On 6 February, Mark Steward, Executive Director of Enforcement and Market Oversight at the FCA, delivered a speech on market integrity and the FCA’s strategic approach to market regulation. We digest some of the key messages and the implications for firms.
The FCA has today written to the UK’s major retail banks, asking them to provide evidence of how they have arrived at their new overdraft interest rates, which have all been set at around 40%. The FCA also asked the banks to clarify how they will deal with customers who could be worse off following the changes, and expects firms to take “positive steps” to helps these customers – for example, by reducing or waiving interest, or offering a continuation of overdraft borrowing at current rate of interest.
The FCA’s letter comes after it introduced wide-spread reforms to the “dysfunctional” overdraft market to end harmful unarranged overdraft charges. From April this year, firms are required to charge a simple annual interest rate, without additional charges for using an overdraft.
Today’s letter is perhaps an acknowledgement from the FCA that its overdraft changes have not been implemented quite as expected, and a warning to banks that the FCA will be “keeping a close eye on the market” and will take action should it “see continued harm”. The banks have until 10 February to voluntarily respond to the FCA’s letter, following which we should expect more communications and possibly further action from the FCA.
The FCA this week published two template ‘Dear CEO’ letters, one to asset managers and one to alternative investment firms, highlighting the FCA’s views on the key risks posed to customers and markets, and setting out its supervision strategy for the coming months.
The FCA’s asset management portfolio comprises firms that predominantly directly manage mainstream investment vehicles, or advise on mainstream investments (excluding wealth managers and financial advisers), whilst its alternatives portfolio is comprised of firms that predominantly manage alternative investment vehicles (such as hedge funds or private equity funds) or alternative assets directly, or advise on those types of investments of investment vehicles.
The FCA’s key concern is that standards of governance in both sets of firms are below what it expects, and progress is needed in both sectors to protect the best interests of customers.
The ‘Dear CEO’ letters make it clear that the FCA will be very active in the asset management and alternatives sectors in the coming months, and firms should expect increasing scrutiny. It will be important for firms to look at the areas identified by the FCA and consider any changes they need to make.
The FCA’s supervision strategy addresses the key issues in each sector, with specific priority areas set out below. Whilst the areas of focus are split between the two sectors, the FCA recognises that there will be overlap between the two.
The asset management supervision strategy will focus on the following key areas:
- Liquidity management – Authorised Fund Managers (AFMs) are responsible for ensuring effective liquidity management in funds but the FCA warns that there can be a liquidity mismatch in open-ended funds between the terms at which investors can redeem and timescales needed to liquidate assets. The FCA expects firms to take necessary action following recent publications from the FCA and the Financial Policy Committee. This has been a continuing theme in light of the issues experienced by some real estate funds after Brexit and the collapse of the Woodford fund.
- Firm’s governance – Following the extension of SMCR at the end of 2019, the FCA expects firms to have refreshed their approach to governance and taken the steps necessary to improve it in line with SMCR requirements. The FCA intends to carry out work in H1 2020 focussing on the implementation of SMCR across asset managers.
- Asset Management Market Study (AMMS) remedies – The FCA published its AMMS Final Report in June 2017 and the consequential rule changes are now in force, including requirements around governing body structure and value assessment on funds. In H1 2020, the FCA plans to undertake work on how effectively firms have undertaken value assessments, with more work envisaged in the future given the breadth of the AMMS reforms.
- Product governance – Following the introduction of new product governance requirements under MiFID II, the FCA has begun reviewing how effectively these requirements have been implemented by asset managers, and expects to complete this work in early 2020. In parallel, the FCA is also reviewing arrangements whereby funds are managed by ‘host’ Authorised Corporate Directors (ACDs) (AFMs that are not within the group structure of the delegate investment manager), as there are concerns that the ‘host’ ACD may not be undertaking their responsibilities effectively in some cases.
- LIBOR transition – The FCA is currently gathering information from some asset management firms to enhance its understanding of business models, including their specific exposure to LIBOR risk, and intends to provide further communications on its expectations for LIBOR transition in due course.
- Operational resilience – Operational resilience remains an area of focus for the FCA for financial services firms as a whole. In the asset management sector specifically, the FCA is conducting technology reviews and ad-hoc reviews of firms’ arrangements and expects to undertake further proactive work in this area. The FCA reminds firms of their obligations under Principle 11 to notify it of any material technology failures or cyber-attacks. For more information on operational resilience in the asset management sector, please see our blog post here.
- EU withdrawal – With the UK’s exit from the EU approaching, the FCA expects firms to consider how the end of the implementation period will affect both the firm and its customers, and take action to be ready for 1 January 2021.
Alternative Investment Firms:
For alternative investment firms, the FCA’s supervisory priorities are as follows:
- Investor exposure to inappropriate products or levels of investment risk – Significant levels of investment risk are inherent in alternative investments, so the FCA expects firms in this sector to carefully consider the suitability or appropriateness of these investments for their target investors. Where investors are allowed to ‘opt-up’ to elective professional client status, firms should robustly assess the client’s suitability to be opted-up. The FCA plans to review retail investor exposure to alternative investment products offered by alternatives firms, with a particular focus on firms being aware of who their clients are and acting in their clients’ best interests.
- Client money and custody asset controls – As part of the retail investor exposure, the FCA also plans to assess whether firms which have client money or asset custody permissions are exercising them in accordance with the Client Assets Sourcebook (CASS) rules.
- Market abuse – In the FCA’s view, market abuse control across the alternatives sector has “significant scope for improvement”. To that end, the FCA has recently conducted an assessment of the adequacy of market abuse controls in the sector and may invite firms to participate in a similar exercise in future. The FCA reminds firms that it may consider enforcement action for those firms which are found not to comply with Market Abuse Regulation (MAR).
- Market integrity and disruption – With scope to take significant investment risk in managing their products (ie. credit risk and market risk), the FCA expects alternatives firms to operate robust risk management controls to avoid excessive risk-taking and effectively mitigate against potential harm or disruption to markets. The FCA may choose to undertake in-depth assessments of firms’ controls in future.
- Anti-money laundering and anti-bribery and corruption – Alternatives firms face a risk of being used to facilitate fraud, money laundering, terrorist financing and bribery and corruption. The FCA intends to review firms’ systems and controls to mitigate this risk, with particular focus on the risks of money laundering and terrorist financing.
- EU withdrawal – As above, the FCA expects firms to take steps to be prepared for the UK’s exit from the EU at the end of the implementation period on 1 January 2021.
The FCA and PRA have confirmed that the next 12 months will be a critical period in transitioning away from the use of LIBOR, advising firms to accelerate their efforts to cease reliance on LIBOR by end-2021. The regulators will step up engagement with firms on LIBOR transition and have contacted senior management responsible for overseeing the transition to set out their expectations for the coming months.
In a suite of documents published last week, the Working Group on Sterling Risk Free Reference Rates (RFRWG), together with both regulators and the Bank of England (BoE), set out the priorities and other actions market participants should take to reduce LIBOR exposure. The documents published include:
- Joint PRA/FCA letter to senior managers of major banks and insurers – Next steps on LIBOR transition
- FCA and BoE statement encouraging switch from LIBOR to SONIA (Sterling Overnight Index Average) for sterling interest rate swaps from 2 March 2020
- RFRWG’s priorities and roadmap for 2020
- RFRWG statement on the use cases of benchmark rates: compounded in arrears, term rate and further alternatives
- RFRWG factsheet – Progress on the transition of LIBOR-referencing legacy bonds to SONIA by way of consent solicitation
- RFRWG factsheet – Calling time on LIBOR: Why you need to act now
Milestones for transition
The documents include the RGRWG’s key milestones and targets for firms over the coming months (see timeline below).
The UK regulators both fully support the timeframe proposed by the RGRWG. The FCA and BoE have also published a statement encouraging market makers to change the market convention for sterling interest rate swaps from LIBOR to SONIA from 2 March 2020.
Alongside these key milestones, the RGRWG will continue its own education, awareness and communication campaigns.
Key regulatory expectations
The key message from these publications is that sterling LIBOR is expected to cease to exist after the end of 2021, and no firm should plan otherwise. Transition plans should cover firms’ stock of legacy LIBOR-linked contracts, as well as new contracts entered into from this year onwards.
Firms should also note several other regulatory expectations highlighted in the documents, including:
Firms should engage proactively with clients and market initiatives
Market participants should be taking appropriate steps to establish that their clients are aware of the risks if new LIBOR transactions are entered into. This expectation to support clients is also brought out in the statement on the use cases of benchmark rates, where the RFRWG suggests within a decision tree that all clients (except large corporates where the transaction size is £25 million or greater) may need to explore with their bank contacts alternatives to compounded SONIA (such as BoE base rates or fixed rates) which are better suited to their needs.
Regulators also expect all firms to play their part in meeting the targets by actively engaging in transition efforts in the market. While progress has been made to date, regulators expect to see clear evidence of engagement from firms from the beginning of Q1 2020.
Senior management should be tracking progress
Senior management should ensure that the management information they receive in respect of LIBOR transition plans tracks performance against targets. This will be relevant to all firms for whom the transition from LIBOR is relevant, but will be particularly important for the senior managers at banks and insurers who have been identified as responsible for overseeing the implementation of the transition plans (in accordance with the FCA and PRA’s Dear CEO Letter on firms’ preparations for transition from LIBOR to risk-free rates and feedback statement published in September 2018 and June 2019, respectively).
Action is expected in key areas and should feature in firms’ planning from Q1 2020
Action in the following areas has been highlighted as being key to delivery and is expected to feature in firms’ planning from Q1 2020: product development; reviewing infrastructure (including updating loan system capabilities); client communications and awareness; and updating documentation.
Firms should be mitigating the risks from the transition
The FCA and PRA are aware that firms are transitioning at different rates, but all firms need to be proactive in taking early action to mitigate the risks from transition.
Increased focus on supervisory powers
The publications from the FCA and BoE make clear that they intend to make use of their supervisory powers if firms are seen to be falling short of their expectations.
In the letter to senior management, the regulators reminded firms that the Financial Policy Committee (FPC) will “keep the potential use of supervisory tools under review“. Firms will need to show sufficient progress by mid-2020 to avoid the FPC seeking recourse to such supervisory tools.
On 20 December 2019, we received a festive treat: the publication of the Money Laundering and Terrorist Financing (Amendment) Regulations 2019 (the “Regulations”). The Regulations, which will come into force on 10 January 2020, implement the Fifth EU Money Laundering Directive (Directive (EU) 2018/843, “5MLD”)) in the UK, and follow a high level consultation in summer 2019.
The Regulations make some limited but important amendments to the existing Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (“MLR“). These include an expansion of the scope of the regulated sector, and changes to aspects of regulated firms’ customer due diligence and enhanced due diligence obligations (including, in particular, an important new requirement to make reports to Companies House in relation to discrepancies between information collected during customer due diligence and information on the Persons with Significant Control register). In this briefing we review the changes and new obligations.
The FCA has warned CEOs that how a firm handles non-financial misconduct is indicative of a firm’s culture. It is the FCA’s view that embedding healthy cultures includes, therefore, taking steps to address the discrimination, harassment and bullying that remains “prevalent” in firms.
In a ‘Dear CEO’ letter (the Letter), which follows recent incidents in the wholesale general insurance sector, the FCA considers the need for fundamental change in firms’ culture and calls on leaders to bring about that change. Continue reading
On 5 December 2019, the Bank of England (BoE), the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) released a number of publications on operational resilience, marking the launch of a consultation phase which will inform how the UK authorities seek to embed the consideration of operational resilience into the regulatory framework.
Welcome to the December 2019 edition of our corporate crime update – our round up of developments in relation to corruption, money laundering, fraud, sanctions and related matters.
In this blog post, we round-up forthcoming developments in the UK and at EU and International levels in financial services regulation which are expected for December 2019.
On 26 November 2019, the FCA announced that it would use its temporary intervention powers to restrict the mass marketing of speculative mini-bonds to retail customers. Although the intervention will allow the promotion of unlisted speculative mini-bonds to sophisticated and/or high net worth individuals, marketing materials which are produced by or approved by an authorised firm will also have to include a specific risk warning and disclose costs or payments made to third parties that are deducted from investors’ money. The FCA has published additional guidance on approving financial promotions for communication by unauthorised persons alongside the announcement.