FCA sets outs its alternatives supervisory strategy

Although the FCA acknowledges that alternative firms mostly deal with professional investors and sophisticated counterparties, the FCA is concerned that some investors (particularly retail or elective professional investors) could be exposed to inappropriate products or levels of investment risk. 

The Letter therefore states that firms should reduce the risk to consumers through thorough investor assessments including ensuring that investments are appropriate for the relevant investor type and meet client needs as well as clearly outlining target markets for distributors.  Firms with retail or elective professional customers should review their processes to ensure they are effective, including the application of the quantitative and qualitative tests for elective professional investors and the procedures for promoting non-mainstream pooled investments (if relevant).  This will be of particular relevance for firms actively looking at retailisation initiatives to broaden their fundraising avenues.

The FCA also advises firms that they should make sure that they are ready for (and make any necessary changes to accommodate):

• The new financial promotions rules for high-risk investments (which start to apply as from 1 December 2022).
• The new rules for the promotion of crypto assets (once made).
• The new rules on the Consumer Duty (which start to apply as from 31 July 2023).

The FCA also gives notice that it will be issuing a questionnaire in the coming months, asking firms for information about their business model, products, investor categorisations and associated control framework.   As part of this, firms will need to evidence the reasonable steps taken to ensure that the target market is appropriately defined and not exposed to an unsuitable level of risk.

In order to protect investors, the FCA will also focus on conflicts of interest.  The Letter states that firms should carefully review their procedures to ensure conflicts are avoided, managed, or disclosed in a way that minimises harm to investors and markets.  Firms should also consider their shareholder structure and its potential implications on the effective governance of their organisation.  We interpret this to be a concern about founders who might have, or be perceived to have, overweening interests which they might exercise inappropriately and this concern is also reflected in the FCA's intention to consider the impact on a firm's culture where its founders or other senior individuals occupy a dominant role.

The FCA raises particular concerns about funds with high leverage or which pose a high risk, and firms with concentrated or leveraged investment strategies. 

It also has concerns that firms may overestimate their liquidity position.  To address these points, it expects firms to ensure that their risk functions are appropriately resourced and commensurate with the levels of portfolio and business risk being taken as well as operate in a way which allows risk to be managed proactively rather than retrospectively. 

The Letter also includes a general observation that market abuse controls across the sector need to be improved with strong prevention cultures and effective systems and controls (which should be tailored to firms' individual business models).

It is apparent from the Letter that the FCA sees a link between a firm's culture and the integrity of its business practices.  The FCA expects to issue a Consultation Paper later this year on diversity and inclusion and, in the meantime, firms should consider the steps they can take to provide an environment which encourages diversity of talent and thought.  Culture will also be a priority in the FCA's next supervisory cycle with a particular focus on how senior managers and firm policies influence an organisation’s culture and whether staff feel able to speak up.

The Letter confirms that ESG is still a priority area for FCA asset management supervision.  In particular, firms offering ESG products will be subject to review to ensure marketing materials accurately describe their product and there is clear and consistent disclosure.

The FCA reminds firms that will be subject to the TCFD disclosure requirements as from 2023 to start preparing for this now.

If you would like further information or assistance in understanding the Letter and its implications, please speak to your usual Travers Smith contact or any of the individuals below.