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The letters pull few punches. Our team have analysed them, and highlighted some relevant extracts. While each letter targets a specific segment of regulated firms, the overall message is unequivocal: Firms must continuously monitor adequacy with their capital and liquidity requirements. If not, they should expect the FCA to act.
| The FCA’s approach, in their own words | In essence: |
| Identify: we will continue to use internal and external data, intelligence, and regulatory tools to identify and substantiate poor behaviours. We are investing heavily in IT and staff training to increase our capabilities and effectiveness. | We’ll be increasingly thorough and forensic in our assessments. |
| Intervene: we will continue to intervene to stop or limit ongoing consumer losses where we see harm. In the most urgent cases, we require firms to cease regulated activities immediately. In less urgent cases, we restrict firms’ activities until the issues are sufficiently remediated. Examples can be seen in Annex 1. | Any necessary interventions will be swift, targeted, and proportionate. |
| Enforce: once ongoing harm has been minimised/ stopped, and where we judge the poor behaviour serious, we will consider formal enforcement action. Such action could lead to fines, public censure and the removal of firms/individuals from the UK regulated market. Enforcement outcomes are usually publicised. | Expect to be held fully and publicly to account for infractions. |
| The key paragraph, in the FCA’s words: | In essence: |
| All firms should have implemented the Investment Firms Prudential Regime (IFPR), which came into force on 01 January 2022, and considered our recently-published observations on wind-down planning. Firms' boards should test the adequacy of their firm's IFPR implementation, including their internal capital adequacy and risk assessments (ICARA), as well as their recovery and wind-down plans. Where we identify material prudential weaknesses, we will take action. This has recently included imposing capital/ liquidity scalars, business restrictions and skilled persons reports. | If IFPR and wind-down planning are not in place, and tested, we may take a range of actions to remedy this. |
| The key paragraph, in the FCA’s words: | In essence: |
| To improve financial resilience, firms should review the level of liquidity that they hold under the new Investment Firm Prudential Regime (IFPR) and ensure that their assessment is commensurate with the risks they face. We will be carrying out targeted work in this space, and where we identify material weaknesses or firms underestimating their liquidity needs, we will take action, which may include business restrictions and Board effectiveness reviews. | Liquidity levels must reflect a realistic view of a ‘worst case’, to avoid FCA action. |
| Firms should also look beyond recent historical precedent when modelling stresses, noting that the past 12 months have produced a series of events that were previously considered implausible based on historic modelling. While we generally expect to see more prudence in this environment we accept there are limits to capital and liquidity that can be held against stresses, which mean a careful balance must be struck. | The last year has proved that ‘implausible’ scenarios are not impossible. Plan accordingly. |
| The key paragraph, in the FCA’s words: | In essence: |
| We found a wide disparity among firms in the quality of compliance with regulatory standards and depth of liquidity risk management expertise. Most firms fell short in some aspects of their framework. | Compliance is uneven across firms, with most falling short. |
| Firms had inadequate frameworks to manage liquidity risk effectively and we have provided detailed feedback to inform remedial plans to address those. The building blocks and tools for effective liquidity management were mostly in place, but these lacked coherence when viewed as a full process and were not always embedded in daily activities. | Processes are often not joined up, and behaviours not habitual. |
| Our review found that many firms attach insufficient weight to liquidity risk management in governance arrangements (SYSC 4.1.1R (1) and COLL 6.11.4R: Duties of the permanent risk management function) with insufficient challenge and escalation, particularly in stressed environments. | Firms often appear not to assign adequate priority to liquid risk management. |
| We observed a wide range of approaches to liquidity stress testing practices, with some methodologies insufficient to assess the actual liquidity of the portfolio (COLL 6.12.9R: Measurement and management of risk). Some firms’ oversight of stress testing was also deficient with little tracking of both actions and trends over time. | Processes and methodologies were often both insufficient and inconsistently applied. |
| The key paragraph, in the FCA’s words: | In essence: |
| In a number of recent scenarios, when we have engaged with firms that are failing, or in peril, they have considered the cause of their stress to be related to 'unprecedented' or 'unforeseeable' events. In many instances the stress was greater than the severe but plausible scenarios firms had based their modelling on. | Firms must expect the unprecedented, and plan accordingly. |
| Firms should expand the scope of their stress scenarios (including reverse stress test scenarios leading to wind-down) and plan on the basis that their own wind-downs are likely to be made more complex by surrounding stressed environments. These may well affect firms' ability to trade and to realise assets at expected value and may also involve the non-availability of suppliers. It is very likely that the scope of events covered by 'extreme but plausible' is now wider than if exercises were done 18 months ago. | Firms must anticipate that a stressed environment can exacerbate wind-down challenges. |
| We will undertake targeted reviews of firms' capital and liquidity now that the new Investment Firm Prudential Regime (IFPR) has been introduced. Where we identify material weaknesses in the adequacy of firms' financial resources or planning, we will take action, which may include business restrictions, the imposition of additional own funds and/ or liquid assets requirements, or other interventions. | Expect us to act if we are unsatisfied with a firm’s arrangements. |
Unquestionably, the FCA considers that for most firms there is work still to do. Whatever type of firm you are, it expects capital and liquidity adequacy to be central to your operational compliance. The letters’ messages are forthright, and not to be ignored. They are about demonstrating that you have embedded prudential compliance into your day-to-day operations, and have appropriate tools in place to monitor it.
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