Recovery plans – initial observations

We recently assessed the compliance of firms’ recovery plans with the Recovery and Resolution Directive (RRD) – a comprehensive recovery and resolution regime that helps firms plan for recovery from financial difficulty – and report on areas for improvement.

This note is aimed at all FCA solo-regulated firms that meet the definition in our Handbook of an IFPRU 730k firm (IFPRU 11.1.1R and IFPRU 11.1.2G) are therefore subject to IFPRU 11 and required to submit recovery plans to the FCA on a regular basis (IFPRU 11 implements the Recovery and Resolution Directive. References to ‘firm’ in the rest of this note should be taken to refer to refer to both firms and groups subject to IFPRU 11, except where qualified.)

It provides feedback on some of the FCA’s observations and the early themes emerging from the FCA’s recent assessment of recovery plan submissions, made in accordance with the legislation and rules already in place.

Please note that this document should not be treated as an exhaustive list of issues or requirements and the material in it should not be interpreted as formal FCA guidance.

Firms are encouraged to review the relevant sections of the FCA’s and EBA’s rules and guidelines for further information on their obligations under the Recovery and Resolution Directive (RRD)[1].

Recovery plan submissions received to date

In general, most recovery plan submissions were timely and reasonably structured. Other positive practices included the following.

• Most plans reflected appropriate Board and senior management sign-off, with a useful (high-level) allocation of relevant recovery planning and crisis management roles and responsibilities.
• There was also a good attempt to identify and assess a set of relevant and feasible recovery options. For example, we noted that some firms initially considered cost reduction as a potential option, but ultimately rejected it as a viable (standalone) option given (i) the lead time required for it to take effect, and (ii) doubts about the level of additional capital/liquidity that would be generated.
• A few plans clearly stated and assessed progressive (e.g. ‘amber’ and ‘red’) early warning risk indicators that were supported by thresholds incorporating both absolute and relative triggers for Board / senior management action.

However, we identified a number of areas for improvement based on our assessment of the Quality, Completeness and Credibility[2] of the recovery plans that we have reviewed to date. This is consistent with other initial observations from across the EU[3].

How firms are expected to treat any gaps or deficiencies in their recovery plans

Firms are required to keep their recovery plans up to date at all times. They also need to be able to demonstrate the (ongoing) viability and effectiveness of their plans and wider crisis management arrangements (IFPRU 11.2.4R, IFPRU 11.3.4R, IFPRU 11.3.19R and IFPRU 11.3.20R). Where we have identified gaps or deficiencies, firms are expected to implement appropriate remedial actions without delay. As part of this, we also expect firms to demonstrate  proactive identification and mitigation of any recovery plan deficiencies and impediments in their recovery plans.

The key areas for improvement based on our reviews to date

Our review identified areas for improvement across almost all recovery plan elements. We have set out some of the most common issues below. (Please note that this should not be treated as an exhaustive list.)

Internal and external interconnectedness

• In general, the identification and analysis of internal and external interconnectedness was insufficient. Recovery plans often failed to identify the firm’s material intra-group and/or external stakeholders and assess the potential impact of failure on these connected parties[4].
  
  • For example, many plans did not clearly identify and assess linkages to other group entities or key third party relationships, including suppliers/recipients of outsourced services, customers and counterparties. Some plans also failed to consider the full range of the firm’s activities that could give rise to material interconnectedness, including financial, operational, technological, legal, governance and other contractual service links.
• Firms that are part of an international group(s) and/or that are subject to multiple regulatory jurisdictions tended to underestimate the impact of such linkages on the firm’s ability to make decisions and execute recovery options.
  
  • For example, some plans did not identify that the entity/group was listed on an exchange, so failed to consider any associated implications for the recovery plan.
• Finally, where material relationships were identified in a plan, the firm’s risk appetite and proactive arrangements to minimise the risk of detriment to consumers and the wider market was often unclear. This issue is of particular concern to us where firms are unable to evidence their ability to recover from all potential stressed scenarios.

Indicators

• A large number of firms struggled with the identification and calibration of recovery plan indicators. This included a lack of consideration of all relevant indicator categories[5], limited risk coverage within indicator categories and, more challengingly, inadequate evidence to support the associated thresholds for each indicator.
• A number of group recovery plans failed to consider relevant indicators and thresholds at both a group and an entity level (where appropriate).
• Many plans failed to demonstrate that their indicators and thresholds were credible and would provide sufficient time (given the effectiveness of their existing governance arrangements and risk management framework) to intervene successfully in situations of financial stress (IFPRU 11.2.17R).
  
  • For example, some firms proposed thresholds that would only be triggered when their Individual Capital Guidance (ICG) was breached. We considered such arrangements unacceptable as an early warning indicator as it was unlikely to provide sufficient time for senior management notification, crisis assessment, decision making and successful implementation of the recovery plan under stressed conditions (i.e. before the firm breached its regulatory requirements).
• In this context, many plans failed to demonstrate through their scenario analysis that:
  
  • the speed and magnitude of a potential stress would lead to a regulatory breach and ultimately firm failure in the absence of management actions (i.e. the scenario was relevant and sufficiently severe); and / or
  • where the scenario was relevant, that the application and timing of both the indicators and recovery option(s) would be sufficient to prevent a breach of the firms’ regulatory requirements.

Recovery options

• Whilst the majority of plans identified a set of potential recovery options, many did not demonstrate that a firm’s recovery options were comprehensive and credible (i.e. that they would be sufficient to restore the firm’s viability in all plausible scenarios).

Please note that we do not maintain a zero-failure risk appetite for FCA solo-regulated firms. However, we expect firms to seek to minimise the risk of a disorderly failure and potential detriment to consumers, counterparties and the wider market. This includes appropriate consideration of the management actions and preparatory measures that might be required to achieve an orderly winding down of the firm’s operations, including under stressed conditions.

• Firms often failed to acknowledge and address material impediments to recovery, including plausible scenarios for which they might not have credible recovery options.
  
  • For example, many plans implied that the firm would never fail or succumb to a stressed event based on an unsupported assumption that their parent or other key providers of funding and guarantees would always be willing and able to provide unlimited support.
• Some firms made reference to a potential sale of a business unit or acquisition by a third party. However, there was often inadequate analysis of the capacity and willingness of a buyer to achieve a timely and successful acquisition under stressed market conditions.
  
  • Recent experience has shown, for example, that potential acquirers may delay an acquisition until the distressed firm is declared insolvent. For example, firms did not always provide sufficient evidence to justify the expected proceeds from a sale under stressed market conditions.
• Firms did not consistently consider the need for regulatory authorisation or pre-approval of group financial support, and any associated conditions that might need to be satisfied by potential providers of group support.
• As noted by the EBA[6], this should include an assessment of the interdependency of the entities within the group, and the impact of financial support provision on the group as a whole.

Scenarios

• Plans did not always capture the minimum expected range of scenarios, or fully explain why certain scenarios might not be applicable. As per the EBA’s guidelines[7], recovery plans should consider both fast- and slow-moving scenarios, based on idiosyncratic and macro events (where relevant).
• Some plans failed to incorporate sufficiently severe stressed scenarios to validate the credibility of the firm’s recovery options (i.e. scenarios where the firm would fail in the absence of timely and effective management actions). In addition, some  plans were not consist across recovery plan elements. Consequently, it was often difficult to confirm appropriate links between a firm’s early warning indicator trigger(s), relevant stressed scenario(s), and the timing and impact of the firm’s recovery actions.
• Most plans only included a ‘static’ description of each scenario[7]. These plans failed to assess or incorporate a timeline of how the scenario might evolve from the point of crystallisation of  the stressed event through to the outcome following the firm’s application of its recovery options.

Core business lines and critical functions

• Notwithstanding the EBA technical advice on this topic[8], a number of plans incorporated an incorrect definition of Core Business lines and Critical Functions in their recovery plans.
• A number of plans also failed to include sufficient analysis to:
  
  • justify the classification of individual operational activities within a firm as either essential or non-essential to the delivery of their core strategic objectives; and
  • assess the importance of the firm’s services or products to the wider economy or financial system (i.e. interconnectedness).

Crisis management and communication arrangements

• The majority of plans included a good summary of the firm’s general governance arrangements. However, for a number of firms these summaries did not appear to be supported by or aligned with an appropriate communication strategy for crisis management[4]. Plans that include an appropriate communication strategy are likely to be more effective, particularly under stressed conditions.
• Whilst most firms recognise the importance of timely and effective stakeholder communication (based on their observation of recent financial and non-financial firm crises), many plans did not appear to apply these lessons to their recovery planning.
  
  • For example, there was limited consideration of how various channels of communication (to and from the firm) would be managed. How responsibilities for monitoring, developing, authorising and providing responses on behalf of the firm should be allocated was also not explored in depth.
  • For (smaller) firms with a high concentration of Board and senior management responsibilities among a few individuals, there was often limited consideration of how any associated key person risks or other potential practical challenges would be managed or mitigated.
• Finally, in a number of cases there were inadequate arrangements to ensure timely notification of and engagement with the FCA.
  
  • For example, some firms alluded to “amber” and “red” notification triggers, but failed to demonstrate the alignment of these thresholds to the RRD requirements or their existing regulatory notification obligations (e.g. under Principles for Businesses – Principle 11).

Other observations

• A number of firms did not include key elements that in practice would be required to support an effective recovery and crisis management process. In particular, many recovery plans developed under simplified obligations failed to consider whether any additional information was needed (see IFPRU 11.2.7R and 11.2.8G).
• A few plans that did not include key elements instead included references to a number of other firm policies and documents. Firms are reminded that recovery plans should be designed as a standalone tool to allow a firm to most efficiently enact a recovery plan should it need to do so. (It would also facilitate a more effective review and validation of the recovery plan by the firm and the FCA.)
• A few firms submitted multiple recovery plans for entities that were within the same RRD group. By default, we would expect a single group recovery plan to be produced for entities within an FCA solo-regulated group. This includes firms that are subject to an investment firm consolidation waiver (CRR Article 15).
• Finally, a number of recovery plans did not provide adequate evidence of integration with the firm’s wider risk management framework.
  
  • For example, it was not always clear that the firm’s choice of recovery indicators and thresholds were linked to the firm’s existing risk appetite, risk metrics, risk reporting and escalation arrangements.

Given the various concerns identified during our review, and in support of the overall objectives of the RRD, we would also encourage firms to review and ensure the effectiveness of their underlying governance and risk management arrangements.