Own Funds, Risk Assessment and Capital Planning for Fund Administrators
Own funds requirement
With respect to the figures used in the calculation of the expenditure requirement under Regulation 29(a), a letter from the firm’s auditors confirming any figures not clearly identified in the most recent audited financial statements should be submitted to the Central Bank.
A fund administrator should note the following when calculating its own funds requirement:
- Under Regulation 29(a) a transfer pricing charge is not an eligible item that can be subtracted from the fund administrator’s total expenses figure; and
- The fund administrator must provide independent verification (i.e. auditor confirmation) of any transfer pricing charge and/or the notional cost of support services provided to the fund administrator by other group companies. This will facilitate the Central Bank’s assessment of compliance with Regulation 29(b).
Approval process for Capital Contributions
The Central Bank must be provided with documentary evidence that the capital contribution has been received by the fund administrator. Documentary evidence may include a copy of the original bank statement showing receipt of the relevant funds by the fund administrator or it may include confirmation that a debt or loan on the general ledger has been forgiven by the party providing the capital contribution. The Central Bank may request independent confirmation of the receipt of additional capital, for example auditor confirmation.
The fund administrator must use the Capital Contribution Agreement on the Central Bank’s website without amendment.
Approval process for capital instruments
With respect to Regulations 32(3)(a), 34(2) and 36(2), the following is relevant. In cases other than the issuance of ordinary shares, including the amendment of the effective terms and conditions of own funds instruments, the Central Bank requires 30 days’ notice starting from the point at which all necessary information has been received by the Central Bank. Necessary information comprises of a full description of the proposed issuance. In cases other than the issuance of ordinary shares, the necessary information should also be accompanied by a legal confirmation addressed to the Central Bank from an external legal advisor confirming that the fund administrator is entitled to recognise the proposed issue within the relevant tier of capital because it and its associated arrangements meet the applicable eligibility criteria set out in the Central Bank Investment Firms Regulations.
Risk Analysis and Stress Testing
Risk Analysis and Stress Testing
Part 5 of the Central Bank Investment Firms Regulations requires a fund administrator to have in place sound, effective and comprehensive strategies, processes and systems to identify and manage the risks to which it is or might be exposed. The board of the fund administrator is responsible for approving these strategies, processes and systems. In this regard, the board should adopt a risk management framework which:
(a) identifies and quantifies all risks relevant to the fund administrator;
(b) confirms the risk appetite for each risk identified;
(c) determines how each risk identified should be mitigated in order to maintain the risk exposure within the fund administrator’s risk appetite for that risk type including whether the appropriate form of such risk mitigation is controls, a change in liquidity management arrangements or additional own funds or internal capital;
(d) estimates the amount of residual risk after risk mitigation is applied; and
(e) incorporates appropriate policies for the measurement, management and monitoring of each risk identified, including the implementation as appropriate of any risk mitigation techniques.
The risk appetite statement should be appropriate and proportionate to the nature, scale and complexity of the activities of the fund administrator. The risk policies should include clear procedures, with thresholds where appropriate, for reporting to the board in order to ensure that risk exposures are maintained within the fund administrator’s risk appetite.
The board should agree how its responsibility for risk oversight and management is discharged. The board should determine the quality, type and format of risk-related information which it requires and put in place arrangements to receive it.
While the board may obtain advice and recommendations on risk issues, including periodic review of the risk management framework, it should retain the ultimate decision-making capability.
Testing Capital and Liquidity Adequacy
For larger,
more complex fund administrators or fund administrators operating in a
particularly dynamic environment, it is likely to be appropriate for the board
to ensure that appropriate testing and scenario analyses of both liquidity
management and capital adequacy arrangements are conducted in order to assess
the nature and level of risks to which the fund administrator may be exposed in
a variety of adverse circumstances.
Where a fund
administrator carries out tests and scenario analyses, it should develop tests
and scenario analyses that are appropriate to the nature, scale and complexity
of the source of risk and to the nature, scale and complexity of the fund
administrator's business. It should be considered whether tests and scenario
analyses are required for all material sources of risk identified by the fund
administrator. Where a fund administrator carries out scenario analyses, such
analyses should include an appropriate set of adverse circumstances of varying
nature, severity and duration relevant to the fund administrator’s business and
risk profile. In this regard, the fund administrator should consider:
(a)
circumstances and events occurring over a prolonged period of time;
(b) sudden and
severe events, such as market shocks or other similar events; and
(c) a
combination of (a) and (b).
Where a fund
administrator carries out tests and scenario analyses, such tests and scenario
analyses should be defined in test documentation, which should be approved by
the board. The test documentation should include the following for each test or
scenario analysis to be conducted:
(a) The
generation process: This should specify whether the test or scenario is
based on historical data, on simulated data or a combination of the two. Where
reliance is placed on a particular historical event, additional scenario
analysis should be included which stresses the relationships and correlations embedded
in that historical scenario. There should be an articulated rationale for the
choices made. For scenario analyses that involve a number of risk correlations,
these risk correlations should be described.
(b) The
testing process: This should set out the sequence in which each side of the
balance sheet is to be tested and how they are to be combined to generate the
test outcome. For scenario analyses that involve a number of risk correlations
and require a variety of calculations to be performed, this should set out the
order in which the various calculations are to be performed. The rationale for
the choices made in this regard should be documented.
(c) The risk
assessment: This should set out how the reliability of data, statistical
models and any judgements relied on should be risk assessed. This should
include back-testing of the sources relied on in the immediately prior test or
scenario analysis to ensure they remain fit for purpose. In back-testing,
forecasting accuracy is compared against actual outcomes.
(d) The
result's analysis: This should set out how the test or scenario
analysis result's are to be reviewed within an internal challenge process in
which the alignment of the test or scenario analysis result's with the defined
risk appetite is reviewed and conclusions documented. The procedure for making
decisions to eliminate, mitigate or accept the risks highlighted by the test or
scenario analysis should be clearly documented. The documentation should
describe who is responsible for developing for decision makers a range of
mitigants that might be considered. Changed reporting arrangements, including
altered reporting thresholds, should also be considered. The result's analysis
process should also consider recommendations for changes to future tests and/or
scenario analyses.
Where a fund
administrator carries out tests and scenario analyses, the fund administrator
should consider and estimate the impact of risk correlations.
Own Funds Plans
Part 5 of the Central Bank Investment Firms Regulations requires a fund administrator to draw up own funds plans. The board of the fund administrator is responsible for approving these own funds plans.
The board should ensure that own funds plans include projections under both normal conditions and under stressed circumstances considered by the fund administrator. Such plans should highlight if and when additional own funds may be required by the fund administrator and should indicate how the fund administrator intends to raise any such additional own funds. Such plans should also indicate whether any additional own funds raised would be held as eligible assets. The plans should take into account any impending changes to the fund administrator’s regulatory requirements.
The fund administrator should ensure that it has a linked risk and capital management system and should reconcile internal capital to the fund administrator’s own funds.
Once finalised, the own funds plan should be embedded in the fund administrator’s business and organisational processes. It should be reviewed regularly during the year in order to assess the risks that are inherent in/material to the fund administrator’s activities. The review should include but not be limited to the following; any changes to the fund administrator’s strategic focus, business plan, operating environment or other factors that materially affect assumptions or methodologies used when the own funds plan was prepared.
Liquidity Risk Analysis and Planning
Part 5 of the Central Bank Investment Firms Regulations requires a fund administrator to measure and monitor liquidity risk over an appropriate set of time horizons so as to ensure that the fund administrator maintains adequate liquidity management arrangements.
When assessing liquidity risk under the various time horizons, the board should ensure that projections are completed under both the normal conditions and stressed circumstances considered by the fund administrator. Such projections should highlight if and when additional liquidity may be required by the fund administrator and should indicate how the fund administrator intends to raise any such additional liquidity. The plans should take into account any impending changes to the fund administrator’s regulatory requirements.
In terms of the specific liquidity time horizons that should be monitored, intra-day liquidity risk is relevant in certain circumstances, such as when fund administrators must comply with the reconciliation requirements under the Investor Money Regulations. Firms must consider their liquidity risk over each of the time horizons listed in Regulation 44(4) and conduct an appropriate level of monitoring for each of the time horizons depending on their individual business model.
Wind-down Plans
Part 5 of the Central Bank Investment Firms Regulations requires a fund administrator to have in place a plan setting out how the fund administrator would wind down in an orderly fashion in a defined time period in the event of failure and to estimate the amount of own funds and liquidity required.
When drawing up a wind-down plan, a fund administrator should consider and incorporate the following elements:
(a) There should be an assumptions section setting out the assumed circumstances of the wind-down scenario including reference to legal risk and determination of ownership of client assets or investor money where relevant.
(b) The fund administrator should define a time period for the orderly transfer of assets under administration to other fund administrators and should complete the wind-down plan with reference to this time period.
(c) The fund administrator should consider which staff would be required to ensure the orderly transfer of assets under administration to other fund administrators within the defined time period.
(d) The fund administrator should estimate the revenues that it would expect to receive within the defined time period for winding-down, bearing in mind that revenue inflows may reduce at a faster rate than costs.
(e) The fund administrator should consider whether it would expect to incur any additional expenses in the wind-down scenario.
Risk analysis
Part 5 of the Central Bank Investment Firms Regulations requires fund administrators to assess their major sources of risk. Fund administrators should be able to demonstrate that they have made an assessment of all risks outlined under Regulation 44(1)(b). These risks represent a minimum list of risks which should be addressed and fund administrators should consider all risks that are relevant in the context of their business models including how they may impact on their capital and liquidity adequacy. For instance, conduct risk which may lead to an operational loss event that could impact on capital should be addressed under the operational risk category.
In addressing sources of risk, fund administrators should consider taking the following into account:
- Credit and Counterparty Risk
Credit and counterparty risk refers to the risk of financial loss arising from a counterparty who fails to meet its obligations in accordance with agreed terms. Credit risk arises any time a fund administrator’s funds are extended, committed, invested or otherwise exposed.
When addressing credit and counterparty risk, a fund administrator should take into account all credit exposures, both on and off-balance sheet, and should in particular address problem credits in order to ensure that it makes adequate value adjustments and provisions for problem credits.
Concentration risk refers to the risk of loss arising from a relatively large exposure to a single counterparty or to a group of related counterparties. It can also arise where there is a relatively large exposure to a particular business line, geographic area or market segment.
When addressing concentration risk, a fund administrator should address concentration risk arising from all exposures, both on and off-balance sheet.
Market risk refers to the risk of losses arising from adverse movements in market prices including in equities, derivatives, interest rates, commodities and FX rates.
When addressing market risk, a fund administrator should address market risk arising from all exposures, both on and off-balance sheet.
Operational risk refers to the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Operational risk should include:
(a) insurance risk, specifically whether insurance policies in place to cover compensation on errors arising are adequate;
(b) legal risk arising from any potential claims or disputes; and
(c) the risk arising from any outsourcing arrangements entered into by a fund administrator.
A fund administrator’s assessment of operational risk should cover low frequency high severity events.
A fund administrator should have in place contingency and business continuity plans to ensure the fund administrator’s ability to operate on an on-going basis and limit losses in the event of severe business disruption.
Liquidity risk refers to the risk that a fund administrator may not be able to fund its cash outflows as they fall due.
When addressing liquidity risk a fund administrator should:
(a) distinguish between encumbered and unencumbered assets;
(b) categorise assets into buckets based on current evidence of their relative liquidity;
(c) take into account the legal entity in which assets reside and the country in which such legal entity is situated and assess whether assets can be mobilised in a timely manner;
(d) take into account all relevant liabilities including off-balance sheet items and contingent liabilities;
(e) take into account the fund administrator’s dividend policy;
(f) consider different liquidity risk mitigation tools; and
(g) include effective liquidity contingency and recovery plans taking into account the outcome of tests and scenario analyses carried out.
- Strategy or Business Model Risk
Strategy or business model risk refers to the risk that fund administrators face if they cannot compete effectively, namely that, in a market economy, others will offer better products or services, or substitute products or services, at better prices and that they may fail because they may not be able to cover their costs. Strategy or business model risk also includes the inherent risk in a strategy, for example overly excessive business growth, merger and acquisitions activity and/or significant business diversification. Business model risk may also include a cost base that is materially out of line with the rest of the market.
Group risk refers to the risk of loss arising from transactions with and exposures to group entities. Both on and off-balance sheet exposures should be considered, including in particular any guarantees given to group entities.
Environmental risk encompasses all risks stemming from a fund administrator’s external operating environment including regulatory changes, the economic environment and financial market activity.
Governance risk refers to risk arising from internal governance structures, including internal control, audit and compliance and oversight mechanisms.
Issued: 13 March 2017
Latest revision: 13 March 2017