We summarise our findings and set out our expectations of FCA solo-regulated fast-growing firms to identify, assess and manage the risks arising from their activities.
1. Who this applies to
This multi-firm review focuses on fast-growing contract for differences (CFD) providers, wealth managers and payment services firms. However, our observations are relevant to all regulated firms that have grown rapidly or have plans to do so.
2. Summary
During 2021-2022, we conducted a multi-firm review of 25 FCA solo-regulated firms which had experienced fast growth over a 3-year period. We assessed the impact of this rapid growth on their financial and non-financial resources. The review was based on business plans, internal capital adequacy assessment process (ICAAP) documents, wind-down plans and other documents submitted by firms.
Our review focused on risk management practices, governance arrangements and adequacy of financial resources (capital and liquid assets) at firms across 3 business models. These were CFD providers, wealth managers and payment services firms.
We saw that for most firms:
- Their risk management framework and governance arrangements (including staffing in second and third line of defence) have not kept pace with the growth in their business activities. While risk management practices at these firms may have been proportionate at authorisation, they had not evolved to scale with the business. This can result in an increased risk of poor outcomes for consumers.
- Firms’ assessment of the adequacy of financial resources did not consider the growth in their underlying business resulting in financial resources assessments that were not commensurate with the size, business model and underlying risks. This can affect the financial resilience of firms, increasing the risk of disorderly firm failure.
- Wind-down plans were inadequate following the fast growth of these firms, increasing risk of harm in the event of firm failure.
Detailed feedback has been given to firms where concerns were identified. The findings corroborated the need for our new Early and High Growth Oversight programme[1], which was announced in 2022. Some of the 25 firms were included in Early and High Growth Oversight for closer supervisory oversight, to address the concerns identified and ensure growth is taking place in a sustainable manner.
We recommended actions for some firms to address the concerns identified, which included:
- Updates to risk management and governance arrangements, including resourcing needs in risk, compliance and audit functions. This is to help ensure that firms have adequate resources in place to identify, assess, manage and monitor risks and potential for harms.
- Updating their assessment of adequacy of financial resources and wind-down plans. For some firms, this resulted in an increase in the level of capital/liquid assets held. This helps in reducing the likelihood of disorderly wind down, which can cause harm to consumers and markets.
All firms that have grown rapidly, or have plans to do so, should read our findings and consider whether they need to make changes to their own arrangements.
3. Why we conducted this review
As part of our ongoing supervision activity, we identified that some firms with very fast growth presented an increased risk of harm to customers and other market participants. This is because they did not enhance their non-financial resources (people, processes, systems and controls) and/or financial resources (capital and liquid assets) in line with their growth. This increased the likelihood that they would not be able to wind down in an orderly manner presenting risks to consumers and other market participants. They also were at risk of breaching Threshold Condition 2.4 (Appropriate resources), impacting their ability to continue to conduct regulated business.
We undertook a multi-firm review of 25 fast-growing firms to better understand the risk of harm from them, identify the root causes of those harms and prompt action to address those risks of harm where appropriate. This multi-firm review supports the FCA's 3-year strategy[2] to reduce harm from firm failure by preventing failing firms from causing significant harm to consumers and market participants.
4. Our approach
For our review, we selected a sample of 25 firms that had experienced fast growth. The firms were CFD providers, Wealth Managers or Payment services firms. The firms had undergone significant growth over a 3-year period (2018 - 2020). The metrics used to assess the growth rate included revenue, total balance sheet assets, client number, client money holdings and/or custody assets/assets under management/outstanding e-money.
We asked firms for detailed information such as ICAAP documents, wind-down plans, business plans, details of risk management framework and financial projections. This was followed by a desk-based review of all documents with further direct discussions with firms where required.
Our review assessed firms’ business models, governance and risk management and adequacy of financial and non-financial resources. The focus of the review was to understand the risk of harm posed by these firms and identify firms that needed to take remedial action.
Detailed feedback letters, which included recommended actions, were sent to all firms where concerns were identified. The letters were supplemented with calls with firms to discuss our findings and recommended actions.
5. What we found
We found that most firms did not update their risk management frameworks, resulting in an inadequate assessment of risks and the potential for harm. Some firms did not have capital and/or liquid assets commensurate with their size, complexity and growth in business.
Our main findings are summarised below.
5.1. Business model
Some firms, especially CFD providers, experienced high growth due to increased market volatility in 2020. Some firms have not been able to maintain their growth rate since 2021. Unsustainable and inadequately planned growth creates longer term uncertainty around firms and weakens their financial resilience, increasing this risk of harm to consumers and the broader market.
Many firms are part of international groups. For some of these firms, we saw significant risks due to intragroup dependencies for financial and non-financial transactions and outsourcing arrangements. If not managed appropriately, this can pose significant risk to the operational resilience of firms, especially in wind down.
Some firms had launched new products during the period such as cryptoassets, copy trading or fractional shares, without due consideration of the associated risks. This can leave both the firms and their clients vulnerable to risks which they have may not have considered adequately.
5.2. Governance, risk management and non-financial resources
Some firms that we reviewed had been given feedback previously about areas of concern. Disappointingly, we found that most of these firms had not addressed our feedback adequately. We used tools such as a governance scalar in the individual capital guidance we issued to the relevant firms.
Many firms appeared to be unaware of the full range of regulatory requirements/ guidance and had not considered upcoming regulatory changes in their forward planning. We found that, at some firms, internal documents including capital/liquidity assessments and wind-down plans were not reviewed regularly. This is symptomatic of inadequate governance/ non-financial resources. One potential impact can be lack of early warnings of stress events, which can inhibit timely management actions and result in financial losses and/or disruption in services to consumers.
Many firms operated the 3 lines of defence model. However, we observed instances of structural weaknesses in the implementation of this model. This was either due to inadequate resourcing in the second and third lines or due to ineffective outsourcing of these activities. There were instances where risk management appeared to be more of a compliance function rather than being actively engaged in challenging the firm on risks. This can affect the quality of challenge provided to first line, resulting in poor conduct and inadequate outcomes.
5.3. Assessment of adequacy of financial resources - capital and liquid assets
Most firms relied on prescribed regulatory minimum thresholds as their capital resource requirements. Their own assessment of adequacy of capital resources was generally poor and did not cover the material risks and potential harms arising from their business activities. Additionally, these assessments did not consider the growth in their underlying business or any new product offerings and business lines.
Most firms did not perform adequate stress testing or scenario analysis and did not consider the impact of a material decrease in the rate of growth.
A small number of firms did not calculate the formulaic regulatory requirements correctly.
Most firms did not understand their liquidity risks adequately. This resulted in weak liquidity risk management frameworks and inadequate assessments of their liquid assets requirement. Additionally, these assessments did not adequately consider the key liquidity risk drivers and impact of growth in business.
Some firms appeared to be reliant on the group or parent for funding their activities on an ongoing basis.
Most firms did not perform a meaningful liquidity stress test.
These deficiencies in capital and liquidity assessments can adversely impact the ability of a firm to meet its liabilities at all times and continue as a going concern in times of stress. It can also result in an inability to pay redress to consumers in the case of upheld complaints. For some firms, where these issues were identified, our intervention resulted in an increase in the level of capital/liquid assets held.
5.4. Wind-down plans
Most firms had significant deficiencies in wind-down plans. These plans lacked operational analysis (Wind-down planning guide 3.7[3]) and had inadequate resource assessment (Wind-down planning guide 3.8[4]).
There was a lack of consideration of events which are likely to make a firm unviable (often referred to as reverse stress-testing) or of the additional costs likely to be incurred during wind down.
Most firms did not have clear wind-down triggers and had optimistic assessments of the time required to complete the wind down. There was significant reliance on the income generated from divestments with inadequate consideration of the practical challenges involved.
We also saw that most firms did not consider the impact of dependencies on other parts of the group. For example, if a firm was part of a larger group and was dependant on group resources, wind-down plans did not include the impact of group failure.
These factors can hinder the ability of a firm to wind down in orderly manner, resulting in serious harm to consumers and financial markets.
6. Our expectations of firms
We have provided detailed feedback to the relevant firms and have put in place remediation plans where appropriate. Some of the firms were included in our Early and High Growth Oversight[5] for enhanced supervision.
However, the findings set out here will be relevant to a large number of firms. We expect all fast-growing firms to continually identify, assess and manage the risks arising from their activities and associated growth. They must also hold adequate financial and non-financial resources to cover these risks and mitigate potential harm.
We expect regulated firms to:
- Have robust plans in place to understand their likely future growth, and to maintain sufficient resources to manage growth or unexpected stress. While firms may have adequate risk management practices at the stage of authorisation, we expect the risk management practices to evolve in line with growth in business.
- Update their risk management framework (including risk appetite and limit framework) and governance arrangements to ensure that they remain proportionate and fit for purpose. This should include consideration of the resourcing needs of risk, compliance and audit functions. For further information related to governance, please refer to our work on the importance of culture and governance[6].
- Ensure that the assessment of adequacy of financial resources continues to be commensurate with the size, complexity and forecast growth of the business. This includes regular stress testing and scenario analysis, that is proportionate in nature. The purpose of adequate financial resources and our expectation of all firms are set out in more detail in FG20/1[7].
- Embed a liquidity risk management framework including liquidity risk policies, controls, contingency funding plans and stress testing.
- Ensure that their wind-down plan is robust, and they have considered the wind down planning guide[8]. This includes liquidity management for wind down as outlined in TR22/1[9].
Finally, we expect all firms to provide accurate and complete data in their regulatory submissions. We consider the poor quality of regulatory data submissions to be an indicator of weaknesses in firms' systems and controls. For some firms, this could indicate a breach of senior manager responsibilities under the Senior Managers and Certification Regime[10]. Our expectations related to data accuracy have been outlined in previous ‘Dear CEO’ letters on Transforming data collection (February 2021)[11] and Quality of Prudential Regulatory Returns (February 2018)[12].