Investment managers must tackle capital adequacy or risk missing market opportunities, warns KPMG report

Investment managers must tackle capital adequacy

Just under half of investment management firms could be forced to hold double their capital requirements, as a result of inadequate capital and risk assessment processes, warns a new KPMG report.

Also on

  • Investment managers may be forced to hold double their individual capital requirements by up to £54m, according to a new KPMG report
  • Internal Capital Adequacy Assessment Process rising high on board agendas, but current practice may expose investment managers to greater risk
  • Capital add-ons are bad news more than ever, as investment managers are deprived of the funds they need to invest in new products and distribution channels

KPMG’s report, ‘Right from the start’, analyses the survey responses and mandatory Internal Capital Adequacy Assessment Process (ICAAP) documents from 32 investment management firms.

The report is unique given the details of these firms’ risk assessment and ICAAP are not publicly available. The report reveals that insurance mitigation and diversification are popular methods employed by investment firms to reduce sizeable chunks of their capital requirements. In 2015, 42 per cent of firms used one of these methods, and 25 per cent used both methods to reduce their capital requirements by an average of 56 per cent. 

However, KPMG analysis show that the Financial Conduct Authority (FCA) has raised the bar on how firms can apply insurance mitigation. Coupled with firms’ lack of understanding of diversification, they could be exposed to regulatory demands for extra capital. 

If the FCA disallows both a firm’s insurance mitigation and diversification benefits alone, to fill the gap, on average firms could be forced to hold double the amount of capital than they originally calculated. Across all prudential categories, the average additional capital is £30m, and, for larger firms, this can rise to as much as £54m.

To meet these higher capital requirements, firms could be forced to dip into retained profits and their dividend pool according to KPMG.

The study revealed that the FCA has become more stringent, with 69 per cent of firms subjected to a Supervisory Review and Evaluation Process (SREP), of which 86 per cent were then issued with Individual Capital Guidance.  With the regulator examining these aspects with greater scrutiny, firms need to review these areas more closely.

David Yim, investment management partner at KPMG, said:

“Being forced to hold higher levels of capital is bad news now more than ever for investment firms. 

“Firms could be missing out on a huge market opportunity in front of them. The pensions freedoms, change in demographics and the long-term savings drive, are driving more money towards investment managers. Firms seeking to take advantage of this growth need to be able to be able to invest in product innovation, distribution and technology. Getting a punitive capital add-on from the regulator would restrict this. 

“Although ICAAP is a regulatory requirement from both the FCA and the Prudential Regulation Authority, it plays an important role in articulating how investment managers manage their risks in achieving their overall business strategy. Inadequate Risk Appetite Statements and incoherent risk processes can expose firms to significant long-term risks and attract further scrutiny from the regulator.” 

Encouragingly, the ICAAP is rising on board agendas. The report revealed an improvement in senior engagement, with over 50 per cent of boards and senior management spending over 10 hours on the process, compared with just over a third of firms last year. 

However more can be done to bridge the gap between the ICAAP, business strategy and performance. Over two thirds of firms were unable to demonstrate a clear link between business strategy, Risk Appetite Statement and other key metrics. Yim concluded:  

“The devil really is in the detail. Basic errors or poor articulation in ICAAP submissions to the FCA can have substantial consequences. Current practice is exposing firms to a real risk of being compelled to seek substantially more capital. Firms must understand how best to deliver to the regulator’s demands. More must be done to properly link firms’ risk management processes and metrics with business strategy. 

“On a positive note, our findings suggest that ICAAPs are improving and it is being taken more seriously than in previous years. More board members are engaging in the process and we’re seeing far more robust capital calculations. 

“Getting this process right from the start can reinforce a firm’s strategy and performance.”




Notes to editors:

About ICAAP:

An ICAAP is an Internal Capital Adequacy Assessment Process. 

All firms categorised as investment firms under ‘BIPRU’ (Prudential Sourcebook for Banks, Building Societies and Investment Firms), and ‘IPRU’ (Interim Prudential Sourcebook for Investment Businesses) are required to complete and regularly update their ICAAP. 

Aside from being a regulatory requirement, it is also used to inform the board of the on-going assessment of the firm’s risks and capital requirements. 

Firms may need to demonstrate their process to regulators. In particular, the FCA may demand a SREP, to review a firm’s ICAAP. Failure to present or an inaccurate ICAAP may lead to greater regulatory scrutiny and potential sanctions. This can include significantly higher capital requirements.

About the research: 

This report, which was conducted in Q3 2015, is based on a study of 32 investment firms, excluding banks. Their business includes a material of traditional asset management, platform, wealth management and hedge funds activity. All responses and data have been anonymised. 

Of the firms that participated, 21 provided us with a copy of their ICAAP documents. As most ICAAPs are developed for a group of companies, some participants noted that their primary business include more than one of the types of firm noted above. 

Participants manage client assets ranging from £4bn to £300bn, comprising institutional, retail, high net worth individuals, platform and other similar types of asset. 

Firms were split more or less eventually between BIPRU (56%) and IFPRU firms (44%), which includes two participants who are both in scope for BIPRU and IFPRU. 

Other findings: 

  • In over 66% of cases, risk appetite was not aligned with business strategy and other risk metrics
  • 52% of ICAAPs did not articulate the risk appetite for individual risk categories
  • 27% of firms who were subject to a SREP received feedback on their risk assessment statements


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About KPMG

KPMG LLP, a UK limited liability partnership, operates from 22 offices across the UK with approximately 12,000 partners and staff.  The UK firm recorded a turnover of £1.9 billion in the year ended September 2014. KPMG is a global network of professional firms providing Audit, Tax, and Advisory services. It operates in 155 countries and has 162,000 professionals working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity.  Each KPMG firm is a legally distinct and separate entity and describes itself as such.

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