The Financial Conduct Authority routinely reaches out to the wider financial industry through a variety of different mechanisms, and one such method is of course the 'Dear CEO' letter.
This appears to be the method of choice now for the FCA to give a general steer on what they are looking for in a collegial tone rather than setting out specific targets in the more formal annual business plan or regulatory initiatives grid.
Now, more than two years since the last 'Dear CEO' letter was sent to the alternatives portfolio, which in FCA parlance is the hedge fund and private equity sectors, the regulator has reached out to note that Covid-19, Brexit and the cessation of Libor have caused them to reassess their supervisory priorities for the sector.
A brief skim of the headline terms does not actually suggest much of a reassessment, however closer reading indicates a broadening of considerations.
In this latest correspondence, the FCA’s view of the main risks of harm that alternative investment firms pose to their customers are as follows:
Putting consumers’ needs first
A staple of almost every FCA correspondence and central to the conduct rules governing those working in the industry is putting consumers’ needs first (or treating customers fairly). The FCA clearly feels there is a substantial risk that inappropriate investment opportunities are being presented to investors.
The FCA notes that within the alternatives portfolio there are firms that deal with retail clients and elective professional clients. Both of these categories of clients can be considered consumers from an FCA perspective.
Investment products/services such as Seed Enterprise Investment Schemes, Enterprise Investment Schemes and venture capital trusts are among the retail investments that may fall into the FCA’s scope of concern that firms within the alternatives portfolio are selling high-risk investments to, but which do not match those investors’ risk profiles or investment objectives.
The FCA is introducing new marketing rules, coming into force from December 1 2022 around high-risk investments and the additional obligations under the consumer duty may also have some impact on firms within the alternative investments sector.
Furthermore, the regulator will be issuing a questionnaire to all its alternatives portfolio firms about their business model, products, investor categorisations and associated control framework. Firms must have clearly defined their target markets and not have exposed investors to an unsuitable level of risk.
How this warning balances against the current proposal to expand the long-term asset funds to more retail investors will be interesting to watch, though interest in those products is less than the regulator and government would have hoped.
Conflicts of interest
The FCA has committed to assessing the extent to which inadequate management of conflicts of interest has played a role whenever harm to investors (all categories of clients) has been identified.