FCA publishes findings from its review of fast-growing ("FGF") firms.

 

The UK financial oversight agency ("FCA") published the findings of its reviews of fast-growing ("FGF") firms on March 10, 2023. The FGF reviews looked at companies' financial and non-financial resources. The review was conducted in 2021-22 and looked into the activities of 25 solo regulated firms that the FCA identified as experiencing "very fast growth" between 2018-20, which could pose a "higher risk of harm to customers and other market participants.

The FCA discovered that each of the firms it chose for review experienced rapid growth in one or more of the following areas:

·       revenue;

·       total balance sheet assets;

·       client number; and/or

·       Client money holdings and/or custody assets/assets under management/outstanding e-money.

CFD providers, wealth managers, and payment services institutions were among the firms examined. The FCA, on the other hand, was quick to point out that its "observations are relevant to all regulated firms that have grown rapidly or plan to do so."

What were the key areas of focus for the FGF reviews?

The FCA stated that its reviews were primarily focused on the following three areas:

·       governance;

·       risk management practices; and

·       Adequacy of financial resources (capital and liquid assets).

Business models, particularly the addition of new products and/or business lines; and

The wider macro-economic environment within which the firms were operating, for example, the extreme volatility that accompanied the onset of the COVID-19 pandemic;

Since each of the firms became authorized.business models, particularly the addition of new products and/or business lines; and

The wider macro-economic environment within which the firms were operating, for example, the extreme volatility that accompanied the onset of the COVID-19 pandemic;

Since each of the firms became authorized.

How did the FCA conduct the FGF reviews?

First, the FCA requested to see the following documents (as appropriate):

·       business plans;

·       Internal capital adequacy process (“ICAAP”) documents;

·       wind-down plans; and

·       Financial projections.

After reviewing these documents, the FCA held follow-up discussions with key individuals from the regulated firms chosen for review.

What were the main findings of the FGF reviews?

·       Firms had planned untenable and insufficient growth. For example, the FCA discovered that many firms had launched new products such as fractional shares, signals trading, or crypto assets without first considering the risks involved.

·       Furthermore, some of the firms chosen for review had not maintained their growth rate since 2021, but had not considered the potential consequences of this;

·       a general overreliance on prescribed minimum regulatory capital thresholds (for example, for investment firms today: £75k, £150k, or £750k) to calibrate capital resource requirements;

·       generally inadequate financial adequacy assessments, with material risks and harms omitted;

·       a lack of (or insufficient) stress testing and scenario analysis

·       a lack of understanding of liquidity risk, resulting in flawed assessments of liquid assets that did not take into account:

o   key liquidity risk drivers;

o   the impact of growth on business;

o   contingency funding planning;

o   liquidity stress testing;

·       structural flaws in firms' three line of defense ("3LOD") models, as evidenced by insufficient resourcing of control functions and ineffective insourcing, development of young people’s overreliance on group entities based overseas for financial or operational support;

·       inadequate wind-down planning (“WDP”):

o   deficient operational analysis;

o   flawed assessments of additional costs likely to be incurred during wind down;

o   lack of clear defined early warning indicators and/or wind down triggers;

o   absence of reverse stress testing;

o   optimistic projected timescales for completing a wind down;

o   overconfidence with respect to income that could be generated from divestments and the practicalities of achieving this;

o   limited consideration given to the prospects of maintaining group outsourcing or funding arrangements during wind down;

o   a lack of fund ringfencing to ensure that a firm is able to pay possible consumer redress;

·       out-of-date documentation, which the FCA claimed "...is symptomatic of insufficient governance / non-financial resources"; and

·       Some firms had not planned for upcoming regulatory changes in terms of forward capital, liquidity, and/or non-financial resources.

What action did the FCA in response to the findings of the FGF reviews?

The FCA expressed concern that the identified flaws would impede informed decision-making and firms' ability to meet their liabilities as they become due, potentially causing serious harm to customers. As a result, the FCA intervened to:

·       give detailed feedback to the firms chosen for review

·       request that some businesses increase the amount of capital / liquid assets they hold;

·       Establish suitable mitigation plans, particularly to address governance issues and resourcing gaps in audit, compliance, and risk functions; and

·       Some firms will be placed in its Early and High Growth Oversight pool for enhanced supervision.

The FCA issued a warning that some firms were at risk of violating Threshold Condition 2.4. (Appropriate resources). In such cases, the FCA has the authority to impose strict conditions on its own initiative, which may include suspending a firm's permission to engage in regulated activities.

The FCA highlighted the importance of submitting accurate RegData returns once more, stating:

Regular readers of our newsletters will notice that the findings of the FGF review echo those of other recent FCA initiatives, such as preliminary findings from a review of firms' ICARA processes and the most recent portfolio letter to wholesale brokerages. Nonetheless, the FCA discovered that many firms had not responded adequately to previous feedback and were "unaware of the full regulatory requirements/guidance."

How C&G can help

The consultants at CG Regulatory Solutions are intimately familiar with the FCA's expectations of firms in terms of governance, financial and non-financial resourcing, product governance, and wind down planning. Please contact us right away if your company is looking for assistance in planning for long-term growth.