What’s on the FCA’s radar: the supervisory strategy going forward

'Dear CEO' letter

Through the letter to the asset management sector the FCA reiterates that good governance and healthy firm culture are critical to achieving positive outcomes. Over the next year, the regulator will be ensuring that governance arrangements effectively assign accountability and are proportionate to the investment firm size and risk.

Earlier this year, the FCA confirmed it will engage with the industry to review the AIFMD regime in the UK, aiming to streamline regulatory requirements and gather data that aligns with its supervisory objectives. This could signal a reduction in reporting which would be well-received by Collective Portfolio Management Investment (CPMI) and Collective Portfolio Management (CPM) firms. 

 The supervision priorities in 2025 are broken down across 3 distinct areas:

1. Investment in private markets 
2. Enhancing financial system resilience against market disruptions
3. Ensuring positive outcomes for consumers

Investment in private markets 

With the UK being the largest centre for private fund management in Europe, investors are more frequently looking towards private markets for diversification and returns. The FCA recognises that with this growth comes an increased risk in respect of inappropriate valuation, this is due to the lack of regular price information that would exist in public markets. Therefore, the FCA believes that conflicts of interest or insufficient expertise will increase the risk of inappropriate valuations. As a result, the FCA performed a multi-firm review on private market valuation processes. Firms are advised to review the findings to ensure their own processes are robust and that effective oversight and governance procedures are in place. There were some very interesting and useful observations made which we have summarised in the section below.

Market integrity and disruption

With disruptive market events becoming more commonplace over the last few years, the FCA has recommended that firms take on board the valuable insights from the System Wide Exploratory Scenario (SWES) report in order to help improve risk management practices. The FCA confirmed that it will continue to follow a data-led approach to identifying outlier firms and funds regarding risk management and it will focus on those with high leverage, illiquid or concentrated investment strategies.

Consumer Outcomes

Throughout the letter the FCA directed firms back to the importance of consumer duty and especially continuing to develop their monitoring capabilities to ensure consumers are receiving good outcomes. The FCA is currently undertaking a multi-firm review of unit linked funds, which is focussed on assessing price and value across the value chain to ensure positive outcomes for investors. The findings are expected to be published later this year.  

Due to the recent growth in model portfolio services (MPS), the FCA announced that it will start a multi-firm review in 2025 to see how firms are applying the duty to MPS and to help share good practices across the industry.

Other targeted work

In addition to the FCA’s key areas of focus it will also be targeting:

• Sustainable finance - engaging with firms on the application of the sustainable disclosure requirement (SDR) and Investment Labels regime
• Financial crime - reviewing the effectiveness of financial crime systems and controls with a focus on AML controls in private market funds

Multi-firm review of private market valuations

The multi-firm review focuses on the valuation processes for private market assets, giving a comprehensive perspective to asset managers, alternative investment fund managers (AIFMs), investment and portfolio managers, investment advisers, as well as other stakeholders of the sector. The key findings and practical considerations for firms are outlined below.

Conflicts of interest

Potential conflicts between firms and investors should be identified and managed, as these could impact the judgement applied in valuations and result in poor outcomes for investors. The FCA has also pointed out that any conflicts should be documented in sufficient detail to demonstrate strong awareness and control over them. The areas in which potential conflict of interest could arise include investor fees, asset transfers, redemptions and subscriptions, investor marketing, secured borrowing, uplifts and volatility, and employee remuneration.

Governance arrangements

Firms should establish clear accountability and robust oversight of the valuation process, as well as accurate and detailed record-keeping of how valuation decisions are reached.  

Functional independence and expertise

Full-scope UK AIFMs performing valuations themselves internally must ensure that this is conducted impartially and functionally independent from the portfolio management. Firms should look to have a dedicated function in place for the purposes of valuation and the staff involved should have the required level of expertise and independence. 

Other notable guidance 

• Firms should aim to improve the transparency of their reporting and engagement with investors, by providing details on fund-level and asset-level performance, which will ultimately lead to increased investor confidence in the valuation process and therefore more informed decision making. 
• There should be a defined procedure for ad-hoc valuations to improve the robustness of the valuation process and outcome.  
• Any methodology applied requires judgement so that the valuations are appropriate and fair and these are applied consistently; the industry guidelines allow firms to apply best practice.
• By using third-party valuation advisers, the process can be considered more independent with added control, although the potential conflicts and limitations that could arise should also be considered. 

So, what’s next?

Following this review, the FCA is intending to liaise with firms and industry bodies in analysing the challenges and work towards further enhancing the valuation practices. The findings from this multi-firm review serve as the foundation for additional work that the FCA will be  carrying out. 

'Dear CEO' letter

The 'Dear CEO' letter starts by evaluating the previous supervisory cycle and the FCA’s conclusions from the numerous reviews and assessments that have been conducted. The three most significant findings and areas for improvement were as follows:

1. Liquidity risk management and stress testing that is not fit for purpose. All firms should review the feedback from the multi-firm review which has been analysed in more detail below. 
2. Improper anti money laundering controls. Due to the inherent risk of wholesale brokers executing trades that would facilitate with financial crime, the FCA undertook the Money Laundering through the markets assessment to review the controls in place at the selected firms. The overall feedback from the review was mixed and the problem areas observed were incomplete firm wide risk assessments, inadequate methodologies for risk-rating clients and reliance on other parties within the transaction chain to complete customer due diligence.
3. Inconsistent application of the remuneration code. The most apparent issues were the avoidance of the rules relating to deferral and non-cash variable remuneration. Firms should also consider the balance between fixed and variable remuneration. 

The letter also outlined the FCA’s strategy for the coming two years and the underlying message that shone through was for firms to assess and enhance their internal culture. The FCA’s programme will focus on 4 strategic areas:

Broker conduct

Businesses should focus on how they manage their brokers to ensure risks such as insider trading, market abuse and misconduct are detected. If these risks do occur, firms should ensure that appropriate steps are in place to be followed. The FCA will take enforcement action where there are a lack of controls in place.

Firm wide culture

The Non-Financial Misconduct (NFM) survey was launched in 2024 with the purpose to better understand how firms record and manage allegations of NFM. The FCA will use the results of the survey to engage with outlier firms to further review policies and procedures for raising NFM concerns and how this is managed once concerns are raised.

Business oversight

The FCA expects to see brokerage firms with positive culture and strong business oversight, and through the work the FCA is conducting on broker conduct it will also be assessing the control environment framework at investment firms. One area of interest will be how firms are using remuneration tools such as deferrals or malus and clawback in instances of misconduct.

Financial resilience

Wholesale brokers are reminded to maintain adequate capital and liquidity to avoid market disruption if they fail. Firms should act on the liquidity review feedback and have strong contingency plans in place. 

Multi-firm review of liquidity risk management at wholesale trading firms 

Shortly after the 'Dear CEO' letter, the FCA published the anticipated multi-firm review on liquidity risk management, which focussed on a sub-set of wholesale firms. It is important to note the findings of the multi-firm review are relevant to all firms in the scope of the Investment Firm Prudential Regime (IFPR), including parent entities of Investment Firm Groups (IFG).

The FCA took a practical approach by analysing a wide range of information including:

• Regulatory returns;
• Detailed questionnaires;
• Meetings with firms; and 
• Review of the Internal Capital Adequacy and Risk Assessment (ICARA) process documentation. 

The significant deficiencies observed as part of this review include:

• A failure to identify the full spectrum of their liquidity risks;
• Underestimating the extent of their liquidity risk exposures;
• A heavy reliance on instant access to liquidity resources to address immediate liquidity requirements; and 
• Non-functional contingency funding plans. 

Senior management teams are reminded of their responsibility to ensure that they adhere to the relevant requirements of the Senior Managers and Certification Regime (SM&CR) and Principle 11 to ensure that the data submissions are of the highest quality and accuracy.

So, what are the next steps?

The FCA is planning workshops and roundtables with firms, industry trade bodies and consultants to share its observations and findings. Firms are encouraged to actively participate in practical discussions to help improve the liquidity risk management of the sector.

Liquidity risk management is a fundamental pillar for regulatory compliance, and it should be revisited frequently by ensuring that consideration has been given to the impact of any market events and changes in business operations. 

The FCA’s feedback is an excellent resource for firms to assess the effectiveness of their own liquidity risk management. The good practices noted in this review should be considered as the minimum for all firms. Failure to implement the recommendations from the review could result in the FCA imposing Individual Liquidity Guidance (ILG) for firms.

The expectations for firms following the multi-firm review into liquidity risk management are high. We will be providing readers with further updates and insights into the requirements to help firms stay ahead of the curve. Keep an eye on our future communications for more expert insights.