MIFIDPRU 7.6 ICARA process: assessing and monitoring the adequacy of own funds

1. (1)

   1The overall financial adequacy rule requires a firm to hold adequate own funds to ensure that:

   1. (a)

      the firm is able to remain financially viable throughout the economic cycle, with the ability to address any potential material harms that may result from its ongoing activities; and

   2. (b)

      the firm’s business can be wound down in an orderly manner.

2. (2)

   To comply with the overall financial adequacy rule, a firm must therefore hold the higher of:

   1. (a)

      the amount of own funds that the firm requires at any given point in time to fund its ongoing business operations, taking into account potential periods of financial stress during the economic cycle; and

   2. (b)

      the amount of own funds that a firm would need to hold to ensure that the firm can be wound down in an orderly manner.

3. (3)

   The own funds threshold requirement is the amount of own funds that a firm needs to hold at any given time to comply with the overall financial adequacy rule.

4. (4)

   The firm’s analysis of potential material harms under MIFIDPRU 7.6.2R is particularly relevant when it is considering the level of own funds that are necessary for the ongoing operation of its business. It is also be relevant when considering how the firm should address potential material harms as part of an orderly wind-down.

5. (5)

   The following diagram summarises the process that a firm should undertake to determine its own funds threshold requirement:


6. (6)

   MIFIDPRU TP 2.25AR and MIFIDPRU TP 2.25BG contain rules and guidance on the interaction between a firm’s own funds threshold requirement and the alternative requirement for its fixed overheads requirement, K-factor requirement or permanent minimum capital requirement.3

* The own funds threshold requirement cannot be lower than the K-factor requirement or the fixed overheads requirement.

** The K-factor requirement does not apply to SNI MIFIDPRU investment firms and the permanent minimum capital requirement (PMR) is not linked to harm.

*** Unless otherwise specified by the FCA.

1. (1)

   MIFIDPRU 7.6.7G and 7.6.8G explain the approach a non-SNI MIFIDPRU investment firm should apply to carry out the assessment in MIFIDPRU 7.6.3R.

2. (2)

   MIFIDPRU 7.6.9G explains the approach that an SNI MIFIDPRU investment firm should apply to carry out the assessment in MIFIDPRU 7.6.3R.

3. (3)

   MIFIDPRU G explains the approach that all MIFIDPRU investment firms should apply when assessing their own funds threshold requirement.

1. (1)

   1MIFIDPRU 4 and 5 explain how a firm must determine its own funds requirement. Where, as part of its ICARA process, a firm has identified potential material harms that cannot be fully mitigated, the firm should first consider the extent to which the impact of the residual harm on own funds is covered (wholly or partly) by the framework in MIFIDPRU 4 and 5.

2. (2)

   Example 1: If the potential material harm arises from the ordinary course of the firm’s portfolio management business, a non-SNI MIFIDPRU investment firm should consider the potential impact of the harm by comparison with the firm’s K-AUM requirement. If the harm is a harm that might typically arise from portfolio management, the firm may treat the harm as covered by the K-AUM requirement. However, if the harm is unusual in nature or might be particularly severe (for example, fraud or other irregularities), it would be unreasonable for the firm to treat the harm as fully covered by the K-AUM requirement. This is because the K-AUM requirement is designed to address typical harms from ordinary portfolio management, and not every conceivable material harm that might result from this activity.

3. (3)

   Example 2: If the potential material harm arises from the ordinary course of the firm investing its own proprietary capital in positions allocated to the trading book, a non-SNI MIFIDPRU firm should consider the nature of that harm. For example, if the harm relates to the ordinary operational aspects of dealing on own account, the firm may treat the harm as covered by the K-DTF requirement, unless the harm is unusual or particularly severe. If the harm arises from adverse market movements in relation to the firm’s trading book positions, the firm may treat the harm as covered by the K-NPR requirement (or K-CMG requirement if the position arises in a portfolio for which the firm has received a K-CMG permission), unless the relevant positions have particular features that mean the harm may be unusual or particularly severe.

4. (4)

   Example 3: Some components of the K-factor requirement, such as the K-CON requirement, reflect specific types of harm. In this case, the firm should consider the purpose of the relevant requirement. As the K-CON requirement is designed to address the potential harm arising from a firm having concentrated exposures to a counterparty or group of connected counterparties, a non-SNI MIFIDPRU investment firm should only compare a harm to the K-CON requirement where that harm arises from, or is connected to, these concentrated exposures.

5. (5)

   Example 4: When assessing harms that may occur during a wind-down of the firm’s business, a non-SNI MIFIDPRU investment firm should consider the potential impact of the harm by comparison with its fixed overheads requirement. In this case, the firm should identify the likely costs of winding down the firm and the potential financial impact of any material harms that might occur while doing so and compare the aggregate amount with the fixed overheads requirement. This will allow a firm to determine whether they are holding sufficient own funds to ensure an orderly wind-down, as required by the overall financial adequacy rule.

1. (1)

   1Some harms may not fit within the own funds requirement framework in MIFIDPRU 4 or 5 because they cannot reasonably be attributed to the activities or risks that the rules in those chapters are designed to address. Where the harms are potentially material in nature, a non-SNI MIFIDPRU investment firm will need to assess their potential financial impact separately and cannot treat those harms as covered (either wholly or partly) by a requirement under MIFIDPRU 4 or 5. This includes potential material harms resulting from any regulated activities that are not MiFID business and from any unregulated activities.

2. (2)

   Example 1: A non-SNI MIFIDPRU investment firm undertakes significant amounts of corporate finance business. The K-factor requirement does not include any components which are designed to address the potential harms arising from this type of business, as none of the K-factor metrics relate to corporate finance business. If the firm identifies potential material harms that may arise from its corporate finance activities, it cannot therefore compare that harm to any part of the K-factor requirement. In this case, the firm will need to assess the potential financial impact of that harm and will need to hold additional own funds to cover that impact.

3. (3)

   Example 2: A non-SNI MIFIDPRU investment firm holds client money in connection with designated investment business that is not MiFID business. The K-CMH requirement applies only to MiFID client money. If the firm identifies potential material harms that result from holding client money for non-MiFID business, it will therefore need to assess the potential financial impact of that harm and hold additional own funds to cover that impact. Similarly, if there are material issues arising from currency mismatches in relation to MiFID client money, this may be a risk that is not adequately covered by the K-CMH requirement.

4. (4)

   A firm is not required to map the financial impact of every potential material harm to components of its K-factor requirement. In some circumstances, it may be impractical or disproportionate to allocate the potential financial impact of harms in this way. Alternatively, it may not be clear that a harm can be allocated to one or more components of the K-factor requirement. A firm may therefore hold an amount that is additional to its K-factor requirement to address a particular harm without determining whether that harm might already be partly covered by the K-factor requirement.

5. (5)

   Example 3: A non-SNI MIFIDPRU investment firm determines that there is a risk of material harm from a cyber incident affecting its IT systems. The firm’s IT systems are used across all its business lines and the firm considers that it is impractical to allocate the financial impact of the cyber incident between particular components of the K-factor requirement. In this situation, the firm may hold an additional amount of own funds (i.e. over and above its K-factor requirement) to cover the potential financial impact of the cyber incident without mapping the impact of the harm to specific components of the K-factor requirement. However, the firm should clearly record the basis on which it has determined the amount of additional own funds that are required.

6. (6)

   2Example 4: A non-SNI MIFIDPRU investment firm is appointed as a depositary. The K-CMH requirement and the K-ASA requirement apply only in relation to MiFID business, and therefore do not apply to its activities as a depositary. If the firm identifies a potential material harm that results from its activities as a depositary, it will need to assess the potential financial impact of that harm and hold additional own funds to cover that impact. A firm may have regard to the general methodology for calculating the K-CMH requirement and the K-ASA requirement when carrying out the assessment in MIFIDPRU 7.6.3R for its activities as a depositary.

1. (1)

   1An SNI MIFIDPRU investment firm is not subject to the K-factor requirement. In practice, this means that its own funds requirement is typically determined by the fixed overheads requirement, although for smaller firms, the permanent minimum capital requirement may be determinative.

2. (2)

   An SNI MIFIDPRU investment firm should therefore identify all relevant potential material harms from its ongoing business operations that cannot be mitigated by other means and estimate their impact on the firm’s own funds. It should then compare the aggregate financial impact on own funds with the firm’s fixed overheads requirement (or, if higher, the permanent minimum capital requirement).

3. (3)

   Separately, an SNI MIFIDPRU investment firm should also identify the likely costs of winding down the firm and the potential financial impact of any material harms that might occur while doing so and should compare the aggregate amount with the fixed overheads requirement. This will allow the firm to determine if it is holding sufficient own funds to ensure an orderly wind-down, as required by the overall financial adequacy rule.

4. (4)

   Where an SNI MIFIDPRU investment firm is close to exceeding one or more of the thresholds in MIFIDPRU 1.2.1R that would result in the firm being reclassified as a non-SNI MIFIDPRU investment firm, the firm should begin to compare its assessment of the own funds that it needs to comply with the overall financial adequacy rule with the K-factor requirement that would apply to the firm if it were a non-SNI MIFIDPRU investment firm. The guidance in MIFIDPRU 7.6.7G and 7.6.8G is relevant in these circumstances. Comparison with the future K-factor requirement will ensure that the firm is better prepared to comply with the additional obligations in MIFIDPRU 4 and 5, and that its ICARA process is calibrated appropriately, at the point at which the firm becomes a non-SNI MIFIDPRU investment firm.

1. (1)

   1MIFIDPRU 7.6.7G to MIFIDPRU 7.6.9G explain the approach that a firm should take to determine if a potential harm is covered by the firm’s own funds requirement. Where a firm has identified potential harms that are not covered by its own funds requirement, or are covered only partly by its own funds requirement, the firm should aggregate the estimated financial impact of those harms to determine the overall additional amount of own funds (i.e. above its own funds requirement) that the firm needs to comply with the overall financial adequacy rule.

2. (2)

   Where the FCA disagrees with a firm’s assessment of the amount of own funds that is required by the overall financial adequacy rule, the FCA may provide individual guidance to that firm about the amount of own funds that the FCA considers is necessary to comply with that rule. Alternatively, the FCA may apply a requirement to the firm that specifies an amount of own funds that the firm must hold for that purpose.

3. (3)

   The effect of MIFIDPRU 7.6.3R(2) is that a firm must not:

   1. (a)

      determine that it needs a lower level of own funds for an activity or harm than is required by a component of the own funds requirement that addresses that risk or harm; or

   2. (b)

      use components of the own funds requirement to cover harms that cannot be attributed to that component.

   This is illustrated by the example in (4).

4. (4)

   Example: A non-SNI MIFIDPRU investment firm carries on portfolio management and determines that its K-AUM requirement is £50,000. However, the firm estimates that the actual financial impact of potential harm that may result from its portfolio management activities is only £30,000. The firm also carries on corporate finance advisory business (which does not give rise to a K-factor requirement) and estimates that the financial impact of the potential harm arising from this business is £40,000. The firm should not conclude that its own funds threshold requirement is £70,000. This is because the firm is not permitted to:

   1. (a)

      conclude that the amount of own funds that it holds in relation to its portfolio management activities is less than the K-AUM requirement. This means that the firm is not permitted to substitute its own estimate of £30,000 for the minimum K-AUM requirement of £50,000; or

   2. (b)

      use part of the K-AUM requirement to cover potential material harms that do not arise in connection with portfolio management. This means that the firm cannot reallocate part of the own funds that should be held to cover the K-AUM requirement to cover risks arising from its corporate finance business.

5. (5)

   Instead, assuming that there are no other relevant potential materials harms to be taken into account, the firm should conclude that its own funds threshold requirement is £90,000, which is the sum of the K-AUM requirement and the firm’s estimate of the potential financial impact of harms arising from its corporate finance business.

1. (1)

   4Where a MIFIDPRU investment firm is also subject to another prudential regime for its non-MiFID business, its own funds threshold requirement can be no lower than the total financial resources requirement under that prudential regime. This is illustrated by the examples in (2) and (3).

2. (2)

   4Firm A is a collective portfolio management investment firm that is required under IPRU-INV 11.6 to comply with the applicable requirements of MIFIDPRU in parallel with its requirements under IPRU-INV 11. Firm A has an own funds requirement of £2,000,000 under MIFIDPRU 4 and, through its ICARA process, assesses that it needs £500,000 of additional own funds to cover potential material harms. However, Firm A also has a total requirement for own funds of £3,000,000 under IPRU-INV 11.2. In this case, Firm A’s own funds threshold requirement would be £3,000,000, because its own funds threshold requirement can be no lower than the total resources requirement under any other prudential regime that applies to it (IPRU-INV 11).

3. (3)

   4Firm B is a collective portfolio management investment firm that is required under IPRU-INV 11.6 to comply with the applicable requirements of MIFIDPRU in parallel with its requirements under IPRU-INV 11. Firm B has an own funds requirement of £2,000,000 under MIFIDPRU 4 and, through its ICARA process, assesses that it needs £1,500,000 of additional own funds to cover potential material harms. Firm B also has a total requirement for own funds of £3,000,000 under IPRU-INV 11.2. In this case, Firm B’s own funds threshold requirement would be £3,500,000. This is because Firm B’s assessment of its own funds threshold requirement is higher than the total resources requirement under the other prudential regime that applies to it (IPRU-INV 11).

1In appropriate cases, the FCA may consider that the early warning indicator should be set at a different level from 110% of a firm’s own funds threshold requirement. In this case, the FCA may invite a firm to apply for a requirement in accordance with section 55L(5) of the Act, or may impose a requirement on the FCA’s own initiative in accordance with section 55L(3) of the Act, to provide for notification to the FCA if the firm’s own funds reach the alternative level.

1. (1)

   1The notification requirement in MIFIDPRU 7.6.11R does not replace a firm’s obligations under:

   1. (a)

      Principle 11 to disclose appropriately to the FCA anything relating to the firm of which the FCA would reasonably expect notice; or

   2. (b)

      the general notification requirements in SUP 15.3.

2. (2)

   Where a firm has submitted a notification under MIFIDPRU 7.6.11R, the notification will generally discharge a firm’s obligations under Principle 11 and the general notification requirements in SUP 15.3 in relation to the matters contained in the notification. However, a firm must still consider whether the FCA should be notified of developments before any of the notification indicators in MIFIDPRU 7.6.11R occur. In addition, Principle 11 and SUP 15.3 may require a firm to notify the FCA of additional material information that is not specifically referenced in MIFIDPRU 7.6.11R.

3. (3)

   A MIFIDPRU investment firm should notify the FCA at an early stage of any significant event which creates a material risk of a firm ceasing to hold adequate financial resources, even if the impact of that event has not yet fully materialised.

1. (1)

   1The table in MIFIDPRU 7.6.15G explains the interventions that the FCA would generally expect to make where there is evidence that a MIFIDPRU investment firm may be at risk of breaching the requirements that apply to its own funds. The table sets out the points at which the FCA would normally intervene and what actions it would normally take.

2. (2)

   The FCA would generally expect that the interventions in the table would be cumulative – i.e. in a declining prudential situation, as the firm hits each intervention point in turn, the FCA would take some or all of the actions associated with that particular point. The actions are intended to be proportionate and progressively stronger responses to address the prudential concerns raised by each intervention point.

3. (3)

   However, if a firm experiences a sudden adverse event which causes the firm to hit multiple intervention points simultaneously, the FCA may immediately take the actions associated with the most severe point.

4. (4)

   The actions specified in the table do not prevent the FCA from taking alternative or additional actions in appropriate cases. The purpose of the table is to provide greater clarity for firms on the FCA’s general expectations and approach to interventions, to assist firms’ own planning and responses.