The 'Dear CEO' letter that the Financial Conduct Authority sent to British wealth managers and stockbrokers on 13th June sets out the regulator’s concerns and the ways in which the sector might harm customers. In this article we suggest some responses to it.

The tone is strategic rather than enforcement-led, sweeping or uncompromising. It explains the risks that the FCA sees, its areas of concern and other important priorities. What messages can we draw from it and how should firms react to it?

I. A diminution in savings and investments through fraud, investment scams and ineffective trade execution

Fraud, scams and unsuitability

The FCA is concentrating on conduct that abuses trust – fraud, investment scams and highly unsuitable investments. It plans to use a range of (undefined) data to identify “the small number of firms who cause issues, deliberately or not.” Wealth managers would be wise to consider their potential to contribute to the risks that the FCA has identified.

A suggested response

Firms have access to a range of information when they are trying to assess the risks that they present. These include statistics about complaints, sales figures, financial promotion standards, product governance data, performance statistics and comparisons with relevant benchmarks.

Having evaluated this information, they might revise product governance policy (and supporting metrics), investment procedures and their Financial Crime Risk Assessments.

Order execution and handling

The FCA repeats the worry that it articulated in its Investment Platforms Market Study that wealth managers' order-handling procedures and execution processes do not lead to the best results. This assertion is based on an analysis of around 2 million trades involving £40 billion in value that occurred over a two-month period on the London Stock Exchange and other execution venues in the UK.

Their analysis concluded that only 80% of orders directed to Retail Service Providers or RSPs received prices at least as good as the best available across all UK venues. In addition to price, the quality of execution delivered to clients was also affected by the number of responses that quotes receive and time delays in the execution process.

The FCA also says that platforms may not allow consumers to trade in times of market distress, a concern it logically extends to any wealth manager using a single platform or a limited number of counterparties. There is also criticism of the quality of 'best execution' monitoring because of over-reliance on third parties, low levels of sampling and over-generous price variation tolerances.

In response, the FCA wants wealth managers to ensure that they have effective day-to-day execution processes, contingency arrangements for periods of market distress and clear, comprehensive and effective oversight and monitoring arrangements.

A suggested response

Firms have paid so much attention to best execution, especially when implementing MiFID II, yet there seems to be so little to show for all the effort. Although it is essential for them to continue to comply with the disclosure requirements introduced by MiFID II, wealth managers should ask themselves whether their order execution arrangements are structured in their clients’ interests. In doing so, each one is likely to have to conduct its own Transaction Cost Analysis (TCA) on the fills that it receives from its platform or counterparties. Second preference would be for the wealth manager to ask the platform provider for the TCA data and reports on its trading. Remember, it is in the interest of the platform or broker to demonstrate why it deserves the wealth manager’s business so, conscious of the obvious conflict of interest, this should be a cost-effective contribution to 'best execution' oversight. Of course, the TCA has to be interpreted, understood and acted upon. In these circumstances, it is important to work with the front office or an external trading consultant – either of these will also support the identification and measurement of other impediments to effective execution and identify alternative liquidity providers.

II. Loss of confidence in the sector through market abuse and/or insufficient or inaccurate disclosures of costs and charges

Costs and charges

The FCA’s website publicises its concerns about good practice and areas for improvement in the provision of information about costs and charges. It is worried that consumers are unable to understand the costs of services provided by wealth managers because they are not receiving sufficient or accurate disclosures.

A suggested response

The wealth management firm in question ought to undertake a formal benchmarking of its disclosures about costs and charges to the ex-ante and ex-post reporting requirements introduced by MiFID II. It ought to determine whether it discloses all transaction and incidental costs and charges to customers, including implicit transaction costs and performance fees. It ought to ensure that it uses accurate data when communicating with customers through financial promotions. Lastly, it ought to incorporate the feedback it receives from clients in a recent round of disclosures about costs and charges and consider how the process can be improved next time.

And while the FCA has your attention...

The FCA seasons the 'Dear CEO' letter with allusions to other risks that it believes could contribute to a loss of investment and confidence. These are such risks as market abuse, inadequate controls over clients' money or assets and the mis-management of conflicts of interest. These risks are not expanded on, so they appear as ubiquitous concerns rather than as the result of any specific behaviour that the FCA has spotted.

A suggested response

Risk 'identifiers' that firms might consider include suspicious order and transaction reports, client money and assets returns or CMARs, conflicts-of-interest inventories and market-abuse-risk assessments. We recommend that firms should review and update  their risk and control assessments for these three areas of risk.

III. Other priorities that the FCA has chosen to mention

The Senior Managers & Certification Regime (SM&CR)

The FCA sees the SM&CR as a step-change for the better regarding individual accountability and standards of professional conduct.

A suggested response

The SM&CR 'goes live' on 9 December but firms should be tackling it now, with practical and process-oriented plans for its implementation.

Withdrawal from the EU

It is important for firms to deal with the SM&CR now because the next round of Brexit uncertainty will soon come along. They should act in their EEA customers’ best interests, maintain clear communications and decide on the best ways in which to service them in accordance with national laws and national regulators’ expectations.

A suggested response

Firms should have their Brexit plans in place already but they would be wise to take account of the risk of regulatory bottle-necks in the fourth quarter of this year.

* Jonathan Wilson can be reached on +44 (0)20 3146 1869 or at jon@elliswilson.co.uk