Preparing an Application for Authorisation: Financial forecast and Stress Testing

Background

Electronic Money Institutions (EMI) and Payment Institutions (PI) are required to submit a financial forecast, covering a period of three financial years, with their application for authorisation. The financial forecast will need to demonstrate that the firm is able to employ “appropriate and proportionate systems, resources and procedures that allow the applicant firm to operate soundly”.

The financial forecast will need to be prepared at a reasonable level of detail, and presented as a Profit & Loss Statement, Balance Sheet and Cash Flow, with accompanying descriptions of the assumptions upon which the forecast has been made. An accompanying narrative should also be included.

A summary of the financial forecast should be included in the Regulatory Business Plan, a key submission document, and the forecast model also included as a supporting document in the application submission. The FCA have also published their own template which will need to be completed and submitted (this is quite high-level so your underlying model should also be submitted).

The FCA will review the financial forecast as part of the assessment of the application for authorisation and will seek to ensure that the forecast, and its assumptions, are consistent with the other descriptions provided in the application (e.g. staffing levels, outsourcing arrangements, service developments, etc.). Consistency between the written content and the numbers is important!

The two main concerns of the FCA, when reviewing the financial forecast, tend to be:

• Whether the business meets its capital requirements; and
• Whether there will be sufficient cash to remain a ‘going concern’ (an accounting term referring to the ability to meet liabilities as they fall due).

Stress tested financial forecasts, as described below, will also need to be submitted in the application.

Duration of the financial forecast

The financial forecast to be included in the application for authorisation will need to cover a period of three financial years from the expected date of authorisation. It would be reasonable to expect the FCA’s assessment of an application for authorisation to take in the region of 6 months (following the date of submission). As such, a view will need to be taken on which financial years should be included. For example, if an application is going to be submitted in March and your year-end date is 31 December, the first financial year for the forecast could reasonably be the current financial year. If submitting in September however, the first financial year should be the following year (since September to December is a bit too short a period).

Scope of the financial forecast

The forecast should be prepared for the applicant entity and be consistent with the written content provided in the Regulatory Business Plan. For example, the forecast will need to be consistent with the written descriptions of the scope of services to be provided, service development plans, marketing activities, number of staff / employees, recruitment profile, outsourcing arrangements, provision of any unregulated services, etc.

If the applicant is part of a group the forecast may need to include some inter-company charges / revenues in relation to the outsourcing arrangements with the group or the reimbursement of the applicant’s costs from the group. Inter-company costs are often recharged using a ‘Cost Plus’ model (this can help the applicant firm maintain capital to meet regulatory requirements).

The application will need to include a financial forecast, and detailed assumptions, for a ‘Base Case’ as well as under stress scenarios – ideally two stress scenarios would be included, basically ‘flexing’ the assumptions made under the Base Case.

Preparing a forecast model

A forecast model should be prepared, using Excel or similar, that facilitates the entry of assumptions to drive the production of the forecast Profit & Loss, Balance Sheet and Cash Flow statements. The model for the Base Case can then be replicated to produce the stress scenario models. These will then need to be submitted to the FCA as part of the application.

The forecast model should be agreed by the Board and used to prepare the written narratives regarding the forecast financials that are included in the Regulatory Business Plan. The model will need to cover the three financial years, as determined above, and as a prudent measure (in case of delayed assessment by the FCA) include an additional year for good measure. The model should be prepared on a monthly basis, i.e. assumptions and the financial statements that are generated will be shown on a monthly basis.

The workings and assumptions included in the model will need to be consistent with the assumptions described in the Regulatory Business Plan. Given that the model will be submitted as part of the application for authorisation you will need to be comfortable that questions raised by the FCA can be answered.

Stress testing the forecast

The Base Case financial forecast will need to be stress tested, ideally to produce two additional stressed scenarios for description in the Regulatory Business Plan with the separate models being submitted as part of the application.

The stress scenarios should make some negative assumptions compared to the Base Case, for example, increased competition in the FinTech market resulting in reduced customer numbers and lower fees / charges as well as increased staffing costs (due to increased competition for recruitment). Additional scenarios could be based on recession, business failures / losses, inflationary pressures, etc.

What do we need to describe in an application for authorisation?

The financial forecast models for the Base Case and stressed scenarios will need to be submitted as part of the application for authorisation and be described in the Regulatory Business Plan.

The Regulatory Business Plan could show separate summary and detailed tables presenting the Profit & Loss, Balance Sheet and Cash Flow with written details on the assumptions relevant to each. The tables in the body of the Regulatory Business Plan could show annual figures and then monthly figures included in an appendix. There is no set format to present the information (other than the FCA’s template mentioned above) – it just needs to be reasonably comprehensive and clear to the reader (including the FCA Case Officer tasked with assessing your application).

How we can assist

We have significant experience in preparing applications for authorisation, including work on financial forecasts and stress testing, gained over our 20+ years providing support to UK and EU fintech firms. If you are working on an application for authorisation and require help on your financial forecasting please reach out to us.