FCA sets out supervision strategy for corporate finance firms
Published on 20th Oct 2023
What steps may firms need to take in areas such as client categorisation, Consumer Duty and market abuse controls?
The UK Financial Conduct Authority (FCA) has published a portfolio letter addressed to CEOs of corporate finance firms (CFFs), detailing the regulator's supervision strategy for the sector.
The FCA's main areas of focus include client categorisation, the Consumer Duty, dealing with "problem firms", and market abuse.
Chapter 3 of the FCA's Conduct of Business sourcebook (COBS) contains detailed rules that firms must follow when categorising clients for regulatory purposes. The FCA letter highlighted its concern that retail clients "may lose important protections and compensation rights when treated as professional, so firms can cause harm if they miscategorise them".
The FCA is interested in how effective CFFs' processes are in ensuring that clients are appropriately categorised as "professional clients" under the rules in COBS 3.5, especially when they have elected to be professional clients.
The FCA's Consumer Duty generally applies to firms that conduct retail market business, where they can determine or materially influence retail customer outcomes in a retail distribution chain, even if firms do not have a client relationship with the retail customer.
The FCA acknowledges that the duty has a "far-reaching and wide perimeter". It is the responsibility of CFFs to consider if they are subject to the duty (and, if so, how). The FCA in its letter was at pains to flag two points.
First, as CFFs typically face both clients and "corporate finance contacts", firms must assess the extent of the Consumer Duty’s application to both sides of their activity. Second, CFFs encouraging clients to seek professional client classification simply to circumvent the protections afforded to retail clients would breach the duty. If a client has been incorrectly classified or the firm becomes aware that a client has been previously incorrectly classified, the firm should reclassify the client and restore the correct level of protection.
The FCA expects CFFs to use their regulatory permissions to advance a legitimate business purpose and to construct and maintain their permission profile in a way that accurately reflects this. The FCA notes that it continues to see "firms that appear to hold permissions for no clear business purpose or in order to favourably influence public perceptions of their unregulated business". This is not the first time that the FCA has expressed its discontent at firms not ensuring that their permissions are a proper reflection of activities undertaken – in January 2021, the FCA published a page on its website, reminding firms to regularly review their permissions and remove them when no longer required.
The FCA stated in its portfolio letter that it "will contact firms that do not appear to be using their regulatory permissions to understand why they need them and will invite firms to vary or cancel their permissions where appropriate. Where firms do not do so voluntarily, [the FCA] will use [its] powers to remove firms’ unused permissions and prevent firms from misleading consumers".
The FCA expects firms to ensure market abuse controls are tailored to their individual business models and have robust prevention cultures, and systems and controls to discharge their obligations under the retained EU law version of the Market Abuse Regulation .
The FCA noted that it has seen examples of CFFs with poor market abuse systems and controls. These include ineffective information barriers, inadequate processes for the identification of inside information, poor wall-crossing controls, and incomplete or inaccurate insider lists. It had also seen failings when undertaking market soundings, including not obtaining the consent of recipients before disclosing inside information and not communicating to recipients that they are no longer inside.
The FCA also expects CFFs to identify, record and manage conflicts of interest properly. These requirements are set out in Principle 8 and the rules in SYSC (Senior Management Arrangements, Systems and Controls sourcebook) 10. CFFs must consider conflicts arising both from their inherent business model, and from new clients and new transactions taken on.
The FCA expects CFF boards to have discussed the contents of the portfolio letter, and agreed appropriate actions and next steps by the end of November. CEOs are asked to notify the FCA immediately if they consider that their firm does not meet the requirements. Given that the FCA has identified these areas as its supervisory priorities, CFFs should ensure that they are confident that they have policies, processes, systems and controls in place to meet the regulator's expectations.
Osborne Clarke comment
Firms should be considering the portfolio letter and whether they need to take any actions. For example:
- CFFs should consider a review to ensure their client categorisation processes are sufficiently robust, particularly around "opted-up" professional clients.
- The Consumer Duty is in force for open products and services, so CFFs will already have considered whether it applies to them and implemented any changes required. The application of the Consumer Duty should also be considered to the extent there is any change to the nature of the firm's activities.
- CFFs should ensure their regulatory permissions accurately reflect the regulated services they undertake, together with appropriate limitations.
- CFFs may wish to take this opportunity to "kick the tyres" on their market abuse systems and controls to ensure they are capable of standing up to regulatory scrutiny.
- Firms could also revisit their conflicts of interest systems and controls, including with respect to personal account dealing.
If you would like help around any of the issues raised in the portfolio letter and their impact on your business, please contact us.