False starts and laggards. The FCA set the tone in their latest “Dear CEO” letter to wholesale broking firms
By Simon Tweddle
Let me start by saying “false starts” and “laggards” are the words that the FCA used, these words set the tone well for what the FCA go on to say in their latest Dear CEO letter sent to the wholesale broking sector. This letter has a sting in the tail. The FCA take the time to remind CEOs about their responsibilities under the Senior Managers and Certification Regime (SMCR), and then give them just shy of 7 weeks to discuss the contents of this letter with “their fellow directors and/or Board” and “agree next steps”.
What are next steps?
Next steps in this case being quite obviously: identify where your firm is falling short of expectations and put a plan in place to meet those expectations. Be careful though. In the previous sentence, the one before they ask that by end-February 2023 firms must have agreed next steps, they leave some room for discretion (i.e., for a firm to make its own decision as to telling the FCA what they found “immediately”); and at the same time reserve the right to criticise a firm for not telling them about something should it come to their attention further down the road.
What are the key areas of concern (this time) ?
Don’t mistake the title for sarcasm, it’s not. There is nothing new in this letter, the frustration is tangible.
Financial Resilience
This is a subject that comes up frequently. It always surprises me, that for something so important – to stay in business – why so many firms, in the FCA’s words “fail to either develop their own competence on liquidity risk management sufficiently, or to recruit expertise externally to help address this issue…” The FCA go on to say that they will be carrying out targeted work on this and, again in their words “…where we identify material weaknesses or firms underestimating their liquidity needs, we will take action…”. What Action will the FCA say they will take? Business restrictions and Board effectiveness reviews.
The FCA have been telegraphing their concerns in this area for over 2 years. With the introduction of the new prudential regime for investment firms in the UK (IFPR) last year and the intervention in June 2019 that started with CP 19/20 and led to FG20/1 “Our framework: assessing adequate financial resources”, is there really anywhere to hide? There are also numerous references in other areas of the handbook. Let’s not forget a good old fashioned ICAAP either. An ICAAP was supposed to describe how liquidity risks arose and were managed too.
It's been our experience, based on actual engagements, that the reason for a firm underestimating their liquidity needs in the wholesale broking sector may be the absence of a comprehensive risk management programme that adequately explores the nexus of credit risks and mitigation techniques, client money rules, the use of funds held under a TTCA agreement, scenario analysis, stress testing, and one that does not appreciate the complexities of how cash and collateral is managed on a day-to-day basis. It doesn’t take very long to explain this (feel free to get in touch with me and have a quick call). Implementing something that delivers the requirements and is commercially sensible will take a little longer, and we’d be happy to help you do it.
Remuneration Structures
I’m not going to dwell on this. I’ve spent enough time in the non-banking environment, especially the broking environment to understand why this is challenging. Maybe the FCA could help the sector by doing more to level the playing field. At the risk of oversimplifying: in this sector whoever moves first loses. If you understand how the high earners in this sector get paid you will also know what’s at risk. Nonetheless you have to comply.
Governance and Culture
These subjects have been batted back and forth between firm and regulator for many years too. I spent a lot of time in the banking environment as well and I would assert that the issues that the FCA highlight here are related, if not directly proportional, to the struggle with remuneration structures.
The FCA assert that “a relatively junior employee (in terms of a traditional hierarchy) can expose broking firms to significant risk of harm to the firm, their clients and the market more broadly”. I’d be interested in hearing what others think this means.
One way to interpret this could be that someone of similar age and experience (at a bank) would have less responsibility and more supervision, earn less, be less valuable to the bank, know they are less valuable and therefore behave themselves. Another way to interpret this (and is this an uncomfortable truth?), the wholesale broking sector has the potential to do more harm to clients and markets than the banks. I think that’s a stretch. As I said, I would really like to hear other people’s views on what they think the FCA meant.
The FCA go on to discuss the importance of regulatory references and paying attention to any adverse information that arises during the hiring process. I suspect there may still be firms out there that don’t run criminal background checks and credit checks. I suspect the FCA think so too. They may have found some examples as part of the fieldwork for this letter.
What is your risk appetite for bringing on staff that have criminal convictions, poor credit and/or disciplinary challenges? It depends on the details of course. Who ultimately makes the decision, and would they make the same decision if they had to put their personal reputation on the line with the FCA? I think this letter is suggesting that they are.
And finally…
Control Functions
I don’t think this will come as a surprise either. In the FCA’s words:
“We expect firms to comply with all relevant FCA rules, to consider relevant guidance, and to have adequately resourced risk management and control functions, with influence at board level…”
They want to see evidence that a firm’s culture actively encourages adherence to the rules. They want to see firms being proactive rather than doing the minimum to get by, or worse, only making investments when forced to by the FCA themselves. They have said that their work has highlighted “widespread deficiencies” in wholesale brokers’ client onboarding processes and will be doing further work in that area during 2023. We have supported several firms over the last 2 years to improve their overall anti-financial crime frameworks including comprehensive money laundering and terrorist financing risk assessments and independent reviews of their client onboarding processes. One such engagement was to support the registration of a crypto broker, read the client story at this link. We have direct experience of what the FCA are expecting in this area. We have similar experiences with market surveillance and market abuse risk assessments. The approach we designed and implemented for clients has, on numerous occasions, stood up to audit and regulatory scrutiny over the last 2 years.
What else is there to say?
I think the tone of this letter is different to letters of the past, it also leaves little to the imagination. The FCA are putting the wholesale broking sector on notice. My interpretation is as follows: We [FCA] are going to engage with some more firms directly after this letter and we expect to see evidence that firms have taken action.
What are next steps after reading this post?
1. Read the letter, you can find a copy of it here
2. Discuss it in the context of your ICARA process with the CEO and Board - evidence that discussion
3. Commission a comprehensive gap analysis that includes traceability back to the appropriate rules and guidance
4. Create and have your CEO and Board approve the action plan
5. Execute your plan
Get in touch with us to help you do this. Shapes First has specialist knowledge of all these subjects and more besides, we also have extensive experience in the wholesale broking sector. We know the subjects and we know your business. Let us help you shape up for the future.
