What is the ICARA?
In order to understand the Internal Capital Adequacy and Risk Assessment ("ICARA"), it is first important to understand its wider context. The UK Investment Firm Prudential Regime ("IFPR") came into effect on 1 January 2022, replacing a number of fragmented reference sources and the prudential sourcebooks contained within the FCA Handbook. The intention being to bring about an 'uplift' in prudential standards for in-scope firms (see below). The IFPR is wide-ranging in its breadth of coverage:
- Own funds and liquid assets.
- Own funds and liquidity requirements.
- Regulatory consolidation.
- Risk management.
- Reporting.
- Disclosures.
- Governance.
- Remuneration.
Firstly, it should be noted that the ICARA is not a document, it refers to a collective process, with the ICARA document capturing the outputs and judgements reached from that process for the regulated firm! In essence, the purpose of the process is to ensure that the firm has appropriate systems and controls in place to identify, monitor and reduce potential harms and that it holds adequate financial resources for the business and risks that it undertakes throughout the anticipated economic cycle (assumed to be three years forward-looking). The key focus of the process is risk and making financial provisions to guard against each businesses' operating risks.
Who is within the scope of ICARA?
The FCA's implementation of IFPR and its expectations around the ICARA process are set out within the MIFIDPRU sourcebook within the FCA Handbook. MIFIDPRU 1.1.1G makes clear that MIFIDPRU applies to MIFIDPRU investment firms, which should be considered in general as UK-based regulated firms providing investment services, considered to be those performing:
- Reception and transmission of orders in relation to one or more financial instruments;
- Execution of orders on behalf of clients;
- Dealing on own account;
- Portfolio management;
- Making personal recommendations;
- Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis;
- Placing of financial instruments without a firm commitment basis;
- Operational of a multilateral trading facility; or
- Operation of an organised trading facility.
Any firm performing the above activities will therefore likely be captured within the MIFIDPRU prudential sourcebook and be required to have an ICARA process in place, culminating in the production/refresh of an ICARA document on an annual basis. MIFIDPRU 1.2 does contain allowances for proportionality for Small and Non-Interconnected MIFIDPRU investment firms, driven by various activity levels (e.g., AUM and Client Orders Handled) and activity restrictions; however, this does not constitute a full exemption by any means.
Why does the ICARA matter?
Put simply, the ICARA process, and its outputs, matter because it enables the firm to demonstrate that it has the appropriate systems and controls, as well as financial resources, in place to meet the FCA's requirements and expectations. In the absence of this integral system and control in place via the ICARA process, a firm could be considered to be deficient against its own funds and / or liquidity requirements, and therefore in breach of the FCA's threshold condition relating to appropriate resources, calling into question the Part IV permissions of the firm. This alone should be as good a reason as any to take the FCA's expectations around ICARA seriously!
At a more procedural-level, the ICARA process should be considered to be more than simply a box-ticking exercise to satisfy compliance requirements. The component parts to an ICARA process should form the basis of governance best practice and well-governed firms would likely have been giving consideration to the below cycle as part of business and planning best practice:
What else should firms be considering other than MIFIDPRU Handbook?
The Annexes to the MIFIDPRU sourcebook, particularly MIFIDPRU 7 Annex 7, within the FCA Handbook contain helpful guidance. As a starter for ten, firms should also have mind to the FCA's published guidance Finalised Guidance 20/1: Assessing adequate financial resources and the FCA's Wind Down Planning Guidance.
What should firms be doing?
In short, and as per the above, firms should have a clearly documented organic ICARA process in place, ensuring clear Senior Management input and oversight in place, alongside a clear and documented basis and rationale for their assessments made in relation to Overall Financial Threshold Requirement, the Liquid Assets Threshold Requirement and the Overall Financial Adequacy Rule. We will cover this in more depth in next week's release!
Please contact Andrew Jacobs or Harry Howe if you wish to have a follow-up conversation on IFPR or ICARA.
