On 22 January 2020, the FCA published a Dear CEO letter that outlines its view of the key risks of harm that alternative investment firms pose to their customers or the markets in which they operate.
Key messages in the Dear CEO letter include:
- overall standards of governance, particularly at the level of the regulated entity, generally fall below the FCA’s expectations. Often the appropriateness of investment products for investors is not adequately considered. It is important that firms offering products and managing investments with exposure to alternative assets and strategies consider the appropriateness or suitability of those investments for their target investors. The Dear CEO letter goes on to set out some of the considerations including identifying the client type and investment need, when manufacturing or distributing products, recognising that alternative products may only be appropriate for a niche market. Where firms allow investors to opt-up to elective professional status, they are expected to robustly assess a client’s knowledge and experience of the relevant market, alongside meeting the relevant quantitative tests, and refrain from re-categorising a retail if they do not meet the threshold. The FCA will review retail investor exposure to alternative investment products offered by alternative investment firms. This will cover a broad spectrum of alternative investment products and strategies. In particular, the FCA will be testing that firms are aware of who their customers are and that they are placing a clear focus on acting in the best interests of their clients and funds;
- CASS oversight and controls are not always robust, creating a risk of loss to client money and custody assets. As part of its review of retail investor exposure to alternative investment products, the FCA will test whether firms that have permission to hold client money and safeguard custody assets are exercising those permissions under robust control frameworks to: (i) support the oversight of CASS operations; (ii) maintain adequate books and records; and (iii) operate in a CASS compliant manner; and
- weak systems and controls can lead to the risks of market abuse, other types of financial crime and harm or disruption to market integrity not being effectively mitigated. The FCA recently assessed the adequacy of market abuse controls in the sector. It visited a number of firms and provided individual feedback. The FCA also sent a questionnaire to a large sample of firms across the buy side. The regulator states in the Dear CEO letter that it may conduct similar exercises in the future. The FCA also reminds firms that where they adopt very high-risk investment strategies, particularly where significant leverage is employed, the FCA expect commensurately high quality risk management controls. The FCA may choose to undertake in-depth assessments of firms’ controls. The FCA will also pay particular attention to the risks of money laundering and terrorist financing when it reviews firms’ systems and controls.