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Regulated firms need to consider and model an orderly wind down plan. This is different to an insolvency, where firms are in financial distress and don’t have adequate financial resources to wind down without causing harm. Although it’s not something most businesses want to think about, there are a number of benefits from having a wind down plan in place. These include looking at break clauses in contracts, re-negotiating long term contracts and putting checkpoints in place to protect your firm, no matter the situation. And, to put it simply, sometimes understanding what can break a firm can ultimately, save a firm.
What does it mean for a business to ‘wind down’?
An orderly wind down is defined by the FCA to be the point at which a firm no longer has part 4A permissions, so is no longer needing to be a regulated entity. A firm can go through an orderly wind down and still be solvent and continue carrying out unregulated business so does not necessarily result in a firm closing.
We sometimes see firms carry out both regulated and unregulated business, which is common with property firms. Some will choose to wind down because their strategy changes, meaning they no longer need regulatory permissions to carry out their current business. Their overseas parent might also no longer want to bear the cost of running a UK regulated firm even though the firm is not in financial distress.
Why is it important to have a wind down plan?
Winding down a firm is a topic that many don’t want to think about and can be counter-intuitive, especially when firms need to prepare a wind down plan as part of their authorisation process.
In surveys we’ve run for clients, wind down planning is consistently cited as one of the most difficult pieces of work in a firm’s calendar, even if the firm has been completing their plan for several years.
The FCA therefore wants firms to consider what events could cause them to fail, and how to minimise harm to clients or markets in the event of a wind down. Even where you might not have retail clients and aren’t large enough to impact markets in failure, a firm can still cause harm with a disorderly wind down, requiring the FCA to step in. In the UK regulator’s 2020 Consultation paper on their approach to assessing adequate financial resources, it cites that the cost of harm based on the annual average of £169.2 million of FSCS compensation payments, over the five-year period between 2013 and 2017, contributed to an increase in what all firms pay to the FCA in their annual fee tariff.
Who needs to think about creating a wind down plan?
The wind down planning guidance applies to all regulated firms – not just investment firms. While this has been a core part of the FCA’s approach to supervision, we’ve seen a greater focus in recent sector strategy letters, with portfolio letters to the following sectors referring to wind down plans:
- Wholesale brokers
- Asset management firms
- Payment firms
- Peer to peer lending firms
- Non-bank lenders
- SIPP operators
Many different types of firms have also been asked for a copy of their wind down plan, especially when the FCA has had any kind of indication that a firm may be in financial difficulty, or after financial resilience surveys sent out during the COVID-19 pandemic.
Firms will usually have two weeks to produce a plan, so drafting one in a short time scale can add to what is already a stressful situation.
MIFID investment firms also need to assess the cost of winding down as part of their assessment of how much capital and liquidity they need to hold their own funds threshold requirements. This should then be embedded into their risk management processes and is usually carried out as part of an annual Internal Capital Adequacy and Risk Assessment (ICARA) process.
Wind down planning has been a tool that the FCA has relied on for some time now, but we’re also seeing the PRA asking non-systematic banks and insurers for plans. Even non-UK regulators, such as BaFIN and Central Bank of Ireland, have requested wind down plans as part of a firm’s authorisation process. Generally, these regulators look to the FCA’s long-time approach when sending out these requests.
What should a wind down plan contain?
In its Thematic Review in 2022, the FCA set out that a plan needs to be “credible, operable, and to minimise harm”. Wind down planning assumes existing staff will implement the plan, so that it doesn’t have to be handed over to a liquidator or third party. This distinguishes it from a bank’s recovery and resolution plan, which has to be much more detailed.
A wind down plan should contain the main points listed in the FCA’s guidance:
- Business background – what regulated activities you carry out and what you’ll do in wind down situation.
- Risk management framework – how are key risks identified and tracked, what early warning indicators are tracked to manage when your business is in difficulty, and what actions should be taken at various points.
- Governance – who owns the plan and makes the ultimate decision on when it’s no longer viable.
- Wind down scenario(s) – there may be more than one situation that results in wind down, but it’s simpler to model the most likely scenario in your plan. You should still set out other scenarios you’ve considered.
- Impact assessment – understanding who’ll be affected if you wind down. Consider all stakeholders including impact on employees, any firm you have a contract with, your landlord, and clients.
- Operational analysis – how you’ll wind down. For example, does this mean selling your business to a third party and novating current contracts, or giving clients notice and winding down current structures. If you’re modelling a third party sale, make sure you’re realistic about pricing and options. Your business will be operating from a point of stress rather than business as usual, so prices will be depressed.
- Resource assessment – consider both financial and non-financial resources needed. It’s worth taking into account that you’ll need to maintain your threshold conditions in wind down, so you might need two directors, for example. Once the operational analysis is complete, assess how long it’ll take to wind down. Consider how you can incentivise key staff to stay to the end of the wind down period, so that business operates effectively during this period.
- Communications plan – communications are key in these scenarios and all stakeholders will need to be contacted. It’s useful to nominate a communications coordinator so no stakeholders are missed.
- Group interdependencies – many rely on their parent company for key services and financial resources, but the wind down plan should also consider a scenario where group support isn’t available, or only certain functions can be relied on.
What are the common pitfalls when creating a wind down plan?
The FCA picked out several challenges firms face when setting out their initial observations following the introduction of the Investment Firms Prudential Regime:
Length of time to wind down: several underestimated how long it would take them to wind down. The FCA won’t cancel a firm’s permissions until they are satisfied that there aren’t any outstanding complaints, the firm doesn’t hold any client money and has no outstanding fees to pay. It can take a long time to track down clients and deal with complaints. At a minimum, we suggest modelling a wind down scenario over a six-month period.
Overly optimistic assumptions: firms can recognise revenues in wind down which can be used to offset the overall wind down costs, especially where for example, a fund manager needs to give notice to existing clients. Despite this, firms need to assume any revenue modelled starts from a stressed point rather than business as usual. When estimating expenses, if for example, firms assume they can sub-lease their offices where they have a long lease, they need to be realistic about what discounts over current rates they may need to offer, particularly in the current rental market.
Wind down scenarios: some firms based their plan on a strategic exit rather than a stressed situation, whilst others didn’t consider a complete range of plausible scenarios. If the firm is part of a wider group, a stress to the parent entity would be a plausible wind down scenario. Because this is difficult to model, the group risk scenario is often overlooked.
Liquidity: assess how much liquidity the firm needs to hold to complete an orderly wind down. Particularly in the early stages, firms may experience unusual cash flows and therefore need to model their liquidity needs accordingly through a detailed cashflow forecast. The FCA found that firms often ignore the liquidity they need to hold for an orderly wind down.
Triggers: for MIFID investment firms, the FCA set out the levels of capital and liquid assets they need to hold. It’s important to note that firms can have different wind down triggers to these, so need to monitor them appropriately. For example, loss of a key client could be a wind down trigger for some. Any trigger should be linked to your risk management framework.
Group interdependencies: the FCA identified that firms were often reliant on their parent company for services and financial resources. Firms need to determine what would happen if this support wasn’t available. Similarly, a UK-regulated firm may provide support to other members of a group. This would need to be modelled in a wind down situation, as it could result in other group entities stopping operations. These factors can result in a more complicated wind down scenario and will need to be built into the plan.
Testing: the FCA set out that they expect wind down plans to be tested to demonstrate their operability (for example, via a fire drill). In practice, this isn’t always feasible, although there may be components of the plan that can be tested. For example, whether the client emails you have on file are all up to date. Firms may also find it useful to have some pre-prepared communication statements on file.
How can Bovill Newgate help you create a thorough wind down plan?
Wind down plans need to be put together by a team of people and firms need to set aside enough time and resource to build out their plan especially when it is being pulled together for the first time. Once the plan is in place, it also needs to be updated regularly to reflect any changes to the current operating model.
We can help on any aspects of wind down planning work:
- Reviewing existing plans for areas of improvement or gaps.
- Supporting in the creation of new wind down plans addressing your unique business needs.
- Checking existing or crating new recovery plans / resolution packs (RRPs).
- Preparing your staff for regulatory visits and exams.
- Ensuring your plans are delivering against IFPR expectations.
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