On 18 April, the Financial Conduct Authority (FCA) published a Dear CEO letter explaining its view on the key harms that brokerage firms operating in wholesale financial markets pose to their clients and markets, and setting a strategy to mitigate those harms.
It is the FCA’s view that brokers in the wholesale markets need to have an appropriate understanding of their obligation to act in their clients’ best interests and to support fair and orderly markets. The FCA believes that wholesale brokers have made less progress than other sectors in embedding a culture of good conduct, and to have not kept pace with, or under-invested in, the requirements of MiFID II and MAR. As a result, the FCA has concluded that action to raise standards across the sector has become urgent.
The FCA has identified four key drivers of harm in this sector, which it will focus over the next two years:
- Compensation arrangements that incentivise poor conduct by linking broker remuneration directly – and potentially exclusively – to the commission they earn (the so called ‘eat what you kill’ remuneration model). This model allows for little or no scope to recognise non-financial indicators of performance in a fair and objective manner. The FCA is currently reviewing market practices through a survey of 50 firms in the sector, which has shown so far “a worrying lack of awareness of obligations around the awarding of remuneration and, in some cases, material non-compliance”.
- Governance arrangements that do not give boards and senior managers the tools they need to properly oversee their staff and business, and act accordingly, failing to embed clear accountability for conduct standards. Individual brokers are often their firm’s principal revenue earners and client-relationship holders, and so have significant negotiating power. It is therefore important that firms have strong governance frameworks that allow their culture and values to drive decision-making across the business, including its approach to dealing with all kinds of misconduct. It is also critical that firms are headed by effective boards, with a suitable mix of skills and experience, to conduct appropriate oversight of the firms’ risks, strategy, policies, and controls. The Senior Managers and Certification Regime will provide greater clarity on roles and responsibilities of senior management and drive a greater sense of responsibility down through organisations.
- Workflows that do not recognise that a broker may be performing different regulated activities or acting in different capacities from time to time. As a result, they do not ensure the necessary arrangements are put in place to identify and address conflicts of interest, or to ensure compliance with relevant regulatory obligations. These weaknesses create a risk of substantial harm, as the arrangements to manage conflicts of interest and fulfil client-facing responsibilities effectively will often be different in each case. More specifically, the FCA remains concerned that brokers are still inappropriately charging commission to liquidity providers from whom they source liquidity, a practice the FCA has described as payment for order flow (PFOF). The FCA will soon publish a supervisory statement that addresses inconsistencies in the application of conflict of interests and PFOF rules, and considers appropriate interventions for cases of continuing non-compliance.
- Culture and mind-set that underestimates the risk of brokers committing or facilitating market abuse and financial crime through their role as market intermediaries, combined with poor monitoring and controls. Brokers acting for market participants can be used to place trades or agree deals that amount to market abuse. They can also be used to facilitate money laundering, if they fail to question or investigate suspicious activity when they are confronted by it. Brokers regularly hold significant non-public information, which if not properly managed and controlled, can easily be abused. In relation to Personal Account Dealing (PAD), the FCA states that it has commonly found poorly designed policies that do not meet requirements, and concerningly low levels of PAD trades being reported. The FCA says will look for improved surveillance arrangements (including communication monitoring), increased resource allocated to this task, and engagement from senior management.
The FCA has found serious deficiencies in resilience and readiness to combat cyber-crime; firms are, therefore, encouraged to properly test their IT controls and pursue necessary improvements in all parts of their businesses.
The FCA strategy covers the period to March 2021, after which the FCA will write to firms again to give an updated view of the key risks firms in this sector pose and an updated supervisory strategy.
What should you do?
The content of this Dear CEO letter should be shared and discussed with your firm’s board, to understand how the points raised by the FCA may apply to your business. If you need any assistance on how to fully comply with the regulatory requirements and the FCA’s expectations, please do not hesitate to contact us.