Money for Something

The FCA’s latest consultation CP 19/20 entitled “Our Framework: Assessing Adequate Financial Resources” is a curious read. Not least as the FCA sees over £90m of new costs it proposes for financial services firms, money well spent.

Regulated investment managers should be familiar with the FCA’s latest “clarity” covering capital, liquidity, wind-down planning, stress-testing and reverse stress testing, spiced with risk assessments, business model harm-analysis and strong governance arrangements. However, the FCA’s aim is not just investment firms conditioned by twenty-five years of EU capital adequacy regulation. It has all regulated firms in its reach, considering costs related to familiarisation, gap analysis and implementing new procedures a price worth paying to reduce the level of Financial Services Compensation Scheme (FSCS) compensation payments which averaged annually £169.2m between 2013 and 2017.

The FCA’s largest target is over 45,000 “Class 3” firms who are not subject to regular supervisory review or required to perform an Internal Capital Adequacy Assessment (“ICAAP”). The FCA estimates these firms are responsible for over three quarters of the FSCS’s relevant compensation to consumers, and it is these firms, the FCA suggests, who need to be accountable to recompense consumers and reduce the burden on the FSCS. Whether these generally smaller firms can ever hold sufficient capital to anticipate prudently the amount of FSCS compensation required is a matter for debate.

Notwithstanding the focus on Class 3 firms, the FCA’s attempt to clarify what the Threshold Condition of “appropriate resources” means is for everyone. So all firms are expected to review their risk assessment and capital adequacy frameworks, whether they currently operate with an ICAAP or not, and all firms should consider the risks of regulatory intervention and the funding of compensation payments in their capital adequacy planning.

One sector that could be impacted dis-proportionately is private equity and other illiquid advisers who, following a long period of sensible and modest base capital requirements, will in future feel the impact of both a new European-wide capital framework and this application of the FCA’s capital forecasting and stress testing requirements.

In addition, considering that the consultation is aimed at everyone but not everyone contributes to the FSCS, with no new rules to back up increased capital requirements and with no explanation of the types of firms whose behaviour contributes most to the volume of compensation claims, many more firms may feel that the FCA’s approach is laudable but not for them. That will create a problem under SMCR for those Senior Managers responsible for finance and capital adequacy whose minds will surely need to be focused on giving the FCA what it expects.

Ellis Wilson provides free monthly regulatory updates to clients and subscribers. If you work for a FCA regulated business, please register here.