PTF Dear CEO letter sets critical risk review deadline

7 August 2023 | UK & Europe | Articles

Published on 4 August, an FCA “Dear CEO” letter was addressed to Principal Trading Firms (“PTFs”), which derive the majority of their revenue from trading as principal and include many algorithmic trading firms, market makers and commodity traders. The letter requires boards to review their firms’ critical risk and control environment and to identify remedial action by the end of September 2023. For firms not on the receiving end, this still provides useful insight into FCA supervisory thinking.

The FCA has listed several challenges for PTFs, including:

• Broader geopolitical instability, such as the war in Ukraine, and macroeconomic factors, which have manifested in the form of large and unexpected margin calls and heightened counterparty risk
• The growing risk of cyber-attacks, as exhibited by the ION Markets incident
• Crypto related volatility, with FTX unsurprisingly getting a mention in the letter
• The continuing need to manage systemic risk that stems from a large trading footprint or the use of algorithmic trading

Across the FCA’s commentary on these challenges, their core concern is that markets are volatile and PTFs need to be able to withstand stress –  the failure of one would serve to compound instability.

What are the FCA looking for?

The letter lays out the key tenets of the FCA’s current supervisory strategy for PTFs:

• For algorithmic trading firms – the FCA has flagged that it will be undertaking review work in this area, pointing firms towards obligations in the RTS 6 and RTS 7 regulations, essentially giving advanced notice that firms should ensure they are compliant before the FCA checks.
• For financial resilience – tying in with the broader goal of managing systemic risk, the FCA has pointed to wind-down planning as a key focus. They have also flagged that targeted reviews of capital and liquidity health are planned; the possibility of business restrictions and additional own funds and liquidity requirements were plainly stated as a potential outcome for firms. The useful prompt to revisit the scenarios used for stress testing, with the regulator suggesting many firms will need to budget for greater severity, shows another area where firms should focus.
• For commodity market volatility – the FCA suggest that they have been learning from recent market stress, which led to credit stress, higher trading costs and capital shortfalls in energy, metals and government bond markets. They will be paying close attention to the capital health of firms in the commodities space, with a particular focus to be firms with a dominant market presence and firms that offer clearing services.
• For operational resilience – with concerns about tech outages and cyber-attacks, the FCA has underlined the need for firms within scope of PS 21/3 to be compliant as soon as reasonably practicable and no later than 31 March 2025. Other firms are expected to consider these rules as good practice. The broad takeaway: PTFs cannot just assume that they are operationally resilient; this needs to be planned and proved.
• For Brexit – the FCA wants to be kept informed of Brexit-related changes, like the movement of staff or a trading desk. Indeed, the risk that stems from multi-jurisdictional trading flows is something the FCA are keen to see managed. Another interesting takeaway is that that firms newly within their remit will be checked for compliance with core regimes.

What should you be doing?

If you are a PTF, the time to act is now. The FCA has explicitly stated that active supervision is planned. As such, firms must follow the FCA’s instruction in this letter: ‘By end-September 2023, we expect all CEOs to have discussed this letter with their fellow directors and/or Board and to have agreed actions and/or next steps.’

If you are a firm that carries out principal trading as a smaller part of your business, you should consider the content of the letter and consider what action you ought to take in view of the FCA’s supervisory strategy in this area.

How we can help

If you are an algorithmic trading firm, a market maker or a commodity firm and need help ensuring you align with FCA standards, we can help across areas including:

Prudential
Our prudential experts can help make sure your stress testing exercises and scenarios effectively demonstrate robust risk management and control processes. We can also help you draft a trading book policy, in accordance with the MIFIDPRU 4.11 requirement. Please follow the link for more information:

Algorithmic trading
We can conduct a thorough assessment of your support arrangements for algorithmic trading, considering compliance with MiFID RTS 6 and RTS 7 as relevant.

Market abuse
We can help ensure your market abuse risk assessments are comprehensive and accurate. We can help to establish effective controls and calibrate and implement surveillance solutions.

We have already helped numerous PTFs to become compliant in this space, and we will help you to develop your arrangements such that they better compare with peers.