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The FCA has published an unexpected report this week concluding its initial observations on the multi-firm review of ICARAs carried out earlier in the year. While we wait for the results of the full thematic review due in Q1 the feedback gives some useful insight into what the regulator is looking for.
The initial feedback from the multi-firm ICARA review was published in February. The FCA has indicated the findings will be issued at some point in Q1 next year in a Thematic review, but in the meantime, somewhat out of the blue, this week they released their concluding report on their observations based on the ICARAs they have reviewed.
Very few firms will receive any input from FCA on their ICARA process. Out of the 3600 or so firms in scope of MIFIDPRU, FCA reviewed ICARAs from only approximately 50 of the largest or more complex firms they supervise. In various feedback sessions they have also confirmed they will not be providing specific guidance or templates for ICARAs so any feedback from them is useful for firms tackling the second iteration of their ICARA document.
The publication: IFPR implementation observations: quantifying threshold requirements and managing financial resources – concluding report expands on what was covered in the first review so there are no new or emerging topics to note. But the feedback is quite practical, sharing what is considered good and bad practice for each feedback point and suggested areas of improvement.
The points made are consistent with what we often see when reviewing ICARAs from our clients. There are lots of themes within the publication, so we have picked out some of the more relevant feedback points and the good and bad practice noted in each area.
Assessment of liquid asset requirements
We know this is an area of focus for the FCA as many investment firms do not consider they have any liquidity risk. The regulator expects all firms to model cash flows under stress and in wind down including inter-day, weekly, and monthly projections of cash-flows under stress, appropriate to the firm’s business model, to identify potential cash shortfalls and timing mismatches. There is a tendency for firms not to focus sufficiently on their cash flow model and what gives rise to a liquidity stress. This is particularly important for broking firms where they can experience significant intra-day volatility and margin calls from clearers.
In our experience very few firms are modelling their liquid asset threshold requirement correctly as many firms are not identifying any liquid asset shortfalls in the next 12 months. Firms also seem to be unable to distinguish between analysis of own funds and liquidity.
Early warning indicators, triggers, and interventions
Firms need to set out intervention points they have in place before they either take recovery actions or initiate their wind down process. Firms need to allow enough time and financial capacity to ensure that the intervention points work, and the firm has not left it too late to implement an orderly wind down. In other words there needs to be enough of a buffer in place between firms taking action when their resources hit an early warning indicator trigger point (EWI) and executing wind down when a wind down trigger point is met. Although FCA specify that all firms need to notify them when own funds fall to below 110% of their own funds’ threshold requirement, many firms will need an EWI which is higher than this so their recovery actions can be put into place in times of stress to either avoid wind down or to facilitate an orderly wind down.
Good practice examples mentioned include where a firm identified internal early warning indicators which were workable and came before the point of critical stress, when the firm may need to intervene. These levels were above the 110% EWI notification point.
Group ICARA processes
The publication sets out that firms can complete group ICARAs if their risk management framework is managed at group level, but they still need to identify the own funds threshold requirement and liquid asset threshold requirement for each investment firm in the group. Firms need to consider the impact of being in a group particularly in a wind down scenario where they may be reliant on group funding or outsourced services .
Good practices cited include where unique wind down scenarios and wind down resource requirements were identified for different firms in the group and how separate boards had challenged the document.
Operational risk capital assessments
In our experience, firms often struggle to quantify the amount of capital needed for operational risk of harm. For smaller firms who have not experienced many operational failures this is particularly hard to model. Firms often do not fully consider the impact that their group entities may have on them, for example infrastructure or reputational impact.
Where firms use operational risk models, they need to make sure that there is governance around how the model is used, and outputs are assessed and understood, and limitations of models are set out.
Where firms identify a risk such as cyber where the impact can cover several areas, the assessment needs to be sufficiently comprehensive.
FCA expects an ICARA to be “joined up” so resources needed for key risks, stresses and wind down are integrated and make sense. Often the ICARA is broken into workstreams and allocated to different parts of the organisation but where this happens the ICARA still needs to read as one document and themes need to be consistent.
Examples of poor practice also included where capital is no longer considered for risks such as credit or market risk as this is not part of the formulaic capital assessment, but the risk is still there and needs to be considered.
Wind-down planning process
Good practice includes assuming wind down starts at a time of stressed financial resources and the costs are modelled accordingly. Firms should also try and identify any non-financial indicators that would result in wind down such as a cyber attack resulting in a key system no longer being available. Wind down plans should be tested. In practice running a full wind down test may not be feasible, but certain key elements can be tested and communication documents could be prepared in advance.
Where firms form part of a group, they need to consider what happens in the event of a group failure and how group services can be accessed in a wind down scenario.
Useability of the ICARA document and process
Example of good practice included where changes to the assessment are laid out clearly and the document is updated if the business model or market risks change. LATR should be updated monthly to take account of changes in future cash flows.
A firm’s MIF007 return needs to be consistent with what is set out in the ICARA document and annual reports.
What you should do
Firms need to review their ICARA process to make sure these points have been captured or if they have already completed their ICARA document, set out what improvements they intend to make. The ICARA is not a static document and in our experience, it is useful to have a section in the ICARA identifying future enhancements.
We can help
We have reviewed over 200 ICARA documents and help clients in all stages of their ICARA process. Please get in contact if you would like to discuss any of these points or help you to review your ICARA process.