IFPR implementation observations: quantifying threshold requirements and managing financial resources

The Financial Conduct Authority, FCA, has published the findings from an initial review of investment firms’ progress in implementing the internal capital adequacy and risk assessment (ICARA) process and reporting requirements under the new Investment Firms Prudential Regime (IFPR) which came into force on January 1, 2022 and which is outlined in the MIFIDPRU Prudential Standards section of the FCA Handbook.
To recall, the new IFRP applies to MiFID investment firms, including „fund managers, asset managers, trading firms, depositaries, and investment platforms“. It requires firms to perform an initial assessment of their capital adequacy so as to identify any shortcomings and possible risks to their operation and build up sufficient (liquid) capital to mitigate any potential risk and to enable them to perform an orderly wind-down, if so needed.
Having reviewed various firms‘ practices and progress in this context, the FCA now outlines some key deficiencies found during the review. These include, but are not limited to the following:
– Many firms within groups chose to apply the „group ICARA process“ focusing on the group as a whole. However, they often forgot to properly assess their own capital requirements taking into account any group level offsets.
– Sometimes, firms within groups applied the capital adequacy thresholds and requirements at group level and thus found their own capital to be adequate, if the group requirements were met, regardless of their own individual risks.
– ICARA processes were sometimes performed in isolation, not providing the necessary input to other departments such as compliance or risk management. This often led to insufficient consideration of the outcomes on stress test scenarios or estimates of own fund and liquid asset requirements.
– Some firms simply did not measure capital adequacy requirements for certain risks (e.g. credit or market risk).
– Others did not use the initial assessment to set up corresponding „liquidity triggers“ or „capital triggers“ that would indicate shortfalling levels of own funds or liquid assets.
– Many firms were lacking adequate wind-down planning as far as their liquidity and capital needs are concerned to facilitate an orderly resolution. In fact, the FCA observed the use of „unrealistic assumptions“ and the application of superficial models to predict capital needs in distress.
– Finally, some firms‘ senior management wasn’t adequately involved in the ICARA process leading to poor oversight and reasonable doubts as to whether or not such firms would have adequate financial resources in times of stress.
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For each of the noted deficiencies, the FCA also briefly outlines its expectations or some good practices that it has observed during the review.
To conclude, the FCA states that it will continue to review firms‘ practices in this context to ensure a proper functioning of the new regime and the adequacy of capital of FCA-regulated firms to prevent harm to the financial market.