Following a strategic pivot to focus on firms that may pose a greater risk of harm to investors, the U.K.’s Financial Conduct Authority (FCA) review of smaller asset managers found shortcomings in their handling of risky investments, conflicts of interest, and conduct standards.
The regulator published the results of a review of over 400 smaller firms (with less than £1 billion in assets under management), which found that most of these firms are meeting their regulatory expectations — yet, that there’s also room for improvement in certain areas.
For instance, the FCA said that, while most firms had processes for categorizing their products as high-risk investments, some didn’t have adequate processes for ensuring that these products were only sold to clients in situations where they were suitable.
“Poor investor categorization can lead to investor harm via the sale of inappropriate or complex products,” the report noted.
The review also found a shortage of effective procedures for managing conflicts of interest.
In particular, smaller firms often had senior personnel fulfilling multiple roles without recognizing the potential conflicts between these functions, mitigating these conflicts — and, in cases where the conflicts can’t be avoided, properly disclosing them.
Finally, the review also found instances where firms aren’t properly implementing the new “consumer duty” responsibilities into their businesses.
“Some smaller firms still need to understand how the duty applies to their business model as they have not yet adjusted their processes,” the FCA noted — warning that “this could lead to firms breaching our rules and causing consumer harm.”
In particular, the regulator said that it found some firms offering “complex, high-cost investment strategies” that are unsuitable for retail investors. “These strategies often performed poorly,” the regulator said.
It also uncovered instances of retail investors “being inappropriately onboarded to alternative investment funds with unclear product structures, uncertain drivers of return, and opaque charging strategies,” it said — adding that, in some cases, firms charged hefty fees that resulted in investor losses.
These firms also couldn’t produce evidence that their products delivered fair value, the report said, nor could they explain “how they would avoid causing foreseeable harm to retail investors,” it said.
The regulator said that it’s working to address these weaknesses with the firms included in the review, and that other firms should use the report to improve their own compliance.
There are about 1,000 smaller firms in the U.K. market with a range of business models, including firms focused on venture capital financing, investing in real assets and small-cap stocks. The FCA said that some of the report’s findings may be relevant to larger firms too.