The FCA’s concluding IFPR implementation observations: key takeaway for firms

Following its earlier publication in February 2023, the FCA has now highlighted key findings from its IFPR implementation thematic review and provided guidance on examples of best practice. This comes at a time of multiple related FCA publications, regarding strengthening financial resilience of personal investment firms and new proposed FCA guidance on the prudential assessment of acquisitions.

All firms should consider the adequacy of their IFPR implementation and ICARA process arrangements relative to the FCA’s latest guidance and expectations. We highlight key considerations below.

Liquid asset assessment requires further enhancement

The FCA has highlighted some fundamental failings in the approach taken by some firms to assess their liquid asset requirements. For some firms, the IFPR signified a step up in formal liquidity requirements (although Finalised Guidance 20/1 expectations were previously applicable to all firms) and, as we noted in our initial SREP observations, many firms are struggling to meet the FCA’s expectations. Specifically:

• Some firms have failed to consider liquidity specific stresses despite the clear requirement in MIFIDPRU.
  
• The granularity of a firm’s cashflow analysis is often inadequate to identify fundings gaps/ timing mis-matches. Expected practice would include sufficient intra-day, inter-day and weekly projections under stress where appropriate, with appropriate justification to explain the firm’s approach.
• Some firms are setting their liquidity requirement purely based on their own funds assessment without any consideration of the specific drivers of liquidity risk.

Good practice highlighted by the FCA included firms who updated their LATR assessments on a regular basis (up to monthly) to capture changes in the risk environment.

Inadequate internal early warning indicators hinder firms from taking timely action

As we explored in our previous blog on stress testing and risk appetite frameworks, the FCA has identified significant weaknesses in the development of internal monitoring metrics by some firms. We previously observed that some firms have taken the MIFIDPRU notification indicators as their own internal monitoring metrics with no other firm-specific indicators. Alternatively, we have observed a number of firms set internal monitoring metrics with no clear documented rationale to justify the calibration of the metric.

Helpfully, the FCA has provided some basic examples of good practice when setting internal early warning indicators (with previous guidance included in Thematic Review 22/1):

• Ensuring a holistic view of stress testing, recovery planning and wind-down planning is considered when setting early warning indicators.
• Calibrating internal buffers based on the largest change in capital/liquidity surplus resources under stressed conditions.
• Identifying clear escalation and actions associated with each internal intervention point.

For firms where the amount of resources to support an orderly wind-down drive the threshold requirements, the FCA highlighted the risk that – if internal indicators are not calibrated correctly – a mild stress may quickly force the firm to wind-down. Under a severe but plausible stress, a firm may then find itself with insufficient resources to wind-down, leading to a disorderly wind-down.

Wind-down planning continues to receive regulatory scrutiny

The FCA continues to highlight weakness that undermine the credibility and operability of many firm’s wind-down planning arrangements. We have noticed that the FCA’s SREP feedback relating to wind-down panning has often focused on an inadequate consideration of group risk and we have previously shared our observations in this blog.

Firms should take particular note of the examples of good practice shared by the FCA, including:

• Wind-down plans are tested through simulations or war games.
• A stressed backdrop is considered when assessing the starting level of financial resources.
• Operational plans are sufficiently granular to support the adequate assessment of costs and cashflows in wind-down, including the identification of wind-down specific items.
• Non-financial triggers for winding-down have been considered, such as reputational risk and client concentration.

Inadequate assessments of operational risk capital

We have observed a recent focus in SREPs on the approach taken by firms to assess operational risk capital. The FCA has raised some specific concerns and failings across both non-modelled and modelled approached, including:

• The assessment of capital did not cover all the risks that a firm is exposed to.
• The quantification methodology (for both modelled and non-modelled approaches) was not clearly understood and key underlying assumptions (such as correlation and diversification) were not justified adequately.
• The inappropriate use of group models (e.g. lack of evidence of appropriateness when using an insurance/banking model for an investment firm business).
• Weak model risk management, especially where a complex modelling approach is used, and infrequent independent model validation.

For further considerations regarding benefits and challenges of non-modelled and modelled approaches to assessing operational risk capital, and for a summary of Deloitte’s Capital Clarity solution, please see our previous blog.

Other areas of good practice

The FCA has also indicated a range of other areas of good practice, including:

• Articulating a clear assessment of risks posed by individual firms when conducting a group ICARA process.
• Ensuring a joined-up and holistic assessment is conducted when assessing required financial resources. To help achieve this, we have observed some firms start to leverage their operational resilience assessments within their ICARA process to maintain consistencies.
• Data/regulatory reporting accuracy and the consistency in MIF regulatory returns (especially the MIF007) and the ICARA document, annual report and other firm internal documentation.

Next steps

Given we are approaching the third year of IFPR, now would be an appropriate time for firms to review the adequacy and operating effectiveness of their ICARA process, taking into consideration the FCA’s feedback. Conducting a gap assessment to FCA recent expectations, independent validation of approaches used to assess own funds/liquid assets or an IFPR ‘health check’ ahead of the next ICARA process iteration can help support your SMF-holders and Board discharge their regulatory responsibilities in reviewing and approving the adequacy of the ICARA document.

If you have queries or would like to discuss options for the effective design and/or independent validation of your assessment approaches, please do not hesitate to contact any member of our IM&W Prudential team.