The FCA's Dear CEO Letter on Asset Management Supervision Strategy

Introduction

On 3 February 2023 the FCA published its latest Dear CEO Letter addressed to asset managers and focused on supervisory priorities for the FCA’s asset management portfolio (“Our Asset Management Supervision Strategy”). This is the first Dear CEO Letter since the supervision of asset management passed to the Buy-Side Directorate of the FCA and the FCA’s launch of a new integrated regulatory structure across the whole of Supervision, Policy and Competition.

The letter outlines the harms to consumers and markets that the FCA thinks are most likely to arise from asset managers’ business models. The letter is informed by the FCA’s latest risk assessment and is based on information taken from its supervisory work, firm and fund authorisations, external data, and interactions with asset managers and global regulators.

Supervisory approach

The overarching theme informing the FCA’s supervisory approach for the asset management sector is governance. This is because the FCA has found ineffective governance to be “a root cause of some Asset Managers failing to mitigate material risks or progress towards better outcomes for their customers”.

In the current regulatory cycle, the FCA’s supervisory approach will be focused on assessing the effectiveness of firms’ governance in identifying, considering, and mitigating various kinds of harm. The FCA is concerned that levels of uncertainty are high at the moment, due to the rising cost of living, volatile markets, and a challenging economic environment, making it more difficult for firms to deliver good outcomes. They are asking firms to focus on good governance that will allow firms to manage risks in a timely and appropriate manner, and in turn to deliver good outcomes. The FCA’s supervisory approach to assessing firm’s governance will include a focus on firms with known issues or those which the FCA identifies as outliers. Firms will be assessed under each of the FCA’s five supervisory priorities.

In future supervisory engagement with asset managers, the FCA will consider whether Senior Managers and governing bodies have taken appropriate action to ensure that consumers and markets are adequately protected from the harms identified in the Dear CEO Letter. It is essential that Senior Managers and governing bodies consider whether the risks of harm outlined in the letter are present in their firms, adopt strategies for mitigating them, and are able to demonstrate to the FCA that that they have taken these steps.  Firms and Senior Managers that fail to do this risk finding themselves under scrutiny by the regulator.

Supervisory priorities

Product Governance

The FCA’s primary focus on product governance is in keeping with other recent initiatives of which asset managers will be aware, including the Asset Management Market Study, the Assessment of Value, and perhaps most importantly the new Consumer Duty. The combined effect of these initiatives has been a shift in how firms across the financial services sector service their customers.

The FCA expects firms to focus on quality and value of product offerings, quality of communications with customers, and delivering good outcomes for the relevant target audience. With respect to the Consumer Duty, the FCA warns firms to consider their responsibilities under the Duty to ensure they are prepared and have made changes to governance and controls to incorporate its requirements. See our client briefing “Implications of the new Consumer Duty for Asset Managers” for further information.

Under the product governance theme, the FCA intends to conduct two reviews:

• a review of the embeddedness of the Consumer Duty in 2024, focussing on price and value

• a follow up to the 2021 Assessment of Value review

Environmental, Social and Governance (ESG) and Sustainable Investing 

The FCA remains focused on greenwashing risks and ensuring that firms deliver on sustainability claims made in their product literature, following the recent FCA consultation CP22/20 Sustainability Disclosure Requirements (SDR) and investment labels and its predecessor, the Guiding Principles on design, delivery and disclosure of ESG and sustainable investment funds.

The FCA will soon publish the results of its thematic review on firms’ implementation of the Guiding Principles and it expects asset managers to benchmark their own practices against the results.  Firms should also consider outlining the extent to which net zero commitments have been considered in transition planning.

Overall the FCA is looking to ensure that governance bodies are appropriately structured to oversee and review management information about product development, ESG and sustainability integration in investment processes, third-party and proprietary ESG information providers, and other ESG and sustainability claims made by firms.

Product Liquidity Management

The FCA has, over the last few years, been considering potential liquidity mismatches between the terms on which investors can redeem and the time needed to liquidate fund assets to meet those redemption requests, and this has been the subject of:

• FCA policy statement PS19/24 Illiquid assets and open-ended funds and feedback to Consultation Paper CP18/27

• FCA consultation paper CP20/15 Liquidity mismatch in authorised open-ended property funds

• FCA policy statement PS21/14 A new authorised fund regime for investing in long term assets

This topic is particularly pertinent when markets are volatile, making liquidity risks relevant for a number of products. The FCA therefore asks firms to review their liquidity management tools and strategies to ensure they:

• are fit for purpose

• can be executed at pace

• can be scaled to handle additional demand when needed

Firms’ liquidity strategies should be able to meet redemptions requests and regulatory requirements while treating customers fairly.

The FCA will be conducting a multi-firm liquidity management review and will continue to work with the Bank of England and international regulators on elements of the financial system that have shown the most liquidity vulnerability, such as money market funds, with a view to strengthening resilience.

Investment in Operations and Resilience

The FCA is concerned for the operational health of the businesses it regulates. In particular, the FCA wants firms to invest more in operations and resilience and to be able to respond to challenges in a timely manner. The FCA is also focused on third party arrangements and stresses that, if third parties (whether external or intra-group) are essential to operational resilience, the regulated firm should ensure that such third parties are able to continually deliver the services required to allow the firm to meet its regulatory obligations.

The FCA asks firms to review policies and procedures and to notify it of any material operational failures, cyber-attacks or other circumstances specified in SUP 15.3. Asset managers are also reminded of the requirement to have set impact tolerances following the 2021 FCA policy statement PS21/3 Building operational resilience and to remain within them by 31 March 2025.

Operational resilience should be a priority for firms, since the FCA will be launching a range of proactive programmes to monitor and test asset managers’ ability to meet these regulatory requirements and may select specific firms for further review.

Financial Resilience

The financial resilience priority ties in with the FCA’s work on IFPR and increased monitoring of asset managers’ prudential health. The main goal is to ensure that asset managers have sufficient capital and liquidity to operate. Firm’s governance processes should allow for prudential health to be regularly and adequately assessed.

The FCA will publish initial observations on firms’ implementation of the IFPR requirements in the first half of 2023.  Firms should consider these observations and assess their processes accordingly, to determine whether any need to be strengthened.

Another focus under the umbrella of financial resilience is client money. The FCA continues to stress the importance of compliance with CASS to ensure client money is protected and capable of being transferred promptly if a firm fails.

The FCA will continue to assess firms' prudential health using internal and external data sources and may conduct targeted monitoring visits.

Next steps

The FCA expects CEOs to be responsible for ensuring that their firms meets FCA requirements, including the obligations and expectations set out in the Dear CEO Letter. CEOs should take all necessary actions to ensure these are met and to hold their Senior Managers accountable for managing these risks. 

How Eversheds Sutherland can help

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