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Compound Growth

29th September 2016

Dear CEO letter to IFPRU Firms

The Financial Conduct Authority recently issued a “Dear CEO” letter to IFPRU investment firms. This was in relation to the Internal Capital Adequacy Assessment Process (ICAAP) and the FCA’s supervisory review and evaluation process (SREP). The letter is particularly useful for firms since it provides details of the regulator’s expectations with regards to completed ICAAP documents and help with preparing for the regulator’s review.

Prudential requirements for IFPRU firms are laid out in the Capital Requirements Regulations (CRR) and provisions in the IFPRU sourcebook (that derive from the Capital Requirements directive).

Per these requirements, IFPRU firms are required to carry out an ICAAP and have in place appropriate policies, processes, systems and controls to manage risk and hold adequate resources to meet the overall financial adequacy rule (found in IFPRU 2.2.1R).

As the FCA stress in their ‘Dear CEO’ letter, the ICAAP should be a ‘risk management tool’ that a firm or group uses to inform their business decisions. Thus it should ‘not be treated as a purely compliance exercise.’

A Firm’s ICAAP must be reviewed and documented at least annually. The Firm’s ICAAP Document must also be available for inspection when the regulator undertakes their Supervisory Review and Evaluation Process, thus this document is incredibly important.

ICAAP Document: Must Haves

Whilst a firm’s ICAAP should be reported to a firm’s governing body, it falls under the responsibility of that governing body and, as the regulator emphasizes, should form ‘an integral part of the firm/group’s management process and decision making culture.’

Firms are reminded that there should be sufficient detail contained within the ICAAP document for those that read it to ‘gain a comprehensive understanding of the firm/group’s ICAAP.’

In essence, a Firm’s ICAAP document should have/cover the following aspects:

The ICAAP document should be a stand-alone document;
It should detail the strategies, processes and systems in place to manage risk at the firm. In addition it must be demonstrated, considered and justified within the document that these measures are both comprehensive and proportionate to the nature, scale and complexity of the firm’s activities;
The risk management tools and governance arrangements should be detailed, including the firm’s overall risk appetite and tolerance along with any metrics that are used to monitor risk appetite;
An assessment of the amounts, types and distribution of financial resources, own funds and internal capital that the firm considers to be adequate to cover the nature and level of risks to which the firm is (or might be) exposed. Firms should also include an assessment for the relevant risks that are not covered by (or not adequately covered by) Pillar 1, such as operational risks that your firm is exposed to. If a risk is considered to be immaterial, then the firm should also ensure the reasoning behind this is included;
Firms should include the identification of major sources of risk to their ability to meet their liabilities as they fall due, while also demonstrating their compliance with all of the parts applicable to them within BIPRU 12;
Scenario analysis and stress tests (that have been undertaken in accordance with SYSC 20 and where appropriate the General Stress Testing & Scenario Testing Rule in IFPRU 2.2.36R) should also be included. These should show how the firm’s capital and own funds requirement would alter in adverse conditions such as a down-turn in future earnings, market events and varying operational scenarios, with particular focus upon forward-looking hypothetical events.
A breakdown of the Pillar 1 own funds requirement calculation would also be useful to include.

Next Steps for IFPRU Firms

Firms should now ensure that they have incorporated these points into their ICAAP documents ready for the regulator’s SREP reviews. Firms should note that reviews will be performed by the regulator alongside other comparable business models to ensure that there is a consistent approach across the sector and that data from their firm’s regulatory reports, such as COREP will also be used.

Once the regulator has undertaken their SREPs, they will then look to publish and share both good practice and common errors for firms’ to learn from going forwards.

ICAAP Support Services

Should your firm require ICAAP support services such as assistance in examining your ICAAP to ensure it is appropriately assessed for your current business plan and activities or require assistance in documenting this review, our experienced ICAAP Consultants can help so please get in touch.