The Financial Conduct Authority (FCA) has set out its findings following a review of liquidity risk management practices across a range of wholesale (sell-side) firms, in the scope of the investment firm’s prudential regime (IFPR). This review examined liquidity risk management across 26 large wholesale firms, including commodity clearing brokers, principal trading firms, inter-dealer brokers, and contract for difference (CfD) providers. While closely linked to the Dear CEO letter for wholesale brokers, the findings are broadly applicable across Markets in Financial Instruments Directive Prudential Rules (MIFIDPRU) investment firms.
Liquidity risk remains a key area of regulatory focus. It features prominently in FCA communications and has been a factor in recent high-profile firm failures. This review offers a timely opportunity for firms to critically assess their current frameworks and determine whether they meet the FCA’s expectations.
The FCA also referenced the recent Financial Stability Board report, underscoring the UK’s alignment with emerging international standards. Raising standards in liquidity risk management is not only about regulatory compliance – it supports market stability, fosters competition, and strengthens the UK’s role in global finance.
The review focused on the practical approach to liquidity risk management and its effectiveness. While many firms applied, and tailored, various approaches to managing liquidity risks – often suitable for their business model's nature, scale and complexity – others fell short.
Key shortcomings:
As a result of the review, the FCA imposed a range of actions, including individual liquidity guidance (ILG) and mandated remediation plans, with firms required to provide assurance and attestations confirming implementation.
While the FCA shares examples of what good and poor looks like in its review findings, it’s illustrative and should complement any existing process refinement exercise. These findings can be grouped into the following areas.
Strong governance is essential, especially in volatile market conditions. Some firms lacked sufficient oversight for cumulative or market-wide redemptions that could pose systematic risks on funding. The established governance process should be clear and well defined, and individuals with a governance remit should have a sufficient level of expertise to challenge or highlight weaknesses. Effective governance involves:
Firms should prioritise managing risks to optimise long-term resilience rather than merely complying with the prudential regulations. Good practices included daily dynamic risk assessments, an actively used risk appetite, frameworks, and ongoing reviews of the overall liquidity framework.
Conversely, many firms struggled to embed strong risk frameworks into their culture, often relying too heavily on individual senior sponsors. They also neglected their Central Counterparty (CCP) membership obligations – highlighting the importance of understanding the appropriateness of the membership category and being prepared for unexpected loss-sharing obligations.
High-quality stress testing was a hallmark of strong firms. Leading practices included:
These drew on a broad range of operational inputs and behavioural analysis, as well as ensuring liquidity is readily available and notifying group companies of potential next-day use of liquidity facilities, where applicable.
Firms showing weaker performance typically relied on infrequent or overly simplistic stress testing. They failed to account for maturity mismatches, client behaviour, and emerging risks such as technological disruptions. In some cases, poor scenario planning resulted in severe liquidity imbalances with systematic consequences.
The FCA highlighted proactive monitoring of all funding providers and establishing alternative arrangements early as vital to effective stress preparedness.
Contingency funding plans that were deemed strong were clearly defined with quantitative action triggers and pre-authorised actions delegated to named individuals. The plans also contained contingency actions to both raise and conserve liquidity (from asset sales to client pre-funding), and were regularly tested through simulations such as drawdowns and facility usage.
In contrast, poor CFPs were found to have a lack of timely and actionable plans, with reliance placed on untested theoretical steps. The plans didn't contain clear action triggers (especially non-financial ones), leading to inappropriate operational responses. Firms had a limited range of contingency actions within their CFP, often relying on a single funding source or parent company support.
Good wind-down plans incorporated reverse stress testing outputs and were operable in stressed conditions. They included detailed projections (in their profit and loss statements, balance sheets, and cashflows) to manage the timing of outflows during the initial stages of a wind-down.
Firms demonstrating best practice had multidisciplinary teams with deep expertise and a holistic view of risk. They regularly refined frameworks in line with evolving business realities and market conditions.
Poor-performing firms had teams lacking the necessary understanding of their operational infrastructure or the specific risks tied to their business models. Many were unable to identify process failures or assess outsourced service risks effectively. A narrow, compliance-only view of liquidity risk, rather than one grounded in sound principles, was a common shortcoming.
The FCA has stressed the importance of robust reporting frameworks to support supervisory confidence. Inaccurate or poor-quality reporting not only undermines the effectiveness of regulatory responses during market events, but can also put firms at risk of breaching their obligations under the Senior Managers and Certification Regime (SM&CR) and FCA’s Principle 11 – Relations with regulators.
With increased regulatory scrutiny, firms must enhance and rigorously test their liquidity risk management frameworks. This includes strengthening their internal capital adequacy and risk assessment (ICARA) process to ensure all relevant liquidity risks are identified and appropriately mitigated under MIFIDPRU 7.
Firms should conduct a comprehensive review of their regulatory reporting suite to ensure that they are providing the regulator with accurate and complete information. This is to reduce the potential for the FCA to consider them in breach of their responsibilities under the SM&CR and Principle 11.
For more insight and guidance, contact Mike Haggis.
