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In a “Dear CEO” letter sent in early August 2022, the FCA outlined the robust approach it will take to supervising companies in its alternative asset management portfolio – namely FCA-licensed hedge funds, private equity firms and private equity firms. companies that directly manage and advise alternative assets. Affected companies can expect the FCA to focus on excessive investment risks for professional retail and elective investors, conflicts of interest, inadequate mitigation against continued market disruptions, poor controls market abuse and culture, as well as ESG disclosures.
The FCA has recognized that most companies in the alternative space deal with professional clients, and these companies should expect the FCA to monitor them proportionately. However, there are companies that deal with retail and elective professionals and as such the FCA will check these companies’ business models and approach to consumer protection – a particular focus for the regulator right now with the upcoming introduction of the new Consumer Duty.
The letter sets out what the FCA considers to be the main risks associated with these businesses and notes that they are in line with the business plan’s commitments to customer needs, strengthening the UK’s position in global wholesale markets and the G. While the letter provides a useful summary of the FCA’s guidance for companies in this sector, the key themes should be familiar to companies who have been paying attention to the mood music emanating from the regulator for some time, as well as to his precedent update from January 2020.
The first set of monitoring priorities related to customer needs:
- Consumer risk level
- The FCA is concerned that the targeting of traditional investors, informal governance and inadequate categorization of investors in some companies may mean that some professional retail and elective investors may access high-risk products that are not appropriate or suitable.
- Firms were asked to ensure appropriate investor assessments were conducted (and firms that onboarded retail clients and elective professionals were required to review the effectiveness of their processes), and only appropriate investors have been offered certain investments, with clearly defined and enforced marketing restrictions and target markets.
- Companies were also reminded of a number of relevant regulatory developments, including marketing restrictions and stricter standards for high-risk investments which come into force in December 2022 and February 2023, new obligations under the consumption obligation coming into force in July 2023 and July 2024, and the final planned rules on the promotion of crypto assets.
- The FCA also explained that it would require all alternative firms to complete a questionnaire about their business model, products, investor categorization, controls, target market and how customers are protected against inappropriate levels of risk. – with a risk for companies where there are concerns. on the harm to consumers from further regulatory scrutiny.
- Conflicts of interest
- Companies were reminded of the Principle 8 requirement to fairly manage conflicts of interest, and the letter noted that failure to do so poses risks of poor client outcomes and damage to the integrity of the market – as well as damage to shareholders.
- The letter also highlighted the need for companies to consider the risks and conflicts arising from cancellation processes by dominant shareholders and to consider the impact of their shareholding structures.
- The letter referred to the recent high-profile financial sanctions it had imposed on blue crest and MAG for inability to adequately manage conflict.
The next set of priorities have been grouped around strengthening the UK’s position in global wholesale markets:
- Market Integrity and Disruption
- The letter said investment managers must manage risks to investors and that for some hedge funds, those risks can be significant. Arrangements should be proportionate to the nature of the business and where these risks are higher for investors, or where funds are highly leveraged (eg for larger hedge funds), firms should ensure that their systems, controls and resources are fit for purpose.
- Current risks resulting from recent heightened market volatility and rising interest rates mean that companies need to have particularly robust risk and liquidity management and need to ensure that their risk management functions have the resources appropriate. The FCA has assessed the risk controls of alternative businesses and will continue to do so where the risk of contagion is higher.
- Market abuse
- The FCA has previously noted that controls across the sector need to be improved. Controls must be tailored to individual business models – with the threat of penalties as a deterrent.
- The FCA has emphasized the importance of a healthy corporate culture. In particular, companies must ensure that employees receive appropriate incentives in a way that does not increase conflicts of interest and the potential for harm.
- The FCA also noted that it will examine how senior executives and company policies influence culture – including a particular concern with speaking culture, as well as the importance of diversity and inclusion – with a consultation paper expected later this year.
- Companies that have founders or other senior executives in dominant roles should expect to receive special attention on their cultures in the next round of monitoring.
The final topic covered in the letter is ESG – which has recently been a hot topic for the FCA given the number of companies increasingly saying they will focus on ESG assets – with particular emphasis on funds with clear and precise marketing material. consistent disclosure. The letter referred to the fact that the companies concerned must comply with the gradual introduction of requirements for large managers of alternative investment funds to make disclosures in line with those recommended by the task force on climate-related financial disclosures. .
Nothing in the letter should come as a surprise to companies – consumer protection has remained central to the FCA for years, conflict management has been reiterated by the regulator in oversight and enforcement contexts, and ESG disclosures are central to the concerns of global regulators at the moment. That said, this letter should draw the attention of senior executives at alternative companies to how they are addressing these issues and what shortcomings they identify.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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