MIFIDPRU 7.10 Supervisory review and evaluation process

1. (1)

   1This section contains guidance on the FCA’s approach to the supervisory review and evaluation process (SREP) of the ICARA process.

2. (2)

   Although there are no rules in this section that impose direct obligations on MIFIDPRU investment firms or UK parent entities, these entities may find the guidance in this section helpful in understanding the FCA’s general approach to considering whether MIFIDPRU investment firms are complying with the overall financial adequacy rule and the other requirements of the ICARA process.

3. (3)

   The guidance in this section relates only to the FCA’s approach to the SREP. It does not apply to any other supervisory action that the FCA may take, except where stated.

1The own funds and liquid assets necessary to comply with the overall financial adequacy rule need to be assessed by the firm and, where appropriate, the FCA. This involves:

1. (1)

   the ICARA process applied by the firm, or, in the circumstances set out in MIFIDPRU 7.9, by the investment firm group;

2. (2)

   the FCA’s monitoring of the information provided by a firm under its ongoing reporting obligations in MIFIDPRU 9; and

3. (3)

   in appropriate cases, a SREP, which is conducted by the FCA.

1. (1)

   1There is no mandatory frequency with which the FCA will conduct a SREP on a particular MIFIDPRU investment firm or investment firm group. Instead, the FCA will prioritise its resources to conduct SREPs by taking into account a range of factors, which include:

   1. (a)

      the nature, scale and complexity of the business carried on by a firm or investment firm group;

   2. (b)

      the FCA’s analysis of the risks associated with the firm or investment firm group and its potential to cause harm to consumers or to the financial markets;

   3. (c)

      the information provided by a firm or other members of its group to the FCA under any notification and reporting obligations under MIFIDPRU or other obligations in the Handbook;

   4. (d)

      the history of the firm’s or investment firm group’s interactions with the FCA;

   5. (e)

      any broader concerns about the types of products or services offered by the firm or the investment firm group, or the markets in which it operates; and

   6. (f)

      any concerns relating to the firm or investment firm group which may be notified to the FCA by other regulators (including non-financial services regulators).

2. (2)

   In appropriate cases, the FCA may conduct a review of a particular population of MIFIDPRU investment firms or investment firm groups that share common features (for example, because they are all active in a particular market sector). As a result, the FCA may issue guidance on a sectoral basis or impose additional requirements on all, or only a subset of, the entities included within that review.

3. (3)

   The scale of a SREP that the FCA carries out on an individual MIFIDPRU investment firm or investment firm group may vary, depending on the nature of the FCA’s concerns and the potential degree of risk posed by the firm or investment firm group. In certain cases, the FCA may limit its review to only a subset of the information and factors that it would normally consider under the general approach described in MIFIDPRU 7.10.4G and MIFIDPRU 7.10.5G.

1When conducting a SREP, the FCA will take into the following:

1. (1)

   the firm’s or investment firm group’s ICARA document;

2. (2)

   any relevant information provided by the firm or other members of its group as part of its reporting obligations under MIFIDPRU 9 or other obligations in the Handbook;

3. (3)

   any other information or documents requested by the FCA for the purposes of the SREP;

4. (4)

   interviews with members of the firm’s governing body, or its employees, advisers, service providers, and auditors;

5. (5)

   information shared by other authorities; and

6. (6)

   any other relevant information that the FCA holds.

1The following is a non-exhaustive list of factors that the FCA will normally consider when conducting its SREP:

1. (1)

   the extent to which the firm’s or investment firm group’s risk management framework includes a clearly defined risk appetite;

2. (2)

   the governance arrangements operated by the firm or investment firm group, including whether there are clear lines of accountability and evidence of appropriate senior management involvement;

3. (3)

   whether the firm or investment firm group has appropriately identified and assessed the materiality of:

   1. (a)

      the harms that may arise from the ongoing operation of the firm’s or group's business;

   2. (b)

      the harms that may result from a disorderly wind-down of the firm or other members of its group;

4. (4)

   whether the firm or investment firm group has adequate systems and controls in place to monitor and manage the risks arising from its business;

5. (5)

   whether the firm or investment firm group has properly integrated its ICARA process into day-to-day decision making within its business;

6. (6)

   whether the firm, and where applicable, other individual members of its investment firm group, have adequate own funds and liquid assets to comply with the overall financial adequacy rule;

7. (7)

   whether the capital and liquidity planning and business model analysis (and, where applicable, stress testing and reverse stress testing) conducted by the firm or investment firm group is based on plausible scenarios that are relevant to the business it undertakes; and

8. (8)

   whether the wind-down planning assessment conducted by the firm, and where applicable, other individual members of its investment firm group, is adequate, contains a clear explanation of the key steps needed to ensure an orderly wind-down and is based on realistic assumptions.

1. (1)

   1Once the FCA has completed a SREP, it will consider whether any corrective action is necessary to ensure that (among other outcomes) a firm:

   1. (a)

      complies with the overall financial adequacy rule;

   2. (b)

      has an appropriate plan in place to ensure an orderly wind-down; and

   3. (c)

      appropriately identifies and manages the material potential harms that may result from the ongoing operation of the firm’s business.

2. (2)

   When considering the action that it may take, the FCA will consider its powers and the potential harms that it has identified during the SREP. The following is a non-exhaustive list of actions that the FCA may take:

   1. (a)

      requiring a firm to hold additional own funds or liquid assets;

   2. (b)

      requiring a firm to implement new risk management or governance arrangements;

   3. (c)

      requiring a firm to provide to the FCA, within a specified period, an improvement plan to ensure that the firm complies with the applicable requirements in the Handbook or other legislation;

   4. (d)

      requiring a firm to apply a particular policy for provisioning or for the treatment of assets when calculating its own funds or own funds requirement;

   5. (e)

      restricting the activities that a firm may undertake as part of its business (which may be on a permanent basis, for a specified period of time, or until certain specified conditions are met);

   6. (f)

      requiring a firm to reduce the level of risk involved in the products or services it provides, including in relation to activities that it has outsourced to third parties;

   7. (g)

      requiring a firm to reduce or limit the amount of variable remuneration it pays;

   8. (h)

      requiring a firm to reduce or limit its distributions of profits;

   9. (i)

      imposing additional or more frequent reporting requirements on a firm;

   10. (j)

       requiring a firm to hold an own funds or liquid assets buffer in excess of the amounts necessary to comply with the overall financial adequacy rule;

   11. (k)

       requiring a firm to make additional public disclosures;

   12. (l)

       requiring a firm to strengthen its data security, confidentiality or data protection processes;

   13. (m)

       requiring a firm to provide additional information to clients or counterparties;

   14. (n)

       withdrawing a permission previously granted under MIFIDPRU to apply a specific treatment (such as a K-CMG permission, or a permission to use an internal model for the purposes of the K-NPR requirement);

   15. (o)

       requiring a firm to use a different wind-down trigger;

   16. (p)

       requiring a firm to modify its legal structure or the structure of its group, where doing so would improve the FCA’s ability to supervise the firm;

   17. (q)

       giving individual guidance to the firm on any of the above matters or on any other matter that the FCA considers is relevant.

1The FCA would normally expect to take the actions described in MIFIDPRU 7.10.6G by using one or more of the following approaches:

1. (1)

   exercising the powers under section 55J of the Act permitting the FCA to vary or cancel a firm’s permission on the FCA’s own initiative;

2. (2)

   inviting a firm to make a voluntary application for the imposition of a requirement under section 55L(5) of the Act;

3. (3)

   imposing a requirement on a firm on the FCA’s own initiative under section 55L(3) of the Act;

4. (4)

   withdrawing a MIFIDPRU permission in accordance with the rules in MIFIDPRU;

5. (5)

   imposing a requirement on a parent undertaking in accordance with section 143K of the Act;

6. (6)

   requiring a firm or parent undertaking to provide additional information to the FCA under section 165 of the Act;

7. (7)

   requiring a report by a skilled person in accordance with section 166 of the Act; or

8. (8)

   giving individual guidance to a firm under section 139A of the Act, as further described in SUP 9.3.

1. (1)

   1Following a SREP, the FCA may conclude that a firm should hold an additional amount of own funds or liquid assets to comply with the overall financial adequacy rule.

2. (2)

   In this case, the FCA will normally specify an amount of own funds and/or liquid assets that the firm should hold by:

   1. (a)

      issuing individual guidance; or

   2. (b)

      imposing a requirement on the firm.

3. (3)

   The amount in (2) normally represents the FCA’s assessment of the firm’s overall own funds threshold requirement or liquid assets threshold requirement. However, in some cases, it may be specified on a different basis (such as by reference to a specific component of the threshold requirement or to a particular risk or harm).

4. (4)

   Where the FCA has undertaken a sectoral review, as described in MIFIDPRU 7.10.3G(2), it may issue guidance to, or impose a requirement on, some or all firms that are active in that sector, without conducting an individual SREP in relation to each firm. The guidance or requirement may relate to:

   1. (a)

      additional amounts of own funds or liquid assets that the firms must hold; or

   2. (b)

      other actions that the firms must undertake.

1. (1)

   1The FCA will determine whether a requirement or guidance is more appropriate. Where the FCA issues guidance, this will normally explain how the FCA will approach supervising the overall financial adequacy rule in relation to the firm. The FCA expects that the firm would normally confirm to the FCA that the firm will treat the amounts specified in that guidance as its threshold requirements going forward (and will therefore hold the relevant of own funds and liquid assets to comply with the overall financial adequacy rule), unless the firm subsequently determines under its ICARA process that higher amounts are required.

2. (2)

   Where the FCA applies a requirement in connection with the overall financial adequacy rule, it may invite a firm to make a voluntary application under section 55L(5) of the Act to impose a requirement on the firm to hold the level of own funds or liquid assets that the FCA has assessed as being the firm’s threshold requirements.

3. (3)

   If a firm declines to make a voluntary application to impose the relevant requirement, the FCA may use its powers under section 55L(3) of the Act to impose the requirement on the firm on the FCA’s own initiative.

4. (4)

   The FCA may also consider whether it is appropriate to invite a parent undertaking of the firm to make a voluntary application under section 143K(1) of the Act, or to impose a requirement on the parent undertaking on the FCA’s own initiative under section 143K(3) of the Act. This requirement may operate by reference to the status of the investment firm group as a whole. Examples of when the FCA may choose to apply this approach include where:

   1. (a)

      an investment firm group is operating an ICARA process that covers multiple firms in accordance with MIFIDPRU 7.9; or

   2. (b)

      the FCA considers that the potential harms arising from a firm’s membership of its group can be addressed more effectively by imposing a requirement on the parent undertaking.

5. (5)

   Guidance on a threshold requirement issued by the FCA (or, where applicable, a requirement to hold a minimum level of own funds or liquid assets imposed on a firm by the FCA) will apply until the FCA issues guidance on a revised threshold requirement (or varies or removes the requirement relating to own funds or liquid assets) in relation to the firm.

6. (6)

   If a firm subsequently determines, as a result of its ICARA process, that it needs to hold a higher level of own funds or liquid assets to satisfy the overall financial adequacy rule, it must hold that higher level. This is because the FCA’s assessment of a firm’s threshold requirement (or a requirement applied to the firm by the FCA) reflects an assessment carried out at that point in time and does not relieve the firm of its obligation to comply with the overall financial adequacy rule at all times.

7. (7)

   A firm’s business model or operating model may change significantly, with the result that the firm considers that the threshold requirement specified in the guidance issued by, or the requirement applied by, the FCA exceeds the amount of own funds or liquid assets that the firm requires to comply with the overall financial adequacy rule. In this case, the firm:

   1. (a)

      should undertake its own assessment of the amounts that the firm requires to comply with the overall financial adequacy rule or, where applicable, to address the risks in relation to which the requirement was imposed; and

   2. (b)

      having undertaken the determination in (a), may contact the FCA to request a review of the existing guidance or requirement.

1The following is a non-exhaustive list of situations in which the FCA may assess that a firm must hold additional own funds to comply with the overall financial adequacy rule:

1. (1)

   the business of the firm or investment firm group may result in material harm that is not sufficiently covered by the firm’s assessment of its own funds threshold requirement and has not otherwise been adequately mitigated;

2. (2)

   the firm or investment firm group does not comply with the governance requirements in MIFIDPRU 7.2 or 7.3;

3. (3)

   the firm’s or investment firm group’s ICARA process does not comply with the relevant requirements in MIFIDPRU 7;

4. (4)

   the adjustments in relation to the prudent valuation of the firm’s or investment firm group’s trading book are insufficient to enable the firm or investment firm group to sell out or hedge its positions within a short period without incurring material losses under normal market conditions;

5. (5)

   the review of the firm’s use of internal models or own estimates of delta for the purposes of the K-NPR requirement or K-TCD requirement indicates that non-compliance with the requirements for applying those models is likely to lead to inadequate levels of own funds;

6. (6)

   the manner in which the firm or investment firm group operates its business suggests that there is a significant risk that it will fail to comply with the overall financial adequacy rule in the foreseeable future; or

7. (7)

   the firm’s wind-down plan does not identify realistic and credible actions for ensuring an orderly wind-down or is based on unreasonable or unrealistic assumptions.

1The FCA may provide guidance on a firm’s own funds threshold requirement (or, where applicable, impose a requirement) by reference to:

1. (1)

   a percentage of the firm’s own funds requirement;

2. (2)

   the requirement that would result from applying a modified co-efficient to one or more K-factor metrics for the purposes of the firm’s K-factor requirement; and/or

3. (3)

   a fixed amount.

1A firm must meet any own funds threshold requirement with own funds that satisfy the conditions in MIFIDPRU 7.6.5R unless the FCA applies an alternative requirement to the firm.

1The following is a non-exhaustive list of situations in which the FCA may assess that a firm needs to hold additional liquid assets to comply with the overall financial adequacy rule:

1. (1)

   the business of the firm or investment firm group may result in material harm that is not sufficiently covered by the liquid assets threshold requirement as assessed by the firm and has not otherwise been adequately mitigated;

2. (2)

   the firm or investment firm group does not comply with the governance requirements in MIFIDPRU 7.2 or 7.3 in one or more material respects;

3. (3)

   the firm’s or investment firm group’s ICARA process does not comply with the requirements in MIFIDPRU 7;

4. (4)

   the firm or investment firm group’s funding profile indicates that there may be a significant liquidity mismatch between amounts payable and receivables;

5. (5)

   the manner in which the firm or investment firm group operates its business suggests that there is a significant risk that it will fail to comply with the overall financial adequacy rule in the foreseeable future; or

6. (6)

   the firm’s wind-down plan does not identify realistic and credible actions for ensuring an orderly wind-down or is based on unreasonable or unrealistic assumptions.

1. (1)

   1A firm can normally meet its liquid assets threshold requirement with any type of liquid assets. This is subject to the overriding requirement that in all cases, a firm must meet its basic liquid assets requirement with core liquid assets.

2. (2)

   However, in appropriate cases, the FCA may require a firm to meet all or part of its liquid assets threshold requirement with a more limited subset of liquid assets. For example, in certain cases, the FCA may require a firm to hold core liquid assets to cover particular risks or may disallow the use of certain non-core liquid assets.

3. (3)

   The FCA may also:

   1. (a)

      require a firm to apply modified haircuts to non-core liquid assets; or

   2. (b)

      impose certain requirements relating to a firm’s funding profile and the matching of expected liquidity outflows and inflows.

4. (4)

   Where the FCA wishes to apply the approaches in (2) or (3), it will normally invite the firm to apply for the imposition of a requirement to that effect under section 55L(5) of the Act. In appropriate cases, the FCA may impose such a requirement on its own initiative in accordance with section 55L(3) of the Act.