Portfolio letter: Wholesale banking sector [pdf]

The Financial Conduct Authority (FCA) published an open Dear CEO letter directed at the wholesale banking sector. The letter outlines the FCA’s supervisory plans for the next two years and its areas of focus within the wholesale banking sector. The key points from the letter are noted below; for more detailed, comprehensive information, please refer to the enclosed original document.
(1) External environment:
In 2022 and continuing into the present year, wholesale banks have faced numerous challenges in the external environment, including ongoing volatility in asset prices, weak global economic growth, rising interest rates, inflationary pressures, and geopolitical tensions. These factors have put significant pressure on the business models of wholesale banks. How well firms manage these risks can significantly impact consumers, firms, and market integrity overall. The FCA is closely monitoring this environment and plans to use its knowledge, technology, and data to provide focused and outcome-oriented supervision. Wholesale banks are expected to uphold high standards of market excellence to ensure financial market stability and to reinforce the UK’s position as a global financial hub.
(2) Risk management:
Wholesale banks are crucial in global financial markets, contributing significantly to the UK’s status as an international financial hub. They facilitate government financing and corporate access to investment capital which is one reason why their activities must be well-monitored to prevent harm. Recent incidents, like the Archegos case, exposed weaknesses in risk management, including poor client relationship management and underestimation of market concentration and liquidity risks. As banks‘ risk management can either mitigate or exacerbate market harm during stress, firms should keep up-to-date their stress testing procedures and assumptions to prevent market disruptions and financial market integrity. The FCA will closely monitor and engage with firms to ensure improved risk management practices and lasting cultural changes, as far as CEO oversight is concerned.
(3) Maintaining high standards of control:
The FCA once again notes the importance of maintaining high standards of control in wholesale banks to mitigate conduct risks, such as financial crime, market abuse, and conflicts of interest. The FCA is particularly concerned that external factors, like pressure for short-term profits or challenging economic environments, may lead to a reduction in adequate control measures. The boards and senior management of wholesale banks need to set out clear expectations regarding the importance of good conduct, so the Authority. Also, boards need to address instances of blurred responsibilities between the first and second lines of defense, especially in activities related to environmental, social, and governance (ESG) commitments. Due to the significance of these matters, the FCA plans to increase its testing capacity and the frequency of in-person supervisory assessments to see how banks control these risks, with a focus on conflicts of interest. It thereby intends to assess actual outcomes rather than just policies and procedures and expects prompt notification of significant issues arising at supervised firms.
(4) Operational resilience:
The FCA expects wholesale banks to maintain operational resilience at all times to ensure the stability of financial markets in accordance with its policy statement PS21/3 on Building Operational Resilience. This goes beyond just the technical systems they use and also encompasses the services they offer. As third-party services have become increasingly important to banks, particularly within middle and back-office functions, they tend to be more vulnerable to cyberattacks, potentially disrupting services and compromising sensitive information. The FCA notes in this context that the regulatory responsibility for operational resilience ultimately lies with the banks themselves, not the third-party providers they use. Banks are expected to understand their dependence on these third parties and take measures to mitigate any potential risks of service or system disruptions. Furthermore, the Authority expects financial institutions to promptly notify cases of cyber-attacks, even when the attacks target third-party providers. The FCA plans to continue reviewing banks‘ compliance with operational resilience requirements and their ability to stay within specified impact tolerances as specified in above noted policy statement. Additionally, the regulator plans to engage with senior managers to assess their understanding of operational resilience.
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As far as the LIBOR transitioning is concerned, the FCA notes that although USD LIBOR ceased on June 30, 2023, wholesale banks are expected to actively transition remaining contracts referencing USD LIBOR and not rely excessively on the temporarily introduced synthetic LIBOR tenors.
With respect to responsible financing, the regulator strongly urges banks to align their financing activities with sustainability goals and fulfill their commitments related to ESG in practice.
And finally, the Authority states that it will engage with wholesale banks regarding the deployment of artificial intelligence (AI) and machine learning technologies in financial services, focusing on current use and future plans, as well as control infrastructures they have put in place for adequate monitoring and oversight.