3. Wind-down Planning: PS21/19 - Changes to the SCA-RTS and Approach Document

  • Posted on: 17 December 2021
  • Written by: David Rodriguez

In this, the third article of our four-part series on the FCA’s Policy Statement 21/19, we cover the latest FCA updates to its guidance in the Approach Document (AD) on prudential risk management and wind-down planning, which is intended to better protect consumers, reduce the risk of financial loss and, ultimately, improve firms’ financial stability.

Prudential Risk Management

The updated guidance in the AD confirms that, under the conditions for authorisation or registration in the Payment Services Regulations 2017 and Electronic Money Regulations 2011, firms are required to have in place procedures to effectively identify, manage, monitor and report any risks to which they might be exposed as part of their business operations. This is not only applicable to regulated firms but also to new applicants.

These procedures must involve liquidity and capital stress testing and scenario analysis, to identify how exposed firms could be to severe business disruptions and to assess the potential impact using both internal and external data. The results of testing should be used by firms to help make sure they can continue to meet their own funds requirements and conditions of authorisation. This may also help firms to understand whether they have adequate liquidity and capital resources, and identify any changes and improvements required to their systems and controls.

On an ongoing basis, it is essential that firms accurately calculate and monitor their capital requirements and resources, and report on this correctly to the FCA via their capital adequacy returns or when requested by the FCA.

The most significant change in the updated guidance is the suggestion for firms operating as part of a group of regulated entities, to reduce exposure to intra-group risk by deducting any assets representing intra-group receivables from their own funds. This is to ensure there is, at all times, an adequate level of financial resources in each regulated entity to absorb losses in difficult times. The FCA suggests that firms do not include uncommitted intra-group liquidity facilities, but just consider their own liquid resources and available funding options to meet their liabilities.

How to stress test?

Unfortunately, there is not a single answer to this question, as firms need to consider the nature, size and complexity on their individual business and the risks it bears, so a ‘one-size-fits-all’ approach would be inadequate.

The guidance clarifies that business failure should be understood as the point at which financial losses are such that the firm is no longer able to carry out its regulated business activities. For example:

  • all or a significant portion of the firm’s critical counterparties are unwilling to continue transacting with it or seek to terminate their contracts:
  • revenue significantly decreases over an extended period of time; or
  • the applicant’s existing investors are unwilling to provide new capital to continue operating its existing business

Additionally, when firms are a member of a group, they should carry out stress testing on a solo basis (as they should their wind down plan), taking into account any risks posed by its membership of the group.

Whatever the approach, the FCA expects firms to document, review and approve their design and results of stress testing at least annually. Stress testing should be carried out more frequently if it is appropriate to do so, especially when any substantial changes occur in the market or the macroeconomic landscape.

Wind-down planning

A controversial topic for payments firms since first introduced by the FCA in its temporary guidance, due to the lack of clarity about the regulator’s expectations on the structure and content of wind-down plans (WDPs) for such firms.

The AD now makes clear that WDPs should be based on reliable, stress-tested financial data including solvent and insolvent scenarios, so prudential risk management becomes an essential element of this process.

In particular, WDPs should consider, as a minimum, the following:

  • sufficient detail to quickly identify customer funds and the customers for whom they are held and to return the funds promptly (including the process that an insolvency practitioner should follow to identify and promptly return relevant funds to customers in the event of an insolvency):
  • funding to cover the cost of wind-down of the firm, including the return of all customer funds
  • realistic triggers to start a wind-down and a strategy for monitoring those triggers:
  • operational resilience and cyber controls during a wind-down period to ensure a smooth and orderly closure:
  • the need for any counterparties (e.g. merchants and customers) to find alternative providers
  • termination of all products and services:
  • wind-down or other arrangements for any subsidiaries or affiliates relevant to the applicant’s regulated activity:
  • non-financial resources (e.g. people, and co-operation from third parties) required for the wind-down:
  • a stakeholder communication plan; and
  • realistic triggers to seek advice on entering an insolvency process, including a strategy for monitoring those triggers.

Furthermore, as part of the process of developing WDPs, the FCA clarifies it expects firms to ensure the following is addressed:

  • The level of financial and non-financial resources required to carry out an orderly wind-down should be assessed, including capital and liquidity funding requirements to cover the solvent wind-down of a firm and the return of customer funds, and key employees required to carry out operational tasks:
  • Thresholds for relevant management information should be set (e.g. revenue, profitability, capital adequacy, liquidity, etc.) and procedures to notify senior management when those thresholds are breached should be put in place:
  • Accurate estimates of the wind-down costs and additional losses such as extra closure costs, potential redress and litigation costs, depleted revenue and impaired asset quality should be produced:
  • Internal and external connectedness should be considered, identifying the interdependencies the firm has with other parties or group members, so it can determine mitigating alternatives to ensure continuity of critical services received by the firm during the wind-down period:
  • An accurate wind-down period should be estimated based on a firm’s activity and size; and
  • Areas which may be difficult to wind-down, such as contracts with third parties that are subject to a longer cancellation period, should be identified

Similar to prudential risk management, the FCA also expects firms’ complexity of wind-down planning to be proportionate to the size and nature of each firm. A firm’s approach to wind-down must be documented, approved by the senior management or The Board and reviewed at least annually. Obviously, any material changes in a firm’s internal arrangements or operations should trigger an immediate review of the wind-down planning process.

What should firms do?

Payments firms should seriously consider the more prescriptive guidance provided by the FCA on prudential, operational and resolution risks management, given it has effectively been a condition of registration/authorisation since July 2020. While the variety of potential scenarios for stress testing and wind-down planning may seem burdensome for firms, it is important that each firm follows the best practice of determining the most probable scenarios that they should plan for based on the specific nature, size and complexity of their operations. However, if in doubt, we are here to help.

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