Wholesale brokers – a tough stance from the FCA

In its Dear CEO letter, the Financial Conduct Authority (FCA) notes that the UK’s wholesale broking market is generally performing well, despite considerable ongoing M&A activity. However, there is always room for improvement and the FCA has highlighted three key areas for further progress, alongside its new strategy for the next two years.

Three areas with room for improvement 

While many firms have implemented regulatory feedback over the last two years, work has been patchy across the sector with some firms lagging behind. Addressing those outstanding gaps will maintain a consistent, healthy and competitive sector. 

1 Prudential risk management 

A small number of brokers still don't have a liquidity risk management framework that’s fit for purpose. This increases the risk of financial losses for clients and a disorderly exit from the market, at a time when many firms are ceasing their business activities.

To ensure financial resilience across the sector, the regulator has directly imposed capital and liquid guidance for some firms. This is undoubtedly an expensive approach for firms, and may result in higher capital and liquidity requirements as the regulator will err on the side of caution. It’s worth noting that poor calculations can go either way. Firms with reduced buffers pose a risk to financial stability, while too high buffers can reduce cash flow and negatively affect competition. 

The FCA will publish an observation paper to summarise what good looks like and to benchmark best practice. Firms need to proactively address and prioritise prudential risk management, supported by robust stress testing to ensure greater resilience across the sector. 

2 Financial crime 

The FCA considers wholesale brokers to be underestimating the risks around money laundering. Following its Money laundering through the markets (MLTM) review, the regulator found that control environments were of varying quality. Poor controls could inadvertently facilitate money laundering and provide greater potential for market abuse. While there have been improvements in collaboration between trade surveillance and monitoring teams, the FCA identified some specific areas of concern:

• Deficiencies around business-wide risk assessments, which were sometimes missing or incomplete
• Inadequate methodologies for client risk-rating
• Over-reliance on others in the transaction chain to carry out due diligence
• Limited information sharing between firms
• Insufficient awareness of the MLTM suspicious activity reports (SARs) glossary code

In order to ensure that their anti-money laundering and counter-terrorist financing (AML/CTF) framework is fit for purpose, firms need to review their controls and check that they meet the FCA’s recommendations for improvement, as outlined in the MLTM review. 

3 Remuneration and broker misconduct 

The Remuneration Code has been inconsistently applied across the sector, with some firms not having an appropriate policy in place. For others, key areas of the code are lacking, such as rules around deferrals and non-cash variable remuneration. It’s essential to address these areas promptly as poor remuneration codes can affect firm-wide culture and conduct, and drive negative behaviours. 

Firms need to take immediate action to make sure their remuneration policies are robust, fit for purpose and compliant with the rules. The FCA may impose higher capital requirements for firms that continue to fail in this area, in line with the heightened risk profile it presents. 

Further planned work includes testing to see how well remuneration policies are used for disciplinary purposes for financial and non-financial misconduct.

FCA strategy for the next two years 

Given that regulatory and conduct compliance varies across the sector, the FCA will be taking steps to bring non-compliant firms into line. The regulator is keen to make sure these firms do not harm the market, negatively affect competition or put compliant firms at any kind of disadvantage. As such, the FCA may impose higher capital requirements, board effectiveness reviews or business restrictions for firms that continue to fall short of regulatory expectations. 

Over the next two years the FCA will focus on the following four areas. 

1 Broker conduct 

The FCA notes that brokers are key revenue earners for firms, which can incentivise employers to leave poor conduct unchecked. However, good conduct is paramount to reduce the risks of insider trading, market abuse, overcharging clients and abuse of gifts. Non-financial misconduct is also a key concern, including bullying, discrimination or harassment. Firms need to take strong action to identity and prevent misconduct. Where the FCA assesses material weakness in conduct frameworks, the FCA will take enforcement action against firms or individuals, or place restrictions on business activities. 

2 Culture 

The FCA reiterates that good culture underpins good conduct and is led from the top down. As such, it’s important to have diverse boards and senior management, with a broad range of experience and skills. This will provide better challenge at a senior level and reduce the potential for groupthink, which can impact every category of risk.

Last year’s non-financial misconduct (NFM) survey highlighted the difficulties in identifying associated issues, and the need for further work to support a good culture and prevent non-financial misconduct. The FCA will use the survey as the basis for further work in this space, with particular focus on: 

• policies and procedures for reporting NFM
• how firms handle reported NFM cases
• processes to ensure fair outcomes. 

3 Business oversight 

Building the FCA’s focus on conduct and NFM, the regulator needs greater assurance over wholesale brokers’ control environment. This includes detecting and preventing harm from negative behaviours, and effective use of remuneration tools such as malus, deferrals and clawback to deter negative behaviours. The FCA is keen to understand how firms are using these tools and if they're being applied effectively.

4 Financial resilience 

Ultimately, firms need to continuously assess their liquidity in line with the Investment Firm Prudential Regime (IFPR) and failings in this area could lead to higher capital and liquidity requirements.

As such, the FCA will continue its work on prudential risks in the wholesale brokers market, to ensure firms have adequate capital and liquidity for an orderly wind down. Firms with outstanding actions from the liquidity review will need to complete the work and make sure they meet good practice. The regulator will assess contingency funding plans and frameworks to make sure firms can withstand a stress event.

The FCA expects CEOs to consult their boards or directors and agree next steps by the end of March 2025.

For insight and guidance on meeting the FCAs expectations, get in touch with Paul Young or Michael Haggis. For information on financial crime compliance, contact Lucinda Hallan.