The FCA and authorised fund managers in 2020: what's important?
The Financial Conduct Authority (FCA) on 20 January 2020 published its latest "Dear CEO" letter to asset managers setting out its supervisory priorities and key risks posed by the industry.
This letter to the industry shows a clear determination to strike a new tone, in light of the suspension of the LF Woodford Equity Income Fund.
Even setting aside Woodford, in many ways, the FCA's promise in the letter to make a significant investment of supervisory resource into the asset management sector is unsurprising, considering the macro-economic picture and wider regulatory landscape outside the sector.
Firstly, global low interest rates over such a sustained period have made even the most cautious retail investors look for other options to make their money work harder for them. The FCA acknowledges in its letter the growing and changing nature of the industry. As the industry has become even more mass market, the legacy of the Retail Distribution Review also means that many investors are not advised. There is no surprise that the investors most impacted by Woodford were often those the least in the know.
In April 2014, the FCA swallowed the supervision of an additional 38,000 firms from the consumer credit industry and it points to its successes in raising standards in that sector. The FCA may regard its consumer credit efforts as a job well done: but the calibration of resource to the consumer credit industry arguably now needs to be reset.
Consequently, while over recent years FCA resource stretch and supervision through the FCA firm contact centre may have left some firms (even large ones) feeling that their regulatory relationship has been somewhat one-sided, in our view, it would be a mistake to assume this level of supervision will continue.
In the letter, the FCA identifies low overall standards of governance as a "key cause of harm" in the asset management sector. Governance is a key theme flowing through all the items of concern for the FCA. It is clear that the way in which a manager approaches governance will determine its effectiveness at addressing all these issues. The FCA sees governance as critical to the success of the industry but firms should not be deceived about what the FCA means in that word. No process, committee structure or paper trail will save a firm or a senior manager that disregards the best interests of the investor and tolerates damaging conflicts of interest sitting in plain sight. Governance means robust decision-making and meaningful challenge at every stage of the product life cycle. In reality, the letter and the FCA's comments on governance can really be distilled to a single clear message: investors must be placed at the heart of firms' decisions. In thinking this way, firms will also be mitigating reputational risk, and the danger of shifting regulatory goalposts.
To achieve the progress in the industry that the FCA desires, the regulator has changed its approach too. The final paragraph of the letter offers firms a direct line to a senior discussion with the FCA: perhaps a lesson learned from Woodford that the firm contact centre and existing channels of raising issues and concerns with the FCA do not work well, spot issues or act quickly enough in all instances. Equally, there has been a change in the FCA's day-to-day work. For example, fund approvals involve an increasingly forensic examination of not only the structure but also of the players and the payment flows. Firms can no longer expect a tick box exercise: the FCA will not be overlooking the difficult questions.
The challenge with all of this for CEOs, is human nature. Mirroring the FCA's fresh approach and taking a new look at products and services, how they are managed and overseen, trying to decide if they are fit for purpose or need root and branch reform, is not always easy when you live with them every day. A decision or practice which has gone unchallenged for many years may now sit on the wrong side of the regulatory goal post. However, identifying where change is needed is not always as straightforward as might be supposed from the tone of the FCA's letter.
The letter identifies the following key areas of focus.
There is nothing new here. The FCA notes that ensuring effective liquidity management in funds is a central responsibility for any authorised fund manager and it remains their responsibility even if they delegate investment management to another person. Referring back to its statements at the end of last year on liquidity management (see PS19/24: Illiquid assets and open-ended funds and feedback to Consultation Paper CP18/27 and FCA Dear Chair letter re effective liquidity management and good practice for authorised fund managers), the FCA has reiterated its expectations of managers to take appropriate action to ensure that liquidity risk is effectively managed. We consider it key to good liquidity management to keep policies and procedures under review. What may have been appropriate in normal conditions may not remain appropriate in times of market stress.
Value for money and the Asset Management Market Study (AMMS)
The FCA will focus in the first half of 2020 on understanding how managers have undertaken value assessments in their authorised funds. Noting the breadth of AMMS reforms, the FCA makes it clear that it expects to do more work in the future to evaluate its effectiveness. We are already seeing managers revisiting their fee structures and headline fee rates as part of this work.
Product governance and distribution
The FCA has also begun a review to assess how managers have implemented product governance requirements which it expects to complete in early 2020. As expected, following the suspension of the LF Woodford Equity Income Fund, host ACDs have been singled out by the FCA as causing concern due to a perceived lack of oversight over investment managers. The FCA is reviewing, in parallel with its product governance review, how effectively "host" ACDs undertake their responsibilities and how robustly they challenge their clients. The FCA's direction of travel seems to be to expect more from the depositary's oversight function, too.
The FCA reminds managers of the importance of transitioning away from LIBOR (which the FCA expects to cease to exist by the end of 2021). The FCA directs all managers to read the letter on LIBOR which, though directed at dual regulated managers, provides broad indications of the FCA's expectations.
The FCA notes that managers are heavily reliant on robust and reliable technology, which underpins the smooth operation of their businesses and the protection of client assets. It expects managers to ensure they manage technology and cyber risk appropriately, including through appropriate oversight of third party firms and intra-group service providers. Service providers will also have much to do here and firms should seek to understand how that might affect service provisions and costs.
Managing Brexit
The FCA reminds managers that they must take action now to be prepared for when the implementation period ends on 31 December 2020.
In our view, CEOs should act now and place the FCA's letter on the agenda for an extended Board or management committee discussion.
In the first instance, firms and their senior managers should ask themselves whether they even have the tools, management information and expertise to make a 2020 regulatory re-assessment of their business. Once all the required tools are in place, firms' analysis should be overseen directly by the management body and should take a forensic approach, focusing on the areas the FCA lists as its supervisory priorities, listed above.
In addition to focusing on these areas, each firm's review should look more holistically at the firm's business plan and services to determine if there is a gap between the firm's practices and regulatory expectations.
CEOs should ask themselves:
How well do our products and/or services function for investors?
Do they deliver on customer expectations, are they safe and good value?
If there was no detailed Rulebook and the only regulatory requirement was to act in the best interests of investors and treat them fairly, how would we be doing? Would we still feel comfortable?
What incentives do we have to place our interests above those of investors?
Firms which are not having meaningful discussions, at senior level, along these lines need to act swiftly to rectify the position.
The FCA also published a letter to the CEOs of alternative fund managers. Our overview of that letter is available here.
Lora Froud Partner
Andrew Henderson Partner
Alexandra Green Partner
Regulated funds and UCITS