Amongst the final observations from the UK Financial Conduct Authority’s (FCA) in its Investment Firm Prudential Regime (IFPR) review was the need for investment firms to better assess their liquid asset threshold requirements during periods of financial stress.
The thematic review specifically focused on the progress made by firms in implementing the internal capital adequacy and risk assessment (ICARA) process and reporting requirements under IFPR – which applies to the investment firms engaged under Mifid.
IFPR is aimed at streamlining and simplifying the prudential requirements for the 3,500 Mifid investment firms that are prudentially regulated.
In terms of the firms’ liquidity adequacy, the FCA found some poor practice across the market and recommended that firms must work on considering all the relevant, plausible stresses which could affect business models, and subsequently do more to ensure that the resources are in place to minimise harm if severe situations should arise.
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Where stress events and time periods were considered, these were found not to be necessarily relevant to their cashflows or liquid asset positions, or applied to only a subset. Further, currently “most” firms have not gotten into the habit of regular reviews and subsequent adjustments to their liquid asset levels in line with external market changes, said the FCA.
Highlighting the importance of doing so, the regulator explained: “Recent events have highlighted the importance of adopting this practice. The financial markets have been affected by heightened geopolitical risks and a challenging macroeconomic environment. There have been periods of rapidly escalating and sustained volatility, and higher prices in some markets.
“These lead to substantial margin calls, higher costs, credit stresses and increased counterparty risks for some firms. The impact of volatility in one market also tends to spill over to others, eventually being felt by other firms.”
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The FCA also highlighted that insufficient consideration has been given by firms to timeframes, specifically in firms with significant intra-day or inter-day funding gaps or increases in liquid asset requirements during stress.
In these instances, only monthly or quarterly intervals were used to analyse stressed cashflows, found to be “insufficiently time granular to understand and plan for the actual timings and prompt mitigation of liquidity stresses specifically intra-day and inter-day stresses,” said the regulator.
It further suggested that these firms were more at risk of running out of cash in stressed conditions – with a possible end result of firm failure.
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Other key areas of improvement found by the FCA included recommendations around: data quality, wind down plans, and ICARA risk processes.
The financial watchdog’s findings stated that the wind-down assessments from firms did not sufficiently consider impact on members and overall had not adequately planned for instances of potential failures.
Notably, it also found that for most firms, their internal intervention points lacked the appropriate structure to ensure actions could be triggered within the appropriate time frame to mitigate firm failure.
The IFPR regime came into force on 1 January 2022 and these final findings follow initial observations from the FCA’s thematic review in February – while all firms receive individual feedback, the regulator has urged the market to consider and proactively address the latest findings.
Despite some pain points, the FCA asserted in its most recent publication that “firms have made progress in understanding the requirements of the new regime. We saw a deliberate shift toward considering and seeking to mitigate the harm the firm can pose, particularly to consumers and markets.”