First Consultation Paper on a New FCA Prudential Regime for Investment firms – It’s now time to join the debate!

January 8, 2021 by Clare Curtis

Further to our regulatory insight published in August, the Financial Conduct Authority (“FCA”) in December published CP20/24 (CP20/24) a consultation paper (“CP”) outlining potential changes to the UK Investment Firm Prudential Regime (‘IFPR’). These rules will directly impact investment managers authorised and regulated by the FCA under MiFID and currently fall within the FCA’s BIPRU and IFPRU rules as well as those managers classified as Collective Portfolio Management Investment Firms and advisor / arranger exempt-CAD firms. If you fall within any of these categories you need to be aware of the key changes being proposed, as set out below, and the impact it will have on your business.  

The objectives of the new regime are to streamline and simplify the prudential requirements for solo-regulated FCA authorised investment firms. Introducing the IFPR should mean that there will be a single prudential regime for all FCA investment firms which it is hoped will reduce the barriers to entry and allow for better competition.  Unlike the current regime where there are many different classifications which apply depending on size and type of firm; once implemented these new rules will have only two categories making the regulations much clearer: (1) those firms that meet the criteria to be ‘small and non-interconnected’, and (2) all other firms.

Specific changes the IFPR will introduce include the following:

  • Prudential consolidation – prudential consolidation will apply to investment firm groups, unless the FCA has granted permission to a group to use the alternative of the group capital test. For example, the regulator is proposing to introduce a group capital test for FCA investment firms that do not wish to be subject to prudential consolidation, provided they meet certain specified conditions. 
  • Own funds – the regulator proposes that own funds should be made up solely of common equity tier 1 capital, additional tier 1 capital and tier 2 capital.
  • Own funds requirements – the FCA proposes to implement a new permanent minimum requirement for own funds, based on the activities that an FCA investment firm undertakes. The FCA also propose to increase the initial capital required for authorisation to the same level and quality to the firms ongoing permanent minimum requirement. 
  • Calculation of K-factors – the proposals confirm a new approach for calculating capital requirements – ‘K-factors’. The CP provides details on the additional K-factors that will apply to FCA investment firms, but at present only to those with permissions to deal in investments as principal (i.e. larger investment firms). However, the new The K-factors could apply to any FCA investment firm and more detail will be provided in the next consultation.
  • Concentration risk monitoring – the FCA is proposing new monitoring requirements for general concentration risk that will apply to all FCA investment firms (including entities with which FCA investment firms place client assets and their own cash).
  • Reporting requirements – the CP sets out proposed changes in regulatory reporting to account for IFPR.

The new rules will also extend the framework for prudential requirements to consider the potential harm FCA investment firms pose to clients, consumers and the market, rather than solely focusing on the risks firms themselves face. This will include changes to the amount of capital and liquid assets the an investment firm should hold to ensure that if a firm needs to wind down, they can do so in an orderly manner.

When finalised these new rules will constitute a complete overhaul to the prudential regime for UK firms authorised under the MiFID creating a new regime specifically for investment firms. All firms will need to identify which “class” they fall into, the class will determine which rules they will need to comply with. Whilst many firms have already been aware of the potential changes this CP provides the details required for firms to classify themselves ahead of the final rules and this classification process should be a key priority for compliance teams during 2021.

This publication is the first of three consultation papers, with the FCA planning to publish two further consultations in 2021 (Q2 and Q3). After each consultation, the FCA will ask the industry for feedback via a list of questions within the CPs, review the feedback and then publish a policy statement and near-final rules. Response to the first CP should be sent to the FCA by the 5th February 2021.

It should be noted that the new IFPR will now come into effect for firms on the 1st January 2022, delayed from the original date of 26th June 2021. The delay is due to a mixture of the ongoing COVID-19 pandemic and Brexit uncertainty. However, as the new regime represents a major change for all FCA investment firms, it is critical that firms adequately prepare for the changes during 2021.

How can Effecta Compliance help?

Effecta have been working with firm’s to ensure they understand the changes being proposed and the impact it will have on their business and we continue to ensure our clients remain up to date with the proposals from the FCA as they are released.

Specifically Effecta can help firms with several aspects of their implementation project which could include all or some of the following tasks:

  • 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

If you would like to review the details previously published on these new rules please click on the link below to access the previous regulatory insight published in August 2020: A New Regulatory Capital Regime for MiFID Investment Firms – Effecta Compliance

If you require any assistance with understanding and implementing these rules please do not hesitate to contact Gary Allan,