Posted: 23/02/2023 | Read time: 3 minutes
In this blog, AutoRek’s Senior CASS Consultant Murray Campbell summarises some of the key messages of the FCA’s recent portfolio letter. This includes the importance of sound governance, investment in operational resilience, financial resilience and CASS. He sets out six actions asset management firms must take to meet the FCA’s new expectations.
Continuing its approach to regulatory communication, the FCA recently issued a portfolio letter to asset managers to set out its supervisory approach and the risks of potential harm it sees in this sector. The FCA has increasingly taken this approach when communicating with firms, as we have seen from the many Dear CEO letters and similar portfolio letters – further examples of which were also recently sent to all portfolios regarding the implementation of the FCA’s new Consumer Duty.
Clearly this is an effective way for the FCA to communicate its message, priorities and expectations to a wide range of organisations. As noted in this recent letter, the asset management portfolio consists of approximately 1,000 firms.
It’s important to note that firms should review the letter in its entirety to understand the impact on their business.
Governance
Sound governance is critical to both a firm’s success and the delivery of good outcomes for clients. In the letter, the FCA is absolutely clear on the responsibilities of governing bodies and accountable individuals. Importantly, the FCA expects a firm’s governing body to be aware of the level of exposure they have in respect of the risks identified by the letter. And it expects to receive timely management information on that risk.
Importantly, the FCA expects firms to review the letter’s contents and assess what actions they should undertake as a result. Furthermore, the FCA will expect to see evidence of the actions taken by those accountable in response to the risks identified in this letter. It is clear the FCA expects this to be more than lip service, highlighting that its previous experience has found “ineffective governance to be a root cause of some Asset Managers failing to mitigate material risks or progress towards better outcomes for their customers.”
The need for better outcomes for consumers is the cornerstone of the FCA’s new Consumer Duty and is reinforced by the FCA in respect of product governance. Ensuring that products are fair and offer value, while communicating clearly with the appropriate target audience, is identified in the letter as being important for meeting the needs of customers. The FCA has signposted a review of the embeddedness of the Duty in 2024. Therefore, firms should now be focusing on their governance arrangements.
Investment in operations and resilience
The FCA identifies underinvestment in operations as a risk in the industry due to the potential harm caused by a failure of – or disruption to – a firm’s services. The consequences for clients and wider markets when firms experience a disruption can be far-reaching, which reflect the origins of the Operational Resilience rules.
Typically for asset management firms, there is a tendency to focus investment on areas visible to clients, or in which clients experience a direct benefit. As a result, investment in operational processes and back-office systems is very often ignored, with processes remaining manual and inefficient. However, the risk of this is not lost on the FCA. It states: “Poor investment in operations can hamper innovation, reduce efficiency and increase cost, and can result in service decline for investors.”
It is important for firms to review their operational processes and systems – or assess the operational health of their business model, as described by the FCA – to identify areas of potential risk and causes of harm. Key to this is capturing those processes that would benefit from automation and articulating the business case, including operational enhancements and business benefits of this investment.
Furthermore, identifying where challenges may be encountered – for example, if a firm’s transactional volumes increase – is important for futureproofing processes and delivering mitigation against the risk of harm materialising.
Financial resilience and CASS
Financial resilience is another key area identified by the FCA as a cause of potential harm and detriment to consumers and markets. In 2022 the FCA’s Investment Firms Prudential Regime (IFPR) introduced a new set of prudential requirements aimed at minimising the risk of a disorderly wind-down when firms fail.
Key to IFPR is that firms must maintain sufficient capital to manage an orderly wind-down should they be at risk of failure. Again, the FCA stresses: the importance of having adequate governance arrangements for regular assessment of the firm’s prudential health; that firms should consider the appropriateness of its wind-down procedures; and that they must notify the FCA should the firm breach the required threshold conditions.
Closely allied to a firm’s financial resilience is the essential requirement to adhere to the FCA’s CASS rules where the firm holds or controls client money or custody assets. The CASS rules remain a significant priority area for the FCA, meaning that the swift return of client assets in the event of firm failure is just as critical as ever.
Firms should consider the need for strict CASS compliance, as risk has been raised by the FCA in respect of underinvestment in operations. Senior decision-makers should question how far they have invested in operational processes to offer sufficient protection of client assets. If processes are manual, and therefore prone to error or inefficiency, this could be identified as an area for improvement.
The way forward: Six actions to take
The FCA expects firms to take the time to fully consider the contents of their communications and be able to explain actions taken in response. Firms should incorporate this as part of their governance agenda, consider the implications for them, and take the following six actions:
- Review the contents of this letter and other correspondence issued by the FCA that may also have an impact on the business of your firm. All resultant actions identified must be recorded and tracked to completion.
- Ensure your firm is ready to meet the Operational Resilience requirements, including remaining within set tolerance levels by 2025.
- Ensure ongoing preparation for the FCA’s Consumer Duty. Implementation plans should have been approved at the end of October 2022, and the FCA recently issued feedback on a review of those plans.
- Identify operational areas that present a risk and would benefit from investment – then develop a plan for modernisation.
- For CASS processes and controls, identify where there is a reliance on manual tasks and plan for automation that delivers benefits for your organisation, including enhanced resilience.
- Horizon scan. Be aware of all upcoming regulatory changes and assess the impact on your firm. Thereafter, plan for how your organisation will meet the new requirements.