Wholesale Banks Supervision – The FCA Writes to CEOs.
In its latest ‘Dear CEO letter’, the FCA has written to wholesale banks setting out their supervisory strategy for the next two years based on recent market events.
It includes information on their internal restructuring, which creates a ‘Sell-Side Directorate’ where the Wholesale Banks Department now sits alongside the supervision of market intermediaries and an area that analyses market interactions. Much of this stems from the lessons learned from the collapse of Archegos Capital, (on which they wrote a separate ‘Dear CEO letter’ in December 2021) and the market liquidity problems of pension funds of a year ago.
In the light of these events heavy emphasis is laid upon improvements in risk management where investigation and remedial work may be required. For example, during their investigations they noted instances of poor management of client relationships, including:
· inadequate knowledge of clients’ business profiles,
· unidentified concentrations of risk within and across firms,
· underestimating concentration in markets that may have a limited group of buyers and sellers in times of market stress.
These risks can be substantially increased by a lack of market liquidity if markets do not have the depth to accommodate stressed sales without a major impact on price or, on the liability side, the speed with which clients or counterparties withdraw money, where able.
The FCA expects banks' risk management teams to take/apply:
· HOLISTIC APPROACH
The FCA expects banks’ risk management to take a holistic approach to all risks as a successful strategy can mitigate harm to a bank in times of stress.
· STRESS ASSUMPTIONS
Firms should ensure that their stress assumptions have been revised and updated in the light of market events over the past twelve months and are fit for the current environment. Stress testing should recognise that severe stresses can affect the entire system, including operations and reaction times and services provided by third parties, which should be taken into account.
At this point we would remind LinkedIn readers that the PRA has a parallel project running with its recent policy and supervisory statements which are being implemented as part of its introduction of its ‘effective model risk management principles for banks’ (q.v. our papers of March and June this year). Time is rapidly passing for investigation to be undertaken and work completed by and the new policy complied with from the effective date of 17th May 2024.
· SENIOR MANAGEMENT AND BOARD RESPONSIBILITIES
Following their strategy of holding senior executives personally responsible for risk management in their banks the FCA has stressed that it will look to senior management to evidence they have delivered better risk management and oversight across the business and how they are underpinned by a strong culture. They will also look to Boards to evidence how they are ensuring that these improvements are long-lasting.
The FCA supervisory testing will look at how well risk management improvements have been embedded, starting right at the root of a product, examining how the holistic risks of new products and certain transactions have been assessed and managed at every stage, starting at the New Product Approval stage and its subsequent implementation.
Among the interconnected risks that the FCA will assess will be internal conduct risks such as financial crime, market abuse and conflicts of interest, particularly between the First and Second Lines of Defence. Their concern is that external market pressures and stresses can impact the management of these risks through a reduction of controls, when short term commercial interests may take priority over regulatory obligations.
· CONFLICT OF INTEREST MANAGEMENT
Assessing how conflicts of interest are managed will be a particular area of focus and they will look to test outcomes and be data-led, rather than focus solely on policies. Second and Third Line of Defence control functions have a key role to play in the oversight of business activities and the FCA will expect to see prompt notification of material issues they identify, with effective action taken to address them and support from senior management and Boards for their work and independence.
Likewise, the FCA expects firms to be operationally resilient and to comply with the requirements set out in their Policy Statement PS21/3 – Building Operational Resilience and they will engage with relevant Senior Managers to assess how they have learnt the lessons of operational resilience events, even if their firm was not directly impacted.
The letter concludes by reminding CEO’s that, under the SMCR, they are personally responsible for ensuring that relevant staff understand the FCA’s rules and principles for their business and for complying with them. CEO’s are requested to discuss the FCA’s current letter with their fellow directors and Boards within two months of the date of the letter and to have agreed any remedial actions and/or next steps.
FMCR has highly experienced senior front-line practitioners, including Regulator experience, in both the First and Second Lines of Defence. We can provide independent advice, assistance and review of risk management strategies, functions and models as part of a firm’s business strategy and risk management together with education, (notably at board and senior management level), to help provide an understanding of the regulators’ increasingly prescriptive requirements on effective risk management.
In the first instance please contact contact@fmcr.com to arrange for an initial discussion.