The FCA says investment firms need to improve their market stress assessments when it comes to liquidity adequacy

Among the final observations made by the UK Financial Conduct Authority (FCA) in its review of the Investment Firm Prudential Regime (IFPR) was the need for investment firms to better assess their liquidity threshold requirements in times of financial stress.

The thematic review focused in particular on the progress made by companies in implementing the Internal Capital Adequacy and Risk Assessment (ICARA) process and IFPR reporting requirements – which applies to investment firms operating under Mifid.

IFPR aims to streamline and simplify supervisory requirements for the 3,500 Mifid investment firms subject to supervision.

With regard to firms’ liquidity adequacy, the FCA identified some poor practices across the market and recommended that firms consider all relevant, plausible pressures that could impact business models and then do more to ensure resources are in place to minimize damage should serious situations arise.

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When stress events and time periods were taken into account, it was found that these were not necessarily relevant to cash flows or liquidity positions or were only applied to a subset. Furthermore, “most” companies are currently not in the habit of regularly reviewing their cash holdings and then adapting them to external market changes, the FCA said.

The regulator stressed the importance of this practice, saying: “Recent events have shown the importance of adopting this practice.” Financial markets have been impacted by increased geopolitical risks and a challenging macroeconomic environment. There have been periods of rapidly increasing and sustained volatility and, in some markets, higher prices.

“This results in significant margin calls, higher costs, credit constraints and increased counterparty risks for some companies. The effects of volatility in one market tend to impact others and are ultimately felt by other companies as well.”

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The FCA also highlighted that firms have not paid sufficient attention to timescales, particularly for firms with significant funding gaps within or between days or an increase in cash needs during stressful situations.

In these cases, only monthly or quarterly intervals were used to analyze stressed cash flows, which proved to be “insufficiently temporally granular” to understand and plan for actual timing and to promptly mitigate liquidity constraints, particularly intraday and interday stress, said the controller.

Additionally, the study suggested that these companies are at higher risk of running out of cash under stressed conditions, with the possible consequence of the company failing.

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Other key areas of improvement identified by the FCA included recommendations on data quality, resolution plans and ICARA risk processes.

The financial regulator’s findings state that the companies’ resolution assessments did not sufficiently consider the impact on members and, overall, potential defaults were not adequately planned for.

In particular, it was also found that most companies’ internal intervention points did not have the appropriate structure to ensure that measures could be taken to mitigate company failures within the appropriate time frame.

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 are receiving individual feedback, the regulator has urged the market to consider the latest findings and address them proactively .

Despite some weaknesses, the FCA noted in its recent publication that “firms have made progress in understanding the requirements of the new regime.” We have seen a conscious shift towards understanding the harm that the firm can cause, particularly to consumers and markets, to be taken into account and mitigated.”

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