The FCA – Improvement still required in ICARA implementation.
Following its initial observations of February last year, the FCA has published a concluding report, on ICARA (Internal Capital Adequacy Risk Assessment) and IFPR (the Investment Firms Prudential Regime) reporting, bringing to a close the FCA’s multi-firm review.
Their review highlighted that, despite making progress, there are still areas for improvement around group ICARA processes, internal intervention points, wind-down assessments liquidity assessments, operational risk capital assessments and regulatory data submissions.
The FCA highlighted four areas for improvement:
1. Inadequate consideration of stressed conditions makes firms unprepared to immediately address liquidity strain.
The FCA reminded firms that they should consider liquidity stresses when calculating liquid assets that may be required for both ongoing operations and an orderly wind-down. They also reminded them that cashflows should be assessed under stressed business conditions which are relevant to the firm's business and be forward looking and regularly reviewed. The FCA commented that a lack of time-granular analysis of cash flows leads to an inadequate understanding of cash needs and impairs resilience. Analysis needs to be granular enough to identify peak cash requirements in stress conditions, which could be inter or intraday funding gaps.
The FCA also reminded firms that liquid assets and own funds requirements are different, with the former looking at cashflows while the latter looked at a firm’s assets and liabilities and capital accounts.
2. Early warning indicators, triggers and interventions:
As outlined in their Final Guidance (FG20/1) the FCA expects firms to anticipate problems, take effective steps to prevent them and rectify problems when they occur. Firms should set their own internal warning indicators, triggers and intervention points and have separate triggers for activating their recovery and wind-down plans. MIFIDPRU specifies an early earning indicator (EWI) for own funds and wind-down triggers which require notification to and may result in intervention by the FCA to allow the FCA time to prepare any actions they may choose to take. They add, in this report, that a firm acting prudently is likely to set internal EWI’s and triggers above the level specified for notifying the FCA.
The FCA also comments that unless a firm identifies appropriate internal EWI’s, intervention points and resource buffers based on stress tests, there is a risk that it may not take appropriate action at the right time. It will then struggle to maintain adequate resources to remain viable and be able to support an orderly wind-down.
3. Wind-down plans:
Little consideration to the role of group relationships potentially leads to inadequate assessment of resources to support an orderly wind-down. The FCA observed that while individual firms operate autonomously, the wind-down of a firm which is part of a wider group is rarely an independent exercise. Group-wide risk appetite and governance may accelerate or delay wind-down processes. Unless these are considered, the individual firm is unable to comprehensively assess the adequate resources needed to support its orderly wind-down. The FCA suggests that insufficient consideration of group-wide wind-down plans may lead to incomplete assessment of harms to be mitigated. Group wind-down plans would help address whether the wind-down had been caused by, or may cause, the wind-down of other firms within the group or even the entire group itself.
Where some or all of the firms in a group are winding down it may create pressures on shared systems, people and financial resources and might also change the roles performed by senior managers and the Board within individual firms. Planning how to address these pressures and changes would give a firm greater assurance of achieving an orderly wind-down. Where applicable, individual firms should also consider any group-wide resolution and wind-down triggers in their own planning.
4. Operational risk capital assessments:
Significant failings in the application of operational risk capital approaches may lead to insufficient resources to mitigate harm and the FCA saw that many firms calculated operational risk capital using approaches that did not lead to adequate assessments of own funds for individual firms. A lack of adequate model risk governance caused some firms to use incorrect models or relatively complex approaches which led to incorrect or poorly understood results. Without good model risk governance and adequate oversight, where models are used, firms cannot confirm that they hold the correct resources to mitigate harm from their operations.
To conclude their final report, the FCA provided a summary of what they consider are good and poor practices and these should be read in conjunction their Observations of last February and the good and poor practices cited in their previous ‘Observations on Wind-Down Planning’ and ‘Assessing liquidity for orderly wind-down’ publications.
Where can FMCR Help?
FMCR has consultants with senior banking and accounting firm practical experience of advising firms on the drafting of ICARA policies and documents and would be very happy to meet new clients to have an initial discussion of where and how we can help. In the first instance, please contact us at contact@fmcr.com.