The Financial Conduct Authority (FCA ) issued a letter on risks Wednesday to several Chief Executives of wholesale brokers in London, highlighting potential "systemic defaults" that may not be resilient towards sudden market shocks and longer periods of stress.

FCA's Concerns over the Business Practices of Brokers

The observations came after last year's macroeconomic tensions and inflation woes, along with the expectation of a recession, that changed the priorities and approaches of central banks.

"The structure of financial markets has changed a lot since the last major downturn, with a changed role for banks, the growth of non-bank finance, and often a reduction in liquidity in times of stress," the letter mentioned which was signed by Simon Walls, the Director of Wholesale Sell-Side at the FCA.

"It is plausible that the next two years see heightened systemic risk and episodes of market stress, as we have seen in energy, metals, and government bond markets in 2022. Boards should consider this context and reflect how their business models may expose them to risk, and how this can be mitigated."

The regulator pointed out concerns about weaknesses in clearing brokers' liquidity risk management and believes that "firms continue to underestimate their exposure to intraday liquidity risks arising from their own business as well as from key clients and counterparties."

With insufficient liquidity to face the "instantaneous shocks as well as periods of extended market volatility and stress," these companies are risking "disorderly wind downs." Also, the impact on these companies can raise the risk of "contagion and potential systemic defaults along with widespread market disruption."

Check out the latest FMLS session on "Regulation Roundup: Everything You Need to Know for 2023."

FCA Is Alarmed after Brokers Faced Liquidity Risks

Wholesale brokers provide services to retail-facing firms and usually match the orders from buyers and sellers. The FCA's letter arrived after several clearing brokers faced heightened liquidity risks, resulting in post collateral to clearing houses at short notice to cover their positions even before the customers paid them. The regulator highlighted some of these firms' "liquidity risk management and stress testing was not fit for the current market environment."

The FCA observed some improvements in governance and compliance controls at larger firms. However, brokers are still behind in "stopping poor conduct and improving culture."

Now, the UK regulator wants the CEOs of these brokers to discuss the letter with the boards and take the necessary action by the end of February. Last month, the FCA sent a similar letter to the CEO of contracts for differences (CFDs) brokers in London, highlighting its continued concerns regarding problems and 'poor practices' of these businesses.