Prudential supervision: Has the FCA muddied the waters?

Anthony Ma Anthony Ma

The FCA recently issued CP19/20 ‘Assessing adequate financial resources’, outlining its future approach to prudential supervision.

The paper is designed to offer clarification over how the FCA carries out prudential supervision, including but not limited to SREP assessments for investment firms. The document appears to be applicable to all FCA regulated firms. Currently, all FCA regulated firms must have adequate financial resources to run their regulated businesses, but not all of them are subject to specific prudential standards. This seems to be suggesting that the FCA is expecting greater prudential soundness from all the FCA regulated firms, which could effectively mean increasing firms’ capital requirements. Further clarifications are needed as the CP could be diverging from the provisions in the FCA Handbook and could lead to greater confusion.

Why has the FCA issued this CP?

There are two key drivers for the FCA issuing the consultation paper:

1) To align its prudential approach to its overall supervisory principle to prevent harm

This is embodied through the FCA’s mission to avoid disorderly failure of firms – which in practice, takes a focused approach to wind-down. In addition to adequate financial resources to run a business as a going concern, firms should have adequate financial resources for an orderly wind-down. 

2) To align its approach to the upcoming EBA new prudential regime

This is expected to be implemented in 2020 regardless of Brexit.

Is the FCA introducing new wind-down requirements?

The FCA regulate around 59,000 firms, but only have prudential oversight for 18,000 of them – predominantly IFPRU and BIPRU investment firms. This matters because the proposed changes make sense if applied to IFPRU and BIPRU firms, but would raise the capital requirements for other firms if applied more broadly.

Looking at wind-down requirements, there are currently no prescriptive rules asking firms to compute wind-down costs as part of their financial resource requirements. But, IFPRU €125k and €50k firms include an estimation of wind-down costs in their ICAAP process, which is used to validate their Fixed Overhead Requirements (FOR). The increased wind-down focus in CP19/20 could be interpreted as suggesting that all FCA regulated firms should also conduct this analysis. 

Some basic conceptual questions remain unanswered

It is also interesting that the FCA did not use this opportunity to address some fundamental conceptual questions around capital and liquidity. Continuing to look at wind-down costs as an example, the resources necessary would have to have appropriate liquidity to be useful during the wind-down period. 

During wind-down, a firm would need to pay ongoing fees for legal services, compliance, support staff etc, so liquid assets are almost certainly required. These payments should not be left until the firm is able to liquidate its capital. Are the FCA planning to introduce new liquidity requirements for wind-down? If so, for which firms?

Status of document and applicability require clarification

The FCA said it did not intend to increase the general levels of financial resources across financial services, but the framework document does not support that assertion. People are concerned that the FCA are introducing new expectations around capital and liquidity, without the corresponding rules in the FCA Handbook. The document feels like it goes beyond general guidance, and instead informs regulated firms of FCA expectations – essentially becoming some form of mandatory requirements.

The implications of this consultation paper could be far reaching, and it’s important to monitor the changes closely. If you’d like to seek clarifications, the consultation is open until 13 September 2019.