In January 2023, the FCA set out in a letter issued to wholesale brokers its new strategy for supervising them. This letter details the FCA’s view of the most important risks arising from wholesale brokers, what drives those risks, and the FCA’s supervisory focus for the next two years.
The FCA expects firms’ Boards to discuss the contents of the letter, to consider how the risks apply to their business, and to take action to manage them effectively.
Since the FCA set out its last supervisory strategy for the sector in 2019, periods of sustained volatility have also resulted in heightened financial, credit, and operational risks in many parts of the markets where wholesale brokers are active. More recently, the FCA has particularly focused on clearing brokers that face heightened liquidity risks as a result of having to post collateral to clearing houses at short notice to cover their positions before having been paid by their own customers. During these periods, it found that some firms’ liquidity risk management and stress testing was not fit for the current market environment.
The FCA’s work suggests that wholesale broking firms generally continue to be behind others in stopping poor conduct and improving culture. This view is supported, for example, by recent work to assess brokers’ controls against financial crime, which found weaknesses in many firms, notably that few firms turn away new or existing clients regardless of the level of money laundering risk they pose.
An exercise on broker hiring practices raised concerns around the quality of brokers’ fit and proper assessments and firms’ willingness to hire individuals who had not demonstrated good standards of conduct at their previous firms.
The FCA finds that, too often, firms’ control functions are not properly resourced or empowered to effectively challenge the business, resulting in compliance controls that are inadequate for effective risk management.
The FCA has drawn on its recent supervisory work to identify the following key areas of focus for wholesale broking firms, as follows.
Financial resilience
The FCA is particularly concerned by weaknesses in clearing brokers’ liquidity risk management. It has observed that firms fail either to develop their own competence on liquidity risk management sufficiently, or to recruit expertise externally to help address this issue. As a result, firms continue to underestimate their exposure to intraday liquidity risks arising from their own business as well as from key clients and counterparties.
To improve financial resilience, firms should review the level of liquidity that they hold under the Investment Firm Prudential Regime (IFPR) and ensure that their assessment is commensurate with the risks they face. The FCA will be carrying out targeted work in this space.
Remuneration structures
The FCA’s 2019 ‘Dear CEO’ letter (which is available here) highlighted issues around weak incentive and reward structures that are understood to remain in place. In particular, the continues to see brokers receiving lower salaries with large cash bonuses based on the value and volume of trades they conclude for clients, which may lead them to focus on achieving short-term financial targets at the expense of clients’ interests.
In 2023, the FCA will focus on ensuring that firms are appropriately applying deferrals, malus and clawback when remunerating relevant staff. This will include looking at how industry practices have changed since the FCA gathered data in 2019, and what boards have done to assess the risks.
Governance and culture
Frequently in its engagement with firms, and particularly with firms that have been the subject of whistleblowing or enforcement investigations, the FCA has found that poor decision making and failures in oversight played a key role in exacerbating the extent of any underlying issues or preventing them from being resolved earlier. Firms should continue to embrace the Senior Managers and Certification Regime (the SM&CR) to promote good decision making and individual accountability.
The FCA explains that firms can help themselves to avoid conduct risk by properly taking into account regulatory references when hiring new certified staff and by considering appropriate risk mitigations with any individuals where adverse information comes to light in the hiring process. This is an area where the FCA’s work has identified weaknesses across a number of broking firms and that it continues to focus on.
Control functions
Financial crime and market abuse mitigation are areas where the FCA commonly finds that brokers have weak systems and controls, and firms should continue to develop safeguards to mitigate these risks. Recent work highlighted widespread deficiencies in wholesale brokers’ client onboarding processes to control financial crime and money laundering and the regulator intends to carry out further work in this field in the year ahead.
Next steps
By the end of February 2023, the FCA expects all CEOs to have discussed this letter with their fellow directors and/or Board and to have agreed their actions and/or next steps.
Thistle Initiatives has supported brokers for over 10 years as a trusted compliance and regulatory advisor. In addition to assisting you as and when our team of specialists can serve as your right hand in a meeting and complying with regulations. We understand the importance of staying up-to-date and compliant and are dedicated to providing the guidance and support needed to do so.
Since January 2022, we have been advising firms on IFPR best practices, including ICARA preparation, MIF reports, remuneration structures, and wind-down plans. Furthermore, we have provided governance, conduct, and culture consulting services to solo-regulated firms since the implementation of the SM&CR.
Are you looking for help with wholesale broking arrangements, compliance, or regulatory questions? Contact our specialist team now to schedule a free consultation. Get in touch with us by calling 020 7436 0630 or sending an email to info@thistleinitiatives.co.uk.