Financial resilience: firms need to up their game on wind-down planning
The FCA have just released their observations from a thematic review which considered the progress firms have made in implementing effective wind-down plans, important for financial resilience, with a particular focus on liquidity needs in light of the ongoing Covid-19 pandemic.
The review was performed by the FCA through a series of bi-lateral discussions with a number of larger firms on their assessment of cashflow needs, modelling methodology, intra-group reliance and pre-wind down risks in the event of a wind-down. The FCA also reviewed firms’ wind-down plan documentation.
The work identified substantial gaps with some firms having no wind-down plans, threatening their financial resilience. Where plans did exist, they remained at an early stage of maturity and did not reflect the FCA Wind-Down Planning Guidance (WDPG) and the Final Guidance on Assessing Adequate Financial Resources (FG20/1). The FCA reminded firms that they have an obligation under Threshold Condition COND 2.4 to hold adequate financial and non-financial resources, including liquidity, and encouraged all firms to review the Guidance and incorporate it as appropriate into their wind-down planning.
The FCA’s key observations are:
- Significant further work is needed to ensure that the wind-down planning of firms is credible and operable. This particularly relates to liquidity and cashflow modelling, intra-group dependency and wind-down trigger calibration.
- Firms should consider the impact liquidity needs in wind-down have on their assessment of resource adequacy, their risk appetite and point of non-viability.
- Testing the outcomes of wind-down planning is the best way of showing the firm’s Board/ governing body, as well as the FCA, that the plan and process is credible and operable and that there is financial resilience.
Ensuring wind-down plans are credible and operable
Liquidity and Cashflow Modelling:
A major contributor to a non-orderly wind-down is a lack of cash assets to ensure liabilities are paid when due. Although a firm may have sufficient cash assets to effect a cash accretive wind-down over the entire duration of the wind-down, it is essential that it adequately models inflows and outflows at a sufficient level of granularity to identify any particular cash pinch points which may arise over the duration of the wind-down. This is especially the case at the early stages of a wind-down where there are significant cash outflows, e.g., redundancy costs, professional fees, increased collateral calls etc.
Recommendations for effective cashflow modelling include:
- Ensuring that the cashflow model is appropriately granular for the firm’s business model to accurately model the cash inflows and outflows under both BAU and stressed conditions. This includes both types of cash inflows and outflows, and the modelling time intervals. The FCA observed that, while the modelling varies between firms, it tended to result in daily cash flow forecasting in the first two weeks, then weekly to the end of the third month and monthly thereafter.
- Ensuring that assumptions used in the model are appropriately prudent and approved by senior management and the Board. This includes establishing sufficient time to implement management actions e.g., to dispose of assets, and allowing for a reduction in cash holdings before the decision to wind-down.
- Challenging assumptions included in the cashflow model, particularly the underlying behavioural assumptions.
- The paper sets out a number of other good practices.
Holding liquidity for wind-down
Having modelled cashflows and quantified the level of cash needed to be held to be able to perform an orderly wind-down, firms are recommended to hold a pool of liquidity specifically to fund an orderly wind-down. Good practice observed by the FCA included liquid funds being ‘ring fenced’ from other business assets and liabilities and no right of set-off for the segregated funds.
Another key observation from the review was inadequate consideration of the impact group membership could have on the ability to complete an orderly wind-down. Most firms had only considered the benefits and not the stresses which may come from group membership e.g., parental failure. The FCA saw this as a particular concern, as a number of firms noted their dependency on group operated services, including group HR functions, intra-group financing arrangements, and group IT. Group entities should therefore assess interconnectivities and how these could potentially impact an orderly wind-down.
The FCA noted that some groups resolved this issue by creating a Group Service Company, which mitigated the risk should other legal entities in the group fail. However, this needs to be implemented correctly, and will not be appropriate for all groups.
Firms should incorporate wind-down planning into their risk management framework, by establishing a series of quantifiable wind-down triggers which are linked to risk appetite and calibrated against financial resource requirements. These triggers should include forward-looking triggers e.g., cashflow and profitability forecasts, and be regularly monitored and reported to senior management and the Board, especially during times of stress. The real benefits of these triggers are to ensure that the firm enters into a wind-down at a point where it will have sufficient financial and non-financial resources to complete an orderly wind-down.
We would recommend that firms review their current wind-down plans in light of the review, including the gaps and good practices highlighted by the FCA. Wind-down planning should be fully integrated with the Risk Management Framework and financial resource adequacy assessment in order to facilitate regular monitoring and reporting of key wind-down triggers aligned with the firm’s risk appetite.
Whilst liquidity was the focus of the thematic review and plays an important part in wind-down planning, firms also need to consider the wider regulatory guidance provided by WDPG and FG20/1 when assessing their wind-down plans.
At Sicsic Advisory we have supported a number of clients with the development of their wind-down plans and we would be happy to discuss and support you with the development of your firm’s plans.