesAll resources
Proposed changes to HNW and sophisticated investors’ financial promotions exemptions watered down
Consumer Duty: a wake-up call to all? Dear CEO letter to Wealth Managers and Stockbrokers
FCA warns on insider dealing risks around market soundings
Terms and Conditions Apply