Financial Conduct Authority identifies supervisory priorities for alternatives
Published on 15th Aug 2022
Actions speak louder than words and the UK regulator wants firms to embed a culture to promote the initiatives
Alternative firms will recognise a number of the supervisory priorities identified by the Financial Conduct Authority (FCA) in its latest portfolio letter published on 9 August 2022, which puts consumers' needs first and considers acting with integrity to be paramount.
The FCA's portfolio letter on its alternatives supervision strategy provides an update on the FCA's view of the key risks for the sector, while also acknowledging that several of the risks outlined in its earlier January 2020 letter continue to be relevant to firms.
The FCA's supervisory strategy and priorities will now focus on ensuring that firms put customers' needs first, supporting its commitment to strengthen the UK's position in global wholesale markets and reflecting its focus on ESG investments in the alternatives sector.
Letter's key points
- Exposure of investors to inappropriate products or levels of investment risk: The FCA remains concerned about inappropriate distribution and marketing practices by firms targeting mainstream investors. To combat this, the regulator requires firms to consider the appropriateness or suitability of the investments they offer for their target customers, be they retail or elective professionals. The FCA also outlines how firms should conduct investor assessments to reduce this risk.
- Inadequate management of conflicts: The FCA's reference in the letter to the fines it has recently levied against asset managers for failing to manage adequately conflicts of interest sends a clear warning message to the market. The FCA expects asset managers and their staff to be scrupulous in identifying conflicts and ensuring they are avoided, managed or disclosed in a way that minimises harm to investors and markets.
- Culture: During the forthcoming supervisory cycle, the FCA will look at how senior managers and firm policies influence an organisation’s culture, including whether staff feel able to speak up. In particular, the FCA is interested to understand how healthy cultures are embedded in firms where founders or other senior individuals occupy a dominant role.
- ESG: There has been a growth of environmental, social and governance (ESG) investments in the alternatives sector, which remains a priority area in the FCA's asset management department. The regulator continues to assess authorised fund applications with an ESG or sustainability focus and the FCA will be checking to ensure that firms' marketing materials accurately describe their product, with funds offering clear and consistent disclosure.
Stay on top of regulatory change
In the letter, the FCA refers to several sets of rules that have either recently been published (but do not yet apply) or are due to be published and consulted on in the near future. Firms are directed by the FCA to familiarise themselves with these rules and monitor regulatory developments with a view to promptly reviewing and amending their business practices accordingly. These rules include:
- PS22/10: Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions. The FCA expects to publish final rules for the promotion of cryptoassets once HM Treasury formalises legislation to bring these into the FCA's remit.
- PS22/9: A new Consumer Duty
- Following the FCA's Discussion Paper 21/2: Diversity and inclusion in the financial sector – working together to drive change, it plans to produce a consultation paper later this year.
- In December 2021, the FCA introduced rules for asset managers and certain asset owners to make disclosures consistent with the Task Force on Climate-related Financial Disclosures recommendations. The rules come into effect for the largest alternative investment fund managers on 1 January 2022 and one year later for smaller firms (with assets under management of over £5bn from 2023).
In response to this letter, alternative firms are directed by the FCA to:
- Discuss the letter with their board or executive committee. The FCA asks that firms discuss the letter with their board or executive committee. They should consider which of the risks outlined in the letter are applicable to their business and whether they have the appropriate strategies in place to address them. The FCA expects firms to take the actions that are considered necessary to mitigate risks and ensure that the firm meets FCA requirements.
- Expect a questionnaire: In the coming months, the FCA will be issuing a questionnaire asking all portfolio firms for information about their business model, products, investor categorisations and associated control framework. As part of this supervisory work, firms will need to evidence the reasonable steps taken to ensure the firm’s target market is both appropriately defined and not exposed to an unsuitable level of risk.
- Stay abreast of regulatory developments: Given the pace of regulatory change in this sector, firms will need to closely monitor developments and consider what steps they need to take to comply with any new obligations imposed.