ICARA – Changing environment for capital adequacy and risk

This article was first published on Thomson Reuters Regulatory Intelligence on September 28, 2022.

The introduction of the new regime not only amends the process for MiFID firms but also brings into scope firms that were previously exempt, meaning that this will be the first time a significant number of firms will have had to complete an ICARA. Firms applying for authorisation for investment activities will also be required to undergo the ICARA process before submitting their application to the FCA.

The FCA introduced the new regime to streamline the prudential requirements for investment firms and put a spotlight on firms' internal risk management processes. The ICARA is designed to ensure firms have adequate systems and controls in place to identify, monitor and offset potential harms from their continuing business, and in the event of a wind-down of their business.

Prudentially, the ICARA requires firms to have adequate financial resources to remain financially viable throughout the business cycle and enable them to conduct — with appropriate financial resources — an orderly wind-down.

The process includes assessing and scoring risks to the business, stress testing, recovery planning and wind-down planning. These components are intended to demonstrate that firms are meeting the Overall Financial Adequacy Rule (OFAR); the minimum threshold for firms' financial resources.

Challenges for firms

The initial process toward the ICARA has presented firms with a number of challenges, including:

• Identifying stress test/wind-down scenarios that are relevant to their business models
• Creating a suitable timeline for the ICARA, ensuring there is enough time between the date at which the underlying data is prepared and the date of senior management review and approval of the assessment, and thereafter timely submission of the MIF007 (the annual ICARA questionnaire)
• Analysis and evaluation of the risks to the business and, once risks are identified, ensuring the firm has systems and controls and/or financial mitigants in place to reduce the risk

Suggested approaches

Firms may wish to consider a number of aspects that could provide support when applying the new regime, such as using plausible but severe scenarios for stress testing and rationalising these within the ICARA document by ensuring the analysis considers how the scenario is relevant to the size, scale, nature and complexity of the business.

During the early stages of the ICARA, firms should prepare a risk register with an appropriate scoring matrix. This is the basis of the ICARA and determines the quality of the assessment.

Once developed, the ICARA should be treated as a continuous exercise throughout the year. Senior management should be engaged throughout the process, as it provides a framework to monitor the continuing financial viability of the firm's business. This avoids delays if taking an annual review approach rather than treating the ICARA as a continuous risk evaluation.

Further considerations

In response to progress during the first nine months of the new regime, firms may wish to consider enhancing their risk registers and risk programs to align with updated considerations of harm.

The more detailed risk management function and K-Factor harm determinations apply to those firms which are not small and non-interconnected investment ("SNI") firms, but SNI firms should also have adequate internal governance to effectively identify, monitor and address harms that affect their business models.

Firms could also consider the FCA Wind-Down Planning Guide in the formulation of tests and scenarios, and plan for such an event accordingly.

In addition, firms may wish to submit a notification to the FCA under MIFIDPRU 7.8.4R to change the submission date for the MIF007 to provide the firm with more time to carry out its assessment.

Intrinsic part of risk management

Firms are completing their ICARA submissions for the first time this year and the FCA also will be reviewing these assessments under the new regime for the first time. As the FCA reviews more ICARAs, it may carry out thematic reviews and provide further guidance if necessary to improve the quality of the assessments.

If the state of the economy in the last few years has shown anything, it is that firms should be prepared now more than ever for extraordinary events, and the ICARA encourages firms to adapt their identification and assessment of risk as an essential component to their day-to-day operations, rather than seeing this as an isolated filing. It is, and should be, an intrinsic part of risk management for FCA firms in scope of the IFPR.