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New FSA Liquidity Rules

Posted on 30 Nov 2009

On 1 December 2009 the FSA’s new rules on liquidity management come into force.


The rules are being introduced to toughen up the existing provisions on liquidity risk management. The FSA is applying the lessons it has learned during the past two years when several large credit institutions faced an acute liquidity crisis.

Whilst banks are encouraged to lend more and provide the market with more liquidity, the FSA maintains that at the other end of the spectrum, liquidity management standards must be significantly improved. By strengthening the liquidity rules, the FSA hopes that it will help improve the perception of the financial soundness of UK financial institutions. The long-term aim is to make the UK financial sector more competitive.

Laven Partners has already assisted several credit institutions abroad to meet similar liquidity requirements which have been based on the Principles for Sound Liquidity Management issued by the Basel Committee on Banking Supervision. The new rules are also partly based on these principles which effectively create a global standard being applied across jurisdictions.

Asset Managers and Investment Advisers

The new rules are applicable to all BIPRU firms, including investment firms such as asset managers and investment advisers. However, asset managers and investment advisers are likely to be excluded from the full scope of the rules as they would usually fall within a BIPRU limited licence or limited activity category.

This newsletter focuses on the new rules as they apply to asset managers and investment advisers who are excluded from the so called ILAS BIPRU Firm category.

What do the new rules cover?

The requirement to have adequate liquidity risk management policies and processes in place already exists under the FSA’s rules in the Senior Management Arrangements, Systems and Controls sourcebook (SYSC 11). The new rules will be contained in the Prudential Sourcebook for Banks, Building Societies and Investment Firms of the FSA handbook (BIPRU 12).

The new liquidity rules introduce more detailed requirements in terms of pricing liquidity risk, intraday management, collateral, liquidity needs of various business lines and funding diversification. Whilst a requirement to conduct stress testing already exists under the requirements in SYSC, the FSA have provided specific scenarios for firms to test. Additionally, firms will be required to report to the FSA on the effectiveness of their systems and controls.

The approach taken here is to explain in broad terms the steps firms should take towards meeting the new requirements.

Board of Directors/Management Committee:

a)    Sets the Firm’s liquidity risk tolerances and documents them; and

b)    Approves the liquidity risk policy and processes, and reviews them at least once a year.

Senior Management:

a)    Is responsible for day-to-day oversight of compliance with liquidity management requirements;

b)    Reports to the Board of Directors/Management Committee on a regular basis; and

c)    Is responsible for the development of risk management policies and processes.

Stress Testing:

a)    Should identify liquidity issues;

b)    Check risk tolerances;

c)    Identify the effects of pricing assumptions; and

d)    Analyse effects of liquidity stresses on cash flows, liquidity positions, profitability and solvency.

Stress testing should be adjusted to be proportionate with the firm’s business activities.

Contingency Funding Plan:

a)    Should include a strategy to deal with liquidity short falls;

b)    Be formally documented and approved by the Board of Directors/Management Committee;

c)    Clearly allocate responsibilities for the firm’s staff; and

d)    Be tested regularly.

Financial Return – Systems and Controls (FSA055)

a)    Non-ILAS firms must demonstrate compliance with the applicable liquidity rules through the completion of the systems and controls questionnaire (FSA055);

b)    Submitted annually, 15 business days after year end; and

c)    First submission will report on the year to 31 December 2010.

What next?

Firms subject to the rules need to take steps now to prepare for the introduction of these requirements.

If you require any further information or advice on the application of the rules please contact your compliance consultant at Laven Partners Limited.