icaap the fsc's the fsc'sfsc'sexpectations, common errors ... · • capital...
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ICAAPICAAPICAAPICAAP
The The The The FSC'sFSC'sFSC'sFSC's Expectations, Common Errors and Expectations, Common Errors and Expectations, Common Errors and Expectations, Common Errors and pitfallspitfallspitfallspitfalls
29292929thththth January 2010January 2010January 2010January 2010
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ContentsContentsContentsContents
• Background to ICAAP
• Main expectations
• Minimum expectations re complexity of firm
• Common errors and pitfalls
• Administrative information
• Future Changes
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ICAAP ICAAP ICAAP ICAAP **** 2222ndndndnd Pillar of CRDPillar of CRDPillar of CRDPillar of CRD
CRD = Basel II = 3 pillars
Minimum capital
requirements
Supervisory Review Process
Market discipline
ALL 3 PILLARS ALL 3 PILLARS ALL 3 PILLARS ALL 3 PILLARS TOGETHERTOGETHERTOGETHERTOGETHER ARE INTENDED TO ACHIEVE A LEVEL ARE INTENDED TO ACHIEVE A LEVEL ARE INTENDED TO ACHIEVE A LEVEL ARE INTENDED TO ACHIEVE A LEVEL OF CAPITAL COMMENSURATE WITH A FIRM'S OVERALL RISK OF CAPITAL COMMENSURATE WITH A FIRM'S OVERALL RISK OF CAPITAL COMMENSURATE WITH A FIRM'S OVERALL RISK OF CAPITAL COMMENSURATE WITH A FIRM'S OVERALL RISK
PROFILEPROFILEPROFILEPROFILE
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Introduction to the ICAAPIntroduction to the ICAAPIntroduction to the ICAAPIntroduction to the ICAAP
• The ICAAP (Internal Capital Adequacy Assessment Process) is a firm's own capital strategy
• Involves an assessment of the additional capital required to mitigate risks not adequately covered by Pillar 1
• Ongoing process
• Followed by a Supervisory Review *evaluation and verification process (SREP)
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The SREP Process The SREP Process The SREP Process The SREP Process **** what does it involve?what does it involve?what does it involve?what does it involve?
• Review and evaluation of the ICAAP
• Testing and challenging of the ICAAP
• Will be hand in hand with risk*assessment process
• Dialogue with FSC
• Supervisory intervention can occur if capital is deemed insufficient
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Why is the ICAAP Necessary?Why is the ICAAP Necessary?Why is the ICAAP Necessary?Why is the ICAAP Necessary?
• It is a requirement introduced by the CRD (Articles 123, 124, 136 and Annex XI)
• Encourages better use of risk management techniques
• Ensures that firms have sufficient capital to support all its risks
• Encourages a firm to better manage its capital
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What What What What MustMustMustMust an ICAAP Include ?an ICAAP Include ?an ICAAP Include ?an ICAAP Include ?
• Executive Summary (an overview of the ICAAP methodology and results and details of risk appetite)
• Background to the firm• Summary of Current and Projected Financial and Capital
Positions • Capital Adequacy
• Timing• Risks analysed (identification of the major risks faced i.e.
credit/operational risk etc.)• Methodology and assumptions (how assessments for each of
the major risks have been approached and the assumptions made * very important for firms using models)
• Stress and scenario tests applied• Capital transferability (where applicable)
• ...
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...What must an ICAAP include...What must an ICAAP include...What must an ICAAP include...What must an ICAAP include
• Capital Planning
• e.g. an analysis of the sensitivity tests undertaken,
• key assumptions,
• financial projections for 3*5 years
• Liquidity Planning
• Aggregation and Diversification (an overall view on capital adequacy)
• Challenge and Adoption of the ICAAP
• Use of the ICAAP within the Firm
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For each risk ICAAP needs to:For each risk ICAAP needs to:For each risk ICAAP needs to:For each risk ICAAP needs to:
• Identify the risk
• Explain the risk
• Potential impact of risk
• Likelihood of risk occurring
• Risk mitigation in place by firm e.g. controls
• Determine if Pillar 2 capital is needed and how much
• (Should also explain why X amount of capital has been assigned or why none has been assigned to a particular risk)
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Stress testing/scenario analysisStress testing/scenario analysisStress testing/scenario analysisStress testing/scenario analysis
• All requiredAll requiredAll requiredAll required to report the result of a 200 basis point shock to interest rates and establish if result exceeds 20% of the firm's capital.
• Typical scenarios: effect of a market downturn on funds under management/transaction volumes; change in business plan.
• For simplest firms * establish a base case scenario and then consider adverse scenarios and effects, and possible actions
• Worst case scenario(s) * should amalgamate two or more scenarios together.
• Larger asset managers should consider a 1 in 200 year event as opposed to a 1 in 25 year event expected of smaller firms.
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ProportionalityProportionalityProportionalityProportionality
• The processes, strategies and systems used, should be proportionate to the nature, scale and complexity of that firm's activities.
• Will use 3 types of firms as examples
• Non*complex firms
• Moderately complex firms
• Credit Institutions and more complex firms
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NonNonNonNon****complex firmscomplex firmscomplex firmscomplex firms
• Cover main risks in more detail (e.g. operational risk and reputational risk)
• Consider whether any other risks are applicable to the firm
• Identify largest losses over last 3*5 years and if these are likely to recur
• Simple stress testing/scenario analysis e.g. shift in key risks identified
• Consider impact of economic or industry downturn on future earnings in business plan.
• Consider capital needed should each of these risks materialise
• Consider holding sufficient capital for an orderly wind down.
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Moderately complex firmsModerately complex firmsModerately complex firmsModerately complex firms
• Comprehensive details of major risks
• Consider losses that might arise from risks using historical data/stress tests
• Assume business will not develop as expected and consider firm's reactions to adverse economic scenarios
• Project business plans in detail for a year and less detail for 3*5 years
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Credit institutions and more complex firmsCredit institutions and more complex firmsCredit institutions and more complex firmsCredit institutions and more complex firms
• Examples of major risks are concentration risk, credit risk, counterparty risk, reputational risk
• Should consider sensitivity of its funding ('sticky').
• Should take into account cyclicality when assessing amount of capital.
• Should consider independent check/challenge
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Common Errors and Pitfalls Common Errors and Pitfalls Common Errors and Pitfalls Common Errors and Pitfalls
• General issues
• Pillar 1 versus Pillar 2
• Assessment/interpretation of risks
• Risk mitigation
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General Issues General Issues General Issues General Issues **** ExamplesExamplesExamplesExamples
• Date ICAAP prepared and date approved not stated.
• Not clear if the ICAAP has been approved by the board.
• Not clear if, and by whom, ICAAP has been challenged and level of independence.
• Appendices, figures etc referred to in the report have been omitted entirely.
• Reports are often too brief.
• Not clear how the ICAAP is being used by management
• ICAAP/Pillar 2 figure omitted
• ICAAPs not taking into account all material facts/changes of firm
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General Issues General Issues General Issues General Issues **** Examples Examples Examples Examples CtdCtdCtdCtd
• ICAAP is not forward looking * it needs to cover 3 to 5 year period.
• No stress testing/scenario analysis carried out or limited stress testing/scenario analysis.
• Each scenario was looked at in isolation.
• Statements/judgement are not justified or evidenced/documented.
• Lack of support for figures and conclusions
• Not Concise/relevant
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Pillar 1 v Pillar 2 Pillar 1 v Pillar 2 Pillar 1 v Pillar 2 Pillar 1 v Pillar 2
• Reference to Pillar 1 capital should be “actuals”.
• Pillar 2 risks are not covered by Pillar 1, hence cannot always justify not assigning capital to a Pillar 2 risk by simply stating that it “is covered by Pillar 1 capital”.
• Pillar 1 plusplusplusplus Pillar 2 needs to be set out as the firm's capital requirement.• Note, a firm's absolute minimum capital requirement is its initial capital requirement (e.g. 50,000 Euros for a Category 3 firm).
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Assessment/interpretation of risks Assessment/interpretation of risks Assessment/interpretation of risks Assessment/interpretation of risks IssuesIssuesIssuesIssues
• Failure to look beyond examples in Guidance Note for specific risks to the firm.
• All of the risks listed in the Guidance Note not necessarily included nor an explanation/indication of why omitted (Note this is expected by FSC)
• Risk appetite not articulated or evidenced. • Likelihood (and impact) of a particular risk
arising not documented.
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Risks Risks Risks Risks **** examples of common examples of common examples of common examples of common misunderstandings misunderstandings misunderstandings misunderstandings
• PI insurance * consider the excess
• Operational risk * consider past errors/losses
• FX risk * funds managed in different currencies than reporting currencies?
• Over reliance on a certain individual/or third party
• Credit risk * consider failure of counterparty
• Loss of key staff * cost of replacement
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Risk Mitigation failingsRisk Mitigation failingsRisk Mitigation failingsRisk Mitigation failings
• Mitigation techniques not explained.
• Not clear whether risk mitigants have been incorporated in the firm's business, systems and controls.
• Where no risk mitigation technique in place it is difficult to determine how a firm can justify that no Pillar 2 capital is required.
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What will the FSC be looking for?What will the FSC be looking for?What will the FSC be looking for?What will the FSC be looking for?Summary Summary Summary Summary
• Is each material risk properly identified and adequately monitored and controlled?
• Are numbers and conclusions supported by suitable analysis
• Does the firm have a good risk management culture?
• Does the firm have a positive track record? (e.g. dealing with customer complaints; level, nature & number of complaints received; history of regulatory breaches)
• Is senior management closely involved in managing capital and designing the ICAAP?
• Is it demonstrated that the ICAAP has been embedded into the firm's processes and that senior management are engaged
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When you need to submit an ICAAPWhen you need to submit an ICAAPWhen you need to submit an ICAAPWhen you need to submit an ICAAP
• Firms who have to re*submit an ICAAP, extension been given to end of February to incorporate discussions today.
• Firms which have been requested to submit an ICAAP, extension given till end of March to incorporate discussions today
• Firms who have not yet been asked to submit an ICAAP * we will request as part of risk assessment process/trigger event.
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Future changes to ICAAPFuture changes to ICAAPFuture changes to ICAAPFuture changes to ICAAP
• International bodies carrying out consultation process on aspects of ICAAP
• Further guidelines on concentration risk expected this year.
• Further guidelines expected going forward.
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Any questions?Any questions?Any questions?Any questions?
Any Any Any Any Any Any Any Any
questions?questions?questions?questions?questions?questions?questions?questions?