The FCA sets out its Asset Management Supervision Strategy

On 3 February 2023, the FCA published a letter, entitled “Our Asset Management Supervision Strategy” which it has sent to the Chief Executives (CEOs) of firms within its Asset Management (AM) portfolio.

The letter, which supersedes the letter sent in January 2020 (see here for our summary) sets out:

• the harms to consumers or markets that the FCA considers most likely to arise from ‘Asset Managers’’ business models; and
• how it intends to supervise the AM portfolio in order to address these.

The risks which the letter flags have been identified from a mixture of the FCA’s supervisory and authorisation work, external data and its interaction with both AM associations, and other regulators.

CEOs are advised to consider whether the risks of harm set out in the letter are present in their firm and to adopt strategies for mitigating them.

The letter also warns that, in its future supervisory engagement with the firm, the FCA will consider whether the firm’s governing bodies and Senior Managers with accountabilities “have taken appropriate action to ensure that consumers and markets are adequately protected from these harms”.

The letter identifies five areas which the FCA regards as its supervisory priorities:

• product governance;
• ESG and sustainable investing;
• product liquidity management;
• investment in operations and resilience; and
• financial resilience.

For each, it explains how it views the risks involved, what it expects firms to do and what actions it will take.

Product Governance

The perceived risk

A key risk is that – for a number of possible reasons - the quality and value of product offerings, or the quality of communications with customers, do not deliver good outcomes for consumers or meet their needs.

The FCA believes that its New Consumer Duty (the Duty) will “fundamentally shift how many firms across the financial system serve their customers”, while several remedies introduced on the back of the FCA’s Asset Management Market Study (AMMS), including enhanced governance and product value assessments, focus on the key risk that products and communications do not meet consumers’ needs.

FCA expectations

The FCA expects firms to meet the New Consumer Duty when they have a material influence over retail customer outcomes.

CEOs should consider their responsibilities under the Duty and ensure they have made any necessary governance and controls changes in order to incorporate its requirements.

FCA actions

Following up on its 2021 Assessment of Value review findings, the FCA will look to identify outlier firms and review how firms have built maturity of ESG in value assessment considerations.

The FCA will also conduct a review in 2024, to assess how firms have embedded the Duty – this work will have a focus on Price and Value.

Environmental, Social and Governance (ESG) and Sustainable Investing

The perceived risk

ESG and sustainable investing are broad descriptors, which encompass a wide range of factors and investment strategies.

Some claims about ESG and sustainable investing risk being misleading or inaccurate and so may both negatively impact the integrity of the UK financial disclosure regime and harm consumer confidence.

FCA expectations

The FCA’s July 2021 “Dear Chair” Letter to Authorised Fund Managers (AFMs) set out its expectations on the design, delivery and disclosure of ESG and sustainable investment funds.

The regulator will shortly publish results of a review of some firms’ ESG oversight practices, and AMs should use this to benchmark their own practices.

The FCA notes that, when considering firms’ conduct in relation to ESG products, it intends to make use of information from the first TCFD-aligned disclosures under the rules in the ESG sourcebook (due in H1 2023) as well as its final rules on Sustainability Disclosure Requirements and investment labels.

FCA actions

The FCA’s attention will focus on the governance structures that oversee ESG and stewardship considerations – it will test how far firms deliver on the claims made in their investor communications.

The FCA will concentrate particularly on outlier firms identified in previous supervisory activities or other ongoing surveillance.

Product Liquidity Management

The perceived risk

Open ended funds can have a liquidity mismatch between (a) the fund’s redemption terms and (b) the time needed to liquidate fund assets to meet a redemption request. In more volatile market conditions, liquidity risks are relevant across a broader set of products.

FCA expectations

The FCA is concerned that, although firms have tools available to improve the quality of their liquidity risk management, they may not always be using these correctly or consistently.

AFMs setting a liquidity strategy to meet redemptions must meet regulatory requirements.

AMs should ensure exiting and remaining investors are treated fairly.

AMs should work with stakeholders to ensure that operational systems and processes are fit for purpose, can be executed at pace, and can be scaled to handle additional demand when needed.

FCA actions

The FCA’s work in this area will continue to focus on elements of the system that have shown liquidity vulnerability to market stress – this will look to strengthen resilience of money market funds, funds with significant liquidity mismatches, and transmission of risk from the non-bank financial sector to the wider market.

The FCA is currently completing a liquidity management multi-firm review and will work with identified outliers to improve practices – it will expect firms to consider their own governance, oversight, and controls in reference to that review’s findings.

Investment in Operations and Resilience

The perceived risk

Operational underinvestment can cause service disruption or failure, which can then lead to investor losses and market detriment to markets – and this can be amplified by increased market volatility or stress.

Poor operational investment can cause a decline in service for investors and lead to vulnerabilities that can be exploited.

FCA expectations

Firms should have appropriate measures to understand the operational health of their business and be able to respond in a timely manner.

Firms should ensure that they have sufficient information, skills, and knowledge to be confident that the service provided by any third party will allow the firm to meet its regulatory obligations.

Where a firm suffers material operational failures or cyber-attacks, it is expected to contact the FCA promptly. Additional rules and guidance on the circumstances in which firms must immediately notify the FCA of certain matters can be found in SUP15.3.

PS 21/3 includes the requirement for in scope AM to identify their important business services, to have set impact tolerances by 31 March 2022 and to stay within these tolerances by 31 March 2025.

FCA actions

The FCA will complete a range of proactive programmes to monitor and test the ability of AMs to meet their regulatory requirements and may select firms for further review.

Financial Resilience

The perceived risk

Since its letter of January 2020, the FCA has implemented the Investment Firms Prudential Regime (IFPR) for in-scope firms. Although few AM firms have failed, disorderly failure could cause significant material detriment to consumers and markets.

FCA expectations

In light of economic headwinds, firms should ensure they have sufficient capital and liquidity to operate and that their governance processes allow their prudential health to be assessed regularly. Prudential concerns should be identified early and appropriate action taken.

Wind-down procedures should be reviewed with reference to the FCA’s Wind Down Planning Guide and Observations on wind-down planning: liquidity, triggers & intragroup dependencies.

SUP 15.3 requires firms to notify the FCA immediately if they become aware of the firm failing to satisfy the threshold conditions.

Where the firm holds or controls client money or safe custody assets, the rules in CASS must be followed to ensure that clients’ safe custody assets and money can be transferred promptly if the firm fails.

FCA actions

The FCA will continue to assess firms' prudential health and conduct targeted monitoring visits.

In H1 2023, the FCA aims to publish initial observations on firms’ implementation of the IFPR requirements, which firms should consider when reviewing and strengthening their processes.