Agent, principal or venue? – FCA clamps down on broker capacity identification

5 August 2019

Agent, principal or venue? FCA clamps down on broker capacity identifcation


In its recent ‘Dear CEO’ letter to wholesale brokers, the FCA refers to the multiple capacities in which brokers act. It raises concerns that firms are generally weak in identifying the particular capacity in which they are operating for a given transaction. The regulator considers this weakness a substantial risk, explaining that the arrangements for managing conflicts of interest between brokers and their clients and for fulfilling responsibilities to clients are often different for different capacities.

The FCA makes it clear in the letter that it expects you to accurately identify the various capacities in which you operate and to apply appropriate safeguards to the related services to clients. There’s a clear warning that the regulator will use supervisory tools and market engagement to assess whether you have in fact implemented the necessary systems and controls. The industry is effectively put on notice of plans by the FCA to publish a supervisory statement on the application of the rules regarding capacity. Firms will then be expected to be fully compliant and will face intervention where this isn’t the case.

You’ll need clear policies, procedures and systems for identifying the trading capacities in which you act. You’ll also need controls to make sure that any consequent obligations to clients are met and potential conflicts with their interests are controlled. To the extent that you act as an agent for your clients – facilitating their trading by matching orders with buying/selling interests without using your own capital – you should have measures in place to accurately identify such trades and make sure you provide best execution to clients.

Similarly, in the context of dealing on own account – trades against your own capital – you’ll need desk-level operating procedures and systems. These will ensure the accurate identification and reporting of the various forms of this capacity, the delivery of any best execution owed and mitigation of potential conflicts with clients. You’ll need to differentiate between different instances. First, where you act in a pure principal capacity – where you’re not acting for clients. Second, cases where you’re dealing as principal with the client, for example where the client has accepted a quote you have provided. Third, cases where you execute clients’ orders by standing between them on a matched principal basis (simultaneous back-to-back trading).

Finally, if you operate an organised trading facility, you should have systems and controls to make sure your exercise of discretion – when deciding to place, retract or match client orders – stays within the permitted parameters. You also need a framework to make sure you meet your investor protection obligations, including best execution. And to the extent you engage in matched principal trading on that platform, then you must make sure this is limited to cases where clients have consented, for example via your terms of business. Outside matched principal trading, you should also take steps to ensure that you only act in a principal capacity for trades in illiquid sovereign bonds.

Responding to the FCA’s Dear CEO letter to wholesale brokers

Bovill is working with the broker community to respond to the FCA’s Dear CEO letter in a number of areas. We can provide a comprehensive healthcheck against all of the issues raised by the letter, and also regularly help firms to develop their regulatory compliance frameworks.

This article is part of a series looking in detail at each of the FCA’s areas of concern.


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