By Harry Barnes, Senior Compliance Consultant
On 28 September 2023, the FCA wrote to some 500 regulated corporate finance firms (CFFs) setting out an updated supervision strategy, the areas in which it considers such firms are failing, and their key areas of concern moving forwards. Here, we summarise those key areas raised.
Drivers of harm
Market abuse is an area where the FCA has been stepping up its supervisory reviews and enforcement action recently, viewing corporate finance activity as involving high risk of potential harm.
Through the market abuse monitoring it has already conducted, the FCA has seen ineffective information barriers, inadequate processes for the identification of inside information, poor wall-crossing controls, and incomplete or inaccurate insider lists in firms.
Poor management of conflicts of interest is another area where the FCA has identified issues, including incomplete or insufficiently detailed conflicts registers and insufficient discussion of conflicts or potential conflicts at committee and governing body levels.
Personal account dealing (PAD) is also of concern to the FCA – in particular the facts that some firms do not adhere to their procedure documentation in practice, staff are able to trade without the proper approval, and firms engage in poor restricted list maintenance.
The FCA is concerned, too, by firms dealing with overseas transactions and complex corporate structures, as it can be difficult to identify the ultimate source or recipient of funds raised or the identity of a counterparty.
In light of changes to the sanctions regime since the Russian invasion of Ukraine, it is expected that firms regularly test, review and update their financial crime systems and controls in order to ensure they are compliant with all relevant sanctions.
Many CFFs are considered low risk in terms of financial resilience as the impact of their failure would be low. However, firms that hold material client assets, are significant liquidity providers or advise a large number of AIM- or AQUIS-listed clients could cause a material impact specifically on those markets and consumers in the event of a disorderly wind-down.
This follows the FCA’s review of firms’ ICARA processes, in which it was highlighted that wind-down planning was often lacking and should be improved significantly across the industry.
The FCA will be conducting reviews of firms’ client categorisation processes. The rules in COBS 3.5.3R are an area of focus. They set out the qualitative and quantitative tests for elective professional clients and the procedure that must be followed, which is:
- The client must state in writing to the firm that it wishes to be treated as a professional client either generally or in respect of a specific transaction or product
- The firm must give the client a clear written warning of the protections and the investor compensation rights the client may lose
- The client must state in writing, in a separate document from the contract, that it is aware of the consequences of losing such protections
Failure to follow the rules in COBS 3.5.3R, or abuse of the corporate finance contact or financial promotion exemption, will lead to robust action by the FCA.
The Consumer Duty
The Consumer Duty applies to all retail business and is intentionally far-reaching with a wide perimeter. Firms are expected to assess the applicability of the Duty to both clients and corporate finance contacts. Retail clients that are classified as corporate finance contacts can be caught by the Duty as well as direct clients.
Firms asking clients to opt up to professional just to avoid regulatory protections, or incorrectly classifying retail clients as corporate finance contacts to avoid protections, would be in breach of the Duty.
Where firms fail to comply with the Duty, the FCA plans to hold senior management to account.
Dealing with problem firms
The FCA is concerned about firms holding incorrect or outdated Part 4A permissions (whether regulated activities or investment types). Therefore, the FCA expects CFFs to conduct regular reviews of the permissions held.
Where any firm does not undertake any business other than regulated corporate finance activity, there is an expectation that CFFs will have applied for the corporate finance limitation on their regulatory permissions. The FCA will be reaching out to corporate finance firms without the limitation about varying their regulatory permissions.
The FCA has also raised concerns about an inability to contact firms, and firms that do not respond properly or promptly to such requests from the FCA. In cases where there is a lack of response to the FCA, it will look to cancel the firm’s regulatory permissions.
As part of a wider effort to more thoroughly scrutinise regulatory returns, CFFs should expect the FCA to pick up on more issues moving forwards.
The FCA has been conducting reviews of firms’ systems and controls, as mentioned earlier. There is a particular focus on the creation and maintenance of insider lists, the maintenance of access logs, wall-crossings and the carrying out of market soundings. The FCA has said that it may extend these reviews to cover governance arrangements or further compliance arrangements.
The FCA has also said there is an expectation of active monitoring and systematic escalation processes around issues relating to market abuse, conflicts and PAD.
What needs to be done?
From the above, there are four key actions for firms to take:
- Determine whether or not the FCA should have categorised your firm as a CFF* and therefore sent you the ‘Dear CEO’ letter
- Review your systems and controls around client categorisation and market abuse to ensure they are meeting the expected standards
- Review the applicability of Consumer Duty to your firm and whether suitable implementation has been completed
- Conduct regular business model and regulatory permission reviews to ensure removal of unused permissions and/or the undertaking of any necessary ‘variation of permission’ applications
* The categorisation of a CFF in this case was based not on firms’ Part 4A permissions or limitations thereto, but whether for their annual fee calculation they attributed the majority of their regulated revenues to the A14 Corporate Finance Advisory fee block.
Contact the team
We have an experienced team that can conduct general compliance health checks as well as in-depth reviews of systems and controls on specific risk topics for CFFs identified by the FCA, such as client onboarding or market abuse.
Our expert Consumer Duty implementation team is able to advise on the applicability of the Duty and assist in its implementation.