In today’s volatile financial landscape, liquidity risk management is more crucial than ever. The Financial Conduct Authority (FCA) recently conducted a multi-firm review of liquidity risk management practices across wholesale trading firms, offering valuable insights into best practices and areas for improvement.
Why Liquidity Risk Management Matters
Liquidity risk—the ability of a firm to meet its financial obligations without significant losses—has been tested by recent global events, including the COVID-19 pandemic, geopolitical tensions, and market disruptions. Firms that fail to manage liquidity effectively risk financial instability, regulatory scrutiny, and reputational damage. This review will be of particular interest to firms in scope of the governance and liquidity risk management requirements of the Investment Firms Prudential Regime (IFPR), and to UK parent entities of investment firm groups in scope of IFPR.
Good and Poor Practices in Liquidity Risk Management
Through this review, the FCA has outlined key liquidity risk management practices that distinguish well-prepared firms from those that struggle during market stress events. Understanding these practices can help firms strengthen their resilience and align with regulatory expectations.
Good Practices
Firms that demonstrated strong liquidity risk management shared several key characteristics:
- Robust Governance and Risk Culture: Firms with clear governance structures ensured that liquidity risk was a board-level priority. They had dedicated liquidity risk committees and well-defined escalation procedures.
- Dynamic Liquidity Stress Testing: Leading firms conducted daily stress tests, adjusting their liquidity assumptions based on real-time market conditions. This allowed them to anticipate liquidity shocks and take proactive measures.
- Comprehensive Contingency Funding Plans (CFP): Well-prepared firms had detailed CFPs that included multiple funding sources, pre-arranged credit lines, and clear action triggers to respond swiftly to liquidity stress.
- Accurate and Timely Data Reporting: Firms with high-quality data submissions ensured that their liquidity risk assessments were based on reliable information, allowing for effective decision-making.
- Client Risk Awareness: Firms with strong risk management frameworks actively monitored client concentration risks, ensuring they were not overly exposed to a single counterparty.
Poor Practices
On the other hand, firms with weak liquidity risk management exhibited several shortcomings:
- Lack of Liquidity Risk Awareness: Some firms failed to update their liquidity risk assumptions despite experiencing market stress events. They underestimated specific asset risks, leaving them vulnerable to liquidity shocks.
- Weak Stress Testing Frameworks: Firms with infrequent or inadequate stress testing struggled to assess the impact of severe market events. Their models lacked dynamic calculations, making them slow to react.
- Over-Reliance on External Liquidity Facilities: Some firms depended too heavily on parent companies or third-party liquidity providers, assuming they would always have instant access to funding—an increasingly risky assumption in today’s market.
- Ineffective Contingency Funding Plans: Poorly designed CFPs lacked clear triggers and actionable steps, making them ineffective during liquidity crises.
- Data Quality Issues: Firms with inaccurate or incomplete data submissions hindered their ability to assess liquidity risks properly, leading to poor decision-making.
These findings echo requirements under MIFIDPRU 7 of the FCA Handbook, which outlines expectations for liquidity stress testing, contingency funding plans, and risk governance for investment firms. Additionally, the importance of effective risk management processes aligns with SYSC 7.1 (Risk control), which mandates sound and appropriate risk systems.
As financial markets continue to evolve, liquidity risk management will remain a critical focus for regulators and firms alike. By adopting best practices and learning from the FCA’s review, wholesale trading firms can enhance their resilience, protect their financial stability, and build trust with stakeholders.
For more details, you can access the full FCA review here.
How Complyport Can Help
Complyport provides tailored support to help your firm align with the FCA’s expectations on liquidity risk management:
- Prudential Risk Management – Delivery of ICARA support, risk management workshops, and prudential health checks.
- Regulatory Guidance – Expert interpretation of the FCA’s liquidity risk requirements, including under IFPR (MIFIDPRU 7) and SYSC 7.
- Compliance Documentation – Policy reviews and bespoke drafting of liquidity risk and contingency funding documentation.
- Ongoing Regulatory Support – Continuous compliance monitoring as regulations evolve and deepen.
- Authorisation Services – End-to-end support for firms entering the wholesale trading market.
Book a consultation with one of our Subject Matter Experts today.
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