UK: Financial Services And Markets Group Bulletin - Is Your House In Order?

Last Updated: 30 May 2009
Article by Giles Murphy


Daniel Edéry

A consultation paper published by the FSA at the end of last year set out proposals on liquidity requirements. We look at the implications these new requirements will have on 'applicable firms'.

On 4 December 2008, the Financial Services Authority (FSA) published consultation paper CP 08/22, Strengthening Liquidity Standards, which sets out far-reaching proposals on liquidity requirements for banks, building societies and BIPRU investment firms (applicable firms).

Impact On Firms

The FSA's proposals will apply to applicable firms on a solo basis. The proposals will result in the introduction of chapter 12 to the BIPRU sourcebook. The FSA anticipates that its new liquidity policy will result in the following changes for firms.

  • Enhanced liquidity risk management capabilities, including greater use of stress testing and improvements to contingency funding plans (CFPs).
  • Less reliance on short-term wholesale funding, including wholesale funding from foreign counterparties.
  • Greater incentives for firms to attract a higher proportion of retail time deposits.
  • A higher amount and quality of stocks of liquid assets, including a greater proportion of those assets held in the form of government debt.
  • A check on unsustainable expansion of bank lending during favourable economic times.

Individual Liquidity Adequacy Standards

In addition to a new systems and controls framework, which applies to all BIPRU firms, the proposals introduce individual liquidity adequacy standards (ILAS), which will apply to banks, building societies and full scope BIPRU investment firms. Such firms will be known as 'ILAS' BIPRU firms. These standards will allow the FSA to see if firms can survive liquidity stresses of varying magnitude and duration, including:

  • idiosyncratic stress – this is specific to the firm, and perceives the firm not being able to meet its liabilities as they fall due for a period of two weeks, followed by longer term issues leading to a credit rating downgrade
  • market-wide stress – this includes unforeseen market-wide dislocation, evolving into longer term concerns about the solvency of financial sector firms
  • a combination of idiosyncratic and market-wide stresses.

For ILAS firms, the adequacy of liquidity is assessed by both the firm and the FSA. The firm will need to produce an individual liquidity adequacy assessment (ILAA) on an annual basis as a minimum requirement. The firm will need to assess the type and quality of liquidity resources it thinks it should hold for the risks that could occur under the relevant stress scenarios, to ensure that it complies with the overall liquidity rule. The rule states that "a firm must at all times maintain liquidity resources which are adequate, both as to amount and quality, to ensure that there is no significant risk that its liabilities cannot be met as they fall due."

The FSA will perform a supervisory liquidity review process of the results of the ILAA and issue individual liquidity guidance (ILG) on the size and make up of the liquidity buffer that it expects the firm to maintain. The FSA will assess the appropriateness of the firm's liquidity tolerance, and will expect firms to give a reasoned explanation of the level of liquidity risk assumed.

Simpler Business Models

ILAS firms with simpler business models, currently viewed as some mortgage banks and building societies, will no longer need to apply the liquidity requirement resulting from their ILAA. Instead, the FSA plans to introduce a standardised buffer ratio by enhancing the 13-week ratio it has been using in assessing liquidity over the last year.

To be eligible for the standardised buffer ratio, firms must meet the following criteria:

  • the firm has no foreign currency exposures in assets or liabilities
  • wholesale funding is no more than 30% of total funding
  • the material majority of assets are mortgages secured on residential property.

If the ILAA requirement is greater than that of the standardised buffer ratio, the firm will be expected to maintain a buffer which is consistent with the results of the ILAA.

Non ILAS Firms

Limited licence and limited activity BIPRU firms will not be required to undertake an ILAA. Instead, such firms will still need to adhere to the systems and controls requirements of the liquidity policy, and the high-level requirement of maintaining adequate liquidity at all times without relying upon other parts of the group. This is in addition to reporting to the FSA on a quarterly basis via a systems and controls questionnaire.


As part of the liquidity standards, firms will need to demonstrate that they are self sufficient and do not have to rely upon liquidity funding from other group entities.

Applications can be made for waivers or modifications. The FSA is expecting such applications from UK branches of foreign entities operating within the FSA framework, or where it may be deemed appropriate for firms to rely on parental funding.

Any firm wishing to benefit from a waiver/modification will need to have applied, and received approval from the FSA, by October 2009.


The format and frequency of the liquidity reporting requirements will be determined by the FSA, which is currently developing new liquidity and business intelligence frameworks to replace existing liquidity reports.

The frequency of reporting will vary, with some firms being required to report quarterly and others monthly. Additionally, as experience demonstrates that liquidity problems crystallise quickly, the FSA will require some data items to be submitted on a weekly basis.

Firms that deviate from their ILG will be required to report daily over a set period of time.


The consultation period ended on 4 March 2009 and the FSA expected to finalise the rules during April 2009. It is anticipated that they will be brought into force from October 2009.

This window is limited and raises concerns that firms will leave implementation until the last possible moment.

We recommend that management teams consider the impact on their firms as soon as the FSA has finalised the relevant rules, and take appropriate action in order to comply.


Colin Aylott

HMRC has recently introduced a programme of significant changes, extending its powers across all taxes, but what does this mean for the taxpayer?

HM Revenue & Customs' (HMRC) programme to modernise and align statute and practice across the whole range of taxes has resulted in the most significant changes to HMRC's powers in nearly 40 years. The new rules are effective from 1 April 2009.

There are a number of key changes. Firstly, HMRC can now check a person's 'tax position', rather than just a tax return or tax payment. This includes future tax liabilities as well as past and present ones. In other words, HMRC can now enquire into a transaction in advance of submission of the relevant return or payment of any tax due.

HMRC can also request information from the taxpayer in relation to his/her statutory records, there being no right of appeal against such a notice.

Also, prior to the issue of a notice requesting information or a document from a taxpayer or a third party, HMRC has the option of seeking prior approval from the new First Tier Tribunal (FTT). Neither the taxpayer nor his/her representative has any right of attendance at the FTT when an inspector applies for such approval. Where a notice has been approved by the FTT, there will then be no right of appeal against the notice. The only available right is that where representations have been made to HMRC in respect of the information requested, a 'summary' of those representations must be given to the Tribunal.

HMRC's power to enable its officers to enter business premises in order to inspect business records, which currently applies to VAT and the operation of Pay As You Earn, has now been extended to apply across the wider tax base.

Ordinarily, at least seven days notice will be given for an inspection visit. Significantly, however, no notice is needed if the inspection is approved by an authorised officer. This power extends to visits to any business premises, including any part of a residential home used as an office.

There is also a new 'behaviour based' penalty regime for understatements of tax liabilities, again applying in relation to documents due to be filed from 1 April 2009. The application of any penalty will depend on the behaviour giving rise to the understatement. The new categories used by HMRC range from a mistake made despite reasonable care having been taken, where no penalty will arise, through to the most serious cases of deliberate understatement with concealment.

Clearly, it remains to be seen how the new powers will be exercised by HMRC, and what this means for all taxpayers. Taxpayers need to be aware that the rules of the game have changed substantially and they will need to keep their professional advisers informed of all developments that could have an impact on their current and future tax liabilities.


Natasha Lee

Natasha Lee looks at how investment firms can prepare ahead of the SREP to avoid adverse reaction from the FSA.

2009 will be a busy year and not just for the FSA. Many BIPRU investment firms will experience the supervisory review and evaluation process (SREP) for the first time, and unless their house and internal capital adequacy assessment process (ICAAP) are in order it could be an expensive process.

Overview Of Pillar 2 ICAAP Review And Timeline

The mechanism that will allow the FSA to undertake the SREP will be ARROW. The intensity of the SREP using the ARROW approach is summarised below.

ARROW Approach

SREP Approach


Full SREP for high impact firms (i.e. full assessment of the ICAAP); likely to include an FSA visit.


Streamlined SREP with emphasis on peer group comparisons; typically desk-based review with no firm visit.

Non-relationship managed firm

Questionnaire approach via FSA019; submitted annually within two months of year end from 30 June 2008 onwards. Firms may then be subject to basic SREP.

An overview of the FSA's SREP is summarised in figure 1.

Fig 1: Overview Of The SREP

The review of the ICAAP takes place in four steps, as part of which the ARROW risk assessment interacts with the SREP. This process is set out in figure 2.

Fig 2: ICAAP Review Process

Step 1

Step 1 assesses the capital allocated against risks detailed in elements one to three, which equate to the quantitative assessment. Examples of these risks include the following for the different elements of the quantitative assessments.

  • Element 1: Pillar 1 risks include credit, market and operational risk.
  • Element 2: risks not fully covered under Pillar 1; including residual and securitisation risk.
  • Element 3: risks not covered under Pillar 1; such as interest rate risk in the banking book, concentration, liquidity, business, settlement, reputation, underwriting, pension and transfer risk, and underestimation and weakness of credit risk mitigation.

Step 2

This stress tests the capital in step 1 for external factors outside the control of the firm, including 1 in 25 events through a cycle. The most obvious example today is an economic recession.

Step 3

This stage results in an intermediate capital assessment, being the sum of capital calculated in steps 1 and 2. This capital requirement is prior to any allowance the FSA makes for internal controls and corporate governance, that being the qualitative assessment of the ICAAP.

Step 4

Step 4 is the capital assessed at step 3 but adjusted, up or down, to reflect the overall qualitative assessment of governance, oversight and the ICAAP itself. The resulting individual capital guidance (ICG) is given as a range and may be subject to panel approval.

Panel Review

The supervisor's conclusions of the SREP are finalised using the panel review, prior to communicating with the firm. However, a panel review of the SREP will take place depending on the risk ratings applied; high-risk firms will automatically be subject to a panel review, whereas for low-risk firms it is optional.

Communicating The Results

The FSA will communicate its results of the SREP to the firm in writing. The letter is addressed to the firms' board of directors, and includes:

  • details of key findings from the FSA's work including a firm's ICG
  • the FSA's view of the main risks and controls within the firm
  • a high-level description of the risk assessment process
  • a summary of the FSA's rating of the firm against its risk model
  • a Risk Mitigation Programme (RMP); setting out the issues identified by the FSA in respect of the firm, the intended outcome the FSA wants for each issue, the action to be taken by the FSA and/or firm to ensure the intended outcome is achieved and the timetable for action.

Depending on its content, the RMP could lead to significant follow up work for the firm, especially if numerous/significant issues are identified by the FSA. This could lead to higher professional fees, but more importantly, a greater pressure on management's time in order to satisfy the FSA that the RMP has been appropriately dealt with.

Ultimately, the more thorough the work performed up front by a firm, the greater the probability that the SREP and resulting outcomes will be less onerous. Therefore, it is important that a firm's ICAAP is appropriately documented by the firm. This may seem expensive initially, but in the long run could be a great cost saver.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Giles Murphy
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