A New Regulatory Capital Regime for MiFID Investment Firms

August 10, 2020 by Clare Curtis

On 23 June 2020, HM Treasury confirmed that the UK will introduce its own prudential regime for investment firms, the Investment Firms Prudential Regime (IFPR), based on the EU’s proposals (Investment Firm Directive (IFD) / Investment Firm Regulation (IFR)).

This will be the first prudential regime specifically targeted at investment firms and should be in force by Summer 2021. At the same time, the FCA published Discussion paper DP20/2 on “A new UK prudential regime for MiFID investment firms” which would replace categories such as BIPRU and IFPRU firms with three new Classes of firm:

  • Class 1 – Systemic investment firms
  • Class 2 – Larger investment firms
  • Class 3 – Small and non-interconnected firms

It is hoped that this new system based on the scale and scope of activities undertaken should create a more risk-focused prudential regime for MiFID Investment firms.

Its is proposed that a small non-interconnecting firm would typically have AUM < €1.2bn; annual gross revenues < €30m; or daily client orders (cash) < €100m. Investment firms holding client money or assets will not qualify as a Class 3 firm and systemically important; and larger investment firms which carry on own account dealing or underwriting / placing will remain subject to the CRD / CRR.

New minimum capital requirements:

For Class 1 and 2 firms: the higher of: Fixed overheads requirement (FOR); Permanent minimum requirement or initial capital (PMR); or a new K-factor requirement (KFR).

For Class 3 firms: the higher of: FOR or PMR

Initial capital is also expected to increase as follows:

  • €50k – €75k
  • €125k – €150k and
  • €730k to €750k.

The new K-factor is a calculation required for each activity that may potentially harm an investment firm’s clients, itself or the markets; and the sum of these factors is known as the KFR. Although the KFR does not form part of a Class 3 firms own funds requirements, it is still advised that they are considered for capital calculation purposes. It is however the Class 2 firms which are likely to find the biggest change.

Liquidity

Liquidity requirements will also apply to all firms with the definition of liquid assets being expanded from their current definition and a requirement to hold liquid assets equivalent to at least one third of the amount of the FOR.

Internal Capital and Risk Assessment

A new internal capital and risk assessment (ICARA) process will also be introduced. This differs from ICAAP in that it is not focused on prescribed risk categories but looks at broader risks in a firm’s business such as risk to clients and markets or changes in the book value of assets. The FCA has stated that it would require all Classes of firms to put in place some sort of ICARA process in line with nature and scale of the business.

Group Capital Test

One of the key areas where the current proposals have differed greatly from the original text is in relation to Groups. Under the proposed new rules groups must consider the overall risk the group poses to clients and markets. This review would need to be undertaken by the parent entity, rather than the authorised firm. This means parent undertakings which may otherwise be unregulated will have to meet regulatory obligations and consolidated prudential requirements as they would apply to the whole group under these proposals. The EU regulations do allow for some derogation from the requirement for an investment firm group to have to comply with all the obligations of prudential consolidation so that an investment firm in a group is not exposed to unnecessary financial strain due to its membership of that group.

Public disclosure

Investment firms will generally have to publish information on risk management, governance, own funds, remuneration, and investment policy. In due course, they will also have to publish information relating to environmental, social and governance risks (ESG) under the Sustainable Finance Disclosure Regulation (SFDR), set to commence in March 2021.

Transition

There will be a transition period of up to 5 years for some of the requirements.

How can Effecta help?

Effecta can help firms with their implementation project and his can include for instance:

  • confirming a firm’s classification under the regime;
  • verifying a firm’s K-factor assessment;
  • evaluating the scope of group consolidation;
  • performing a gap analysis in areas of significant change, eg governance and remuneration