potential harm analysis and risk management framework
by Anthony Ma potential harm analysis and risk management framework ‘Risk of harm’ is a central concept in FCA’s Approach to Supervision, Guidance FG20/1, and various policy papers related to the new Investment Firm Prudential Regime (IFPR, or ‘MIFIDPRU’). Two questions would be of interest to risk managers in FCA solo-regulated firms: 1.) Is ‘risk of harm’ a new risk category in a firm’s risk taxonomy? 2.) What are the implications to a firm’s risk methodology? Conceptual clarity is crucial to risk assessment processes such as Pillar 2 or ICARA.
aligning with the FCA’s methodology From the FCA’s perspective, ‘risk of harm’ means risk to FCA regulatory objectives due to the harm caused by firms to their customers and the markets. Hence, the FCA will do business model analysis to identify such risks and take actions when risks of harm materialize. But the FCA also asks firms to identify risks of harm, especially for investment firms in their ICARA process. This does not mean there will be new risk categories in a firm’s risk taxonomy. But it will imply some adjustments to a firm’s own risk framework. In practice, financial institutions usually view risks as uncertainties that will lead to negative variability to their revenue and profits. Even conduct-related risks are ultimately focusing on the financial impact on the firm due to conduct failures. To embed the ‘risk of harm’ approach in the risk methodology, firms must explicitly identify the victims outside the firm. i.e., a potential harm analysis. The analysis requires consideration of the negative impact on these stakeholders and evaluation of the redress actions that the firm is expected to take. Effectively, this is a pervasive embedment of conduct outcome analysis in the risk management framework. In addition, the risk of harm also includes risk of harm to the firm itself. Broadly speaking, this covers existing credit risk, market risk, liquidity risk etc. analyses. There is perhaps no harm to other stakeholders involved in this context. However, if these risks materialize and lead to significant capital depletion or liquidity difficulties, then the FCA would want to ensure there is an effective recovery, or an orderly winddown. It is understood that disorderly wind-down of a financial institution presents great deal of harm to customers and to the market.
Intelligent Risk - February 2022
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