IFPR: Observations and current expectations one year on

We are now a full year on following the implementation of the Financial Conduct Authority’s (FCA) Investment Firms Prudential Regime (IFPR) and the MIFIDPRU handbook. Last year has been a particularly busy period for FCA-regulated MIFIDPRU investment firms to ensure compliance with the new prudential regulations and to respond to further regulatory feedback, including the FCA’s Thematic Review 22/1 (TR22/1) on wind-down planning. This blog series will focus on some of our key observations and lessons learned from the past year that MIFIDPRU firms may wish to consider as part of their future workplans.

Internal Capital Adequacy and Risk Assessment (ICARA)

The ICARA process is one of the key elements introduced under IFPR, designed to ensure that firms have adequate financial and non-financial resources to address any harms from ongoing activities and to achieve an orderly wind-down if required. Many firms will now have completed or are near to completing their first assessment of their ICARA process, including securing Board approval of the ICARA document. For most firms, this is likely to have uncovered a range of areas for further clarification, enhancement and/or embedding, examples of which are highlighted below.

Although risk classification, identification and assessment are foundational elements of a firm’s risk management framework (RMF) arrangements, many firms have had to undertake improvements to these processes to ensure effective consideration of all relevant risk and harms. This often included, for example, a need for a more detailed assessment of their business model, key activities and forward-looking business plan. In some cases, firms also needed to revisit feedback and gaps identified under the previous prudential regime to ensure that any relevant concerns or weaknesses had been adequately mitigated. These actions, among others, have helped firms provide supporting evidence of the completeness and robustness of their assessments of their Own Funds Threshold Requirement (OFTR) and Liquid Assets Threshold Requirement (LATR) to support compliance with the Overall Financial Adequacy Rule (OFAR).

Group considerations are another key area where additional assessment work has been required to meet various MIFIDPRU requirements and expectations. Some notable examples include the following:

• For some firms operating a group ICARA process, there was an inadequate articulation of the rationale for this approach or its expected alignment to their RMF arrangements.
• Additionally, while utilising a group ICARA process, firms had not always provided adequate details to confirm the appropriateness of their risk/resource allocation to their solo MIFIDPRU entities. A robust allocation methodology is required to demonstrate solo-level compliance with the OFAR.
• Group risk assessment remained as an area for improvement for many firms both from the consideration of potential on-going exposures and wind-down planning implications.
• Separately, it should be noted that while MIFIDPRU does provide an option to undertake the ICARA on a consolidated basis, this is only possible with the prior approval or instruction of the FCA, either where a firm proposes a consolidated approach or where the FCA requests this.

Supervisory Review and Evaluation Process (SREP)

The FCA has conducted a number of SREPs already and some firms will now be receiving formal feedback. Some of our key observations from the FCA’s initial SREP reviews include the following:

SREP approach

• In advance of the formal assessment, the FCA has typically required firms to submit their ICARA document, wind-down plan and other specific supporting documentation. Where possible, the FCA has also sought to have introductory meetings with senior management to gain a better understanding of the business model, key products and strategic initiatives. Senior management should be able to provide a clear and consistent overview that demonstrates (among other things) how business activities and performance deliver both internal and regulatory objectives.
• These initial SREPs have been conducted via on-site visits and/or desk-based reviews. However, as on-site visits may not be used for every SREP, firms should ensure that their ICARA document and any supporting information provide a sufficiently clear, credible and prudent assessment on a standalone basis.

SREP observations

In addition to the various ICARA improvement areas noted above, examples of other areas of challenge or concern we observed from the initial SREPs include the following:

• Several firms needed to review previous management assumptions on the (non) applicability of prudential consolidation to ensure the appropriate application of consolidated own funds (or group capital test) requirements.
• From a risk management perspective, some firms had not identified adequate key risk indicators (KRIs), early warning indicators (EWIs) or triggers for relevant risks. Weaknesses were also identified in other risk appetite framework arrangements, which suggested potential ineffective risk oversight, monitoring and management arrangements as part of the ICARA. This included, for example, ICARA processes that appear to rely only on the FCA’s MIFIDPRU notification indicators with no other documented (firm specific) internal indicators.
• Where risk indicators were identified, further action was often required to justify their design and calibration, and demonstrate effective embedding and practical alignment across key elements of the RMF and ICARA process arrangements.
• Similar to concerns raised under previous prudential regimes, firms’ documentation of their stress testing often failed to demonstrate that that capital and liquidity related stress tests were sufficiently severe, relative to their business model and risk appetite framework arrangements. This is particularly relevant given the FCA’s recent Wholesale Broker strategy letter highlighted liquidity risk and stress testing as focus areas for strengthening financial resilience.
• Another area of continued regulatory challenge was firms’ approaches to wind-down planning and assessment. This included several the concerns that were previously raised in the FCA’s TR22/1, including the assessment of liquidity requirements, its alignment to other key ICARA and RMF elements and inadequate evidence that the Wind-Down Plan can be practically implemented, for example through supporting playbooks and process testing where appropriate.

Additionally, whilst SREPs have primarily focused on material ICARA inputs, assumptions and conclusions, firms could also consider how other key topics, for example conduct considerations, could impact the conclusions of the process.

Regulatory reporting

Data quality and the accuracy of regulatory reporting continues to be a focus area for the regulator. The IFPR has introduced new regulatory reporting templates (MIF001-008) and firms will now have had one year of relevant experience. It is, therefore, important that internal process arrangements implemented to meet these new reporting requirements are reviewed to ensure that they are reliable, with proactive enhancements made where deficiencies are identified. Some areas for consideration include:

• Checking the accuracy of data submitted within new returns and ensuring that all relevant returns are being submitted. Many firms will be preparing to submit the FCA’s MIFIDPRU Remuneration Report (MIF008) for the first time this year, in relation to the 2022 performance year. Firms should note that the extent of these reporting requirements will depend on whether the firm is subject to basic, standard or extended remuneration requirements.
• The FCA recently clarified in its Quarterly Consultation 22/26 (CP22/26) several industry queries and areas of potential ambiguity in the calculation of rules-based requirements and the corresponding MIF returns. Firms should review their existing arrangements, including supporting policies and procedures, to verify on-going alignment to the clarifications included in CP22/26 and ensure accurate and reliable data submissions to the regulator.
• Additionally, firms will need to consider their requirements under MIFIDPRU to publicly disclosure certain information (Annual Public Disclosures). Ensuring there is a consistent message across their FCA returns, Public Disclosures, published financial statements and ICARA document will be important.

Beyond IFPR implementation: areas for focus and integration

For firms that have completed their initial IFPR design programmes, attention may now turn to ensuring that any new systems, policies or procedures continue to be embedded within the business. Feedback from our industry roundtables and forums – in addition to the FCA’s Asset Management strategy letter – have pointed to three key priorities that firms expect to consider:

• Following the first iteration of the ICARA process, firms are beginning to consider how best to integrate and align the process to their wider governance, strategic and risk management arrangements, adding further value to the wider business, clients and key stakeholders. For example, effective embedding of the ICARA process within the RMF could lead to greater synergies and opportunities for efficiencies.
• Similarly, the UK regulatory regime has set clear standards for operational resilience across multiple industries in recent years. There is the potential for firms to identify overlapping processes and potentially optimise the delivery of some aspects of operational resilience arrangements alongside their ICARA assessment, stress testing and wind-down planning requirements.
• Finally, firms are also considering the potential alignment of their ICARA and RMF arrangements to the strategy and actions taken to address environmental, social and governance (ESG) risks. Further consideration of ESG integration can be found in our recent asset management blog.

Conclusion: future opportunities

The maturity of the ICARA process will vary across the industry, but all firms can take the opportunity after the first iteration of the ICARA process to consider whether any future enhancements are required. In parallel with such reviews, we have also observed some firms beginning to revisit their legal entity structure and internal business practices to consider opportunities for further integration and optimisation. Making these enhancements and changes can support firms not only in meeting regulatory requirements based on the FCA’s objective of reducing harm but also in achieving important internal objectives such a business model efficiency.

If you have queries or would like to be involved in future industry roundtables, please do not hesitate to contact any member of our IM&W Prudential team.