FCA Custody and Fund Services Supervision Strategy

Concerns

Whilst the FCA acknowledged that there has been investment in CASS compliance by firms, they have observed weaknesses in change management (operational, regulatory and business), high dependence on legacy/end of life IT infrastructure and high levels of manual processing and controls in some cases.

The FCA have also seen instances where the root causes of issues stem from a lack of adequate CASS knowledge.

Overall, the FCA believe that the challenges with CASS compliance often have their root causes in poor governance and oversight, under-investment in systems, and failure fully to consider CASS impacts when managing change.

Expectations

The FCA expect firms to take steps to deal with these challenges. Should the FCA witness firms falling below expectations, they have stated that they are prepared to use the full range of regulatory tools, including enforcement action where we identify serious misconduct.

The FCA have also stated that they expect firms to have considered and to be appropriately prepared for technological developments, such as potentially increasing use of distributed ledger technology (DLT).

Concerns

In the letter, the FCA stated that they continue to observe weaknesses in depositaries’ oversight and often an absence of effective challenge of the fund manager. When this occurs, it can lead to potential harm to unitholders and investors.

They FCA also have concerns about the robustness of controls used to oversee fund liquidity, and investment and borrowing limits. Examples include a lack of holistic judgement, including a narrow interpretation of the applicable COLL rule requiring a ‘prudent spread of risk’ and the lack of policies or procedures related to it.

Expectations

In order to address the above concerns regarding depositary oversight, the FCA expect firms to ensure that they are undertaking the oversight function effectively.

In order to ensure firms are meeting their oversight requirements, the FCA may seek evidence that firms have an appropriate level of access to an AFM’s operations, adequate resourcing and ask firms to demonstrate that they have been able to challenge AFMs effectively in investors’ and unitholders’ interests.

Concerns

Speculative and illiquid investments, such as mini-bonds, are often very high risk and are unlikely to be suitable for most retail investors. These securities are not normally covered by protections under the Financial Services Compensation Scheme, may be unregulated, can have a high instance of scams and may offer unrealistic returns.

Firms in the sector may contract with and provide services to the issuers or promoters of these products, such as trustee, safekeeping and administrative services. In some cases, FCA regulated custody and fund services firms may inadvertently provide increased legitimacy to the marketing of unregulated products. Promoters of these products may exploit the FCA badge of a regulated entity from which it is procuring services, to create false confidence surrounding a product, marketing claims or consumer protections.

The FCA have observed a small number of instances where firms have displayed a disregard for consumer outcomes in their activities and inadequate due diligence on parties with which they have contracted.

Expectations

The FCA has issued a reminder that where firms are engaged in unregulated activity related to speculative and illiquid investments, they are still subject to certain relevant regulatory requirements, including specific Principles for Business. They need always to demonstrate that they are satisfying the minimum requirements for authorisation as set out in Schedule 6 FSMA.

Concerns

Firms not keeping abreast of, and adequately preparing for market developments and regulatory change.

Expectations

The FCA expects firms to keep abreast of, and adequately prepare for market developments and regulatory change. One recent change in regulatory requirements is the Investment Firms Prudential Regime (IFPR). IFPR came into force on 1 January 2022. It refocuses prudential requirements and expectations away from a sole focus on the risks firms face, to also consider and look to ensure adequate capital to manage the potential harm firms can pose to consumers and markets.