On 10th March 2023 the UK Financial Conduct Authority (“FCA”) published the findings from its reviews of fast growing (“FGF”) firms. The FGF reviews examined firms’ financial and non-financial resourcing. The review was conducted in 2021-22 and studied the activities of 25 solo regulated firms that were identified by the FCA as experiencing “very fast growth” between 2018-20 which could present “an increased risk of harm to customers and other market participants”.

The FCA observed that rapid growth was typically experienced in one or more of the following areas at each of the firms it selected for review:

• revenue;
• total balance sheet assets;
• client number; and/or
• client money holdings and/or custody assets/assets under management/outstanding e-money.

The types of firms reviewed included CFD providers, wealth managers and payment services institutions. However, the FCA was keen to stress that its “...observations are relevant to all regulated firms that have grown rapidly or have plans to do so”.

The purpose of this article is to summarise the key points from the feedback published by the FCA for the benefit of busy professionals.

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).

The regulator was particularly keen to examine how firm’s risk management frameworks (“RMFs”) had evolved to maintain pace with changes to:

• 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 authorised.

How did the FCA conduct the FGF reviews?

First, the FCA requested sight of the following documents (where applicable):

• business plans;
• Internal capital adequacy process (“ICAAP”) documents;
• wind-down plans; and
• financial projections.

Once it had reviewed these documents, the FCA then held follow up discussions with key individuals working for the regulated firms that were selected for review.

What were the main findings of the FGF reviews?

The main findings of the FGF reviews can be summarised as follows:

• firms had planned growth unsustainably and inadequately. For example, the FCA found that many firms had launched new products such as fractional shares, signals trading or cryptoassets without prior consideration of associated risks;
• in addition, some firms that were selected for review had not maintained their growth rate since 2021 but had not considered the potential implications of this;
• a general overreliance on prescribed minimum regulatory capital thresholds (for example, today: £75k, £150k or £750k for investment firms) to calibrate capital resource requirements;
• generally weak assessments of capital adequacy, with material risks and harms omitted;
• a lack of, or inadequate, stress testing and scenario analysis;
• poor understanding of liquidity risk, leading to flawed assessments of liquid assets that did not sufficiently consider:
  • key liquidity risk drivers;
  • the impact of growth on business;
  • contingency funding planning;
  • liquidity stress testing;

• structural weaknesses in firms’ three line of defence (“3LOD”) models, characterised by the inadequate resourcing of control functions and ineffetive outsourcing, particularly potential overreliance on group entities based overseas for financial or operational support;
• inadequate wind-down planning (“WDP”):
  • deficient operational analysis;
  • flawed assessments of additional costs likely to be incurred during wind down;
  • lack of clear defined early warning indicators and/or wind down triggers;
  • absence of reverse stress testing;
  • optimistic projected timescales for completing a wind down;
  • overconfidence with respect to income that could be generated from divestments and the practicalities of achieving this;
  • limited consideration given to the prospects of maintaining group outsourcing or funding arrangements during wind down;
  • a lack of fund ringfencing to ensure that a firm is able to pay possible consumer redress;

• out of date documentation, something which the FCA asserted “…is symptomatic of inadequate governance / non-financial resources”; and
• some firms had not considered upcoming regulatory changes in forward capital, liquidity and/or non-financial resource planning.

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

The FCA expressed concern that the weaknesses identified would inhibit informed decision making and the ability of firms to meet their liabilities as they fall due, potentially leading to serious harm to customers. Consequently, the FCA intervened to:

• provide detailed feedback to the firms selected for review;
• request that some firms increase the level of capital / liquid assets held;
• put in place remediation plans where appropriate, particularly to address governance issues and resourcing deficiencies in audit, compliance and risk functions; and
• place some firms in its Early and High Growth Oversight pool for enhanced supervision.

The FCA warned that some firms were at risk of breaching Threshold Condition 2.4 (appropriate resources). Where this is the case, the FCA has powers to impose strict conditions on its own initiative, which could include suspending a firm’s permissions to carry on regulated activities.

The FCA again reiterated the importance of submitting accurate RegData returns, stating:

“We consider the poor quality of regulatory data submissions to be an indicator of weaknesses in firms’ systems and controls”.

Regular subscribers to our newsletters will note that the findings of the FGF review echo those that have resulted from other recent initiatives taken by the FCA, including: initial observations from a review of firms’ ICARA processes and the latest portfolio letter to wholesale brokerages. Still, the FCA found that many firms had not engaged adequately with such previous feedback and were “unaware of the full regulatory requirements/guidance”.

How C&G can help

C&G’s consultants have deep knowledge of the FCA’s expectations of firms as regards to governance, financial and non-financial resourcing, product governance and wind down planning. Please contact us today if your firm is seeking help in planning sustainable growth.

References

2023. Fast-growing firms (“FGFs”) multi-firm review. Financial Conduct Authority, available at: https://www.fca.org.uk/publications/multi-firm-reviews/fast-growing-firms (last accessed 15th March 2023).