Published by Gbaf News
Posted on January 18, 2018
12 min readLast updated: January 21, 2026
By Michael Chambers, Head of Prudential, Cordium
Having spent the last year running the MiFID II marathon, buy-side compliance officers could be forgiven for having taken their eyes off some of the other regulatory changes that have taken place.
Under-the-radar changes always present a risk of non-compliance and the FCA’s revised wind-down guidelines are a case in point. Published to little fanfare a year ago, they could be a significant trap for the unwary.
As increasing numbers of firms have seen, the results of a Supervisory Review and Evaluation Process (SREP), where a firm’s Internal Capital Adequacy Assessment Process (ICAAP) is scrutinised in granular detail by the regulator, can be costly in terms of management time taken, external report required and, not least incremental capital requirements.
Following their guidance, the FCA expects that detailed plans and costings to execute an orderly wind down are a principal consideration within the ICAAP. So any negative findings of an SREP can easily lead to the regulator setting punitive ‘scalars’ on the firm’s capital requirement. In plain English, this means that neglecting the revised guidelines can result in a need to hold more capital than would have been necessary had a thorough wind down plan been conducted in the first place.
It seems many smaller hedge fund managers/investment firms have been operating with a false sense of security, lulled by the fact that these have been billed as guidelines rather than rules, by the belief that they don’t apply to firms their size, or by both.
So what are the revised guidelines, what do they mean for hedge fund managers/investment firms and what can firms do to protect themselves?
New wind down guidelines
After a brief consultation, the new guidelines came into force in late 2016. Simply put, they provide guidance to firms setting out their strategies for a variety of triggers for an orderly wind down, should the business no longer be able to continue.
Core to those strategies are capital requirements – the money set aside in order to implement the strategy, should it become necessary. The issue here is that the FCA found many firms to be taking far too aggressive an approach, significantly underestimating how much they needed in reserve.
Common mistakes include failing to take into account supplier relationships such as office leases or external consultancy services. In the event of a wind-down, hedge fund managers/investment firms might understandably be prioritising investor protection, but if they’re one year into a five-year lease, the landlord might take a dim view of that attitude.
Staff are also a key consideration. Many firms budget for staff costs at current levels, but how many people are inclined to stick around a company in the process of shutting up shop when they could be seeking their next role? It’s quite likely that companies may have to incentivise key people more in order to secure their services for the duration of the orderly wind down.
And there’s a lot of misunderstanding around that word: orderly. Many interpret this as a strategic exit or planned wind-down; one the firm has chosen. However, that’s not the intended meaning. Orderly refers to the execution of the wind-down, not the reason for it. It could be precipitated by an unpredicted, catastrophic event – but the FCA still wants to know that there is a fully developed, realistic and executable plan in place. This common misperception leads firms to both underestimate their capital requirements and fail to assess the full breadth of risks they face.
But they’re guidelines – why does this matter?
These are guidelines on what the FCA expects to be in a wind-down assessment, but that does not mean the assessment itself is optional.
Firms throughout Europe must carry out and document an ICAAP. UK firms do not submit this ICAAP to the FCA but are held to account by the requirement to submit, once a year, a questionnaire via the regulator’s GABRIEL system. For many firms which are not supervised on a relationship basis, this is the only communication they have with the regulator, so it needs to be right. The questionnaire includes questions around the firm’s wind-down assessment including how long it would take and how much it would cost (gross and net). So the wind-down assessment is very much mandatory, even if not directly mandated.
And the FCA is taking it seriously. There have been cases where the FCA has judged the wind-down assessment to be too aggressive or insufficiently comprehensive, and enforced higher capital requirements as a result – in most cases higher than they would have been if correct in the first place.
What’s a firm to do?
The first thing to do is to canvass input and opinion from a variety of internal stakeholders. Chances are that different people throughout the firm with different viewpoints will have different perspectives over what that end-point might look like. It may also be advantageous to consult externally as this will help benchmark against the industry. We are talking about envisaging and planning for scenarios that spell out the end of the business and many will have access to pertinent information that others don’t.
By having those conversations and – crucially – documenting them, firms will be better prepared for a range of scenarios and be able to demonstrate a sensible approach to the FCA.
The second thing to do may well follow naturally from the first, but that is to make sure wind down scenarios are sufficiently conservative. Being too aggressive on how quickly and cheaply a wind down process can happen is a red flag to the regulator.
It’s also important to make sure that plans are kept up to date. This is easier said than done. Imagine a scenario where the annual wind down plan was created six months ago, and someone signs the company up to a strict and significant supplier contract. The two are seemingly unrelated, but that employee may have unknowingly put the firm in breach of its capital requirements based on its new obligations. It’s essential to put in place processes where wind down assessments are updated as circumstances change.
So, wind down assessments: certainly not as big, scary or all-encompassing as MiFID II, but the SREP regime means that it isn’t safe to ignore the regulator’s expectation that the revised guidelines will be followed. With new regulatory requirements coming thick and fast, it’s tempting to focus energies on the headline threats. However, whether by going it alone or enlisting the help of third party expertise, the possibility of an SREP means that hedge fund managers/investment firms shouldn’t take their eyes off other material changes such as the FCA’s revised wind down guidelines.
By Michael Chambers, Head of Prudential, Cordium
Having spent the last year running the MiFID II marathon, buy-side compliance officers could be forgiven for having taken their eyes off some of the other regulatory changes that have taken place.
Under-the-radar changes always present a risk of non-compliance and the FCA’s revised wind-down guidelines are a case in point. Published to little fanfare a year ago, they could be a significant trap for the unwary.
As increasing numbers of firms have seen, the results of a Supervisory Review and Evaluation Process (SREP), where a firm’s Internal Capital Adequacy Assessment Process (ICAAP) is scrutinised in granular detail by the regulator, can be costly in terms of management time taken, external report required and, not least incremental capital requirements.
Following their guidance, the FCA expects that detailed plans and costings to execute an orderly wind down are a principal consideration within the ICAAP. So any negative findings of an SREP can easily lead to the regulator setting punitive ‘scalars’ on the firm’s capital requirement. In plain English, this means that neglecting the revised guidelines can result in a need to hold more capital than would have been necessary had a thorough wind down plan been conducted in the first place.
It seems many smaller hedge fund managers/investment firms have been operating with a false sense of security, lulled by the fact that these have been billed as guidelines rather than rules, by the belief that they don’t apply to firms their size, or by both.
So what are the revised guidelines, what do they mean for hedge fund managers/investment firms and what can firms do to protect themselves?
New wind down guidelines
After a brief consultation, the new guidelines came into force in late 2016. Simply put, they provide guidance to firms setting out their strategies for a variety of triggers for an orderly wind down, should the business no longer be able to continue.
Core to those strategies are capital requirements – the money set aside in order to implement the strategy, should it become necessary. The issue here is that the FCA found many firms to be taking far too aggressive an approach, significantly underestimating how much they needed in reserve.
Common mistakes include failing to take into account supplier relationships such as office leases or external consultancy services. In the event of a wind-down, hedge fund managers/investment firms might understandably be prioritising investor protection, but if they’re one year into a five-year lease, the landlord might take a dim view of that attitude.
Staff are also a key consideration. Many firms budget for staff costs at current levels, but how many people are inclined to stick around a company in the process of shutting up shop when they could be seeking their next role? It’s quite likely that companies may have to incentivise key people more in order to secure their services for the duration of the orderly wind down.
And there’s a lot of misunderstanding around that word: orderly. Many interpret this as a strategic exit or planned wind-down; one the firm has chosen. However, that’s not the intended meaning. Orderly refers to the execution of the wind-down, not the reason for it. It could be precipitated by an unpredicted, catastrophic event – but the FCA still wants to know that there is a fully developed, realistic and executable plan in place. This common misperception leads firms to both underestimate their capital requirements and fail to assess the full breadth of risks they face.
But they’re guidelines – why does this matter?
These are guidelines on what the FCA expects to be in a wind-down assessment, but that does not mean the assessment itself is optional.
Firms throughout Europe must carry out and document an ICAAP. UK firms do not submit this ICAAP to the FCA but are held to account by the requirement to submit, once a year, a questionnaire via the regulator’s GABRIEL system. For many firms which are not supervised on a relationship basis, this is the only communication they have with the regulator, so it needs to be right. The questionnaire includes questions around the firm’s wind-down assessment including how long it would take and how much it would cost (gross and net). So the wind-down assessment is very much mandatory, even if not directly mandated.
And the FCA is taking it seriously. There have been cases where the FCA has judged the wind-down assessment to be too aggressive or insufficiently comprehensive, and enforced higher capital requirements as a result – in most cases higher than they would have been if correct in the first place.
What’s a firm to do?
The first thing to do is to canvass input and opinion from a variety of internal stakeholders. Chances are that different people throughout the firm with different viewpoints will have different perspectives over what that end-point might look like. It may also be advantageous to consult externally as this will help benchmark against the industry. We are talking about envisaging and planning for scenarios that spell out the end of the business and many will have access to pertinent information that others don’t.
By having those conversations and – crucially – documenting them, firms will be better prepared for a range of scenarios and be able to demonstrate a sensible approach to the FCA.
The second thing to do may well follow naturally from the first, but that is to make sure wind down scenarios are sufficiently conservative. Being too aggressive on how quickly and cheaply a wind down process can happen is a red flag to the regulator.
It’s also important to make sure that plans are kept up to date. This is easier said than done. Imagine a scenario where the annual wind down plan was created six months ago, and someone signs the company up to a strict and significant supplier contract. The two are seemingly unrelated, but that employee may have unknowingly put the firm in breach of its capital requirements based on its new obligations. It’s essential to put in place processes where wind down assessments are updated as circumstances change.
So, wind down assessments: certainly not as big, scary or all-encompassing as MiFID II, but the SREP regime means that it isn’t safe to ignore the regulator’s expectation that the revised guidelines will be followed. With new regulatory requirements coming thick and fast, it’s tempting to focus energies on the headline threats. However, whether by going it alone or enlisting the help of third party expertise, the possibility of an SREP means that hedge fund managers/investment firms shouldn’t take their eyes off other material changes such as the FCA’s revised wind down guidelines.
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