FCA requires improvements in wholesale broking

In its letter to wholesale brokers, the FCA has outlined the risks it sees in the sector and its supervisory focus for the next two years on improving firms' standards and market outcomes. The letter clearly outlines actions the FCA expects firms to take to manage the risks. The FCA also expects that by end-February 2023, all CEOs will have discussed this letter with their fellow directors and/or Board and have agreed next steps.

The four main areas of supervisory focus will be:

• Financial resilience
• Remuneration structures
• Governance and culture
• Control functions

The 2019 supervisory letter to wholesale brokers highlighted weaknesses in remuneration structures, governance and culture, and financial crime and market abuse controls. There is a sense of frustration in the 2023 letter that firms have not addressed these risks. Therefore, it is likely that the FCA will increase its supervisory focus (and take further action) if it finds firms continue to fail to effectively manage these risks.

This is not an area that was called out by the FCA in the 2019 letter. The FCA references the stark change to the macroeconomic environment in markets in 2022. There is likely to be heightened systemic risk and episodes of market stress over the next two years, as seen in 2022 in the energy, metals and government bond markets. It asks Boards to consider this context and reflect how their business models may expose them to risk, and how this can be mitigated.

The FCA is concerned about firms' competence to manage liquidity risk. Firms may continue to underestimate their exposure to intraday liquidity risks arising from their own business as well as from key clients and counterparties, especially those brokers that provide clearing services. 

The FCA asks firms to review the level of liquidity that they hold under the relatively new Investment Firms Prudential Regime (IFPR) and ensure that their assessment is commensurate with the risks they face. Where the FCA identifies material weaknesses or firms underestimating their liquidity needs, it will take action, which may include business restrictions and Board effectiveness reviews.

As the last 12 months have produced a series of events that were previously considered implausible based on historic modelling, the FCA suggests that firms stress testing should take account of more extreme events. It is likely that there may be systemic events, so stress scenarios should include a feedback loop with other market participants.

The FCA continues to see weaknesses in firms' remuneration structures that incentivise brokers to achieve short-term financial targets at the expense of client interests.

The FCA expects wholesale broker Boards and CEOs to ensure that their remuneration structures comply with the new requirements introduced under IFPR in January 2022. In its supervision, the FCA will focus on ensuring that firms are appropriately applying deferrals, malus and clawback when remunerating relevant staff. Where firms have failed to evidence that they have taken appropriate steps to implement the required IFPR remuneration requirements, the FCA will take further action. This will include routinely imposing additional capital requirements to account for the increased risk that weak incentives can drive.

Through its engagement with firms, the FCA has found that poor decision making and failures in oversight played a key role in exacerbating the extent of any underlying harmful issues or preventing them from being resolved earlier. The FCA suggests that Boards with a suitable mix of skills and experience that can provide effective challenge to management, are more likely to make better decisions, manage risks and to succeed in this competitive sector. Boards should be paying particular attention to financial resilience and the issues around remuneration that the FCA has highlighted.

Firm should also use the Senior Managers and Certification Regime (SMCR) to promote good decision making and individual accountability. The nature of wholesale broking means that relatively junior employees (in terms of traditional hierarchy) can expose their firms to significant risk of harm to the firm, their clients and the market more broadly. Firms can contribute to management of this risk by properly taking into account regulatory references when hiring new certified staff, and developing and maintaining a robust control environment. 

The FCA continues to find weaknesses in brokers' systems and controls around financial crime and market abuse — particularly it has found widespread deficiencies in wholesale brokers' client onboarding processes and surveillance controls. The FCA plans further work in this area in the coming year. The FCA expects firms to have adequately resourced risk management and control functions, with influence at Board level.

With this letter, the FCA has sent a strong signal to the sector that it expects demonstrable improvement in standards and market outcomes. The scope of review and action the FCA expects firms to implement is wide and the time frame is short. Through many years of experience, KPMG firms have developed methodologies that are designed to be agile, robust and proportionate in helping firms address their conduct risk, strengthen financial resilience and governance. KPMG firms can help with targeted health checks to identify areas of improvement, and reviews of remediation plans against regulatory expectations and industry practices. For more information, please contact us: