Investment management and wealth

With the first Board report due in July 2024, firms need to focus on refining and embedding their frameworks for monitoring outcomes. We think firms need to challenge themselves on whether they have sufficiently robust data to evidence good customer outcomes and consideration of foreseeable harm, and if not, what additional data they need. One challenge is poor information-sharing between manufacturers and distributors, especially along complex distribution chains. We would expect the FCA to intervene if lack of cooperation impedes effective information-sharing which is needed for product governance and value assessments.

As the Duty moves into business as usual (BAU), firms need to embed a culture and operating model that facilitates good customer outcomes. The FCA has signalled a greater willingness to intervene where it does not find evidence of this – for example it has been forthright about failings in the wealth management and stockbroking sector⁵, including its finding that 49% of portfolio managers and 69% of stockbrokers had identified no vulnerable consumers. In our view, good practices for embedding a Duty-conscious culture include appointing Duty Advocates and communicating to each individual what the Duty means for their role. How proactive firms are at remedying poor value in closed products by July 2024 can also be an indicator of culture, as these often receive less attention.

In the EU, many firms are anticipating the retail investment strategy, which may include significant new requirements on value for money and inducements. While the details are unlikely to be finalised before 2025, firms can already start considering lessons from the UK’s experience in these areas.

Greenwashing risk will be a key concern for investment and wealth managers across the UK and EU in 2024. Final rules under the FCA’s Sustainability Disclosures Requirement (SDR) were published in late 2023 with the key objective of mitigating greenwashing. The SDR’s sustainable investment label regime will help firms to communicate their sustainability goals more clearly and consistently to investors. However, challenges remain. For example, the SDR has not defined ‘sustainability’ - how firms define this will have an impact on all their disclosures and the way they procure and use Environmental, Social and Governance (ESG) data. Firms need to be pro-active about ensuring a consistent understanding of what greenwashing means across functions, before establishing new or enhancing existing controls. Firms also need to carry out comprehensive risk reviews across their functions to determine the various sources of this risk. This will allow for smoother implementation and enable firms to demonstrate to the FCA that they have considered and mitigated multiple sources of the risk.

In the EU, a fundamental review of the Sustainable Finance Disclosures Regulation (SFDR) is underway. This may change the way in which the Article 8 and 9 categories are used. Several firms have already changed SFDR categories previously and more changes may erode investor trust. This, in combination with expected restrictions from ESMA on the use of ESG terms in fund names and implementation challenges associated with SDR, may cause some firms across the UK and EU to re-think their sustainability ambitions. This will clearly have commercial implications if firms are not able to participate in the sustainable funds market – and it might also undermine firms’ reputation.

Furthermore, stakeholders will expect firms to step up their efforts in relation to transition planning in advance of new detailed regulatory requirements that we anticipate coming in for many firms in the EU (from 2024) and UK (from 2025). Firms will need to move beyond viewing transition planning as a disclosure exercise with siloed pockets of activity. They will need to embed sustainability strategies across the organisation. They will also have to define the steps and KPIs needed to achieve targets and be clear about the interplay between firm‑level commitments and product‑level ESG performance.

To monitor liquidity risk effectively, firms will need metrics, escalation triggers and processes (including the use of anti-dilution tools) that are tailored to each asset class and calibrated for the risk profile of each fund. For many firms, putting these arrangements in place will require significant work and senior management time.

Firms should ensure that they have robust liquidity risk stress tests with scenarios that are sufficiently severe and consider forward-looking risks. Firms should also use conservative assumptions, such as a ‘pro-rata’ approach (where a proportionate ‘slice’ of every asset comprising the portfolio is sold to accommodate the redemption) where appropriate. More stringent stress tests may result in firms needing to adjust their funds’ liquidity profiles.

Firms will need to build a model to estimate market impact cost for swing pricing and other anti-dilution tools – the International Organization of Securities Commissions (IOSCO) guidance says⁸ that firms should analyse previous transactions under similar market conditions or use relevant market data/models. Since firms will need to apply judgement, their models should be subject to robust governance and back-testing.

In view of rules expected from the FCA on redemption notice periods for open-ended property funds, and the FSB’s recommendation that funds investing significantly in illiquid assets should not have daily dealing⁹, firms will need to review their redemption terms for funds holding illiquid assets and consider how they can remain attractive to investors.

As investment and wealth managers work hard to comply with evolving regulatory expectations, they also need to understand the impacts on their business strategy. For example, as firms integrate value assessments into BAU processes, the assessments will need to become an integral part of product/service design, rather than solely a compliance exercise. Similarly, supervisory scrutiny of greenwashing and transition plans will prompt firms to consider the viability of their sustainable product offering. Finally, new requirements on fund liquidity may result in changes to product design.