How to design and implement an effective ICARA

Robust prudential requirements are prescribed within the European Investment Firms Regulation (IFR) and Directive (IFD), accounting for the specific risks entailed in the provision of investment services. EU-regulated investment firms, such as Cyprus Investment Firms (CIF), shall employ sound processes for assessing and maintaining capital and liquidity levels, proportionate to the nature, scale and complexity of their activities. For that purpose, a CIF is required to design and implement an effective Internal Capital Adequacy Risk Assessment (ICARA) process to determine adequately the said levels.

Within this article, the SALVUS Risk Management team outlines important information for the ICARA process and discusses specific implementation principles and factors, as follows:

1. What is ICARA?
2. What are the ICARA implementation principles?
3. ICARA building blocks
4. Implementation success factors

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1. What is ICARA?

Under the scope of IFR, the Internal Capital Adequacy Risk Assessment (ICARA) process is considered an enhancement of the Internal Capital Adequacy Assessment Process (ICAAP).  ICARA follows the Pillar II prudential requirements for investment firms considering the prudential requirements of the IFR. According to Basel II Capital Accord structure, Pillar II assesses the completeness and adequacy of a firm’s capital concerning the risks the CIF is facing or might be exposed to.

Now, ICARA is further analysed into the

  • Internal Capital Adequacy Assessment Process (ICAAP), through which the CIF
    • identifies and assesses the risks that it is exposed to,
    • ensures that it maintains sufficient capital to face the presented risks,
    • develops appropriate risk management methods and tools to manage these risks.
  • Internal Liquidity Adequacy Assessment Process (ILAAP), through which the CIF
    • detects and evaluates the risks that it is exposed to, specifically to the amounts, types, and distribution of liquid assets,
    • assesses the procedures and systems employed for the measurement and monitoring of liquidity risk and the level of available liquid resources.

For investment firms, except for the ICARA process, Pillar II also includes the Supervisory Review and Evaluation Process (SREP). The SREP is conducted by the respective national competent authority (NCA) of the EU member state, which for CIF regulated entities is the Cyprus Securities and Exchange Commission (CySEC). SREP aims to identify important weaknesses and risks within the firm’s internal controls and communicates them back to the firm for the necessary mitigation measures to be taken.

2. What are the ICARA principles?

The ultimate responsibility of having in place, an effective ICARA lies with the CIF, irrespective of whether this is outsourced to a third party or not. In this respect, the ICARA shall be implemented based on the following principles:

  • the ICARA design should be fully specified and approved by the Board of Directors (BoD) and implemented by the Senior Management (SM).
  • the ICARA results should be reported to the SM and BoD.
  • should form an integral part of the management decision-making, that allows the SM and BoD to assess the business’s inherent and material risks, on an ongoing basis.
  • should be reviewed regularly and at least annually, to ensure that the identified risks are covered adequately and that the capital and liquidity reflect the CIF’s risk profile.
  • should be subject to an independent assessment by the firm’s Internal Auditor.
  • should be adjusted based on changes that occurred in the CIF’s strategy, business plan and operating environment.
  • should be risk-based, where additional capital charge arises from the CIF’s risk profile and operating environment.
  • should be comprehensive and capture all material risks the CIF is exposed to.
  • should be forward-looking, coinciding with the CIF’s strategic plans.
  • should result in a reasonable outcome, with the CIF being able to provide sufficient evidence and justification for the methods used to derive the capital requirements.

We would like to stress that ICARA requires adequate measurement and assessment of the risks faced. Such assessment processes should be proportional to the complexity of operations and the availability of resources.

3. ICARA building blocks

The process of ICARA plays a pivotal role in the CIF’s risk management practices and facilitates the business’s strategic and operational management. Thus, it builds on the following eight blocks:

  • Plan & Design
  • Assessment of the Internal & External Business Environment
  • Assessment of the Internal Governance and Control system
  • Risk Management Framework
  • Identification of Future Business Plans and Objectives
  • Stress Testing
  • Pillar II Capital Allocation & Additional Controls
  • Next Steps & ICARA Report

At this point we must highlight that projected Pillar II capital needs, based on capital planning and the budget prepared, shall be compared to the firm’s available capital and own funds.

4. Implementation success factors

The successful implementation of ICARA can be achieved in consideration of the following factors

  • Early detection of weaknesses – comparison of the current procedures concerning capital and risk management, internal governance and control system versus the required ones.
  • Plan development – provisioning for all implementation activities by prioritising tasks, allocating human resources and setting adequate timeframes.
  • BoD and SM engagement – effective communication of the results and actions taken, for the BoD and SM to make informed decisions on capital and liquidity management.
  • Communication to all employees – of the advantages and the need for implementing ICARA, as well as changes in the organisational structure.
  • Data quality – use of complete and accurate data that ensures the generation of reliable results.

Final thoughts

In conclusion, the ICARA process is a valuable tool for determining whether a firm maintains adequate capital and liquidity reserves and manages risks that fall in or out of the set risk limits and appetite efficiently. For that reason, stakeholders of a CIF shall be able to design and implement the ICARA process effectively, addressing existing weaknesses and budgeting for its capital and liquidity resources.

In this respect, SALVUS Funds in collaboration with the Institute for Professional Excellence (IforPE) has developed a self-study Continuous Professional Development (CPD) course with the title Internal Capital Adequacy Risk Assessment Process (ICARA): practical examples and stress testing. The course is geared towards Compliance and Risk Management Officers, as well as Brokerage and Dealing on Own Account (DOA) Officers.

The course is designed to provide professionals with all the necessary information about ICARA, ICAAP and ILAAP, and guide them on how to create a complete ICARA report through practical examples of the required risk assessment analysis and stress testing.

Lastly, the SALVUS Risk Management team can support investment firms in establishing an effective ICARA process and report and support them, as well as other CySEC regulated entities through their capital and liquidity needs.

Contact us at [email protected] or call us at +357 7000 7898 if you have any questions about your ICARA process and report or require more information about our ICARA course on IforPE.


Should you be interested to read more about the IFR & IFD framework, the ICAAP, or Cyprus Investment Firms, please visit the selected articles below:

The information provided in this article is for general information purposes only. You should always seek professional advice suitable to your needs.

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