UK’s FCA Turns Up the Heat on Wholesale Brokers over Compliance & Culture

Topics: Brokers, Client Relations, Compliance, Financial Crime, Fraud, Government, Government Regulation, Regulation & Compliance, Regulatory Intelligence, Thomson Reuters Regulatory Intelligence, United Kingdom


Despite not being known as bastions of best practice for compliance, conduct, or culture, wholesale brokers in the United Kingdom have avoided the wrath of the Financial Conduct Authority (FCA) — the nation’s main financial regulator — for quite a long time.

Of course, that’s all changed with the arrival of the Markets in Financial Instruments Directive II (MiFID II). And soon the Senior Managers and Certification Regime (SMR) will apply to wholesale brokers too.

MiFID II increases brokers’ regulatory risk in a big way. As Thomson Reuters Regulatory Intelligence (TRRI) reported in January 2018, it lands wholesale brokers with a long list of regulatory obligations on everything from best execution to enhanced record keeping requirements.

Indeed, inter-dealer brokers (IDBs) in the UK have mostly avoided large-scale regulatory investigations and fines that have hit some UK banks. Since 2013, only two IDBs have been fined by the FCA, and both were related to Libor rigging. Still, the FCA’s comments on the two cases outlined many compliance and oversight failures, such as poor oversight, poor risk management controls, and a poor compliance culture. Many market observers were left wondering if other brokers were in fact experiencing the same problems.

A Big Step Up in Regulation

Brokers running organized trading facilities (OTF), a new MiFID II designation, will experience a big step up in regulatory obligations for IDBs, which tend to see compliance as a cost center and are broadly characterized as having less effective compliance functions than banks.

OTFs have obligations to provide pre- and post-trade transparency and best execution, as well as some prohibitions and restrictions regarding matched-principal trading and interacting with systematic internalizers. TRRI reported in February 2018 that brokers best execution policies really weren’t in line with regulators expectations, an approach that some may regret in light of greater regulatory scrutiny on their businesses.

At the time, Dermot Harriss, senior vice president of regulatory solutions at OneMarketData, summed up this characterization by saying: “[Brokers] are pretty relaxed about [best execution]. …A lot of smaller firms — buy side, sell side — are almost sort of breezing through it and hoping the regulator ignores them for another year.”

And now, SMR will hold brokers’ senior management accountable for their conduct and that of their employees. It’s a new world for wholesale brokers and a recent Dear CEO letter from the FCA gives its verdict on how they’re acclimatizing. Not too well, really.

In fact, the FCA’s Letter stated: “In our view, brokers in wholesale markets have made less progress than other sectors in embedding a culture of good conduct, and so action to raise standards across the sector has become urgent.”

The FCA’s list of concerns shows how closely it’s studied brokers’ remuneration, conduct, culture, conflicts of interest management, market abuse surveillance systems, and financial crime controls. In short, the FCA wants improvements across the board. Brokers would do well to take the FCA seriously because the deficiencies listed are all key regulatory priorities.

Targeting Payment for Order Flow

Since at least 2012, the FCA has tried to get wholesale brokers to accept its vision of conflicts of interest and how that impacts its treatment of customers in terms of best execution and charging payment for order flow (PFOF). That’s the practice of charging liquidity providers a commission to trade with broker clients from whom a fee is also collected. The FCA says PFOF is always a conflict and breaks its rules.

TRRI has reported extensively on the PFOF argument between the FCA and the broker community, noting at the time that “payment for order flow remains common practice among some UK brokers and interdealer brokers despite [the FCA’s] near-complete prohibition” and upcoming legislation (such as MiFID II) that would significantly raise the risks for prosecution under the Bribery Act 2010.

Pre-MiFID II brokers largely ignored the FCA’s views on conflicts of interest rules making charging PFOF impossible. As reported by TRRI, brokers threatened to route orders overseas and charge PFOF. A recent FCA paper urging brokers to stop PFOF completely stated that brokers had made good on their offshoring threat.

The FCA made it clear it wants that practice to stop. However TRRI’s latest reporting suggests brokers have legal arguments and case law on their side in at least some aspects of PFOF.

Whether the FCA is bold enough to test those precedents remains to be seen.