The FCA’s new strategy for supervising wholesale brokers: addressing key harms

The FCA, in its recently published supervisory strategy for wholesale brokers, recognised the critical role these firms play in well-functioning financial markets. While acknowledging the sector's overall strength and competitiveness, the FCA emphasised the need for further action to mitigate potential harm to clients and markets. In particular, the FCA noted that firms need to have effective and comprehensive risk and control oversight frameworks to facilitate proactive detection and prevention of harm, whilst deterring or penalising undesirable behaviour.

Although the FCA has raised several key messages, below, we highlight key considerations related to prudential matters, risk management and governance. 

Prudential risk management: a critical focus area

Building on its recent focus on clearing brokers, the FCA will continue to scrutinise liquidity risk management frameworks (LRMF) across the wholesale broker sector. This follows instances of liquidity risk crystallising due to deficient risk management. As highlighted in our overview of the FCA’s Investment Firm Prudential Regime (IFPR) implementation observations, liquidity continues to be an area where further work is required. For wholesale brokers in particular, this would include liquidity risk management arrangements, consideration of the dynamic nature of liquidity requirements and sufficiently time-sensitive monitoring arrangements. We have observed that this has led to the FCA imposing levels of liquidity (and capital) threshold guidance on firms following supervisory reviews, especially where intra- and inter-day settlement risks have not been adequately assessed.

All firms should also consider the FCA’s earlier public feedback on IFPR implementation, which challenged the adequacy of various elements of firms’ underlying (enterprise-wide) risk management frameworks, including risk appetite frameworks, risk identification, assessment, stress testing, reporting and risk mitigation arrangements.

The FCA also highlighted the continued strategic focus on prudential risk management, indicating that additional proactive work in this area will be undertaken. Firms should proactively review and enhance their practices, leveraging insights from FCA’s upcoming observation paper to further strengthen their LRMFs.

The power of governance and culture

Governance is a recurring theme in recent FCA feedback, including SREP letters and public communications, highlighting the need for further enhancement.

Effective prudential risk management is underpinned by strong governance and healthy culture. This goes beyond simply establishing policies and procedures, as it requires firms to embed a genuine commitment to ethical behaviour, market integrity and consideration of risk at all levels.

This begins with strong, diverse, and experience leadership at Board level, who fosters an open 'speak up' environment, empowering employees to raise concerns without fear of retaliation. However, a positive culture alone isn't sufficient. Firms are expected to implement robust oversight frameworks – comprehensive systems of controls to detect, prevent and address undesirable behaviour. This includes a range of elements, from rigorous trade and communications surveillance to clear escalation procedures and use of remuneration tools (such as deferrals, malus or clawback) in cases of proven misconduct.

Addressing financial crime and broker misconduct

In addition to consideration of the foundational framework arrangements, the FCA will also be paying close attention to how firms manage material key risks including the potential for conflicts of interest and misconduct in the broker role. In support of these objectives, the FCA's supervisory strategy will employ a multi-pronged approach to examine, among other areas, financial crime and remuneration practices, where a lack of robust arrangements can heighten such risks.

The FCA recently conducted a multi-firm assessment on money-laundering, outlining its expectations for firms to move beyond a tick-box approach and develop a comprehensive understanding of their financial crime risks, highlighting the need for robust risk assessments and enhanced client due diligence.

Building financial resilience

As part of its strategy to minimise the risk of harm, the FCA expects all firms to also maintain adequate resources to support their on-going operations and put things right when they go wrong. Whilst the FCA observed some progress from their review of wholesale brokers, they highlighted that prudential risks remain, and reiterated the importance of maintaining adequate levels of capital and liquidity, alongside effective (credible and tested) wind-down planning arrangements, so that firms are less likely to cause harm should they fail (as also highlighted in our overview of the FCA’s Investment Firm Prudential Regime (IFPR) implementation observations).

As part of their supervisory strategy, the FCA will revisit previously assessed firms to ensure that feedback and good practice recommendations have been implemented. More broadly, they will also seek to test firms’ frameworks and contingency funding plans to assess firms’ ability to navigate potential stress events and impose additional capital and liquidity requirements where necessary.

Conclusion and next steps

Firms should view this as an opportunity to review their practices relative to the FCA’s expectations and address proactively any identified areas for improvement. Board and senior management in particular must be able to demonstrate effective embedded arrangements and resources to minimise the risk of harm. 

If you would like to discuss any of the areas above in further detail or require any further support in prudential risk management, governance or other areas, please contact any author of this blog.