The Financial Conduct Authority (FCA) has released its latest portfolio letter outlining its approach to wholesale broker firms. Tina Bhardwaj reviews the key points and what firms can take from it.

In January 2023, the FCA sent a 'Dear CEO' letter detailing its view of the most significant risks arising from wholesale market broker firms, and what's driving those risks now. The main focus remains on wholesale brokers' responsibility to maximise risk management processes by making continual improvements in an increasingly volatile market. The FCA made it clear that firms need to reassess their frameworks to ensure that these targets are being met, and to carry out changes as soon as possible to mitigate the risks.

Financial resilience

One potentially damaging area to wholesale broker firms is the insufficient investment in risk management arrangements. This is occurring across the industry, leading to poor management of liquidity measures and other associated risks. In the regulator’s view, firms underestimate their exposure to liquidity risks and are therefore underprepared for potential periods of market volatility and stress. Adequate capital and liquidity are important controls required to minimise market disruption and the risk of failure and should be at the forefront of business planning within firms.

Firms should also prepare for the FCA’s intention to review liquidity management controls and oversight frameworks and put tools in place to meet these expectations and avoid regulatory action. Modelling your stress events in more extreme or reverse stress scenarios will highlight where changes are required. This should provide effective testing results that showcase what can be changed to reduce vulnerabilities and improve financial resilience ready for this review.

Remuneration structures

Another area of concern is the overall remuneration structure at wholesale broker firms. The FCA's focus is primarily on the structures around lower base salaries that create larger cash bonuses dependent on the value of trades concluded for clients, potentially leading to short-term financial targets at the expense of the clients themselves.

Remuneration structures should also comply with updated IFPR requirements. The FCA plans to ensure that firms are applying their deferrals correctly when remunerating relevant staff, and firms that fail to showcase this are likely to face regulatory pushback. To uphold this, the FCA is considering using a range of regulatory tools, including capital requirements, for increased risks. Firms should therefore review remuneration structures to check they're in line with IFPR requirements.

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Governance cultures

Upholding a sustainable and holistic culture is vital for wholesale brokers in order to make good decisions. The FCA views poor decision-making and weak oversight as key components to many underlying issues that firms face now. In turn, establishing governance from the top down – that combines a mix of skills and experience at the board level – is fundamental to improving a firm’s overall processes and providing better oversight.

Building a strong infrastructure allows firms to draw on and provide effective challenges to management, enabling better decision-making and risk management. To achieve this, firms should look to see how they can implement the Senior Managers and Certifications Regime (SMCR). Incorporating SMCR encourages good decision-making and accountability by understanding the nature of the business and the risks attached to it by having strong governance foundations in place.

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Control functions

The FCA is also looking at control functions. The letter highlights the regulatory view that widespread deficiencies exist within wholesale broker firms' controls for financial crime and market abuse mitigation, leading to poor risk management.

Remaining compliant means reviewing and ensuring your control functions are in line with current FCA policies and procedures. Acceptable risk management processes and compliance functions need to be in place and up to date with emerging risks that impact risk models and appetites. It's also important that these processes are developed around a culture that promotes ubiquity with these rules and is influenced from the top down. With these tools in place, you can then review your control functions and make sure you're taking the necessary steps to tackle financial crime and market abuse.

You're responsible for ensuring the correct rules are in place to meet FCA expectations. Consider reviewing your current processes to confirm that these standards are being met and that the correct action is being taken to mitigate any breaches or potential risks. Once this is achieved, you can be assured that your framework is up to standard and protected to enhance your overall operations.

For more information and guidance on meeting the FCA’s updated regulatory expectations, contact Tina Bhardwaj.

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