In March this year, the Financial Conduct Authority (FCA) sent a Dear CEO letter1 to custody and fund services providers2.
Whilst the letter is addressed to service providers, I would suggest all participants who provide services to UK funds and their fund boards should discuss the implications of the letter and ensure that they have a response from their service providers on each of the points raised in the letter.
The FCA pointed to four areas of “potential harm” to clients, end-consumers or to market integrity.
‘Disruption to consumers and market participants, or the loss, compromise, or lack of availability of data, due to insufficient operational resilience or weak cyber controls.’
It is my view that the directors on fund boards should ask for a detailed response in this area and have it reviewed by people with appropriate expertise. This area is particularly relevant to the delegated functions of the authorised fund managers (AFMs) such as transfer agency and fund accounting where the AFM has overall responsibility. Boards should also ask what the response of the firm has been to the recent Policy Statement (PS 21/3)3 on building operational resilience.
‘Sub-standard oversight and control of client money and assets leading to financial losses for investors and/or an inability to recover assets efficiently.’
CASS (client assets and money) compliance has been key focus for the FCA and in recent years they have given out significant fines to firms who breach the regulations. Ensuring the proper identification and segregation of client money and assets and fund boards should ask the right questions of service providers. In terms of UK funds, I would suggest, the client money/assets issues can occur at the transfer agent, the depositary (focussed on own books and records) and at the custodian.
‘Inadequate depositary oversight of fund managers, and failure to take reasonable care to ensure an authorised Collective Investment Scheme (CIS) is managed in accordance with applicable rules and solely in the interests of the CIS and its unitholders.’
The sentence above is fundamentally an overview of a significant part of the depositaries responsibility and implies to me that the FCA has significant issues with the way that the depositary responsibilities are being discharged. It is imperative that fund boards ask the right questions of their depositary, irrespective of any other services that the parent company might be providing. In my previous role I would regularly attend fund board meetings, but was rarely given any guidance as to what the board would want to know.
‘Inadequate oversight of business linked to high risk, illiquid or speculative investment products sold to retail investors, and failures to consider related consumer outcomes.’
Both the AFM and the depositary should have checks in place to ensure that funds invest in instruments that are appropriate for the type of fund, the prospectus of the fund and investors that can buy the fund. Fund boards should ensure that both the authorised corporate director (ACD) and depositary have the appropriate monitoring in place.
In my view, there are strong implied criticisms of the service providers who received this letter. Given the critical role that these firms have in the UK funds industry, it is extremely important that fund boards move quickly to understand the position of their service providers. In some cases, central procurement or supplier management teams lead in the appointment and monitoring of service providers. Given the responsibility of the fund board, they need to take a lead role and ensure that those service providers are appropriate for UK funds.
Peter Christmas is the founder and managing director of Peter Christmas Advisory Ltd and a senior adviser with FBC. Peter has had a multi-jurisdictional career in financial services for the past 35 years, with the last six years as Director of Client Management at NatWest Trustee and Depository Services. He can be contacted at firstname.lastname@example.org