Compliance Matters: week ending 16th August 2024

After a week away in the Oxfordshire sunshine, the Compliance Digest returns with a summary of recent FCA activity and a note about crypto assets.

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• PwC fined £15 million for failing to alert the FCA to suspected fraudulent activity at London Capital & Finance plc

• FCA censures auditor for failings in client asset reports

• FCA progresses framework to drive long-term value for workplace pension savers

• Is a bitcoin allocation a diversification ‘cheat code’?

PwC fined £15 million for failing to alert the FCA to suspected fraudulent activity at London Capital & Finance plc

In a press release, the FCA confirmed that it has  fined PricewaterhouseCoopers LLP (PwC) for failing to report to the regulator their belief that London Capital & Finance plc (LCF) might be involved in fraudulent activity.  This is the first time the FCA has fined an audit firm.

PwC encountered significant issues throughout their 2016 audit of LCF.  A senior individual at LCF acted aggressively towards auditors, and the firm provided PwC with inaccurate and misleading information.  PwC found the audit very complex, and it took considerably longer to complete than anticipated.  LCF’s actions, and PwC’s own work on the audit, led PwC to suspect that LCF might be involved in fraudulent activity.  PwC was duty bound to report those suspicions to the FCA as soon as possible, but they failed to do so.

PwC eventually satisfied itself that LCF's 2016 accounts were accurate.  Whether or not its suspicions remained, it still had an obligation to report its previous concerns to the FCA.

The full FCA Final Notice can be read here

The issues with LCF and its marketing of minibonds are well documented as is the FCA oversight and regulation of the firm.  One could argue that the regulator is shutting the door after the horse has bolted but the reconstituted Treasury Select Committee may be working to a new agenda, and we should be prepared to react to a re-invigorated regulator.

FCA censures auditor for failings in client asset reports

In another regulatory action against an auditor, the FCA has censured the auditor Macintyre Hudson LLP (MHA) for failing to prepare client assets reports to the required standard.  In a press release the FCA confirms that MHA failed to notify the FCA of rule breaches by firms it had audited, which could have put customers’ money at risk.

Client asset protection is a key part of maintaining market confidence, financial stability, and consumer protection.  Firms that hold client assets are required to have an auditor provide a client assets report to the FCA on an annual basis except in limited circumstances.  The FCA relies on the accuracy of these client assets reports to monitor whether firms are complying with its rules, so it is important that auditors ensure their reporting is accurate.  CASS rules are particularly important when firms fail or exit the market.  Around 3,100 firms, holding around £175 billion of client money, and around £17.4 trillion of custody assets, such as investments, are subject to these rules.

The Final Notice can be read here.

This will be of particular interest to firms with permissions to hold or control client money or client assets and are subject to the CASS rules.  Compliance Matters UK Limited can review your CASS arrangements and recommend any changes necessary.

FCA progresses framework to drive long-term value for workplace pension savers

The FCA, the Department for Work and Pensions (DWP) and the Pensions Regulator (TPR) aim to implement a joint framework for workplace defined contribution schemes.

The joint framework would be used by pension providers and those making decisions on behalf of savers to provide greater transparency over how schemes are performing.

Schemes will be compared on public metrics that demonstrate value – not just costs and charges, but also investment performance and service quality.  They would, once the final framework is decided, be publicly rated red, amber, or green.

Poorly performing schemes will be required to improve or ultimately protect savers by transferring them to better schemes.  This should lead to better value pensions, without savers themselves having to take action.

The proposals will also support the FCA’s secondary growth and competitiveness objective.  Focusing on value rather than costs will enable providers to invest in assets which could deliver greater long-term returns but have higher management costs, such as infrastructure or venture capital.

The press release can be read here, the proposals are in CP 24/16: Value for Money Framework which can be read here.

Is a bitcoin allocation a diversification ‘cheat code’?

This was the title of an article in Portfolio Adviser recently.  Digital assets continue to work their way into the professional investment space despite caution from regulators and misconceptions around the asset class, according to industry commentators.

While the SEC and the FCA have both taken a cautious approach to crypto, regulation introduced over the course of the year so far has seen spot bitcoin ETFs approved in the US while UK asset managers are now able to offer physically backed products to professional investors.

Despite increased interest from asset managers, however, we are still in the very early phases of adoption of the asset class.  According to Syz Capital’s head of liquid alternatives Richard Byworth, less than 4% of the global population have any exposure, while far less understand the “core value” of a “highly portable, and absolutely scarce, asset”.

The positive correlation between equities and bonds in recent years has left investors considering alternatives to further diversify their portfolios.  John Plassard, Mirabaud Group senior investment specialist, says that digital assets can provide this due to their low correlation with traditional assets.

“They offer high growth potential as emerging technologies with significant upside if widely adopted, making them attractive to risk-tolerant investors,” he says.  “Cryptocurrencies are also seen by some as a hedge against inflation, due to their limited supply and decentralised nature.

“However, their high volatility poses substantial risks, suggesting they should only comprise a small portion of a portfolio, typically 1% to 5%.  Additionally, the evolving regulatory environment and security concerns introduce further risks that investors must consider.”

He believes the adoption of bitcoin and ethereum ETFs has given a “new dimension” to the asset, as the products have made it easier to integrate crypto into a diversified investment strategy, while the increased accessibility also lowers the barriers to entry for investors who were previously reluctant to gain direct exposure due to perceived risks or technical complexity.

According to research from WisdomTree — who are among the asset managers to embrace digital assets — looking at the 11-year period between 31 December 2013 to 30 April 2024, adding a 1% allocation to bitcoin to a 60/40 portfolio (60% MSCI All Country World, 40% Bloomberg Multiverse) would have increased returns by 0.67% per year, while adding only 0.07% of volatility and 0.5% of maximum drawdown.

The article goes on to make the case for an element of crypto assets in a portfolio despite reticence from institutional investors.

There is no question that crypto assets are making their way towards the mainstream as an asset class.  This will become more evident as regulators bring them into the regulatory perimeter.  Compliance Matters UK Limited an assist you with your considerations of how to integrate crypto assets into your clients’ portfolios.

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