FCA warns Asset Managers of key harms in Dear CEO Letter

On 3 February 2023, the FCA published a Letter addressed to the Chief Executives of Asset Management firms, detailing its supervisory priorities in this sector. As the letter explains, Asset Managers are now supervised by the Buy-Side Directorate of the FCA and contact details are helpfully provided. It supersedes its previous strategy Letter sent out in January 2020.

Which firms does this apply to?

The FCA now divides regulated firms into portfolios of firms so that it can better focus on the key harms identified in each sector. The Asset Management portfolio consists of about one thousand firms managing some £11 trillion of assets, mostly with mainstream, long-only strategies. Their clients range from large institutions to small retail investors, competing in a global market.

Note that the FCA treats Asset Management as distinct from its Alternatives portfolio which focuses on hedge fund and private markets managers and advisers. Alternatives firms received their own supervisory Letter in August 2022.

Good governance: an over-riding priority

The FCA believes that ineffective governance is a root cause of firms failing to address material risks or bring about better outcomes for their customers. The current volatile economic environment, especially in relation to the cost of living, puts even more importance on the effectiveness of firms’ governance in identifying, considering, and mitigating harms as they arise.

Supervisory priorities

The letter details the FCA’s top five supervisory priorities for Asset Managers, including (as it sees it) the key risks, its expectations on firms and what it proposes to do about it.

1. Product governance

The FCA warns that firms’ products, and their communications with customers,  often fail to deliver good outcomes for consumers or meet their needs. It reminds firms of the remedies introduced by the Asset Management Market Study some five years ago, which included enhanced governance and value assessments. Building on that, the new Consumer Duty will radically affect the way financial firms treat their customers. Firms must carefully consider their new responsibilities and ensure they have made any necessary governance and controls changes in order to incorporate its requirements. CEO’s are directed to the accompanying Letter to Asset Management, Custody & Fund Services and Alternatives firms for further details on their Consumer Duty obligations.

The FCA also plans to follow-up on its 2021 Assessment of Value, which exposed failings such assessing value at fund level rather than unit class, or measuring performance against yardsticks that don’t correspond to the investment strategy. It also commits placing the Consumer Duty at the core of its proactive supervision going forward, with a review in 2024 to assess its effect on product price and value.

2. ESG and sustainable investing

Since its last strategy letter in 2020, the FCA has seen an increase in ESG and sustainable products. Unfortunately, there has been a corresponding increase in misleading or inaccurate claims and information. Asset managers must implement their new obligations under the climate-related disclosure rules (set out in the ESG sourcebook) which came into force this year for firms with assets under management of greater than £5 billion. Firms must also be aware of the FCA’s wider proposals for Sustainability Disclosure Requirements and investment labels set out in CP22/20. The FCA warn that they will place particular focus on the governance structures in firms that oversee ESG and stewardship arrangements.

3. Product liquidity management

The potential for liquidity problems in open-ended funds has long been recognised, typically triggered by mismatches of redemption terms offered to investors and the time needed to liquidate the corresponding assets. Unfortunately, the last three years is replete with examples of market and pricing shocks leading to liquidity issues, including Liability Driven Investment (“LDI”) portfolios and property and money market funds. The FCA believes that firms generally have the tools available to improve their liquidity risk management but are failing sometimes to use them correctly or consistently. Stung by the recent LDI debacle, the FCA is committed to working with the Bank of England and international regulators to improve its surveillance and is in the process of completing a multi-firm review of liquidity management governance and controls.

4. Investment in operations and resilience

Under-investment in operations is a major cause of service disruption or failure and is often triggered or exacerbated by market volatility or stress. Firms are expected to have a proper understanding of the operational health of their businesses, and to report material failures and cyber-attacks under their Principal 11 obligations. Under Policy Statement PS21/3, in-scope firms were required to have identified their important business services and to have set impact tolerances by 31 March 2022, and to remain within these limits until 31 March 2025.

5. Financial Resilience 

Although there have been relatively few failures amongst asset management firms in recent years, the FCA has increased its monitoring of the sector with the implementation of the Investment Firm Prudential Regime (“IFPR”) at the start of 2022. Firms are required to regularly review (through the ICARA process) whether they have adequate capital and liquidity to cope with economic or commercial headwinds. In particular, they are directed towards the FCA’s Wind-down Planning Guide and the more recent thematic review TR22/1.

Further thoughts

The FCA’s Dear CEO Letter provides a helpful guide to its supervisory focus areas in the coming months. Firms seeking to prioritise their compliance monitoring areas should complement this with a review of the Regulatory Initiatives Grid, the latest edition of which was originally due in November but is now expected very shortly. In the medium term, firms should also be mindful of the broad regulatory reform initiatives collectively announced as the Edinburgh Reforms in December 2022 (see here for our summary).