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MIFIDPRU 7.7 ICARA process: assessing and monitoring the adequacy of liquid assets

MIFIDPRU 7.7.1R

1This section applies to a MIFIDPRU investment firm.

MIFIDPRU 7.7.2R
  1. (1)

    1As part of its ICARA process, a firm must produce a reasonable estimate of the maximum amount of liquid assets that the firm would require to:

    1. (a)

      fund its ongoing business operations during each quarter over the next 12 months; and

    2. (b)

      ensure that the firm could be wound down in an orderly manner.

  2. (2)

    The assessment in (1) must take into account any potential material harms that the firm has identified under MIFIDPRU 7.4.9R and been unable to reduce appropriately through its systems and controls.

  3. (3)

    Without prejudice to the ongoing nature of the ICARA process, the firm must update the analysis in (1) immediately following any material change in the firm’s business model or operating model.

  4. (4)

    To produce the estimate in (1), the firm must ensure that it has in place reliable management information systems to provide timely and forward-looking information on its liquidity position.

MIFIDPRU 7.7.3G
  1. (1)

    1The overall financial adequacy rule requires a firm to hold adequate liquid assets to ensure that:

    1. (a)

      the firm is able to remain financially viable throughout the economic cycle, with the ability to address any potential harm 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 sum of the basic liquid assets requirement and the higher of:

    1. (a)

      the amount of liquid assets that the firm requires to fund its ongoing business operations, taking into account potential periods of financial stress during the economic cycle; or

    2. (b)

      the additional amount of liquid assets that a firm would need to hold when commencing its wind-down process to ensure that the firm could be wound down in an orderly manner.

  3. (3)

    The firm should use the analysis it produces under MIFIDPRU 7.7.2R to ensure that it complies with the overall financial adequacy rule.

  4. (4)

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

MIFIDPRU 7.7.4G
  1. (1)

    1When considering the liquid assets that are required to fund its ongoing business operations under MIFIDPRU 7.7.2R(1), a firm should consider, among other factors:

    1. (a)

      the ordinary level of liquid assets that would typically be required to operate the firm’s underlying business, taking into account any seasonal variations;

    2. (b)

      any material harms that may realistically occur during the next 12 months and their potential impact on the firm’s liquidity position;

    3. (c)

      any liquid assets that a firm may need to use as collateral or to meet margining requirements; and

    4. (d)

      any estimated gaps in funding, including during periods of severe but plausible stress.

  2. (2)

    The liquid assets that a firm requires at any given time during the 12-month period in MIFIDPRU 7.7.2R(1) may fluctuate, depending on the timing of a firm’s expected liabilities and the nature of its business. Therefore, a firm should divide the 12-month period into quarters and assess the highest amount of liquid assets that it would require in each quarter. The FCA accepts that forecasts of the liquid assets that a firm requires may become less accurate for later quarters, but expects firms to use a 12-month time horizon to ensure that adequate attention is given to potential harms and significant liquidity outflows that may occur during that period.

  3. (3)

    As a firm’s liquidity requirements are typically dynamic in nature, MIFIDPRU 7.7.2R requires a firm to update its liquid assets assessment where there has been a material change in the firm’s business model or operating model. This ensures that the firm updates its liquidity analysis to reflect material changes in its circumstances that may affect the availability of liquid assets or the firm’s liquidity requirements, while also assessing future needs over a rolling 12-month time horizon.

  4. (4)

    As part of its reporting obligations under MIFIDPRU 9, a firm must report liquidity information to the FCA on a regular basis. The FCA will use this information to monitor both the liquid assets that the firm is holding and the firm’s assessment of its liquid assets threshold requirement.

MIFIDPRU 7.7.5G
  1. (1)

    1A firm’s basic liquid assets requirement provides a minimum level of core liquid assets that the firm must maintain at all times. The purpose of the basic liquid assets requirement is to ensure that the firm always has a minimum stock of liquid assets to fund the initial stages of its wind-down process if wind-down becomes necessary. The firm cannot, therefore, use the value of the core liquid assets that it holds to meet the basic liquid assets requirement as liquid assets for the liquidity needs of its ongoing business.

  2. (2)

    The basic liquid assets requirement may, however, be insufficient to provide the liquid assets that the firm has assessed would be necessary to facilitate an orderly wind-down as part of its wind-down planning under MIFIDPRU 7.5.7R. Therefore, the firm may identify that it needs to hold an additional amount of liquid assets to meet its funding needs as part of the wind-down process. This is not necessarily the whole amount of the liquid assets that would be required to fund the entire wind-down process, because in some circumstances, the firm may reasonably expect to generate additional liquid assets during wind-down. However, the firm should identify if it could have a funding gap during the wind-down process that the firm needs to cover by holding more liquid assets at the point that wind-down begins.

  3. (3)

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

    MIFIDPRU_7_7_5_20230929

* When a firm assesses the amount of liquid assets it needs for ongoing operations, it cannot use the value of the core liquid assets held to meet the basic liquid assets requirement to fund those operations.

** The basic liquid assets requirement may be insufficient to provide the liquid assets that the firm has assessed would be necessary to facilitate an orderly wind-down. Therefore, the firm may identify that it needs to hold an additional amount of liquid assets (above the basic liquid assets requirement) 3to meet its funding needs to commence its wind-down process.The amount of additional liquid assets under assessment (B), therefore, does not include the amount of the basic liquid assets requirement (as explained in MIFIDPRU 7.7.3G(2)(b)).3

*** Unless otherwise specified by the FCA.

  1. (4)

    3The following example illustrates how to determine the firm’s liquid assets threshold requirement once assessment (A) and assessment (B) have been calculated:

    1. (a)

      A firm has a basic liquid assets requirement of £1,000,000 under MIFIDPRU 6.

    2. (b)

      Through its ICARA process, the firm assesses that it needs a total amount of liquid assets of:

      1. (i)

        3£1,500,000 for ongoing operations under assessment (A); and

      2. (ii)

        £5,000,000 for an orderly wind-down, which means that the firm’s additional amount of liquid assets (above the basic liquid assets requirement) under assessment (B) is £4,000,000.

    3. (c)

      As assessment (B) (£4,000,000) is higher than assessment (A) (£1,500,000), assessment (B) (£4,000,000) is added to the firm’s basic liquid assets requirement of £1,000,000.

    4. (d)

      The firm’s liquid assets threshold requirement would, therefore, be £5,000,000 (the sum of the basic liquid asset requirement (£1,000,000) and assessment (B) (£4,000,000)).

MIFIDPRU 7.7.6R
  1. (1)

    1Subject to (2) and (3), a firm may hold the liquid assets necessary to comply with its liquid assets threshold requirement in any combination of:

    1. (a)

      any core liquid asset, except trade receivables under MIFIDPRU 6.3.3R; or

    2. (b)

      any non-core liquid asset, as defined in MIFIDPRU 7.7.8R, provided that the firm applies an appropriate haircut in accordance with MIFIDPRU 7.7.10R.

  2. (2)

    This rule does not apply in relation to the liquid assets that a firm is holding to meet its basic liquid assets requirement, which must be core liquid assets.

  3. (3)

    A firm may only use a non-core liquid asset for the purpose in (1) if the firm is satisfied that the asset can easily and promptly be converted into cash, even in stressed market conditions.

MIFIDPRU 7.7.7G

1When considering whether a non-core liquid asset meets the requirement in MIFIDPRU 7.7.6R(3), a firm should take into account the following principles:

  1. (1)

    low risk: assets that are less risky tend to have higher liquidity. High credit standing of the issuer and a low degree of subordination tends to increase an asset’s liquidity. Low duration, low legal risk, low inflation risk and denomination in a convertible currency with low foreign exchange risk all tend to enhance an asset’s liquidity;

  2. (2)

    ease and certainty of valuation: an asset’s liquidity tends to increase if market participants are more likely to agree on its valuation. Assets with more standardised, homogenous and simple structures tend to be more fungible, promoting liquidity. The pricing formula of a high-quality liquid asset should be easy to calculate and not depend on strong assumptions. The inputs into the pricing formula should also be publicly available. In practice, this should rule out the inclusion of most structured or exotic products;

  3. (3)

    low correlation with risky assets: the stock of assets should not be subject to wrong-way (highly correlated) risk. For example, assets issued by financial institutions are more likely to be illiquid in times of liquidity stress in the financial sector;

  4. (4)

    listed on a developed and recognised exchange: being listed tends to increase an asset’s transparency and liquidity;

  5. (5)

    active and sizable market: the asset should have an active market at all times. This means that:

    1. (a)

      there should be historical evidence of market breadth and market depth. This could be demonstrated by low bid-ask spreads, high trading volumes, a large and diverse number of market participants, and the existence of a repo market. Diversity of market participants reduces market concentration and increases the reliability of the liquidity in the market; and

    2. (b)

      there should be robust market infrastructure in place. The presence of multiple committed market makers increases liquidity as quotes will most likely be available for buying or selling the asset;

  6. (6)

    low volatility: assets whose prices remain relatively stable and are less prone to sharp price declines over time will have a lower probability of triggering forced sales to meet liquidity requirements. Volatility of traded prices and spreads are simple proxy measures of market volatility. There should be historical evidence of relative stability of market terms (e.g. prices and haircuts) and volumes during stressed periods; and

  7. (7)

    flight to quality: historically, the market has shown tendencies to move into these types of assets in a systemic crisis. The correlation between proxies of market liquidity and financial system stress is one simple measure that could be used.

MIFIDPRU 7.7.8R
  1. (1)

    1Except as specified in (2), the following assets are eligible as non-core liquid assets:

    1. (a)

      short-term deposits at a credit institution that does not have a Part 4A permission in the UK to accept deposits;

    2. (aa)

      short-term non-sterling deposits at a UK credit institution;2

    3. (b)

      assets representing claims on, or guaranteed by, multilateral development banks and international organisations;

    4. (c)

      assets representing claims on, or guaranteed by, any third country central bank or government;

    5. (d)

      financial instruments; and

    6. (e)

      any other instrument eligible as collateral against the margin requirement of an authorised central counterparty.

  2. (2)

    A firm must not treat any of the following as a non-core liquid asset:

    1. (a)

      any asset that belongs to a client;

    2. (b)

      any other asset that is encumbered; or

    3. (c)

      any asset issued by the firm or any of its affiliated entities, except a short-term deposit with an affiliated credit institution.

MIFIDPRU 7.7.9R
  1. (1)

    1For the purposes of MIFIDPRU 7.7.8R(2)(a), an asset may belong to a client even if the asset is held in the firm’s own name. Examples of assets belonging to a client include money or other assets held under the FCA’s client asset rules.

  2. (2)

    For the purposes of MIFIDPRU 7.7.8R(2)(b), an asset may be encumbered if it is pledged as security or collateral, or subject to some other legal restriction (for example, due to regulatory or contractual requirements) which affects the firm’s ability to liquidate, sell, transfer, or assign the asset.

MIFIDPRU 7.7.10R

1A firm must apply an appropriate haircut to the value of a non-core liquid asset to reflect the potential loss of value when converting the asset into cash during stressed market conditions.

MIFIDPRU 7.7.11G

1The FCA considers that a minimum haircut of no less than that in the range specified in the table in MIFIDPRU 7.7.12G is likely to be appropriate for the purposes of MIFIDPRU 7.7.10R.

MIFIDPRU 7.7.12G

1This table belongs to MIFIDPRU 7.7.11G.

Non-core liquid asset

Haircut

Short-term deposits at a credit institution that does not have permission in the UK to accept deposits

0%

2Short-term non-sterling deposits at a UK credit institution

0%

Assets representing claims on, or guaranteed by, multilateral development banks or international organisations

0%

Assets representing claims on, or guaranteed by, any third country central bank or government

0% - 50%

Regulated covered bonds, or comparable covered bonds regulated in a third country

7% - 30%

Asset-backed securities eligible for ‘STS’ designation under the Securitisation Regulation, and backed by residential loans, personal loans, leases or commercial loans for purposes other than commercial real estate development, or comparable asset-backed securities regulated in a third country

25% - 35%

High quality corporate debt securities

15% - 50%

Shares that form part of a major stock index

50%

Financial instruments not covered above for which there is a liquid market as defined in article 42(1)(17) of MiFIR or article 42(1)(17) of EU MiFIR

55%

Other instruments eligible as collateral against the margin requirement of an authorised central counterparty

25% - 55%

MIFIDPRU 7.7.13G

1For the purposes of applying MIFIDPRU 7.7.10R and 7.7.11G to shares or units in a CIU:

  1. (1)

    where a firm is aware of the exposures underlying the CIU, it may look through to the underlying exposures to assign an appropriate haircut;

  2. (2)

    where a firm is not aware of the exposures underlying the CIU, it should assume that the CIU invests, up to the maximum amount allowed under its mandate, in the highest risk assets permissible; and

  3. (3)

    in either case, a firm should consider applying an additional haircut to reflect any additional loss of value that could result from the underlying exposures being held through a CIU.

Requirement to notify the FCA of certain levels of liquid assets

MIFIDPRU 7.7.14R
  1. (1)

    1A firm must notify the FCA immediately in each case where:

    1. (a)

      its liquid assets fall below its liquid assets threshold requirement; or

    2. (b)

      its liquid assets fall below its liquid assets wind-down trigger or the firm considers that there is a reasonable likelihood that its liquid assets will fall below its liquid assets wind-down trigger in the foreseeable future.

  2. (2)

    A notification under (1) must include the following information:

    1. (a)

      a clear statement of the current level of the firm’s liquid assets in comparison to:

      1. (i)

        the firm’s liquid assets threshold requirement; and

      2. (ii)

        in the case of a notification under (1)(b), the firm’s liquid assets wind-down trigger;

    2. (b)

      an explanation of why the firm’s liquid assets have reached the current level;

    3. (c)

      in the case of a notification under (1)(a), an explanation of the recovery actions specified for the purposes of MIFIDPRU 7.5.5R(2)(b) and 7.5.6G that the firm has already taken or will take to restore compliance with its liquid assets threshold requirement; and

    4. (d)

      in the case of a notification under (1)(b), the firm’s intentions in relation to activating its wind-down plan.

  3. (3)

    A firm must submit the notification in (1) through the online notifications and applications system using the form in MIFIDPRU 7 Annex 5R.

MIFIDPRU 7.7.15G
  1. (1)

    1The notification requirement in MIFIDPRU 7.7.14R 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 7.7.14R, 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 7.7.14R 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 7.7.14R.

  3. (3)

    A MIFIDPRU investment firms 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.

FCA approach to intervention in relation to liquid assets

MIFIDPRU 7.7.16G
  1. (1)

    1The table in MIFIDPRU 7.7.17G explains the interventions that the FCA would generally expect to make where a MIFIDPRU investment firm has breached, or there is evidence that the firm may be at risk of breaching, its liquid assets requirements. The table sets out the points at which the FCA would normally intervene and what actions it would normally take. Note that unlike for own funds, there is no early warning indicator requirement in relation to liquid assets.

  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 the 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.

MIFIDPRU 7.7.17G

1This table belongs to MIFIDPRU 7.7.16G.

Intervention point

Purpose

Potential FCA supervisory actions

Threshold requirement notification:

Firm holding insufficient liquid assets to meet its liquid assets threshold requirement

The liquid assets threshold requirement is the amount of liquid assets that the firm needs at any point in time to comply with the overall financial adequacy rule. The FCA will monitor a firm’s assessment of its liquid assets threshold requirement through the information that the firm provides under MIFIDPRU 9.

This notification is intended to prompt the firm and the FCA to address the breach of threshold conditions in a timely manner.

Where a firm has ceased to hold sufficient liquid assets to meet its liquid assets threshold requirement, the focus should be on restoring liquid assets to at least the level of the liquid assets threshold requirement and recovery of the firm (unless the firm chooses to exit the market by voluntarily winding down). However, any proposed actions for recovery must be credible and achievable within a reasonable and realistic timeframe.

The FCA would normally expect that:

(a)

the firm will have considered taking the recovery actions identified under MIFIDPRU 7.5.5R(2)(a) and MIFIDPRU 7.5.6G before breaching its liquid assets threshold requirement and will be considering whether to take, or will have taken, any relevant recovery actions identified under MIFIDPRU 7.5.5R(2)(b);

(b)

the firm’s governing body will regularly evaluate whether the firm should take additional actions to restore its level of liquid assets to at least the level of the liquid assets threshold requirement; and

(c)

the FCA will consider whether to request the firm to report additional information to the FCA.

If, having considered the information provided by the firm about its proposed actions, the FCA reasonably considers that the firm may fail to restore its liquid assets to the level required by the liquid assets threshold requirement within a reasonable timeframe, the FCA may consider the following actions:

(d)

requesting that the firm cease making discretionary payments;

(e)

requesting that the firm cease taking on new business;

(f)

requesting that the firm’s parent undertaking provides additional liquid assets for the firm;

(g)

where appropriate, inviting the firm or its parent undertaking to apply for a requirement under section 55L(5) or section 143K(1) of the Act, or imposing a requirement on the FCA’s own initiative under section 55L(3) or section 143K(2) of the Act, in relation to (a) – (f) above; or

(h)

where appropriate, inviting the firm to apply for variation or cancellation of permission under section 55H of the Act, or varying or cancelling the firm’s permission on the FCA’s own initiative under section 55J of the Act.

The FCA would also expect the firm to consider whether it is appropriate to trigger the firm’s wind-down plan under MIFIDPRU 7.5.7R to ensure an orderly wind-down of its business. This may be the case where the firm’s identified wind-down actions will require a reasonable length of time to execute, such as where the firm will need to transfer customers or close out its own positions.

Wind-down trigger notification:

Firm’s liquid assets fall below its liquid assets wind-down trigger

The liquid assets wind-down trigger is an absolute minimum level of liquid assets that a firm must maintain at all times to provide the necessary financial resources to commence wind-down. This is equal to the firm’s basic liquid assets requirement (or such higher amount as the FCA may have imposed for these purposes in a requirement).

In order to maximise the potential for an orderly wind-down, the FCA expects that firms that breach this trigger should normally commence winding down immediately unless the firm’s governing body and the FCA determine that there is an imminent and credible likelihood of recovery.

The FCA would normally expect the following to occur:

(a)

the firm’s governing body will make a formal decision to initiate the firm’s wind-down plan, unless the governing body has a reasonable basis for determining that there is an imminent and credible likelihood of the firm’s recovery; and

(b)

where the firm decides to initiate its wind-down plan, the FCA will invite the firm to apply for a requirement under section 55L(5) of the Act, or will impose a requirement on the FCA’s own initiative under section 55L(3) of the Act, that prevents the firm from taking on any new business.

The FCA may consider the following additional actions if it has concerns that without these actions, the potential risk of harm to consumers or the markets is likely to increase:

(c)

taking appropriate action to protect any client money or client assets, including, where appropriate, inviting the firm to apply for a requirement under section 55L(5) of the Act, or imposing a requirement on the FCA’s own initiative under section 55L(3) of the Act, to achieve any necessary protection; and

(d)

where appropriate, inviting the firm to apply for variation or cancellation of permission under section 55H of the Act, or varying or cancelling the firm’s permission on the FCA’s own initiative under section 55J of the Act.

If a firm refuses to commence an orderly wind-down despite its governing body or the FCA having concluded that there is no imminent and credible likelihood of recovery, the FCA will consider the full range of its supervisory powers. In particular, the FCA may use a combination of its own initiative powers under section 55L(3) and section 55J of the Act to:

(e)

prevent the firm from continuing to carry on any regulated activities; and

(f)

direct the firm to take appropriate actions to ensure the fair treatment and appropriate protection of clients and counterparties during any run-off period for its existing regulated business.