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FCA Launches Investigation Covering OTC Derivatives Market

The Financial Conduct Authority (FCA) plans to launch a wholesale market study to look at whether competition is working properly in the investment and corporate banking sector, in response to concerns around transparency and conflicts of interest.

The announcement follows the publication on 19 February of the FCA’s review into competition in the wholesale sector, which also looked at how asset management firms control the risk of committing market abuse.

The wholesale sector review found that limited clarity over price and quality of services may make it difficult for clients to assess whether they are getting value for money. In addition, the bundling and cross-selling of services could make it difficult for new entrants or smaller established firms to challenge established large players in the market.

It also pinpointed other competition issues that should be looked at, including: the impact of a reduction in the number of clearing members and a lack of client clearing in OTC derivative markets; how purchasers get value for money when buying asset management services; the pricing and availability of data and related services; and vertical integration of clearing and execution services.

“What was clear from the discussions we had with stakeholders and firms was that there are unanswered questions about potential conflicts of interest and value for money in this market,” says Christopher Woolard, director of strategy and competition at the FCA, adding that the study will form part of the authority’s wider work in the wholesale markets, together with the Bank of England’s Fair and Effective Markets Review (FEMR).

Woolard highlights the crucial role investment banking plays in the UK economy and says that the benefits of effective competition in the market could be “significant”.

In response to the FCA’s announcement, the British Bankers’ Association (BBA) emphasised the competitive nature of the UK banking industry. “Banks compete vigorously for new clients every day and we believe that the market in London is one of the most competitive in the world,” says Sally Scutt, BBA deputy chief executive.

“All banks will cooperate fully with this investigation, but we would urge the regulator to take into account the considerable and fast-moving changes that are currently taking place in wholesale markets. It is also important that this investigation is aligned closely with the broader Fair and Effective Markets Review,” she adds.

Although the Institute of Directors broadly welcomes the FCA’s announcement, it adds that there remain some unanswered questions about potential conflicts of interest and value for money in the investment banking industry.

In addition, Oliver Parry, senior corporate governance adviser, suggests that the FCA should prioritise the fund management industry. “There are many reasons to be proud of the UK’s fund management sector, but a centrepiece of reform in fund management has to be greater transparency,” he says. “Greater clarity is required about their pay, fees, trading activity and perhaps most pertinent, their commitment to stewardship and their voting record.”

The FCA says it will launch the study in the coming months and invites feedback from industry, trade bodies and bank clients.

In addition, the UK authority is considering a market study into asset management and related services later in the year, but will wait until it sees how impending regulations will affect the way competition works. The UK asset management sector manages approximately £5.4 trillion institutional assets, according to the FCA. 

The review found that, while asset management firms had put in place some practices and procedures to control the risk of market abuse, these are only comprehensive in a limited number of firms.

The FCA calls upon firms to do further work to ensure practices and procedures operate effectively and cover all material risks.

“In particular, firms need to pay more attention to the possibility of receiving inside information through all aspects of the investment process and take steps to manage this risk. Firms generally also need to improve the effectiveness of post-trade surveillance. Only a minority of firms had appropriate controls for these matters,” said the report.

The UK watchdog says that it will write to all the firms to provide individual feedback. Where firms did not effectively manage the risk of market abuse, the FCA expects them to make improvements to their practices.

The FCA announced it won’t launch a competition probe into market infrastructure, which was the third section of its wholesale sector competition review, nor will it continue researching the potential for data providers to exploit their market power, or the effect of high pay within the financial sector.

During the wholesale sector review the regulator met with around 70 organisations and individuals, through a combination of roundtables and one-to-one meetings and received 40 written responses.

As of 1 April, the FCA will gain competition concurrency powers that will allow it to enforce against breaches of the Competition Act and to refer markets to the Competition and Markets Authority for in-depth investigation. Twitter @Profit_and_Loss

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