In its annual review of the sector, published on Thursday (10 January), the FCA identified outsourcing, the growing use of sophisticated technology and liquidity levels as issues it is actively monitoring.
Firstly, the regulator said the growing use of outsourcing to third-party technology providers means that should there be a failure of one of more of the “small number” of firms relied upon for these services, the proportion of assets which could potentially be affected by an IT failure is mounting and thereby increasing the likelihood of “significant harmful side effects”.
The FCA also noted “the barriers to successful financial crime” are being reduced as a result of improved technology, which is increasing the availability of sophisticated tools. It added that this is exacerbated by “gaps in controls and oversight” at some firms.
Also, with regard to the use of more sophisticated technology, the FCA said “inappropriate technology-led asset management decisions”, using techniques deriving from the likes of artificial intelligence and big data, could also result in harmful side effects.
The FCA explained: “The speed of machine reactions could have serious consequences. If artificial intelligence using an algorithm were to make an inappropriate asset management decision, any resulting losses could be quickly compounded.
“Greater use of Big Data and developments in artificial intelligence are likely to see growing use of machine-based decision making by asset managers in security selection, asset allocation and trade execution.”
Away from technology, the FCA said the proliferation of funds investing in less liquid assets could also threaten stability and resilience as a result of the consequences of potential contagion.
However, referencing the fallout from the 2016 Brexit referendum, in which a number of property funds were forced to gate assets to prevent further redemptions, the FCA said the employment of liquidity management tools to avoid a sell-off of underlying assets was “successful and resulted in no material consumer detriment“.
It added: “In addition, there have been moves by IOSCO [International Organisation of Securities Commissions] and other regulators, including the FCA, to mitigate potential issues from funds invested in less liquid assets.”
Finally, the FCA said the fact all AUM in the sector is held for “safekeeping” by a small ancillary service providers means the serious failure or disruption at one or more of these could result in “widespread harmful side effects, which could threaten stability and resilience”.