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Update to Conflict of Interest ‘Dear CEO’ letter

Where the focus is and what do firms need to do

Asset managers will recall that the Financial Services Authority (FSA) published a ‘Dear CEO’ letter in November 2012 concerning the management of conflicts of interest. This followed a series of thematic visits during which the regulator reviewed arrangements for the management of conflicts of interest at selected firms. The FSA was concerned that a significant number of firms visited were not managing conflicts properly. As a result, all asset managers were required to review their conflicts management, discuss the FSA paper at Board level and review their firm’s operations against the FSA’s findings to ensure they are effective and comply with the FSA rules. The FSA wrote directly to a number of firms requiring the CEO to provide a written attestation that their firm’s arrangements were effective and compliant with FSA rules.

The deadline for submitting the attestation was 28 February 2013 and the FSA will now be evaluating the responses received.

The FSA said that a second round of visits to firms will be conducted in 2013 which we understand will include more firms this time. Some of the firms who were required to provide a written attestation will be selected on the basis of their responses in the attestation, although the regulator has not said how they will be chosen.

What do firms need to be doing?

It is important that firms can demonstrate that they have conducted such a review and have either concluded that their arrangements are effective and compliant or put a remediation plan in place. The monitoring of conflicts and the management information received by the senior management will be important aspects of the arrangements for conflicts management. The FSA highlighted the culture within a firm as being central to conflicts management. The regulator considers that monitoring is more effective when conducted by both compliance and the business and where Boards receive adequate information.

The Financial Conduct Authority (FCA) becomes responsible for conduct regulation from 1 April 2013 and will certainly take a close look at how asset management firms deal with conflicts, not only in their regular dealings with clients, but from the very outset so that potential conflicts must be identified and steps to mitigate them are considered at the product design stage. The FCA is concerned that firms may design products or services that do not respond to real consumer needs or are not in the long term interests of consumers and plans to conduct thematic reviews of firm’s product governance processes during 2013. Firms should conduct a review of their existing and planned products and services to ensure that:

  • An appropriate target market has been identified;
  • Distribution strategies are likely to deliver fair outcomes for consumers;
  • Product oversight will enable the firm to check that the product is delivering what was promised;
  • Fee structures are not complex so that comparisons are difficult for consumers; and
  • Financial incentives for distributors and remuneration structures for portfolio managers do not incentivise mis-selling and excessive risk taking.

The FCA has made it very clear that it intends to pursue firms which do not deal appropriately with conflicts and firms cannot afford to ignore the warnings.  

A focus on corporate access

We have previously referred to the areas covered by the Dear CEO letter but would like to again draw firms attention to the use of dealing commission, as the FSA has expressed concerns over the practice of paying for corporate access.

Corporate access is often included as part of the research service provided by a broker and is rarely invoiced as a separate item. In its Dear CEO letter the FSA commented that “Firms were unable to demonstrate how brokers arranging for access to company management or providing preferential access to IPOs, constituted research or execution services.”

During March the FSA has repeated its concerns and raised the prospect of “multi million pound fines for fund managers found to be in breach of its rules”. ¹ The FSA expects firms to have a clear justification for using client commission to pay for corporate access because the regulator considers that a significant amount of clients’ money is being spent which may not be permitted under the rules.  

The Investment Management Association published a consultation paper on corporate access on 12 February 2013 in which it says that the FSA Dear CEO letter cast doubt on the legitimacy of paying for corporate access and describing this as a ‘new approach’ by the regulator. Whether or not the regulator is taking a fresh approach to this matter, firms will have to take a hard look at the relevant rules and assess whether any payments they make for access are within the rules. We anticipate that it will not be easy for many firms to show that such payments are within the rules.

 ¹Financial Times 4 March 2013

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