By Harry Barnes, Senior Compliance Consultant
The Financial Conduct Authority (FCA) has published its final observations on the Investment Firms Prudential Regime (IFPR) implementation following the publication of the initial observations published in Q1 2023. The FCA has clarified its expectations for firms in a number of areas relating to IFPR. Here, we summarise the key clarifications and how firms may be impacted.
Liquid asset assessments
Inadequate consideration of stressed conditions
Liquidity crises are, in the FCA’s eyes, one of the most potent harms a firm can face. Liquidity crises can cause otherwise profitable firms to become deeply stressed in a very short timeframe and have been a significant factor in the largest financial crises over the past 50 years.
When assessing the level of liquid assets needed by a firm under the Liquid Asset Threshold Requirement (LATR), firms must assess the level of liquid assets required to a) support ongoing operations in both business-as-usual conditions as well as stressed conditions, and b) to initiate an orderly wind-down of the investment firm. The FCA has identified that firms are not adequately considering the effect of stressed conditions in this assessment.
Firms should be applying realistic and relevant stress tests to their liquidity to assess cash flows under stressed conditions in order to ensure that they are practically prepared for potential stress scenarios.
Lack of time granularity in cash flow assessments
The FCA identified that some firms failed to make time granular assessments to their cash flows. The FCA didn’t specify the appropriate timeframe for assessing cash flows, since this will be dependent on the size and nature of each firm. Quarterly cash flow analysis will be appropriate for some firms and daily cash flows appropriate for others.
The FCA noted that it was particularly important for wind-down planning to assess a firm’s cash flows on a more granular basis. There may be significant peaks in terms of costs in this period or moments when inward cash flows may change more quickly.
Failure to distinguish between liquid assets and own funds
Some firms were failing to distinguish between liquid asset requirements and own funds requirements, or were using the same analysis for both requirements. This can potentially create a mismatch between the need for liquidity and the liquidity set aside by the firm.
Early warning indicators, triggers and interventions
Firms are required to set an appropriate trigger and intervention point framework alongside the FCA’s imposed early warning indicator and notification thresholds. The FCA expects this framework to identify the appropriate trigger points at which the firm will make interventions to ensure the financial health of the firm before problems arise. These triggers should be specific and tailored to both own funds and liquid assets, with clear interventions and a record of who will be responsible for taking specific actions within defined timeframes. This internal framework should be consistent with the firm’s ICARA assessment.
Typical interventions seen by the FCA include the recovery plan activation and the wind-down plan. Some firms were setting the wind-down plan activation point below levels of own funds or liquid assets that were required to support an orderly wind-down process. The FCA was clear that it doesn’t consider this approach to be consistent with due care and diligence, which is one of the conduct rules that senior managers are personally subject to. This once again highlights the importance of good governance practices across all areas of FCA regulatory requirements.
Wind-down planning
The FCA has identified that firms haven’t given sufficient consideration to the impact of their membership of a group, and that wind-down plans were not in line with previously published wind-down planning guidance.
Firms should be considering group-wide risk and governance structures, and how these may impact wind-down process. Failing to understand where group governance structure may slow down the wind-down process can lead to individual firms failing to have sufficient resources available to support an orderly wind-down.
Firms should also be considering where the wind-down is caused by the wind-down of group entities. The FCA found situations where individual wind-down plans were inconsistent with group wind-down plans. There were also instances where the group had an intervention or trigger framework that differed from the individual firms framework. This creates a potential mismatch and means individual firms may not have sufficient resources available for an orderly wind-down.
Operational risk capital assessments
The FCA noted that many firms haven’t properly assessed the operational risk faced by the firm itself. Firms are expected to assess operational risk and ensure that there is adequate capital and liquidity to cover the risks identified.
It wasn’t just light-touch risk assessments that were considered inadequate. Firms that used overly complicated models or processes to assess operational risk were also failing, often because the senior management didn’t fully understand the risks and the results of the complex models. Operational risk assessments should be sufficiently comprehensive to cover the risk profile of the firm but must also be fully understood to be practically useful to the firm.
Good vs poor practice
The FCA identified a comprehensive list of good and bad practices across IFPR that should act as a comprehensive guide for firms.
What needs to be done?
Given how much the FCA’s expectations around IFPR have changed since the end of 2021, it’s clear that firms should conduct a wholesale review of their implementation of the IFPR rules, including:
- Calculation methodologies for capital and liquidity requirements as well as the firms MIFIDPRU reporting to the FCA
- ICARA processes and the associated risk of harms analyses
- Remuneration framework, particularly where the firm is subject to both the MIFIDPRU and Alternative Investment Fund Manager (AIFM) remuneration code
- The firms MIFIDPRU 8 disclosures, the last deadline for which to publish for most firms was 31 December 2023
How IQ-EQ can help
We’ve a comprehensive methodology for reviewing firms implementation of IFPR covering regulatory requirements and FCA expectations of good vs poor practice, along with comprehensive templates and guidance for all areas of IFPR. Our expert team is also able to provide full support with the ongoing requirements of IFPR, including ICARA updates, annual disclosures and financial reporting.
