A year of ICARA – firms “underestimated work required”

The Investment Firms Prudential Regime is about to reach its first birthday and Bovill has worked with over 300 clients to adapt to the new rules. Inevitably the focus for many of these clients has been the internal capital and risk assessment process – or ICARA. There are some themes we have seen time and time again that anyone looking to draft an ICARA in 2023 would be wise to take on board.

In general, firms have underestimated the amount of work required to put an ICARA together, even where they have an existing ICAAP, and as a result we have seen many firms push back their MIF007 submission dates two or three times in order to get a decent document across the line. In some cases this has been as a result of push back from the board. This has been encouraging to see from a governance and challenge perspective.

In the banking sector, developing a risk management framework has been an iterative process which generally gets better over time. We expect something similar for MIFIDPRU firms.  Where firms we’ve seen have made a good start there are some common themes which anyone developing an ICARA can build from.

Business model and strategy

  • From our review of ICARAs most firms provided either no or limited information regarding their business outlook or external factors that influence the success of the business model and strategy.  Narrative on regulatory and market trends and the competitive landscape would be a good start.

Governance

  • Firms that used to run the ICAAP process have generally continued to use the same governance structure for the ICARA. Approval of the ICARA tends to be at the end of the process; most firms do not involve the Board in the scenario selection process.
  • We have been encouraged to see that the senior management and boards of Non-SNI firms have been keen to learn about the ICARA process in order to provide robust challenge. However, this has been less common in SNI firms.
  • The governance process around stress testing, recovery plan trigger points and the implementation of recovery actions is nebulous for many firms.
  • Many firms struggled to identify, and include in their ICARA document, information on the key personnel that are involved in stress testing, recovery planning and the implementation of recovery actions.

Risk management and risk of harms assessment

  • Firms have struggled with identifying their risks of harm. We have found that many firms have found it difficult to engage the wider business on the ICARA process and instead rely mainly on the risk function. More engagement with the business should be a priority for the 2023 ICARA.
  • Most firms have been unable to clearly articulate their risk appetite.
  • Risk appetite statements are generally not linked to Key Risk Indicators which should be used to track risk limits and outline the process used to mitigate risks which are outside of appetite.
  • Most firms have struggled to work out how much additional financial resource to hold against their risks. We have also seen a lot of uncertainty around how to assess risk of harm to customers.
  • With the FCA’s Consumer Duty regime coming into effect on 31 July 2023 and 31 July 2024 (depending on the types of products and services that firms offer), the focus on harm to consumers is of utmost importance. Firms should already have in place a plan of how they are going to implement the consumer duty principles and be able to evidence that their Boards have scrutinised and challenged the plans to ensure they are deliverable and robust to meet the new standards. A reference to this implementation plan should be included in the ICARA document for best practice.
  • Firms tend to think about holding sufficient capital, but not enough on how much additional liquidity they need to hold against ongoing risks. Few firms have considered how much additional liquidity would be required for wind down.
  • Firms need to be careful not to double count or have the same scenario both for the Risk of Harms Assessment and the Stress and Scenarios.
  • Several firms struggled to move from the ICAAP’s risk assessment approach to the ICARA’s where risks need to be classified in three categories – risk to firm (‘RtF’), risk to market (‘RtM’) and risk to customers (‘RtF’).

Recovery planning

  • Recovery planning is new for many firms so, for most, it has not been fully thought through. Credibility of recovery options is a real weakness in the ICARAs we have seen, particularly around the practicalities of execution, such as timing, individual responsibilities, or ability to execute in a stress.
  • Nearly all firms have struggled to come up with a diverse menu of recovery options that would provide a benefit in a capital or a liquidity stress.
  • Few firms have been able to articulate exactly how or when they would actually invoke the recovery plan.

Stress testing and scenario development

  • We have found that firms struggled to identify severe but plausible scenarios for stress testing. Many have needed assistance in thinking through the scenario development process and have benefited from facilitated scenario design workshops.
  • Very few firms outlined the financial impact of their stress scenarios on a pre and post recovery actions basis and so the benefit of recovery actions in these scenarios are not clear.

Reverse stress testing

  • Most firms have chosen not to do reverse stress testing this year.

Wind down planning

  • Firms tend to understand the need to have a proper Wind Down Plan in place and how it links to the ICARA however there are still areas which need to be developed within their Wind Down plans.
  • Some firms still consider that they would be able to wind down their regulated business and cancel their Part 4A permissions within a 6-month period, rather than the generally accepted 12 months.

We can help

Our dedicated prudential team can advise on any aspect of IFPR and have extensive experience helping firms with their ICARA process.

Our ICARA template has provided a crucial starting point and saved time for many of our clients. We have also seen very high demand for our workshops on risk management, stress testing and wind down planning.

With our support our clients can get on with the essence of the ICARA process – managing the risks in their business – while leaving the regulatory compliance challenges to us.

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