Regulatory scrutiny delves deeper into risk

    Regulatory scrutiny delves deeper into risk

    Over the past year, many investment firms will have observed that the FCA is requesting more information about prudential risks. Most recently and in the wake of the EU referendum result, the FCA has been asking broker/dealers about their liquidity risk.

    Banks are now familiar with the annual process of sending in their individual capital adequacy assessment process results (ICAAP document) to their regulator.

    Other investment firms have been required to conduct the same process on an annual basis, but until recently, few were required to send their ICAAPs to the FCA for review.

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    What has changed?

    The key change is that the regulators themselves are now under scrutiny. From 1 January 2016, all EU regulators have applied a new framework to their supervisory regulatory evaluation process (SREP) as indicated by the chart.

    Consequently, the FCA has refreshed its own expectations of ICAAPs.

    While the EBA categorisation of institutions means the FCA must focus on CRD IV market makers, broker/dealers and investment managers, the FCA has indicated it will apply this approach to commodity brokers and advisers/arrangers subject to the ‘old’ CRD III rules.

    It will also take a similar approach to other investment firms that are currently exempt from EU legislation.

    What are the FCA’s objectives?

    The FCA wants a firm’s ICAAP to demonstrate that it has sufficient capital and cash to run its business and protect its customers.

    The ICAAP should identify the major sources of known and potential risks inherent in implementing a firm’s strategy and assess their impact. It should then go further and consider the impact of potential adverse events and stresses on a firm’s risk profile and capital adequacy.

    The ICAAP document is the evidence that a firm has a process to consider those risks and their impact on the firm’s solvency.

    Although an in-depth ICAAP review only needs to be conducted annually, the FCA expects the ICAAP to underpin ongoing capital and risk management of the firm.

    When early warning indicators are triggered, it is expected that decision makers will be notified and take action. If there are significant external market or internal changes during the year, then ICAAP assumptions should be reviewed and risk parameters reset.


    Clearly, more is expected of larger investment firms with greater market penetration and more complex products. However, most investment firms are expected to explain how the principles of capital and risk management apply to their business even if the FCA terminology is not embedded in their management practices.

    All firms are expected to meet the FCA principle of maintaining adequate resources, including capital and cash, and the FCA’s systems and control requirements.

    None of this is new. However, standards applied to ICAAP have risen as regulators became familiar with them and incorporated the principles into their supervisory reviews. The new SREP framework is only the latest supervisory approach.