Liquidity risk management: CBI findings for MiFID firms

The review analyses whether methods of liquidity risk control are consistent with Joint European Banking Authority (EBA) and European Securities and Markets Authority (ESMA) Guidelines and CBI expectations by looking primarily at two aspects, namely the firms’ analysis of exposures to liquidity risk and the adequacy of their current risk management frameworks. 

The results indicated that the sample of firms was generally handling liquidity risk in accordance with both the Joint Guidelines and CBI’s expectations. However, it also highlighted the varying levels of maturity across the firms’ liquidity risk management frameworks and noted areas for improvement.

Despite being largely encouraging, these findings reinforce the responsibility of the boards and management of these investment firms to ensure that problems identified are addressed appropriately to adequately maintain the liquidity resilience of the firms.

The CBI’s findings on liquidity risk of a sample of MiFID investment firms

This review assessed material liquidity risks from both normative and economic perspectives to determine whether firms are following regulatory requirements and are identifying risks that could reduce their liquidity resources. Some of the good practices identified in the results included firms adopting a broader assessment approach by considering additional events that could give rise to liquidity outflows. Where the firms concluded that liquidity risk was not a significant issue, clear rationales were provided in their Internal Capital Adequacy and Risk Assessment Process (ICARAP). Every firm assessed its intraday liquidity risk, with the CBI finding no significant concerns in this area. All firms also demonstrated that they could maintain compliance with minimum liquidity requirements in Business as Usual (BAU) and stress conditions, while also showing consideration of the stability of their funding.

Areas for improvement

While the CBI review found that firms generally had appropriate risk management frameworks in place that were aligned with expectations, it also highlighted some key areas for improvement. For instance, some firms’ ICARAPs lacked sufficient detail on liquidity risk exposures and their potential impact on the firm. Furthermore, some firms failed to provide analysis of the impact of liquidity risks from both a normative and an economic perspective and did not provide sufficient information on liquidity risk exposures and controls.

Regarding liquidity limits, some firms failed to supply adequate justification for the calibration of threshold levels, and some relied on binary thresholds that lacked buffers or associated Early Warning Indicators. There were also examples where firms applied identical thresholds to both liquidity and own funds metrics without presenting any rationale for this decision.

Additional areas for improvement included insufficient detail on the impacts of stress scenarios and a failure to consider the economic perspective when conducting liquidity stress testing. Concerning contingent funding arrangements, some firms did not establish any formal contingent funding and some lacked any external funding sources. Where contingent funding arrangements were present, some firms’ actions were focused on reducing expenses instead of identifying additional sources of liquidity, while others possessed no reliable contingent funding alternative other than parental support.

What should MiFID investment firms do

These findings encourage MiFID investment firms to analyse their current liquidity risk management frameworks and address any gaps that exist to ensure that their practices are in line with the requirements.

MiFID investment firms should address whether:

• Sufficient detail on liquidity risk exposures and their impact is provided in ICARAPs.
• Analysis of the impact of liquidity risks is completed from both normative and economic perspectives.
• Limit frameworks are adequately calibrated and backed by rationale.
• Buffers and Early Warning Indicators exist to identify liquidity risks before they develop into significant issues.
• Sufficient detail is provided on the impact of stress scenarios on the firm’s liquidity position.
• Stress testing frameworks exist to provide a means of testing the firm’s liquidity position in stress scenarios and are conducted from both a normative and an economic perspective.
• Formal contingent funding arrangements are established, and external funding sources have been identified.
• Focus is placed on obtaining liquidity rather than reducing costs.
• Contingent funding sources are reliable and do not excessively depend on parental support.

Firms could, for instance, pre-empt a critical liquidity issue by reviewing current limits and assessing whether funding resources will persist in such a situation. This would demonstrate the firm’s awareness of its current liquidity position and of what steps it would take to respond to liquidity challenges.

How Forvis Mazars can help

The CBI highlights the ever-increasing requirement of integrating liquidity risk management into a firm’s ongoing growth and development. We at Forvis Mazars work alongside our clients to find problems in existing frameworks and address these issues to constantly improve a firm’s financial resilience in the event of liquidity stress. Our support includes:

• Reviewing liquidity risk management frameworks against the regulatory requirements.
• Reviewing and improving ICARAP.
• Reviewing and enhancing stress testing methods.
• Reviewing contingent funding sources and overall financial planning.