Jonathan Wilson, the project director at the City consultancy of Cordium, offers his views about the Financial Conduct Authority's progress throughout its first year.

Jonathan Wilson, the project director at the City consultancy of Cordium, offers his views about the Financial Conduct Authority's progress throughout its first year.

The FCA’s first birthday has given everybody the opportunity to look back at the progress it has made in the supervision of asset managers and also to look ahead to what the future might offer. In particular, it’s a chance to review how the original strategy proposed in the Journey to the FCA publication has been put into effect through thematic reviews and enforcement over the year-and-a-month since the regulator's inception on April Fool's Day 2013. It is also an opportunity to take stock of FCA Chief Executive Martin Wheatley’s vision for the asset management industry, which he announced last October.

Visions of better times ahead

The FCA’s starting point was an acknowledgement that rules- and principles-based regulation had largely failed. It recognised the fact that the market needed a more deep-rooted approach if it wanted to improve the public’s perception of financial services and the quality of its regulation.

Because consumers expected and wanted more, the government promised that the FCA would “make markets work well” and provide consumers with “a fair deal”. On this point, the Journey to the FCA stressed that the conduct of regulated firms would be at the core of FCA policy: “Meeting fair and reasonable [consumer] expectations… should be at the centre of how firms operate [and is] their responsibility in the first instance, not the responsibility of the regulator”. A firm’s business model is considered central to its conduct; so important that a new so-called 'threshold condition' was created to help offset the risks that a firm might pose to its customers and to the integrity of the UK's financial system through its business model.

Through its new style of supervision, the FCA proposed to heap extra scrutiny on conduct at the very tops of firms. At the same time, it also planned to take a “more assertive and interventionist” approach. This would include stepping in “earlier” and acting “faster” whenever it identified or became aware of problems.

So has the nascent FCA made its presence felt in the alternative asset management sector? And has it done so both from a supervisory and from an enforcement perspective?

The supervision of alternatives

In the first six months of its existence, there was little evidence that the FCA was pursuing a sustained campaign to improve standards in the asset management industry. Only two out of thirteen thematic reviews listed on the FCA’s website had implications for investment managers.

“Thematic Review 13/10 - Outsourcing in the Asset Management Industry”, published on 6 November 2013, contained the FCA’s findings on its predecessor’s concerns about the industry’s over-reliance on a limited number of service-providers, often part of large banking groups . The focus of the review seemed to catch the industry with an unexpected problem – one that, in fact, seemed too difficult to resolve and now relies on an industry-led Outsourcing Working Group to help map the way forward.

The other thematic review was “TR14/1 – Transition Management Review”. The FCA had observed failures in the management of conflicts of interest, poor governance and insufficient oversight. These were to be found  throughout the transition management industry and, as a result, it conducted a sweeping review to better its understanding of that market. The main findings highlighted the FCA’s concerns about 'asymmetries of information' and the need for better transparency, a better demonstration and application of the best execution rules, clearer marketing materials and contractual terms, and improvements in governance.

Enforcement actions

When it comes to enforcement actions, it is clear that the FCA is sincere in its desire to minimise risks to market integrity and consumers. However, the same trend of a marginal focus on alternative asset managers is evident.

Since last spring, the FCA has only promulgated one case against a firm in the asset management industry. This was against an administrator for its client money practices - an area the FCA and its predecessor had focused on intensively. It is entirely possible that these enforcement cases had long been in the FSA pipeline and that more time is needed for the FCA’s own enforcement agenda to emerge.

Of course, other enforcement actions and the cost of regulatory fines continue to provide important reminders of where firms should focus compliance resources, without being targeted at asset managers. These include anti-money laundering, anti-bribery and anti-corruption systems and controls, mis-selling and suitability, financial promotion and transaction-reporting. The highest fine imposed in 2013 was £105m, levied on Rabobank in relation to misconduct concerning the London Interbank Offered Rate (LIBOR), a valuable reminder of the gravity of (and regulatory risk inherent in) market abuse.

Looking to the future

Although past thematic and enforcement cases highlight some important points, they do not necessarily provide a reliable guide to the FCA's future activities. For that, we must remember what it said at its annual asset management conference in October 2013. Here it had the perfect platform to set out its agenda for the industry.

In his keynote speech, “Shaping the Future in Asset Management”, FCA Chief Executive Martin Wheatley rallied asset managers to provide greater transparency and better management of conflicts of interest, particularly the inherent conflict represented by bundled 'research' and corporate access services. Clive Adamson, Director of FCA Supervision, mapped out a broader “supervision strategy”, which he expected to focus on the role of asset managers as “trusted agents” who “do not let conflicts of interest interfere with the best possible decisions” for their clients. He asserted that “asset managers spend their clients’ money as though it was their own, and manage costs with as much tenacity as they produce returns”.

The issues arising from this vision are now emerging. Wheatley announced “Consultation Paper 13/17 - Use of Dealing Commission” in October 2013 (the consultation period is now over). The FCA took the opportunity to clarify its idea of what its rules meant, asserting that they allowed the use of dealing commissions (paid from customers’ funds) to buy execution- and research-related goods and services. Most recently, Market Watch 45, published in February 2014, sought to remind firms of their duty to obey the FCA’s 'best execution' rules in the best interests of consumers and in the context of making wholesale markets work well.

Other matters with which asset managers are currently dealing may well fall within this 'conduct' remit. Issues such as whether the implementation of the Alternative Investment Managers Directive (AIFMD) and service costs can be charged to the funds, the format and content of disclosures in fund documents, marketing strategies and their consistency with investment strategies, the quality and accuracy of periodic reporting to investors and the regulator or the independence of risk management functions and of valuation arrangements. These are all issues the FCA expects asset managers to approach from a 'conduct' perspective.

Culture shock

The supervisory challenge for asset managers, then, is perhaps best summed up in Wheatley’s own words. They are expected to achieve a “cultural transition”, not a hit-list of regulatory targets that the FCA publishes periodically. In other words, they should evolve towards a way of doing business that produces the right results and ensures that “consumers are treated more fairly”.

Firms must focus on corporate governance, transparency and accountability as a priority. They must also ensure that their systems and controls are commensurate with their commercial activities and business models and and able to deal with ever-changing regulatory policies and laws. As for the regulator, you must expect it to show interest in your business activities, to become “more probing on sources of revenues” to understand “how firms make their money” and, despite all this, to remain able to live up to its (and your consumers’) expectations.