Conflicts of interest between asset managers and their customers: Identifying and mitigating the risks is a ‘Dear CEO’ publication in which the FSA summarises the output of a thematic review undertaken between June 2011 and February 2012. The review was initiated after reports from supervisors suggested that the standards and practices of asset managers had suffered some relaxation from what FSA considers to be well-established market norms.
The FSA highlights the potential for conflicts between the interests of a firm and its customers or between the interests of different customers that acting as an agent for customers may create. Its thematic work identified a range of key issues:
- failures to establish an adequate framework for identifying and managing conflicts of interests;
- breaches of rules governing the use of customers’ commissions and the fair allocation of trades between customers;
- inability to demonstrate that customers avoid inappropriate costs and have fair access to all suitable investment opportunities;
- the key determinant in whether firms managed conflicts well or badly was the attitude towards customers established by senior management .
The FSA believes the seriousness of the issues identified requires it to take action to ensure firms comply with the various FSA rules relating to conflicts of interest.
Those firms visited during the project have been given feedback and, those found wanting have either asked to justify their approach or, where necessary, required to take remedial action. Some have been required to undertake skilled person reviews under s166 of FSMA; in more serious cases enforcement action is being considered.
Findings from this thematic review are now being communicated to the wider asset management sector through this Dear CEO letter. Overall the paper discusses the following, identifying some good (and bad) practices to look out for:
- Firm culture is central to identifying conflicts of interest
- The best control frameworks are designed jointly by business and compliance functions
- Conflicts monitoring is more effective when conducted by both business and compliance functions
- Conflicts monitoring is more effective when boards receive adequate management information
- Conflicts are better managed when UK boards have committees dedicated to conflicts of interest management
- Spending on research and execution services should be adequately controlled
- Firms should regularly review whether services are eligible to be paid for using customers’ commission
- Firms with strong controls over commission are better able to demonstrate control over the execution of customer orders
- Non-compliance with requirements to disclose to customers details of commission payments
- Limited thinking about how accepting gifts and entertainment could compromise their duty to act in their customers’ best interests
- Failure to allocate trades between different clients in an equitable manner
- Inability to show that cross trading between customers was always in the interests of both customers (see for example the enforcement action against Martin Currie)
- Controls and oversight over the allocation of investment research ideas between customers may be inadequate
- Although arrangements for managing conflicts arising from employees’ personal dealing are clear, their application to staff can be inconsistent
- Although arrangements for handling errors are clear, there has been some over-reliance on contractual limitations to avoid reporting the cost of errors to customers
The FSA’s expectation is that the board of each asset management firm will now discuss this document, and the CEO of asset management firm is effectively being required to attest by 28 February 2013 – by returning the ‘attestation’ in Appendix 1 – that
- the Board has received the paper
- the Board has considered the paper
- the Firm’s arrangements have been assessed in the light of the paper’s findings
- the Board has resolved that the firm’s arrangements are sufficient to ensure that the firm manages conflicts of interest effectively and in compliance with FSA rules
The aim of the attestation process is to hold the CEO (and the Board) directly responsible for ensuring the firm’s compliance with the firm’s obligation to identify and manage conflicts between the firm and its customers. The expectation is that firms should be able to demonstrate that the FSA’s principles and rules are embedded in their businesses and that they are taken into account when considering new products, processes or business models. The FSA also expects boards of firms to regularly review their practices to ensure compliance with FSA requirements.