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MIFIDPRU 7.4 Internal capital adequacy and risk assessment (ICARA) process: overview and baseline obligations

MIFIDPRU 7.4.1R

1This section applies to a MIFIDPRU investment firm.

Purpose

MIFIDPRU 7.4.2G

1MIFIDPRU 7.4 to MIFIDPRU 7.9 contain rules and guidance which supplement the overarching requirements for MIFIDPRU investment firms under:

  1. (1)

    the appropriate resources threshold condition in Schedule 6 to the Act (as explained in COND 2.4) under which a firm must have appropriate resources in relation to the regulated activities that it carries on; and

  2. (2)

    Principle 4 (Financial prudence) under which a firm must maintain adequate financial resources.

MIFIDPRU 7.4.3G
  1. (1)

    1The overall purpose of the rules in MIFIDPRU 7.4 to MIFIDPRU 7.9, together with the other requirements in MIFIDPRU, is to ensure that a MIFIDPRU investment firm:

    1. (a)

      has appropriate systems and controls in place to identify, monitor and, where proportionate, reduce all potential material harms that may result from the ongoing operation of its business or winding down its business; and

    2. (b)

      holds financial resources that are adequate for the business it undertakes.

  2. (2)

    The requirement for adequate financial resources is designed to achieve 2 key outcomes for MIFIDPRU investment firms:

    1. (a)

      to enable a firm to remain financially viable throughout the economic cycle, with the ability to address any potential material harms that may result from its ongoing activities (including both regulated activities and unregulated activities); and

    2. (b)

      to enable the firm to conduct an orderly wind-down while minimising harm to consumers or to other market participants, and without threatening the integrity of the wider UK financial system.

  3. (3)

    The rules and guidance in MIFIDPRU 7.4 to MIFIDPRU 7.9 build on the FCA’s general approach to assessing the adequacy of financial resources explained in Finalised Guidance FG20/1. Firms should also refer to that guidance when considering their obligations under those sections of MIFIDPRU.

MIFIDPRU 7.4.4G

1The FCA recognises that:

  1. (1)

    there is a vast range of potential harms and it will not be possible for the FCA or firms to eliminate all potential risks and sources of harm;

  2. (2)

    the FCA and firms should focus on material harms, adopting a proportionate and risk-based approach to each firm’s business and operating model; and

  3. (3)

    some firms may still fail, but the FCA and firms should aim to ensure that any wind-down of those firms occurs in an orderly manner, minimising the impact on consumers and the wider market.

Proportionality and application to different business models

MIFIDPRU 7.4.5G

1Although all MIFIDPRU investment firms are subject to the appropriate resources threshold condition and Principle 4, the practical steps that a firm must take to meet these requirements will vary according to the firm’s business model and operating model. Therefore, a firm with a more complex business or operating model should generally take a more detailed approach to the monitoring and management of a wider range of potential harms than a smaller firm carrying on simpler activities.

MIFIDPRU 7.4.6G

1MIFIDPRU 7.4 to MIFIDPRU 7.8 contain a set of core requirements that every MIFIDPRU investment firm should incorporate into its ICARA process. This does not mean that the manner in which each firm implements these core requirements will be identical. When considering the appropriate way to satisfy these core requirements, a firm should focus on the potential material harms that may arise:

  1. (1)

    from the ongoing operation of its business; and

  2. (2)

    during a wind-down of its business.

Overall financial adequacy rule

MIFIDPRU 7.4.7R
  1. (1)

    1A firm must, at all times, hold own funds and liquid assets which are adequate, both as to their amount and their quality, to ensure that:

    1. (a)

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

    2. (b)

      the firm’s business can be wound down in an orderly manner, minimising harm to consumers or to other market participants.

  2. (2)

    The requirement in (1) is known as the overall financial adequacy rule.

MIFIDPRU 7.4.8G
  1. (1)

    1The overall financial adequacy rule establishes the standard that the FCA applies to determine whether a MIFIDPRU investment firm has adequate financial resources. The amount and quality of own funds and liquid assets that each firm must hold will vary according to its business model and operating model, the environment in which it operates and the nature of its internal systems and controls.

  2. (2)

    The remainder of this section explains the basic requirements of the ICARA process. The ICARA process is the collective term for the internal systems and controls that a firm must operate to identify and manage potential material harms that may arise from the operation of its business, and to ensure that its operations can be wound down in an orderly manner.

  3. (3)

    A firm should use the ICARA process to identify whether it complies with the overall financial adequacy rule. The focus of the ICARA process is on identifying and managing risks that may result in material harms. Depending on the nature of the potential harms identified, the only realistic option to manage them and to comply with the overall financial adequacy rule may be to hold additional own funds or additional liquid assets above the firm’s own funds requirement or basic liquid assets requirement. However, in other cases, there may be more appropriate or effective ways to manage the potential harms. MIFIDPRU 7.4.16G contains further guidance on reducing the risk of material potential harms.

  4. (4)

    MIFIDPRU 7.6 contains rules and guidance about how a firm should use the ICARA process to assess the own funds that the firm requires to comply with the overall financial adequacy rule.

  5. (5)

    MIFIDPRU 7.7 contains rules and guidance about how a firm should use the ICARA process to assess the liquid assets that the firm requires to comply with the overall financial adequacy rule.

  6. (6)

    MIFIDPRU 7.10 contains guidance on how the FCA will normally conduct a SREP on a firm’s ICARA process or may conduct a thematic review of a sector in which multiple firms are active. Where the FCA considers that the firm’s ICARA process has not adequately identified and managed the risks of material harm, the FCA may require the firm to take corrective action. In appropriate cases, this may include requiring the firm to hold additional own funds or liquid assets to ensure that the firm is complying with the overall financial adequacy rule. The FCA may also take supervisory action in connection with the prudential requirements of a MIFIDPRU investment firm outside the context of a SREP. Where the FCA has conducted a sectoral review, it may impose additional requirements on some or all firms that are active in the relevant sector.

ICARA process: baseline obligations

MIFIDPRU 7.4.9R
  1. (1)

    1A firm must have in place appropriate systems and controls to identify, monitor and, if proportionate, reduce all material potential harms:

    1. (a)

      that the ongoing operation of the firm’s business may cause to:

      1. (i)

        the firm’s clients and counterparties;

      2. (ii)

        the markets in which the firm operates; and

      3. (iii)

        the firm itself; and

    2. (b)

      that may result from winding down the firm’s business, to ensure that the firm can be wound down in an orderly manner.

  2. (2)

    If any material potential harms remain after a firm has implemented the systems and controls in (1), the firm must assess whether to:

    1. (a)

      hold additional own funds to address the harms in accordance with MIFIDPRU 7.6.2R; and

    2. (b)

      hold additional liquid assets to address the harms in accordance with MIFIDPRU 7.7.2R.

  3. (3)

    The requirements in this rule apply to a firm’s entire business, including:

    1. (a)

      all regulated activities, irrespective of whether they are MiFID business; and

    2. (b)

      any unregulated activities.

  4. (4)

    The systems, controls and procedures operated by a firm to comply with the requirements in this rule are known as the ICARA process.

MIFIDPRU 7.4.10R

1A firm’s ICARA process must be proportionate to the nature, scale and complexity of the business carried on by the firm.

MIFIDPRU 7.4.11R

1A firm must ensure that its ICARA process complies with the requirements in MIFIDPRU 7.4 to MIFIDPRU 7.8 in a consistent and coherent manner.

MIFIDPRU 7.4.12G
  1. (1)

    1MIFIDPRU 7.4.11R requires a firm to ensure that the inputs to, analyses applied by, and conclusions arising from, its ICARA process are properly linked and reflect a consistent and coherent analysis of the firm’s business and operating model.

  2. (2)

    The following are examples of the consistency and coherence required by the ICARA process:

    1. (a)

      the potential material harms that the firm identifies under MIFIDPRU 7.4.13R are consistent with the firm’s articulation of its business model and strategy under MIFIDPRU 7.5.2R(1) and with the firm’s stated risk appetite under MIFIDPRU 7.5.2R(2);

    2. (b)

      the firm’s analysis under MIFIDPRU 7.5.2R(4) of the own funds and liquid assets that are necessary to comply with the overall financial adequacy rule is consistent with:

      1. (i)

        the potential impact of the potential material harms that the firm identifies under MIFIDPRU 7.4.13R;

      2. (ii)

        the firm’s projections of its future requirements under MIFIDPRU 7.5.2R(4); and

      3. (iii)

        the impact of the stressed scenarios that the firm has identified under MIFIDPRU 7.5.2R(5);

    3. (c)

      the potential recovery actions specified by the firm under MIFIDPRU 7.5.5R(2) are consistent with the firm’s projections of its future requirements under MIFIDPRU 7.5.2R(4) and the potential stressed scenarios that the firm has identified under MIFIDPRU 7.5.2R(5);

    4. (d)

      the firm’s wind-down planning under MIFIDPRU 7.5.7R is consistent with the levels of own funds and liquid assets that the firm has assessed would be necessary to wind-down the firm for the purposes of the overall financial adequacy rule and with the firm’s assessment of the potential harms that might result from winding down its business under MIFIDPRU 7.4.13R; and

    5. (e)

      the firm's wind-down planning is consistent with the potential recovery actions specified by the firm under MIFIDPRU 7.5.5R(2) and the circumstances in which the firm has concluded that no further recovery actions would be feasible or desirable.

ICARA process: identifying harms

MIFIDPRU 7.4.13R

1As part of its ICARA process, a firm must assess its business model and identify all material harms that could result from:

  1. (1)

    the ongoing operation of the firm’s business; and

  2. (2)

    the winding-down of the firm’s business.

MIFIDPRU 7.4.14G

1When assessing potential material harms for the purpose of MIFIDPRU 7.4.13R, the FCA considers that the following non-exhaustive list of considerations will be relevant:

  1. (1)

    the level of detail required in the assessment is likely to vary depending on the complexity of the business and operating model. More complex business and operating models are likely to involve a wider range of potential material harms and so will generally require a more detailed assessment;

  2. (2)

    the obligation under MIFIDPRU 7.4.13R is to identify all material harms that could result from the firm’s business, even if those harms can be appropriately mitigated. It is important that a firm starts by identifying all potential material harms that could arise from its business and operating model. The issue of how the identified harms can be mitigated should be considered separately, including assessing under MIFIDPRU 7.6 and 7.7 whether the firm should hold additional own funds and liquid assets;

  3. (3)

    the potential for harm may evolve throughout the course of an economic cycle. Therefore, the assessment should consider how the risk of harm may develop in the future, rather than simply performing a static assessment based on current economic circumstances;

  4. (4)

    risks to the firm itself may result in an increased risk of harm to the firm’s clients or counterparties and therefore should form part of the assessment. For example, if the firm is affected by a significant disruption or suffers a significant loss, this may prevent the firm from providing important services to clients or from being able to meet its liabilities to counterparties. Significant and unexpected financial losses sustained by a firm may also decrease the financial resources available to the firm to address other potential harms and may increase the risk of disorderly wind-down and sudden disruption of services to the firm’s clients; and

  5. (5)

    firms should refer to the guidance in Finalised Guidance FG20/1 on “Identifying and assessing the risk of harm” when assessing the impact of potential harms.

MIFIDPRU 7.4.15G
  1. (1)

    1MIFIDPRU 7 Annex 1 contains additional guidance on identifying potential material harms that are relevant to the business models of most firms.

  2. (2)

    MIFIDPRU 7 Annex 2 contains additional guidance on identifying potential material harms that are likely to be relevant to firms that deal on own account or hold significant investments on their balance sheets. This guidance is intended to apply in addition to the general guidance in MIFIDPRU 7 Annex 1.

  3. (3)

    The FCA may issue further guidance or publish additional information to reflect its observations of how firms are implementing the ICARA process or to take into account developments in relation to particular products or sectors. Firms should consider any additional guidance or information that the FCA has published when applying the requirements in this section.

ICARA process: risk mitigation

MIFIDPRU 7.4.16G
  1. (1)

    1The ICARA process is an internal risk management process that a MIFIDPRU investment firm must operate on an ongoing basis. As part of that process, a firm should consider whether the risk of material potential harms can be reduced through proportionate measures (other than holding additional financial resources) and, if so, whether it is appropriate to implement the measures. The nature of any potential measures will vary depending on the firm’s business and operating model. Examples may include implementing additional internal systems and controls, strengthening governance and oversight processes or changing the manner in which the firm conducts certain business. A firm will need to form a judgement about what is appropriate and proportionate for its particular circumstances. That judgement will be informed by the firm’s risk appetite.

  2. (2)

    A firm must assess whether it should hold additional own funds or additional liquid assets to mitigate any material potential harms that it has identified. This may be the case where the firm cannot identify other appropriate, proportionate measures to mitigate harms, or where it has applied these measures, but a residual risk of material harm remains. Any assessment must be realistic and based on severe but plausible assumptions.