Some key areas of consideration…
It’s hard to believe that it’s only been 15 months since the Investment Firm Prudential Regime (‘IFPR’) came into force. Since the go live date, we have seen an avalanche of firm queries, clarifications and warning shots fired by the FCA. The result of which has shone a light on the level of complexity and nuance involved with the new rules and the subsequent sense of unease across the sector. Many are now questioning whether they have fully implemented IFPR correctly.
In a timely intervention the FCA has recently published its observations on the implementation of the IFPR (IFPR Implementation observations: Quantifying threshold requirements and managing financial resources). For those firms not previously subject to Supervisory Reviews and Evaluation Processes (SREP) visits, this publication makes for an interesting read, as it clearly articulates the FCA’s view of what good looks like when it comes to managing risk, capital and liquidity as well as broader issues seen in the implementation of the new regime.
Drawing on this recent feedback from the FCA and our experiences with clients over the last 15 months, we’ve set out the key areas to consider when assessing whether you’ve got further to go with your implementation of the IFPR or not.
Alignment to risk frameworks
The FCA’s observations on firms’ ICARA processes suggest that it believes firms have been approaching their ICARA as a ‘tick box’ exercise. The FCA identified that, for a number of firms, there is a disconnect between their day-to-day approach to risk management and their ICARA process as evidenced by the risks identified by firms (and documented in their risk registers) being different to the risks captured in the ICARA. This has been a consistent finding by the FCA following SREP visits since before the implementation of the IFPR and demonstrates that firms should still be looking to ensure that their approach to managing capital and liquidity is embedded within their organisation, in line with previously issued guidance.
Another key concern of the FCA was that firms had not used their ICARA assessment to help inform the setting of their risk appetites, risk indicator triggers and early warning indicators – with some firms simply falling back on the prescribed intervention points set out under MIFIDPRU 7. Further, even where firms did implement their own limits and thresholds these do not always clearly stimulate management actions or responses even if crossed.
Takeaways: As these are issues which the FCA has previously provided guidance in respect of, it’s clear that there is still work for the industry to do and the FCA’s expectations for firms have not been tempered due to the implementation of a new regulatory regime. Indeed, the recent publication by the FCA made clear that firms which have significantly reduced their own funds requirements since the implementation of the IFPR, or discounted risks that they previously assessed as relevant (such as credit and market risk), should have a very clear reason for doing so. The change in regulatory regime should not impact the risks and harms businesses face and it may be an opportune time to reincorporate these into your ICARA process.
- The FCA has made clear that in some instances firms’ boards and senior management do not have sufficient knowledge of their activities, operations and risk management processes to provide effective challenge and oversight in respect of their ICARA process. The best practice demonstrated by firms included in-depth training on the IFPR. Failure to provide this support to enable the exercise of appropriate diligence could represent a failure of a senior manager to meet their fundamental requirements under the Senior Management & Certification Regime (SM&CR). For any board members reading this article who have not received training in respect of the IFPR it may be time to ask for some.
2. Wind-down Plans
Lack of attention
Under the previous regime, despite the publication of a significant volume of guidance by the regulator, wind-down planning was sometimes treated as an ‘optional’ extra by firms. The implementation of the IFPR demonstrated the importance the FCA places on this assessment and made the need to conduct wind-down planning a regulatory requirement for MIFIDPRU investment firms. Despite this, there has been a persistent lack of attention paid to wind-down planning compared to the ongoing own funds and liquid asset requirement assessments.
The FCA’s recent publication has stressed that equal attention should be paid to the wind-down plan and the ongoing assessment, suggesting that firms have been slow to react to the guidance provided by the FCA since the publication of the wind-down planning guide in 2016. This has resulted in firms conducting high level wind-down assessments, typically only considering the costs of winding-down and neglecting the development of a detailed operable wind-down plan.
Takeaways: All firms should take stock of their existing wind-down plans and assess whether these have fully taken on board the guidance provided in the FCA’s published Wind-Down Planning Guide and in its final guidance FG20/1 (Assessing adequate financial resources). Whilst these publications have the status of guidance they should not be treated as such. Where there are gaps against this guidance boards must hold the business to account and challenge the lack of complete and credible wind-down plans.
Stressed wind-downs and key dependencies
- The FCA’s recent observations on wind-down planning echo the messages shared with the industry in the thematic review published in Q2 of 2022 (TR22/1 Observations on wind down planning). Despite this guidance being shared over nearly a year ago the industry has been slow to respond, with the regulator specifically pointing to a lack of consideration of stressed events leading up to a wind-down decision being taken. Further, for those firms which rely on financial or non-financial resources provided by other parts of their group, insufficient attention continues to be paid to the reliance on other group entities during a wind-down scenario and whether the individual investment firm would have access to these resources.
Takeaways: It’s clear that there is still work to do for a number of firms and wind-down planning should be considered as a particular area of focus for firms as they plan their review of their overall ICARA process in 2023.
3. Data Quality and Reporting
Unsurprisingly the FCA has continued to flag concerns around the quality, completeness and accuracy of firm’s regulatory submissions. This is not the first time the regulator has taken the industry to task over reporting, with ‘Dear CEO’ letters published in 2018 and 2021. It’s clear that the IFPR implementation ‘grace period’ that the industry has been operating in is well and truly over.
A number of these issues related to regulatory reporting, in our experience, appear to stem from an incomplete or inaccurate implementation of the new regime. A number of firms are playing ‘catch up’ with the IFPR, as previous assessments in respect of the impact of the new regime (including an assessment of relevant K-factors) have been informal in nature, poorly documented or not subject to internal review and governance.
Takeaways: Firms should consider the consistency of the data they supply to the FCA against their ICARA document, annual accounts, and other management information – with incorrect or inconsistent reporting being an indicator of firms failing to meet their internal governance requirements and potentially breaching senior managers’ responsibilities under SM&CR. Firms should also take the opportunity to formally document their judgements in respect of the applicability of the new regime and then scope the data requirements to fulfil their reporting and monitoring obligations. The development of formal, documented processes in respect of periodic data gathering, completion of submissions, and the review of these submissions should be prioritised going forward. This will also help mitigate the potential for key person risk within the reporting process, which we have seen impact several firms due to the high turnover of staff in risk and finance functions over the last 12 months.
The new regime introduced a more far-reaching scope of the consolidation rules that were in place prior to IFPR, with a lot more firms, namely Exempt-CAD firms, having to consider whether they were part of an investment firm group, and therefore subject to supervision on a consolidated basis for the first time.
Firms have struggled in a number of areas over the last year in respect of consolidation. One key issue has been the identification of groups – with a number of firms still to complete this assessment and conclude on whether they form part of an investment firm group. Secondly, where firms are part of an investment firm group, there has been significant difficulty in understanding the basis of preparation of their ICARA and, by extension, whether threshold requirements should be set at a consolidated level.
Scope of consolidation
We have seen a number of firms have difficulty in applying the regulatory consolidation rules. Where firms are part of a wider group structure and do not have a formally documented and approved view on whether they belong to an investment firm group, they should seek to conduct this analysis. This should include an understanding of whether regulatory consolidation applies, which entities would meet the definition of relevant financial undertakings (and therefore be within the regulatory perimeter) and whether there are any identified connected undertakings.
The responsibility to identify whether there is an investment firm group and ensure that the associated consolidated reports are submitted to the FCA is the responsibility of each individual firm. Where your MIFID investment firm is part of a wider group structure, no matter how simple, there is the possibility that you may form part of an investment firm group without realising.
Consolidated versus Group versus Solo ICARAs
For those firms that have identified that they are part of an investment firm group, there has been confusion around how they should approach the ICARA process.
A consolidated ICARA is where a group conducts its assessment on a combined basis and determines a threshold requirement for the investment firm group as a whole. This process must incorporate a sufficiently granular view of each MIFID investment firm in the group to enable threshold requirements to be set for each individual investment firm. However, the FCA has made clear that firms would need to apply for a VREQ (voluntary requirement) to be able to conduct a consolidated ICARA process. If a firm is currently completing a consolidated ICARA but have not applied to the FCA to do so the regulator has made clear that they will ignore the results of their ICARA process.
A group ICARA process is where groups, with multiple MIFID investment firms, conduct a single process but apply this individually to each MIFIDPRU investment firm within the group. This is better thought of as an aggregation of multiple solo entity ICARAs. The FCA has made clear in its recent feedback that groups conducting a group ICARA process should ensure that they have conducted the analysis with sufficient granularity for each MIFIDPRU investment firm to ensure that the outputs are sensitive to the specific business model and harms posed by each firm. In conducting a group ICARA process investment firm groups are not required to conclude on a consolidated threshold requirement in respect of own funds or liquid assets.
As firms look forward it appears there is still some distance to travel before the implementation of the IFPR is complete and fully embedded. Whilst the industry appears to be experiencing some degree of IFPR fatigue (following a year of consultation and then a year of initial implementation) it does however feel that the end may be in sight. If a firm ensures that its approach to implementing the IFPR has been formalised, documented, and reviewed it will avoid the need for time-consuming and costly revisiting of the rules. Tackling the FCA’s concerns in respect of broader approaches to managing risk, capital, and liquidity will likely take longer to remediate, but we anticipate that firms that seek to enhance and embed their ICARA process proactively will stay ahead of the curve when it comes to the FCA’s expectations.
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