On 9 August 2022, the FCA issued a “Dear CEO” letter to firms within the “Alternatives” portfolio setting out its Alternatives Supervision Strategy for 2022. The letter outlines the FCA’s views on the main risks of harm that alternative investment firms, and the markets in which they operate, pose to their customers. The FCA is asking firms’ boards to consider which risks are applicable to their business and whether they have the appropriate strategies in place to address them and meet regulatory requirements.
Marketing and Distribution of Alternative Investments
The FCA urges firms to consider the appropriateness or suitability of the investments they offer to their target customers, particularly retail and elective professional clients, and to review their onboarding processes and client categorization processes to ensure they are effective. Firms must also consider the newly published rules for the marketing of high-risk investments and the new obligations under the Consumer Duty. The FCA is planning to issue a questionnaire in the coming months to collect information about firms’ business model, products, investor categorization and associated control framework. The FCA will then follow up with any firm “exhibiting characteristics that increase the potential of consumer harm.”
Conflicts of Interest
In recent years, the FCA has observed a variety of conflicts of interest, including internal firm conflicts and firms seeking to bypass their own processes to make sales or increase their assets under management (AUM), all of which can cause harm to investors. Firms are reminded of recent fines levied as a result of inadequate management of conflicts (for example, see the Decision Notice and the Final Notice recently published by the FCA concerning two alternative investment firms). The FCA also calls on firms’ boards to review their procedures to ensure conflicts are avoided, managed or disclosed in a way that minimizes harm to investors and markets.
Market Integrity and Disruption
Firms are reminded to implement strong prevention cultures and effective systems and controls to ensure compliance with the UK’s Market Abuse Regulation. Should they fail to do so, the FCA may proceed with criminal, civil or supervisory actions. The FCA is also concerned about market disruption which can be caused by firms with highly leveraged or concentrated investment strategies which can negatively impact liquidity during stressed market conditions. Firms employing such strategies should review their risk management systems, controls and resources to ensure that these are fit for purpose. Firms' boards must ensure that risk functions are appropriately resourced and proportionate to the levels of portfolio and business risk.
A firm’s corporate culture has a direct influence on its business culture. The FCA plans to look at how senior managers and firms’ policies influence organizational culture. Evidence of staff being unable to speak up about poor and damaging behavior, together with senior individuals within a firm who occupy dominant roles, is an area of particular concern to the FCA. Diversity and inclusion are also important factors contributing to a firm’s culture. Boards are expected to consider diversity and inclusion as part of fostering a healthy culture. Last year, the FCA published a Discussion Paper setting out potential policy interventions in this area and plans to publish a Consultation Paper later this year.
With regards ro ESG the FCA's strategy will focus on the following matters:
- The FCA recognizes the importance of ESG-based investments and their contribution to addressing sustainable investment goals. However, the rapid pace of change in recent years has presented challenges to both industry participants and investors. Firms are encouraged to ensure that the documentation of products which are labelled as ESG focused are clear, not misleading and concise. In addition, firms’ actions should match their stated claims.
- The FCA will continue to assess authorized fund applications with an ESG or sustainability focus and calls on firms to ensure that marketing materials accurately describe their product, with funds offering clear and consistent disclosures.
- Firms with AUM of over £5 billion (bn) that are in scope of the FCA’s new rules on TCFD aligned climate-related disclosures contained in the new ESG Sourcebook, are reminded of their new obligations to disclose both qualitative and quantitative elements at both entity and product level from 2023. Firms with AUM of over £50 bn should already be complying with these rules. These new rules are contained within the FCA’s new ESG Sourcebook.
What Should You Do?
We encourage firms to:
- Review their onboarding processes and records for retail and elective professional clients to ensure they are fit for purpose and effective. Firms should also consider what enhancements may be required as a result of the new Consumer Duty and high-risk investment rules.
- Undertake a granular assessment of their conflicts of interest procedures to ensure conflicts are avoided, managed or disclosed in a way that minimizes harm to investors and markets.
- Implement strong prevention cultures and effective systems and controls to enable them to discharge their obligations under the UK’s Market Abuse Regulation.
- Ensure that their risk functions are appropriately resourced and proportionate to the levels of portfolio and business risks being taken.
- Review the documentation of products that are labelled as ESG focused to ensure these are clear, fair and not misleading.If in scope of the requirements, ensure compliance with the FCA’s TCFD aligned climate-related disclosure requirements if they already apply or assess readiness and prepare for compliance from 1 January 2023.
How Kroll Can Help?
Our team of compliance and regulatory experts are on hand to assist and support you with any of the matters raised in the FCA’s “Dear CEO” letter and any of the actions mentioned above.
Please reach out to your usual contact at Kroll, or one of the contacts listed below, if you would like to discuss further.