The FCA has released its feedback on how well firms are implementing the requirements of ICARA and IFPR reporting and concludes there is clear room for improvement.
The regulator has identified four specific areas of concern and it’s evident that stepping up access to expertise in this area either in-house or through a third party provider, will go a long way to meet the required standards of the FCA:
- Assessment requirements for individual firms within a group
Where an investment firm exists within a group – it might be in a simple group or part of a very complex structure, within or outside the jurisdiction of UK or EU – the individual investment firm is inevitably affected by the activities of, and risks to, the whole group. The FCA believes not enough consideration has been given to the impact of the group on the single firms. Where ICARA reports are prepared by the individual firms, they do not necessarily reflect at group or the consequences to each individual party. In a wind-down situation of the group, for example, the overall financial adequacy rule (OFAR) might fall short if an overreliance is placed on group support.
Absence of unified and integrated assets
The FCA noted that firms, individually and within groups, could benefit from a more joined up approach to ICARA process and information sharing. This could ease pressure across teams, including IT, compliance, reporting and leadership and management. Clear examples of such inefficiencies are where finance teams conduct budgeting and then forecasting for ICARA purposes takes place separately. Another example is where the business operates a bespoke risk management process and then a separate one is conducted during the ICARA review. Joining these up and leveraging the skills and knowledge of the subject matter experts makes for a more effective process and less effort duplication.
Risk capital requires fuller explanation
The FCA has observed that there has been a large reduction in the risk capital requirement for many firms compared with their assessments under previous regimes. Some firms made no capital allowance at all where previously they had allocated some. Minimum requirements for credit risks and market risks, which used to be prescribed previously, are not anymore under IFPR. The FCA consider that, in many cases, justification for such reduction in risk capital is inadequate.
Monitoring framework for own funds and liquid assets
These two sets of measurements demonstrate that a firm is both solvent and liquid, but the FCA has observed that many firms lack an appropriate framework to monitor either one or both. Internal trigger points, or soft limits, should be in place to alert firms to potential dangers approaching in either measurement sets, providing there is a structure to anticipate problems before they occur and take action to prevent them. It is not enough to monitor financial resources against the minimum requirements defined in the FCA’s Handbook, limits should be set with reference to the firm’s understanding of its own risk, scenario testing and orderly wind-down planning. The FCA noted some confusion over what action firms should take once internal intervention points had been triggered, including at what point a wind-down plan should be initiated. Many firms did not have the capital to minimise harm in failure in order to sustain losses and stay solvent.
Board and governing bodies should be familiar with ICARA reports
Some firms have embraced the requirement for their Board and Executive members to be a detailed understanding of the firm’s activities, operations, risks and controls as documented in the ICARA. But, some still rely on one person or a small group owning the responsibility of ICARA reporting. Firms acting in best practice provide training to Boards’ and committees’, enabling thorough review, rigorous challenge and suitable engagement with ICARA processes.
- Wind-down planning
The FCA found that some firms did not give enough consideration to orderly wind-down plans, which can place clients and markets at risk of potential harm. Wind-down plans should be regularly evaluated and updated to be effective in providing an orderly exit in a worst case scenario. The regulator regrets that this point has come up before and so urges firms to heed their long-established guidance and implement stress testing procedures which take account of the likely behaviours of counterparts, outsourcers and clients should the firm cease to trade. Recognising a stressed environment allows firms to properly prepare in order to reduce negative effects. In group situations, attention should also be given to the knock-on ripple effects on other dependencies. Their recent analysis revealed several cases where firms had failed to make sufficiently comprehensive assessment of the obligations, processes and costs of a wind-down scenario. Modelling and stress testing are essential for a structured and well-managed exit.
- Data quality
Not for the first time inaccurate or incomplete data in regulatory submissions was observed by the FCA, which it perceives as indicative of weak systems and controls. Part of senior managers’ responsibilities under SM&CR require the quality of the data to be at a certain standard. The FCA would like all firms to view the transition to IFPR as an opportunity to update and improve their regulatory reporting strategies. Comprehensive and accurate data allows the firm and regulator to see the firm’s activities clearly. The FCA has a duty to monitor data and the firm has a duty to ensure that data is accurate, forthcoming and appropriate.
The goal of the IFPR was to simplify prudential requirements for investment firms, but implementing appropriate systems and ensuring all processes are in place can be time-consuming especially for a small or midsize firm, often drawing focus away from the core activities of the business. Consider working with a third party provider to improve accuracy and efficiency of your processes and reporting.