If you’re a UK-regulated alternative asset management firm, change is afoot.
In an August 2022 letter — mercifully, this is addressed Dear CEO, not Dear John — the FCA has set out the supervisory approach it plans to take moving forward. And while it’s not exactly radical, the devil is in the details.
Here’s a look at the letter’s key themes, and what they mean for the alternative asset management industry.
Who’s in scope?
The FCA kicks off the letter by reaffirming the proportionality principle — the idea that the level of oversight should be appropriate to a firm’s size and the risk it presents.
“As a rule,” the letter states, “alternative firms mostly deal with professional investors and counterparties capable of managing their own interests and our supervisory approach is reflective of this.”
If your firm deals with retail or elective professional investors, though, it’s a different story.
“These firms,” the FCA argues, “have a very different risk profile from a regulatory perspective, including the risk that investors are misclassified and subsequently denied appropriate protections.“
As a result, the FCA intends to supervise these firms more closely, including making sure they’re meeting the requirements of the Consumer Duty that’s coming into force in 2023.
What are the FCA’s new supervisory priorities?
With that out of the way, the letter goes on to set out the FCA’s key supervisory priorities for alternative asset managers.
There are three overarching themes:
- Consumer protection
- Strengthening the UK’s position in the international wholesale markets
- Environmental, social, and corporate governance, or ESG.
Let’s take a deeper look at the FCA’s key priorities under each theme.
Putting investors’ needs front and centre
The FCA aims to achieve two main goals in this area.
First, it wants to ensure retail and elective professional investors don’t inadvertently access products that are high-risk and, so, unsuitable for them. To this end, firms need to:
- Review their onboarding processes, and create clearly defined target markets and marketing restrictions
- Comply with a number of new rules, specifically:
- The new rules on marketing high-risk investments that are coming into force in December 2022
- The Consumer Duty, which we’ve already mentioned above
- Rules on promoting crypto-assets. These are still in the pipeline
- Fill out a questionnaire about their business model, products, investor categorisation, and control framework.
The FCA will follow up with firms it concludes are “exhibiting characteristics that increase the potential of consumer harm.”
Firms also need to produce evidence they’ve taken reasonable steps to ensure they’ve properly defined their target market and not exposed investors to unsuitable levels of risk.
The FCA’s second goal is to ensure firms manage conflicts of interest fairly.
“Poor management of conflicted positions,” it observes, “can encourage market manipulation or improper fund performance reporting, in turn producing poor consumer outcomes and loss of market integrity.“
The FCA plans to take “appropriate” enforcement action whenever it believes investors have been harmed.
Firms will also have to take into account the risks and conflicts that might arise if dominant shareholders overrule processes, and to consider reviewing shareholder structures to prevent this from happening.
Strengthening the markets
Given the current market turmoil, particularly following the UK government’s (not-so) mini-budget, it seems especially appropriate that the FCA has made strengthening markets one of its central themes.
The FCA’s plans have three pillars.
First, it wants to ensure market integrity and minimise the risk of disruption (if only it knew what would happen when this letter came out!).
Firms, particularly those that are highly leveraged or sell riskier investments, need to review their systems, controls, and resources to make sure they’re fit for purpose. The letter singles out risk and liquidity management as areas firms should focus on.
Second, firms have to put tailor-made controls in place to prevent market abuse.
“…market abuse controls across the sector need to be improved,” the letter says. “We expect firms to have strong prevention cultures and effective systems and controls to enable them to discharge their obligations under the UK Market Abuse Regulation.“
The FCA plans to consider supervisory, civil, and even criminal sanctions for non-compliant firms.
Third, the FCA is extremely keen to promote a healthy culture.
“…a firm’s corporate culture has a direct influence on its business practices,” it says, “with a healthy culture seen as critical for consumer protection and our ambition for well-functioning and world leading markets.”
With this in mind, firms need to ensure staff incentives don’t create scope for conflicts of interest.
The FCA also plans to look more closely at how senior managers and policies influence culture, with a special focus on firms that have founders or senior people in dominant roles.
With ESG-focused investment soaring — by 2026, PwC reckons ESG funds will make up 21.5% of all assets under management — it’s no surprise ESG compliance would figure prominently in the FCA’s supervisory plans.
“We have also seen growth of ESG investments in the Alternatives sector, with increases in the number of AIF (Alternative Investment Fund) registrations that have a stated focus on these themes,” the letter states.
“It is important that investors have confidence in the products they are being offered, and this has specific relevance for products labelled as being ESG focussed and with investment strategies benchmarked against ESG themes.“
With this in mind, when products are marketed as ESG-compliant, the FCA will be scrutinising product documentation and marketing materials more closely to make sure they’re clear and not misleading, and that firms’ actions are in line with their claims.
Put simply, if a product is marketed as being ESG-compliant, the FCA wants to make sure investors can be confident that the product is, in fact, ESG-compliant.
Second, and more to the point, every firm that offers ESG products will have to comply with the climate-related disclosure requirements the FCA has started phasing in starting in January 2022.
Preparing for the challenge ahead
To anyone who’s been following regulatory developments in the UK for any span of time, the content of the FCA’s letter shouldn’t be surprising. The FCA has been doubling down on its efforts in many of the areas — particularly consumer protection, ESG, and conflict management — for years.
That said, if you’re in scope, you’re going to have to ask yourself some tough questions, and review your processes to make sure you stay compliant. And this entails a significant amount of work.
Fundipedia can make this easier by giving you a global, unified view of your data — including your written processes, policies, and marketing documentation.
Our system collects, cleans up, and organises all your static and dynamic data in one place.
More importantly, it verifies accuracy and alerts you when something isn’t quite right, so investors can count on the information you’ve given them even after it’s been sent downstream.
Want to learn more about how we can help you stay compliant easily, efficiently, and cost-effectively, no matter how regulations change and evolve?