FCA raps brokers over ‘inappropriate’ use of clients’ assets
UK market regulator makes latest in series of complaints over brokerage industry
The UK market regulator is cracking down on brokers, saying it has seen evidence that some are making “inappropriate” use of clients’ assets through legal loopholes.
In a so-called “Dear CEO” letter — a rare form of correspondence that signals concerns over industry-wide practices — the Financial Conduct Authority gave 357 wholesale brokerages just three weeks to attest they were abiding by the rules.
The warning is the latest example of scrutiny of the conduct of wholesale brokers, which act as middlemen and negotiate trades in equities, energy, commodities and interest rate derivatives markets, for customers such as asset managers and wealthy individuals. They also carry out trades for their own accounts.
In its letter, sent last week, the FCA said some brokers had been inappropriately using a standard legal agreement, in which customers agree to transfer legal ownership of collateral to their broker for use in meeting margin calls on trades. The collateral is designed to be a safety net for customers, and is ringfenced in case the broker itself gets into financial difficulty.
But some brokers have been holding an “inappropriate” amount of money or assets compared to a client’s risk. Some brokers did not have permission from the customer to hold these accounts, while others were not supposed to hold client money, the watchdog added.
“We are especially concerned about such cases where firms lacked arrangements to promptly return collateral to their clients, or to segregate it as required by [client asset standards],” the regulator warned.
Simon Bird, co-founder of Objectivus Financial Consulting, a risk and governance specialist, said that a number of brokers had “transferred all the clients’ money to cover trades, so there’s been a certain amount of free capital available” for the firm.
Brokers were also “misidentifying” some trades, the FCA’s letter said, labelling them as clients’ trades rather than their own, and therefore incurring lighter capital charges. Clients of these brokers include investment banks and smaller independent brokers.
Last year the FCA sent brokers another “Dear CEO” letter warning that they had “not kept pace” with the tougher markets regulations of the previous five years. Moreover, there was a “complacent attitude and resultant failure to meet expectations across all the areas of regulation,” the letter said.
The regulator blamed the industry’s pay and incentive schemes, which typically hand brokers cash payments for generating revenue. The FCA promised to publish a report into market practices but has yet to do so, blaming the coronavirus pandemic for the delay.
In a separate warning last year, it also told brokers to guard against potential conflicts of interests in payments for order flow, when a broker charges fees on both sides — to the client that placed the order, and also the counterpart that matched it.