Broking Business: Wind-down planning: the FCA’s recent guidelines
The FCA has published the findings of its Thematic Review on wind-down planning in TR 22/1 – observations on wind-down planning: liquidity, triggers and intra-group dependencies. Paul Goldwin helps you navigate the key points.
The regulator’s latest review follows its Wind-down Planning Guidance (WDPG) in June 2020, refreshed in August 2021, reflecting its concerns about the financial resilience of regulated firms following the impact of COVID-19.
As a reminder, regulated firms have an obligation under Threshold Condition (TC) 2.4 to hold adequate financial and non-financial resources and to put in place a wind-down plan (WDP) which demonstrates how they will exit the market, if required, in an orderly manner without causing harm to their clients or to the market itself.
The FCA found in its Thematic Review that most firms’ WDPs, processes and risk management frameworks remained at an early stage of maturity, with substantial gaps. There was still significant work to be done to meet the minimum expectations highlighted in the original WDPG.
There were three key findings in the FCA’s report: liquidity and cash flow modelling, intra-group dependencies, and establishing and evaluating the correct WD trigger. We examine each of these in turn.
1. Liquidity issues
The FCA said that firms need to consider the impact that their liquidity requirements in a wind-down period will have on the adequacy of their resources, their risk appetite, and how they identify the point of non-viability.
It’s important that firms remain compliant with TC 2.4 during the wind-down period and can continue to pay their liabilities as they fall due. The regulator found that firms were good at monitoring their capital needs during the wind-down period but not so strong on their liquidity.
The FCA encouraged firms to find a way of ring-fencing liquid funds so that they have sufficient cash to get them through the wind-down period efficiently. One example of good practice is to calculate the ‘TC 2.4 cash buffer’ and ring-fence this in a separate account to be used only to fund the wind-down, if ever required.
The findings highlighted three key liquidity points:
- The need for firms to be able to fund any cash flow timing mismatches during the wind-down period
- The requirement for firms to carefully map out the ‘net cash impact’ of the wind- down exercise. This is so that they remain cash positive throughout, once the cost of the wind-down and the realisable value of their assets have been considered.
- The need to have a healthy cash balance at the start of the wind-down, to avoid entering the period with a stressed cash position.
2. Intra-group dependency
The regulator allows groups of firms to carry out their wind-down planning on a group basis, as long as the planning adequately covers each individual regulated firm and an ‘entity view’ is available. They must also have considered the impact of group membership on the ability of a UK regulated firm to wind down in an orderly way.
The FCA identified three types of intra-group dependencies:
- Financial inter-connectedness (for example, where financial support from a parent or other group undertaking is required)
- Operational inter-connectedness – where the entity depends on shared group resources such as IT and HR
- Contingent financial support – where there may be such items as cross-guarantees in place.
In these situations, the firm must assess and map out this inter-connectivity and the impact it may have on wind-down, and consider the mitigating actions it can take.
This requires a clear governance structure that sets out the roles and responsibilities of the respective boards and Executive Committees of each legal entity and how they interact across the group. There must also be an operational plan explaining how each relevant entity in the group will be wound down. And, thirdly, an impact assessment – especially where some entities in the group will be wound down and others will carry on.
3. Wind-down trigger
Another common weakness was the failure to identify, and act on, a well thought out wind-down trigger or ‘initiation point’ which determines whether wind-down is required or not.
In the FCA’s view, firms should consider a range of appropriate triggers, linked to their risk management framework. Otherwise, wind-down decisions were often occurring too late at a time where the firm was already in ‘stress’.
The best examples of good practice were where firms looked at several possible trigger events, including forward-looking triggers such as cash forecasts, considered how these interacted with each other and carried out stress testing of the various outcomes.
The FCA requires firms to step up the implementation and sophistication of their wind-down plans and to consider the observations from the Thematic Review when finalising their plans. The regulator believes the only way a firm can demonstrate that its WDP is credible and operable is to test its outcomes.
Please feel free to contact the PKF Broking team if you need any help in developing or improving your WDP.