Our supervision strategy for corporate finance firms: portfolio letter [pdf]

The Financial Conduct Authority (FCA) has published a supervisory letter addressed at corporate finance firms in which it outlines its current risk assessment with respect to such firms, that is, it states the risks the FCA finds to be relevant in this market segment, and subsequently outlines its supervisory strategy as regards the monitoring of those risks.
##### The following brief summary presents the key risks identified by the FCA:
(1) Product (un)suitability and client miscategorization: The FCA is highly concerned that CFFs wrongfully categorize small businesses or local authorities as professional clients or treat retail investors as corporate finance contacts. Such actions can cause great harm, as investors would lose necessary protections, exposing them to high-risk products and potential financial losses. The same holds true, if CFFs inaccurately classify retail investors as sophisticated or high-net-worth individuals and subsequently use existing exemptions under the Financial Promotion Order (FPO) (SI 2005/1529) for communications to sophisticated investors and high-net-worth individuals. Finally, the FCA notes that some CFFs engage in unregulated activities – besides their regulated activities, possibly associated with entities or individuals conducting themselves unregulated business. This can create a false impression of consumer protection for the unregulated activity, potentially misleading clients to believe they are safeguarded by FCA authorization, when they are not.
(2) Market abuse: According to the FCA, market abuse is particularly risky in the case of corporate finance firms that work with publicly traded companies, as CFFs often have access to confidential information and engage in trading on behalf of the firm and its clients. In the past, the FCA found many CFFs to have inadequate systems and controls to prevent market abuse, including issues like ineffective information barriers, problems in identifying inside information, weak controls on sharing sensitive information, and incomplete insider lists. CFFs also sometimes fail to obtain consent from recipients before disclosing inside information and neglect to inform recipients that they are no longer „inside“. Furthermore, the FCA is concerned about the mismanagement of conflicts of interest and a lack of transparency on such conflicts which can harm market integrity and result in poor outcomes for clients and consumers. In fact, the FCA has noted instances where firms did not properly identify and record conflicts of interest, leading to incomplete and insufficiently detailed conflict registers.
(3) Financial crime: Financial crime is another key concern of the FCA for CFFs, especially concerning those CFFs dealing with overseas clients and advising on cross-border transactions. Complex corporate structures and offshore entities can make it difficult to trace the source of funds or counterparty to a transaction. Failure to conduct rigorous financial crime due diligence can harm markets and consumers, and non-compliance with evolving sanctions regimes may event result in sanctions breaches.
(4) Financial resilience. varies among CFFs. While some primarily provide advisory services and their failure would mainly impact their clients, others hold significant client assets, provide liquidity, or advise a large number of clients listed on stock markets. The disorderly failure of the latter group could have a substantial impact on markets and consumers, eroding confidence in the entire sector.
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##### As a consequence of the above noted concerns, the FCA’s supervisory strategy will focus on the following:
(1) Client categorization: The FCA will perform targeted reviews of firms practices in this regard with a focus on firms‘ compliance with client categorization requirements under COBS 3.5.3R which sets out clear criteria for when a client can be classified as professional or elective professional clients.
(2) Consumer Duty: Although the duty primarily applies to firms facing retail customers, the Duty is also of relevance for CFFs, particularly in view of their approach to categorize clients and the potential harm they may cause in this context. Therefore, the FCA will soon gather data regarding CFFs‘ adherence to the Duty and expect firms to demonstrate how the Duty has been taken into account in their business practices.
(3) Market abuse: Due to the high potential for market abuse among CFFs, supervising firms‘ practices in this context will remain a key priority. The FCA intends to conduct targeted reviews across various business models and potentially intensify reviews as far as adequate system and controls to prevent market abuse are concerned.
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To conclude, the FCA also notes that it will engage with CFFs that have registrations for regulated activities which they obviously are not using. Such firms shall be prepared to justify to the FCA why the registration is still needed. If the explanations are unsatisfactory, the FCA will use its new powers to cancel registrations.