In June, the FCA announced it was asking around 13,000 firms to respond to a survey considering their financial resilience to help its view of the impact of COVID-19. Separately, the regulator also published its finalised guidance framework for assessing adequate financial resources.
For businesses in scope, the Internal Capital Adequacy Assessment Process (“ICAAP”) document is key to firms’ assessment of their capital positions. The regulator’s expectation is that the ICAAP should be a ‘living document’ and therefore that it will appropriately reflect consideration of the ongoing commercial, operational and financial impacts arising from the pandemic. Here, we have identified some of the key areas that we believe firms will need to consider:
Market and operational risk scenarios should reflect “severe but plausible” conditions. Typically, the analysis will be undertaken using historic datapoints, such as value at risk and information from previous operational risk events. This data may no longer be reflective of conditions that could occur in the current market environment and may need to be supplemented.
The scenario analysis may also refer to risks assessed from a firm’s key outsourcing relationships - in relation to a cyber-security incident, for example. In this case, the information supporting the evaluation would need to be refreshed to ensure changes and developments at outsourced providers are captured.
The framework for stress testing should be reviewed to give consideration of any additional areas which would not have reasonably been foreseen without the current unprecedented market and operational disruption. Examples could include cessation of an entire strategy or product and significant people risk.
Outputs and governance
Regulatory reviews have a very strong focus on the governance aspects of the ICAAP. Comprehensive documentation of how senior reviewers have evaluated the scenarios applied in light of COVID-19, challenged approach and considered alternative positions is key.
The results and output from the ICAAP should be clearly embedded within decision-making, business planning and risk assessment processes. This linkage should be demonstrated particularly in evaluating the appropriateness of discretionary expenditure, dividends and other outflows. The increased level of risk from these new conditions means that firms should also review their internal policies in relation to surplus levels for liquidity and capital they have chosen to maintain - and whether these remain appropriate.
The risk appetite and framework, limits, key risk indicators and monitoring should all be updated and reviewed regularly to ensure that they align with the business assessment.
The liquidity assessment supporting the ICAAP will also need to be reviewed. Firms will likely have experienced reductions in travel costs and other similar expenses. However, they may need to include additional ongoing costs for the new working environment, such as adapting offices to support social distancing and resources to enable ongoing remote working. In addition, assumptions around exchange rates for fee receivables or consideration of hedging policies may need to be amended to reflect volatility.
Firms’ winding-down assessments should consider the risks that this environment may pose to an orderly process and that the approach they have taken to wind-down planning remains realistic. The regulatory emphasis on operational resilience and the greater level of potential risks to firms means that this is likely to be an area of continued scrutiny.
How can we help?
Our Financial Services & Markets Group can undertake review of ICAAPs, liquidity assessments and regulatory reporting more generally, as well as assistance with their preparation. Our work provides feedback on compliance with regulatory requirements, benchmarking and identification of good practice or opportunities for enhancement.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.
Smith & Williamson LLP is regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.