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Readers of the latest Dear CEO letter to wealth managers and stockbrokers will note a distinct shift in the FCA’s tone. This is the regulator in combative, sabre-rattling mode for this “higher risk” sector – calling out the work it expects firms to have completed and warning CEOs of the tougher consequences that will follow where serious misconduct is identified.
The FCA uses the letter to acknowledge the scale and impact of the sector, highlight the harms it poses to consumers, detail the recent issues it has been tackling with firms, and signpost its plans for increasingly data-led “intrusive and assertive supervision”. Warning shots are fired on both financial crime and the consumer duty, with specific reference to a new, dedicated financial crime function focused solely on the sector. The FCA also name checks CASS, diversity and inclusion (including non-financial misconduct), and operational resilience as areas of ongoing supervisory focus.
Elsewhere, firms can expect to see more ad-hoc information requests on key topics as part of the regulator’s transition to being more data led, with the next survey scheduled for December 2023. The FCA plans to use this to analyse and detect the risks of harm they warn against in the letter, and undertake faster and more robust regulatory interventions where things are not to its liking. Potential focus areas include elective professional clients, portfolio turnover, complex/high-risk products, high-charging services and service delivery.
While the key messages within the letter are relatively simple, the consequences are likely to be challenging for many. It’s important to:
- take note of the key risks that are being highlighted
- understand whether and how your firm is exposed to these risks
- ensure you have invested the necessary time, energy and resources to manage them
- be ready to demonstrate this when the FCA sends out a tailored firm survey in December 2023
- expect more targeted and increasingly assertive supervisory action as a result.
We’ve been helping firms across all of the areas the FCA has called out. And while it’s clear that a lot of work has been completed, many firms still have further to go to meet these revised expectations, especially in known problem areas (like high-risk products) and in areas where the Consumer Duty has raised the bar (like price and value and consumer understanding).
The FCA calls out cross-sector losses to scams and fraud through “greed or incompetence”, and expects firms to “fully implement” the guidance in its Financial Crime Guide, which covers the full range of financial crime risks from fraud and money laundering to market abuse. The FCA has mandated implementation of this guide, making it likely to pose challenges for some.
Key areas of focus on financial crime include:
Transaction monitoring: The FCA makes it clear that it expects firms to monitor customer transaction patterns and understand whether they are expected or not. This is likely to require firms to have modern, robust systems and controls able to consume significant volumes of data, piece it all together and provide much deeper visibility into client behaviour. Not only may this require significant investment but, more importantly, far higher standards of data hygiene.
Financial crime risk assessments: The FCA reiterates its view that firms can still do more to understand the breadth of financial crime risk within their client bases and the way they offer products and services. This makes the quality and depth of any risk assessment key to success, as well as finding ways to provide a rich, detailed view that can be assessed and mitigated across the firm.
This will require firms to “dig deeper” into their risks at a more forensic level. A clear articulation of the risks a firm faces is the starting point, and this needs to be understood at the highest level and be baked into the strategy of the firm. Then, through appropriate and effective risk-based controls, you can clearly demonstrate how you’re managing that risk inside of your risk appetite.
Reliance: Taking greater responsibility and being more forensic about the financial crime risks customers pose will bite within the wealth management sector in areas such as reliance. Many rely heavily on the due diligence work done by others and, although we have seen a decline in recent years, it’s still widely used. Platforms, and firms interacting with them, use reliance, although the regulatory risk of this strategy can be complex.
Sanctions risk – effective screening systems: As a result of new and ongoing global conflicts, sanctions risk remains top of mind. Accordingly, the FCA has adopted its “intrusive and data-driven” approach to understand the effectiveness of firms’ sanction screening and payment screening capabilities. We have first-hand intel from clients that the approach being taken is certainly intrusive, having required significant time, money and resource from the firm outside of normal day-to-day operations. As the FCA increases engagement within the sector, so will the focus on the performance of quality sanction screening.
The FCA expects the implementation of the Duty to have already resulted in “meaningful change” at business, service and proposition level. So expect to be asked what you have changed as a result of the Duty and to be able to demonstrate those changes to the FCA.
The FCA highlights the following areas of focus (informed by the failings it has seen already):
Target market: You are expected to have a clear and detailed understanding of the needs and objectives of your target market. This will mean defining your target market not only in terms of wealth and portfolio size, but by other key factors such as investment goals, life-stage, sophistication, and knowledge and experience.
Ongoing alignment to consumer needs: You should ensure your products and services remain aligned to your consumer’s needs, risk profile and circumstances throughout the product/service lifecycle. The key issues here are likely to be around the quality and timeliness of fact-find data and ensuring services are being used as intended (for example, acting when you identify investment accounts with large, uninvested cash balances for extended periods).
Vulnerability: You are expected to reassess the vulnerability status of your consumers based upon the FCA’s guidance. Surprisingly, the regulator found that 49% of portfolio managers and 69% of stockbrokers identified no vulnerable consumers, even though 50% of us will be classified as vulnerable over our lifetime.
Suitability and appropriateness: This focus is driven by the findings from the FCA’s work on high-risk investments and the impact of the Duty on how firms design their products and services. The regulator also wants firms to ensure consumers are able to make effective investment decisions. It’s important that you:
- ensure consumers fully understand all aspects of their investment products and services – and not exploit any information asymmetries caused by limited financial knowledge and experience
- fully justify any complex and/or unregulated investments, with a clear view of the suitability or appropriateness for the consumer
- not uprate consumers from retail to professional unless this is supported by robust systems and controls, given the loss of protections
- ensure consumers understand any limitations to FOS/FSCS protection linked to the above.
Price and value: The FCA is using the Duty to target a number of areas that it believes result in or contribute to consumers receiving poor value. These include:
- charging for services which are not delivered (such as ongoing advice)
- overtrading on portfolios to generate high transaction fees
- placing consumers in high-charging products/services not matched to their needs (such as expensive discretionary services for low-risk consumers)
- not passing on fair interest and/or charging fees on client money balances
- not providing clear disclosures on charging structures and specific fees.
You are expected to review whether these issues apply to your business on an ongoing basis and make changes where poor value is identified.
We can help
Embedding the Consumer Duty into the day-to-day culture and running of your firm must remain a key focus. We discussed some of the main issues arising from this in our webinar.
Concentrating on making your financial crime framework more efficient and effective should also be top of mind.
Our team of experts can help you assess your financial crime framework, Consumer Duty implementation or CASS arrangements.