Speech by Nikhil Rathi, FCA Chief Executive, delivered at the Investment Association Annual Conference.
Speaker: Nikhil Rathi, Chief Executive
Event: Investment Association Annual Conference 2024
Delivered: 5 June 2024
Note: This is a drafted speech and may differ from the delivered version
Introduction
UK asset management – the second largest asset management centre in the world, responsible for £11 trillion of mainstream assets, roughly half of which is managed for overseas clients – is a global success story for the UK. It is undoubtedly a sector where the UK holds a comparative advantage.
It is one that, in addition to the 46,000 direct jobs and 80,000 indirect roles it sustains, holds the key to 75% of our wealth in retirement, and the liquidity on which investment in the real economy so often relies. Many of these jobs are located across the UK, with more than 13,000 of them in Scotland, where nearly 1 in every 5 pounds (16%) of UK Assets Under Management is managed.
Maintaining that position is not easy. Ours is a globalised world, yours is an especially globalised industry.
The case for placing one’s trust with money managers here needs constantly to be made. That relies on a strong and respected regulatory regime, with consistent international engagement. Embracing of innovation. Technological in product mix, and in the way we regulate.
Take the first of these.
We play a significant role in international discussions on global regulatory standards and the risk environment.
Let me highlight some of the key international initiatives.
First, liquidity Risk Management has been an area of focus, particularly in relation to Open Ended Funds following the dash for cash in March 2020.
Last year, the International Organization of Securities Commissions (IOSCO) finalised its guidance[2] on anti-dilution Liquidity Management Tools and achieved a good compromise on Anti-Dilution Tools (ADTs) which garnered international support. There is joint work underway with the Financial Stability Board on the design and use of stress tests for Open Ended Funds. And in the UK, the FCA has been engaging closely with the work of the Financial Policy Committee on a system-wide exploratory scenario[3], including non-bank financial institutions for the first time. This is similar to a scenario-based stress testing exercise.
These different pieces of work are crucial for helping us understand risks to financial stability and market integrity and where there may be data gaps that we need to work on with industry over time.
Another area of focus, where the FCA jointly chairs a working group with the European Central Bank (ECB), is on leverage in non-bank financial institutions. We are finalising a stocktake of the existing data and policy tools authorities have to monitor and address the build-up of systemic risk from leverage. And we will be engaging with industry in an outreach event in New York in June.
Linked to this is international work on margin preparedness, where there is a consultation currently open.
This aims to reduce procyclical behaviour of market participants in response to margin and collateral calls during times of market-wide stress, by enhancing participants’ liquidity preparedness and by strengthening the ability of authorities to monitor and manage associated financial stability risks.
And finally let me mention valuations where again we are leading work on updating principles for the valuation of Collective Investment Schemes to keep pace with market developments.
This is alongside work we are doing here in the UK on valuation practices in private markets to consider, in particular, issues around governance and conflicts of interest.
Global innovators
Let me turn now to technology and innovation which is driving radical change in your industry and client expectations.
Through our domestic initiatives, such as the Digital Securities Sandbox[4] and our project work on fund tokenisation, we have been working to support firms as they innovate with the tokenisation of financial assets and Distributed Ledger Technology (DLT).
We have undertaken work, for example, to identify whether there are any significant regulatory barriers to the adoption of fund tokenisation models, based on use cases we are seeing in the UK market. Here we have been working closely with the technology working group[5], where the Investment Association (IA) is leading the work. Through those experiences, we have concluded that to fully reap the rewards that tokenisation offers of efficiency, liquidity, and accessibility, we need globally connected networks to support globally connected firms.
We are participating in Project Guardian[6], in partnership with the Monetary Authority of Singapore (MAS), Japan’s FSA and the Swiss Regulator FINMA. This is a collaborative initiative with the financial services industry on asset and fund tokenisation. As well as sharing knowledge we are jointly examining the benefits, regulatory challenges and commercial use cases of asset and fund tokenisation.
We have been closely engaging with firms to understand their tokenisation use cases and identify regulatory barriers to adoption. We stand ready to test a number of these use cases in our regulatory sandboxes.
Let me turn now to AI.
Advanced analytics of massive data sets guide investment decisions, assess risks, and mark portfolio managers’ school reports.
We have welcomed the increased engagement from Big Tech and data service providers. It is through this that we can solve some of the questions around the framework of regulation – for example, whether we treat traditional technology differently to generative AI.
Or how we cope with the concentration risk where a handful of powerful global firms could exercise control over vast swathes of data across the financial and other sectors and how this impacts competition.
With firms having differing amounts of resources to invest in technology and data, could this exacerbate the risk of concentration and correlation in markets?
How do we make sure data does not entrench bias?
How should firms’ governance respond to the adoption of these new technologies? And we know that many of you are thinking hard about the skills and capabilities in your organisation as we are too, particularly when there are reportedly fewer than 10,000 deep AI experts in the world.
While we are a technology neutral regulator, we still have an objective to ensure market integrity. With that in mind, how can we guard that in a stampede to maximise profits, the use of the most advanced AI in trading does not lead to market manipulation?
Even if clear rules are given, will the most advanced AI applications report objectively on how they are followed? Would we know if they didn’t?
We do not want to put the brakes on innovation. Our view has been that, for now we can rely on governance embodied in our senior manager regime and outcomes-based regulation, encapsulated in the Consumer Duty[7] and our market integrity framework.
We are also bringing forward proposals with the Bank of England around oversight of Critical Third Parties[8] to the financial system to support resilience.
What investors want
We are also mindful that beyond technological innovation, other changes are having a huge impact on the industry. For example, the growth of passive investing.
In January[9] in the US, passive funds controlled more assets than active ones for the first time. There is a lively debate about the implications of this for active fund management and access to capital for smaller businesses.
We know geopolitical risk is high on your agenda and that global investing now must contend with more challenges than ever before, for example implementing sanctions and periods of considerable volatility.
Demographic changes features in markets around the world. With longer life expectancy and varying savings levels, there is a need for people’s money to work harder for them to support them in retirement. And that means discussing the appropriate level of risk.
We want to support more investors to carefully assess the risk that is right for them over the long-term, with for example our review of the advice/guidance boundary.
That will allow for innovation – perhaps aided by the deployment of AI I talked about earlier to build technology-based solutions – in the advice market. Providing more advice to the mass market, rather than being the preserve of the wealthiest.
And in partnership with the IA and other market participants, we developed the regulatory regime for the Long Term Asset Fund (LTAF) – a scheme that gives defined contribution pensions in particular access to less liquid investments, allowing them to diversify their portfolios and help clients reach their retirement goals. As well as supporting investment in infrastructure.
At the FCA, we have authorised 4 LTAFs so far. We have also broadened access[10] to retail investors as well as self-selected DC (Defined Contribution) pension savers and Self-Invested Personal Pensions. Feedback from firms confirms that demand is picking up.
Making regulation more efficient
Many of the regulations that apply to asset management are contained in EU law with a forest of acronyms such as UCITS, MIFID and AIFMD.
We published a discussion paper last year on updating and improving the regime.
We are working our way through, retaining, repealing, and replacing EU legislation.
We agree there are benefits to making the system more proportionate for alternative managers whilst keeping in place other rules to avoid unnecessary disruption. We are ensuring that our policy has regard to the global distribution models of many of our asset managers.
How the FCA is preparing for the future
To support this demanding agenda, we must also retain our focus on the FCA’s operational effectiveness.
One of the top concerns was our authorisations times, and we have sped these up significantly. Between January and March this year, 98.1% of authorisation applications were determined within the statutory deadline. We have started to introduce automated forms which will make the process even more efficient.
We also recognise that a few years ago a significant concern for the industry was the size of the Financial Services Compensation Scheme (FSCS) levy and we set ourselves a goal of reducing it over time.
We wanted to take steps to make sure that the 'polluter pays' principle applied – so that the cost was distributed in a fair way. And this was achieved by prevention, by deploying more assertive supervisory action, a more robust yet efficient authorisations gateway as well as through our aim to make the 'polluter pay', with a more proactive approach to redress where there has been the risk of significant harm.
We recently closed a consultation on whether investment advisers should set aside a buffer for potential redress liabilities.
We have stepped up significantly work on tackling fraudulent financial promotions and seen reducing harm, as measured by complaint levels in relation to principals of appointed representatives.
We welcome the news earlier this month, that the latest estimate for the FSCS annual levy in 2024/25 is £265m, the lowest for a number of years.
Asset management is a great British industry. Trusted round the world. It supports growth, gives people financial security. It is a lynchpin in our financial services industry.
We have shown – whether that is on LTAF, tokenisation, on other reforms – that we make most progress when we agreed shared goals and work together with open minds.