The FCA appears to be using Dear CEO letters quite liberally at the moment. 

There have been two most recently addressed to: 

•  Wholesale brokers; and, 
•  Asset managers.

On the latter, this letter marks an interesting shift in the FCA’s focus towards private funds. Whilst not new, this represents a doubling down on the concerns around the risks arising from the growth of the sector. In this context, the change in quantum balance between listed and private funds in their various forms speaks for itself when one looks at the quants. I think that the overarching message is that this area will no longer be viewed as less important for regulators due to the systemic risks posed.

It is worth noting, as always, that it is as much about ‘reading between the lines’ as it is ‘reading the lines’ and I wanted to bring out a few key points below. 

Private markets

The first priority relates to the general concerns around valuation. 

The FCA has since published its findings regarding its multi-firm review of the valuation process for private market assets, coupled with commentary. We have published a short summary of the review here.

In my view, the big message for firms working in the private equity and broader private assets market is that the FCA is demanding a new level of governance around all aspects of the valuation process. I think that this ranges from the substantive question of how the methodology and consistency of valuation (and alternative approaches) takes place within a firm, through to all of the normal procedural questions surrounding governance. 

There is clearly a particular focus on conflicts of interest. As those of us working in this area are aware, those questions are easier posed than answered. For example, the role of the front office in giving expert views that feed into the process, versus the role of senior management and that of technical experts, all need to be factored in. I think that a thorough look at a firm’s three lines of defence model will be an important action point for these purposes.

As always with the FCA, the old adage that ‘if it isn’t written down, then it doesn’t exist’ should be borne in mind in this context. So making sure that there is an audit trail on the valuation process and its governance will be important.

I think the message is clear that firms need to take a proper look at all their procedures surrounding this area.

Market integrity and disruption

The second area of focus is the question of liquidity management. 

In a sense, this is more predictable. The FCA’s message to firms – i.e., that they need to test all of their liquidity management and operational resilience in this area – comes as no surprise. 

The FCA makes reference to the Bank of England’s SWES report and IOSCO’s consultation paper on Liquidity Management for Collective Investment Schemes. I think the FCA’s messaging surrounding this is clear in this regard.

My main comment on this is to flag the amount of work that firms are going to need to do to demonstrate an adequate audit trail in advance of FCA scrutiny. 

Consumer outcomes

The FCA allude to good outcomes for retail consumers. I think that for the institutional managers the point to watch here is how this impacts where you have created a “retail” side pocket or C class of shares. Whilst you might be targeting high net worth or mass affluent at various levels, the Consumer Duty will come into play. Issues such as differential fees between the pure institutional offering and the extended offering will need to be looked at in this context.

Sustainable finance

The next substantive area is the fairly light touch treatment given to the FCA’s sustainability disclosure rules. The message here is less clear and I do not think that the letter really advances the discussion. I think that the point is that they are carrying on with their plans. This is significant given developments in the United States, but beyond this, there is little transparency on the proposed approach.

Financial crime and market abuse

The last issue is financial crime and market abuse. 

There is nothing new here conceptually, but again, it is interesting that the FCA has cast a light on private funds’ due diligence on investors, broader know your customer (KYC), and on market abuse controls in relation to all managers. The main point here is that there is no sense that the private funds world is somehow subject to a light touch approach in this area. On the contrary, the FCA is interested in the thinking firms have given to appropriate KYC and anti-money laundering reviews for the various parties they interact with, for example, investors as well as investee companies.

Wholesale broker contrast

All of the above points are interesting, but it is worth asking: what has not been emphasised in this Dear CEO letter contrasted with the wholesale brokers letter. I would pick out a couple key points to note:

• The FCA has chosen not to major on remuneration issues regarding asset managers, particularly those relating to non-financial misconduct. I think this is interesting and the contrast in tone to the brokers letter is marked in this context. 
• There is no assertion that there is a systemic cultural problem in the sector. Whilst the FCA is clearly interested in good governance, the cultural theme is dealt with in a very light touch way in the letter.

When viewed in this context, the FCA does not appear to be raising the alarm about the sector as a whole. That said, the key messages that there is a lot of work to do and no sense that private fund management is somehow out of scope of the FCA’s regime are clear.