Six common weaknesses in wind-down plans
“We therefore intend to do more in the coming years to increase our confidence that firms can exit the market without disturbing it, in an orderly way and without having to rely on the backstop of an insolvency or resolution process.” (Sam Woods, CEO PRA, September 2021)
Since the concept was first introduced, wind-down plans have become an increasing regulatory priority for firms, filling the space between recovery and resolution/insolvency. Both regulators and the public want to know that firms are governed and adequately resourced to not only operate effectively, but also to exit the market with minimal disruption to customers, clients and markets if required. This includes under stressed conditions due to adverse firm specific and or market conditions. This requirement has been highlighted by the FCA through its Wind-down Planning Guide (WDPG) and Finalised Guidance now covers most FCA firms, and as Sam Woods made clear in his recent Mansion House speech, the PRA intends to provide more structure to the approach for small and medium-sized firms.
This blog may be of interest to those FCA and PRA regulated firms preparing a wind-down plan or those reviewing one as part of the governance exercise, and while not comprehensive, it gives an insight into six areas where weaknesses commonly arise.
Overall approach and key implications
Preparing an effective wind-down plan is far more than a “tick-box” regulatory exercise and can provide senior management with improved insight into the risks associated with a firm’s strategy, business model and activities. Ideally, its production and supporting workstreams should simply build on and combine existing firm-wide risk management processes, including operational risk, stress testing, resilience, and crisis management. Failure to produce a good plan could potentially indicate to regulators wider governance, risk management and resourcing weaknesses that could increase the potential for harm to customers.
Some wind-down plans are not clearly actionable and fail to include to include elements such as timelines and the steps that a third-party could follow. This often results in a lack of credible actions to deliver wind-down or arises from inadequate key assumptions (e.g. wind-down timeline / duration). To avoid this, it is important that there is proper involvement from specialists from across the firm - while there must be a clear overall owner and coordinator for the plan, its development should not fall solely to a single individual or team to ensure that all angles are covered.
An important question to ask when drafting or reviewing a plan is, “could an independent team understand and implement this plan during a solvent or insolvent wind-down?”
Triggers and scenarios
Another wind-down plan element that often requires improvement relates to the supporting indicators and triggers. These often fail to provide a practical and effective framework to a firm’s board and senior management as to when it is necessary to invoke the plan. This significantly increases the risk that the plan might not be invoked until there are insufficient resources to support an orderly wind-down.
Effective stress testing and scenario analysis, including reverse stress testing, can help firms to strengthen the link between the wind-down plan, triggers and other parts of a firm’s risk management framework (including the ICAAP / ICARA and Recovery Plan). All scenarios should be relevant to the firm’s business model, with any supporting indicators and triggers configured to ensure adequate decision points prior to any potential points of non-viability. It is vital that firms can demonstrate that they have adequate monitoring and governance arrangements for their indicators and triggers.
Operations and technology
A common weakness is the failure to demonstrate that the firm will have sufficient non-financial resources to complete a solvent wind-down, including the critical systems and infrastructure. This applies not only to internal infrastructure, but also third-party and outsourced resources.
Linking back to the idea that plans must be actionable, not including a detailed picture of these resources would not make it clear to an independent reader what systems and other non-financial resources are required. Where these are critical to a successful wind-down, they need to be identified and the plan must consider how access to these assets will be maintained and the scope for security breaches reduced.
Some wind-down plans do not present clearly that the firm has the financial resources (capital and liquidity) available to complete a solvent wind-down. This does not necessarily mean that the firms actually have insufficient resources, but rather that the estimated cost and potential available resources are poorly presented or evidenced.
Linking the financial analysis to the firm’s scenario analysis and stress testing will help to ensure that it is tied to a rigorous exercise and also presents a clear estimated cost of wind-down. The information needs to be sufficiently detailed so that it can be used in setting wind-down triggers and buffers.
As introduced above, the primary regulatory objective of the wind-down planning process is to reduce the risk of harm to clients and other relevant stakeholders. For example, firms with client money / asset or deposit permissions must demonstrate an ability to mitigate and manage the additional risks that could arise from these activities. However, some plans lack actionable details and or fail to explain the mechanism by which client assets are reconciled, how they would be secured and returned in the event of a material crystallised risk, increasing the risk of harm to consumers. These details need to be provided so that a third-party insolvency practitioner could use the plan to return funds.
Inadequate evidence of governance over the plan is also common. This can materialise both during the development of the plan itself, potentially leading to a plan that incoherent across departments and management, or for the governance of a wind-down itself. For the latter, some plans lack detail about the conditions for entry into wind-down and the associated decision-making process. Once within wind-down, plans are not always clear about how wind-down will be managed operationally, such as the committee structure overseeing it, and the role of the executive and Board.
Getting it right
The above is a summary of some of the common flaws in wind-down plans, but does not cover all, and the idiosyncratic nature of each firm’s business model means that there can be variety of challenges when preparing the plan.
If a plan has been prepared without sufficient support, it could lead to negative feedback from regulators and result in a request for material redrafting, enhanced scrutiny, and potentially even stricter regulatory requirements, such as capital and liquidity add-ons. It is therefore essential to develop plans in a structured way with the appropriate level of resource, support, and expertise.