The new UK prudential regime for investment firms (IFPR) applied from January 2022. At the time, firms were encouraged to implement on a “best efforts” basis, given the big change this new regime represented and the relatively short time to implement it. The FCA has been conducting supervisory review and evaluation processes (SREPs) since summer 2022 and has now published some initial observations from its ongoing multi-firm review on firms’ IFPR implementation. The FCA comments relate to the internal capital adequacy and risk assessment (ICARA) process and IFPR reporting. The key focus is on how the ICARA process should be approached in groups, the adequacy of, and detail required in, wind-down plans, how coherent firms’ ICARA processes are (including the need for senior manager involvement and challenge), and a reminder about the importance of including accurate data in IFPR reporting.
The FCA urges firms to consider these observations and how they can strengthen their IFPR processes. It is clear that, in 2023, the FCA will have much firmer expectations on IFPR.
The FCA’s multi-firm review will continue – presumably with the FCA checking whether firms are starting to reflect these initial observations. Further interim observations may follow, and there will be a concluding report at the end of the review.
Key observations include the following:
ICARA process – investment firm groups
- For firms which are part of investment firm groups, most opted to complete a ‘group ICARA process’, i.e. a single process analysing the financial impact of risks at group level. However, the IFPR rules require that each individual firm in the group needs to identify its threshold requirements, risk appetite and triggers for capital, liquid assets, and wind-down appropriate to its operations, and hold the required financial resources. The FCA found that in most cases there was insufficient consideration of the individual group entity’s firm-specific risks and harms in the assessment of threshold requirements. The FCA also raises concerns about the way some groups allocated own funds and liquid asset requirements to individual firms within the group, including allocating wind-down resources without a clear reference to individual firms’ wind down actions.
- In its comments, the FCA also calls out the need to involve senior managers at individual entities within the group, who need to understand how and why financial resource requirements are adjusted and allocated to the individual firm.
- Among investment firm groups who completed an ICARA process on a ‘consolidated basis’ (i.e. on the assumption that the investment firm group forms a single IFPR firm), the FCA observed that only a few of them also operated solo ICARA processes by independently assessing the financial resource requirements of individual firms in the group, as required by MIFIDPRU.
- If firms want to complete a consolidated ICARA (as opposed to just a group ICARA process), the FCA will not accept the outcome of this unless the groups has obtained a voluntary requirement (VREQ) to this effect, which will ensure clarity of the process, governance and requirements. The FCA reiterates that these groups would still need to complete the ICARA on a solo basis for individual entities in the consolidated situation. Both the solo threshold requirements and the consolidated threshold requirement will need to be monitored.
FCA assessment of firms’ ICARA processes
- Generally, ICARA processes were not always as coherent as they could be. Identified risks and harms and risk appetites ought to feed into stress tests, triggers, recovery actions and wind-down planning, all of which should, in turn, coherently feed into the calculations of own funds and liquid assets threshold requirements.
- The FCA notes that risks in respect of which firms held capital under the previous prudential regimes (e.g. credit or market risk) should still be captured (even if not by K-Factor calculations) in the ICARA process and reflected in firms’ threshold requirements. Only risks which are genuinely no longer flow from a firm’s business model can be excluded (and this should be explained in the ICARA document). Similarly, previous feedback from the FCA on firms’ financial resource requirements should still be reflected under the new IFPR regime.
- MIFIDPRU sets certain own funds and liquid asset thresholds which, once a firm falls below them, trigger a notification to, or intervention by the FCA. The FCA suggests that firms should not simply use these triggers but should set their own internal frameworks to manage financial resources, tailored to their business model and the risks identified. This should include specified actions which a firm will take when different triggers occur (including trigger points for actions before wind-down). The FCA has also reminded firms of their obligations to notify the FCA under PRIN 11 when certain trigger points are reached.
- Senior manager involvement in ICARA is not as good as it could be in all firms. The FCA expects senior managers to have a level of understanding about IFPR requirements, the firm’s activities, risks etc. to challenge assumptions and the way risks are described in the ICARA document. Firms which demonstrated best practices also provided senior managers with in-depth training on IFPR.
Wind-down plans
- The FCA found issues with the robustness of the assessment of resources to support an orderly wind-down. This is evidenced in unrealistic assumptions, insufficiently detailed modelling and poorly justified estimates of resources needed to support an orderly wind-down.
- One gap identified by the FCA was that several firms did not consider the stress backdrop of a wind down which can, for example, impact assumptions about cash outflows, the amounts that can be realised from asset sales, or can trigger liabilities under credit clauses.
- The FCA also highlights the need to reflect group risk in wind-down plans, such as the impact of group wide stresses or the resilience of a group service company.
- In addition, the FCA reiterates the need for wind-down plans to be comprehensive (reflecting the particular firm’s bespoke processes, obligations, or products) with a wind-down strategy, wind-down triggers, underlying assumptions and scenarios, financial forecasts for wind-down, and details of any testing of the wind-down plan (e.g. validation again reverse stress tests).
Data quality
- The FCA observed some firms providing inaccurate or incomplete data in their regulatory submissions which it considers to be an indicator of weaknesses in firms’ systems and controls. This may also breach senior managers’ responsibilities under the SMCR.
- Given that the FCA uses the data reported under IFPR to monitor markets for emerging risks, it is a fair assumption that FCA supervision (and, in time, enforcement) will focus on data quality in the year ahead.
The FCA webpage published on 27 February 2023 is available here.
This publication includes our initial observations on how firms are implementing the IFPR in relation to the ICARA process and reporting… Firms should refer to our rules and guidance… and review these observations to help them understand our existing policy. They should consider whether to apply any of these observations to their processes.
For further information, please contact:
Karen Cooper, Linklaters
karen.cooper@linklaters.com
