Financial Services Authrity ICAAP submissin suggested frmat v2.0 Last updated: 22/11/2007 Firms are nt required t adpt this frmat when asked t submit their Internal Capital Adequacy Assessment Prcess (ICAAP) dcument t the FSA fr review. The FSA expects there t be a fair degree f variatin in the length and frmat f submissins since firms business and risk prfiles differ and the ICAAP dcument shuld be prprtinal t the size, nature and cmplexity f a firm s business. Hwever, adpting this frmat may be cnvenient fr firms as it cvers mst f the matters which typically wuld be the subject f review by the FSA and if nt prvided in the initial submissin are likely t be cvered in fllw up discussins with the firm. Use f this frmat may therefre make the review prcess mre efficient fr bth the firm and the FSA. Equally, use f this template is nt a substitute fr being aware f the relevant rules. What is an ICAAP dcument? The purpse f the ICAAP dcument is t infrm the Bard f the nging assessment f the firm's risks, hw the firm intends t mitigate thse risks and hw much current and future capital is necessary having cnsidered ther mitigating factrs. The ICAAP dcument is als hw the firm explains t the FSA its internal capital adequacy assessment prcess. Whilst the ICAAP may be based n existing internal dcumentatin, the FSA will clearly find it helpful t have a bespke summary prepared t cmmunicate the key results and issues t it at a senir level. Since the FSA will be basing many f its views n the infrmatin cntained in the ICAAP dcument it wuld be unusual if the firm s gverning bdy r senir management had nt frmally apprved its cntents. Given that the firm s gverning bdy r senir management are likely t apprve the ICAAP dcument we wuld expect that dcument t be in a frmat that can be easily understd at a high level and t cntain all the relevant infrmatin that is necessary fr the firm and FSA t make an infrmed judgement and decisin as t the apprpriate capital level and risk management apprach. Where apprpriate technical infrmatin n risk measurement methdlgies, capital mdels and all ther wrks carried ut t validate the apprach (e.g. bard papers and minutes, internal r external reviews) culd be cntained in appendixes. Cntents 1. EXECUTIVE SUMMARY 2 2. BACKGROUND 2 3. SUMMARY OF CURRENT AND PROJECTED FINANCIAL AND CAPITAL POSITIONS 2 4. CAPITAL ADEQUACY 2 5. CAPITAL PLANNING 6 6. LIQUIDITY PLANNING 7 7. AGGREGATION AND DIVERSIFICATION 7 8. CHALLENGE AND ADOPTION OF THE ICAAP 8 9. USE OF THE ICAAP WITHIN THE FIRM 8
1. EXECUTIVE SUMMARY The purpse f the Executive Summary is t present an verview f the ICAAP methdlgy and results. This verview wuld typically include: the purpse f the reprt and which regulated entities are cvered by the ICAAP; the main findings f the ICAAP analysis: hw much and what cmpsitin f internal capital the firm cnsiders it shuld hld as cmpared with the capital resurce requirement (CRR) pillar 1 calculatin, and the adequacy f the firm s risk management prcesses; a summary f the financial psitin f the business, including the strategic psitin f the firm, its balance sheet strength, and future prfitability; brief descriptins f the capital and dividend plan; hw the firm intends t manage capital ging frward and fr what purpses; cmmentary n the mst material risks, why the level f risk is acceptable r, if it is nt, what mitigating actins are planned; cmmentary n majr issues where further analysis and decisins are required; and wh has carried ut the assessment, hw it has been challenged, and wh has apprved it. 2. BACKGROUND This sectin wuld cver the relevant rganisatinal and histrical financial data fr the firm. e.g. grup structure (legal and peratinal), perating prfit, prfit befre tax, prfit after tax, dividends, sharehlders funds, capital resurces held and as cmpared with regulatry requirements, custmer accunts, depsits by banks, ttal assets, and any cnclusins that can be drawn frm trends in the data which may have implicatins fr the firm s future. 3. SUMMARY OF CURRENT AND PROJECTED FINANCIAL AND CAPITAL POSITIONS This sectin wuld explain the present financial psitin f the firm and expected changes t the current business prfile, the envirnment in which it expects t perate, its prjected business plans (by apprpriate lines f business), prjected financial psitin, and future planned surces f capital. The starting balance sheet and date as f which the assessment is carried ut wuld be set ut. The prjected financial psitin might cnsider bth the prjected capital available and prjected capital resurce requirements based n expected plans. These might then prvide a baseline against which adverse scenaris (see later) might be cmpared. 4. CAPITAL ADEQUACY This sectin might start with a descriptin f the risk appetite used in the ICAAP. It is vital fr the FSA t understand whether what is being presented t it represents the firm s view f the amunt
f capital required t meet minimum regulatry needs r whether what is being presented is the amunt f capital that a firm believes it needs t meet business bjectives. Fr instance whether the capital required is based n a particular desired credit rating r includes buffers fr strategic purpses r t minimise the change f breaching regulatry requirements. Where ecnmic capital mdels are used this wuld include the cnfidence level, time hrizn, and descriptin f the event t which the cnfidence level relates. Where scenari analyses r ther means are used, then sme ther descriptin f hw the severity f scenari has been chsen wuld be included. The sectin wuld then include a detailed review f the capital adequacy f yur firm. The infrmatin prvided wuld include: Timing the effective date f the ICAAP calculatins tgether with cnsideratin f any events between this date and the date f submissin which wuld materially impact the ICAAP calculatin tgether with their effects; and details f, and ratinale fr, the time perid ver which capital has been assessed. Risks analysed an identificatin f the majr risks faced in each f the fllwing categries: i) credit risk, ii) iii) iv) market risk, peratinal risk, liquidity risk, v) insurance risk vi) cncentratin risk vii) viii) ix) residual risk securitisatin risk business risk x) interest rate risk xi) xii) pensin bligatin risk; and any ther risks identified (fr example this may take the frm f yur standard risk register) And fr each, an explanatin f hw the risk has been assessed and the quantitative results f that assessment; where risks have been highlighted as part f yur ARROW risk assessment r are included in the ARROW risk mitigatin prgramme, an explanatin f hw yu have mitigated these; where relevant, a cmparisn f that assessment with the results f the CRR pillar 1 calculatins; a clear articulatin f the firm s risk appetite by risk categry if this varies frm the verall assessment; and where relevant, an explanatin f any ther methds apart frm capital used t mitigate the risks. Fr thse firms subject t the Fixed Overhead Requirement (FOR), a cash flw frecast shwing estimated cash in flws and ut flws ver the perid the firm believes it wuld take t wind dwn the business in distressed circumstances, either returning client assets and mney r transferring them t a purchaser f the business.
Methdlgy and assumptins A descriptin f hw assessments fr each f the majr risks have been apprached and the main assumptins made. Fr instance, firms may chse t base their ICAAP n the results f the CRR calculatin with additinal risks (e.g. cncentratin risk, interest rate risk in the banking bk etc.) assessed separately and added t Pillar 1. Alternatively, firms may decide t base their ICAAP n internal mdels fr all risks, including thse cvered under the CRR (i.e. Credit, Market and Operatinal Risks). The descriptin here wuld make clear which risks are cvered by which mdelling r calculatin apprach. This wuld include details f the methdlgy and prcess used t calculate risks in each f the categries identified and reasn fr chsing the methd used in each case. Where the firm uses an internal mdel fr the quantificatin f its risks, this sectin wuld explain fr each f thse mdels: the key assumptins and parameters within the capital mdelling wrk and backgrund infrmatin n the derivatin f any key assumptins; hw parameters have been chsen, including the histrical perid used and the calibratin prcess; the limitatins f the mdel; the sensitivity f the mdel t changes in thse key assumptins r parameters chsen; and the validatin wrk undertaken t ensure the cntinuing adequacy f the mdel. CRR and ICAAP cmparisns Shuld the internal mdels vary frm any regulatry mdels apprved fr pillar 1 purpses, this sectin wuld prvide a detailed cmparisn explaining bth the methdlgical and parameterisatin differences between the internal mdels and the regulatry mdels and hw thse affect the capital measures. A chart f the fllwing type may be useful:
Internal mdel is less cnservative Internal mdel is mre cnservative e.g. Cncentratin risk e.g. Diversificatin benefits Internal capital Regulatry capital The explanatin f the differences between the internal mdel and the CRR wuld be set ut at the level at which the ICAAP is applied. Therefre, if the firm's ICAAP dcument breaks dwns the calculatin by majr legal regulated entities, an explanatin fr each f thse individual entities wuld be apprpriate. Similarly, we wuld expect the explanatin t be sufficiently granular t shw the differences at the level f each f the Pillar 1 risks. Stress and scenari tests applied Where stress tests r scenari analyses have been used t validate, supplement, r prbe the results f ther mdelling appraches, then this sectin wuld prvide: details f simulatins t capture risks nt well estimated by the firm s internal capital mdel (e.g. nn linear prducts, cncentratins, illiquidity and gapping f prices, shifts in crrelatins in a crisis perid); details f the quantitative results f stress tests and scenari analyses the firm carried ut and the cnfidence levels and key assumptins behind thse analyses, including, the distributin f utcmes btained fr the main individual risk factrs; details f the range f cmbined adverse scenaris which have been applied, hw these were derived and the resulting capital requirements; and where applicable, details f any additinal business unit specific r business plan stress tests selected. Capital transferability Details f any restrictins n the management ability t transfer capital int r ut f the business(es) cvered, fr example, cntractual, cmmercial, regulatry r statutry restrictins that apply. Statutry restrictins culd be limited t the maximum dividend that culd be declared and paid fllwing certain actins t maximise distributable reserves, thrugh fr example, crystallising unrealised gains. Regulatry restrictins culd be the minimum
regulatry capital psitin acceptable t the lcal regulatr after releasing capital back t the grup. 5. CAPITAL PLANNING This sectin wuld explain hw a firm wuld be affected by an ecnmic recessin r dwnswings in the business r market relevant t its activities. The FSA is interested in hw a firm wuld manage its business and capital s as t survive a recessin whilst meeting minimum regulatry standards. The analysis wuld include financial prjectins frward fr, say, three t five years based n business plans and slvency calculatins. Fr that purpse, the severity f the recessin wuld typically be ne that ccurs nly nce in a 25 year perid. The time hrizn wuld be frm the present day t at least the deepest part f the recessin. Typical scenaris wuld include: hw an ecnmic dwnturn wuld affect the firm's capital resurces and future earnings; and the firm s CRR taking int accunt future changes in its prjected balance sheet. In bth cases, it wuld be helpful if these prjectins shwed separately the effects f management actins t change the firm's business strategy and the implementatin f cntingency plans. prjectins f the future CRR wuld include the effect f changes in the credit quality f the firm's credit risk cunterparties (including migratin in their ratings during a recessin) and the firm s capital and its credit risk capital requirement (nte that this scenari stress test is a requirement fr firms with an IRB permissin); an assessment by the firm f any ther capital planning actins t enable it t cntinue t meet its regulatry capital requirements thrughut a recessin such as new capital injectins frm related cmpanies r new share issues; This sectin wuld als explain which key macrecnmic factrs are being stressed, and hw thse have been identified as drivers f the firm's earnings. The firm wuld als explain hw the macrecnmic factrs affect the key parameters f the internal mdel (and fr credit risk, the regulatry mdel) by demnstrating fr instance hw the relatinship between the tw has been established. Management Actins This sectin wuld expand n the management actins assumed in deriving the ICAAP, in particular: the quantative impact f management actins sensitivity testing f key management actins and revised ICAAP figures with management actins excluded. evidence f management actins implemented in the past during similar perids f ecnmic stress. Nte that where a firm has an IRB permissin then this sectin may set ut management actins which mitigate the additinal capital suggested by the mandatry credit rating migratin stress test. Alternatively, such actins might be set ut in a separate capital management plan r
therwise apprved by senir management as actins the firm is cmmitted t realistically taking in such circumstances. 6. LIQUIDITY PLANNING This sectin wuld summarise hw liquidity risk is managed (as distinct frm any capital set aside t cver lsses incurred in a liquidity stress). In particular, it wuld set ut the key assumptins and cnclusins frm stress testing f cash flws undertaken t manage the risk 1. It wuld generally be helpful fr the ICAAP t include as appendices the fllwing, where relevant: Asset Liability Cmmittee (ALCO) papers and samples f Management Infrmatin (MI) used day t day in Treasury departments: daily cash flw frecasts, weekly, mnthly etc Liquidity and funding plicy dcumentatin (sl and grup) Internal Audit reprts relating t Treasury departments An rganisatin chart that cvers liquidity and funding risk management delegated authrities and reprting lines within the firm Limit breach plicy dcumentatin Securitisatin dcumentatin detailing hw the prgrammes functin. Liquidity stress testing dcumentatin An explanatin f intra grup liquidity arrangements, especially if perating in several cuntries Number, scale and timeline f cmmitments whether frmal r infrmal twards: ff balance sheet financing vehicles, market cunterparties (including margin r cllateral bligatins) r twards clients Analysis f liquidity demands and surces f liquidity (ie funding risk and market liquidity risk affecting assets) by name any cnsidering strategic and tactical management f the risk Quantified Cntingency Funding Plans Whilst capital is an imperfect mitigant (ie is nt a preventative measure) fr liquidity risk, there may well be a capital cst f a liquidity stress. Firms shuld therefre cnsider here r in the previus sectin such scenaris as a ratings dwngrade r ther event which might increase their cst f funding and therefre absrb capital reserves. 7. AGGREGATION AND DIVERSIFICATION This sectin wuld describe hw the results f the varius separate risk assessments are brught tgether and an verall view taken n capital adequacy. At a technical level, this therefre requires sme methd t be used t cmbine risks using quantitative techniques f sme srt. At 1 See fr instance GENPRU 1.2.30R which requires analysis f liquidity risk and SYSC 11, in particular SYSC 11.1.23E and IPRU(BSOC) 5.2.7R which explain in mre detail ur expectatins fr a cntingency funding plan and liquidity plicies.
the brader level, the verall reasnableness f the detailed quantificatin appraches might be cmpared with the results f an analysis f capital planning (see sectin 5) and a view taken by senir management as t the verall level f capital that is apprpriate. Dealing with the technical aggregatin, this wuld describe: i) any allwance made fr diversificatin, including any assumed crrelatins within risks and between risks and hw such crrelatins have been assessed, including in stressed cnditins; ii) the justificatin fr any credit fr diversificatin benefits between legal entities, and the justificatin fr the free mvement f capital between them in times f financial stress; iii) the impact f diversificatin benefits with management actins excluded. It might be helpful t set ut revised ICAAP figures with all crrelatins set t 1 i.e., n diversificatin; and similar figures with all crrelatins set t 0 i.e. assuming all risks are independent. As regards the verall assessment, this wuld describe hw the firm has arrived at its verall assessment f the capital it needs taking int accunt such matters as: i) the inherent uncertainty in any mdelling apprach; ii) weaknesses in the firm s risk management prcedures, systems r cntrls; iii) the differences between regulatry capital and internal capital; and iv) the differing purpses that capital serves: sharehlder returns, rating bjectives fr the firm as a whle r certain debt instruments the firm has issued, avidance f regulatry interventin, prtectin against uncertain events, depsitr prtectin, wrking capital, capital held fr strategic acquisitins etc. 8. CHALLENGE AND ADOPTION OF THE ICAAP This sectin wuld describe the extent f challenge and testing f the ICAAP. It wuld include the testing and cntrl prcesses applied t the ICAAP mdels r calculatins, and the senir management r bard review and sign ff prcedures. It might be helpful if a cpy were attached f any relevant reprt t senir management r the bard and their respnse. Details f the reliance placed n any external suppliers wuld als be detailed here e.g. fr generating ecnmic scenaris. In additin, a cpy f any reprt btained frm an external reviewer r internal audit wuld als be included. 9. USE OF THE ICAAP WITHIN THE FIRM This wuld demnstrate the extent t which capital management is embedded within yur firm including the extent and use f capital mdelling r scenari analysis and stress testing within yur firm's capital management plicy, e.g. in setting pricing and charges and the level and nature f future business. This wuld als include a statement f yur actual perating philsphy n capital management and hw this links t the ICAAP submitted. Fr instance differences in risk appetite used in the ICAAP as cmpared t that used fr business decisins might be discussed. Lastly, it wuld be helpful if yu culd detail any anticipated future refinements within yur ICAAP (highlighting thse aspects which are wrk in prgress) and prvide any ther infrmatin that yu believe will help us review yur ICAAP.