New Prudential Regime for MiFID Investment Firms

MiFID Investment Firms

May 31, 2021

All MiFID investment firms will be subject to a new prudential regime tailored for their business model, risk profile, complexity and interconnectedness.

MiFID investment firms across the EU will be subject to the Investment Firms Regulation (IFR) and the Investment Firms Directive (IFD) from June 2021. Whilst the FCA has made clear its intention to introduce a prudential regime for UK MiFID investment firms, the Investment Firms Prudential Regime (IFPR), which is largely based on EU IFR/IFD with amendments to account for the specifics of the UK market.

Explore our insights and what this might mean for your firm.

Background

The current prudential regime of the Capital Requirements Regulation and the Capital Requirements Directive (CRR/CRD), which was introduced after the last financial crisis, is more suitable for credit institutions like banks that take deposits and make loans, and is not suited to investment firms.

In December 2019, the European Parliament approved a new prudential regime for investment firms which represented a significant reform in the EU regulatory framework and will likely have a material impact on most investment firms.

Both the UK and EU regimes present a range of challenges for firms covering capital, liquidity, risk management, remuneration, group consolidation, disclosure and reporting.

The EU IFD/IFR creates a prudential framework tailored to various ‘classes’ of investment firms that is intended to be more proportionate, risk-sensitive, and adapted to investment firms’ business models and risk profiles, than the current CRD regime. The new regime will re-focus the prudential requirements and expectations away from the risks the firm faces, to prioritise the assessment of potential harm to clients and the market.

As part of its implementation of the investment firms’ prudential framework the European Banking Authority (EBA) has published a number of consultation paper on:

  • Regulatory Technical Standards on disclosure of investment policy by investment firms (under development)
  • Guidelines on internal governance for investment firms (under development)
  • Guidelines on remuneration policies for investment firms (under development)
  • Regulatory Technical Standards on prudential requirements for investment firms (Final draft adopted by the EBA and submitted to the European Commission)
  • Regulatory Technical Standards on own funds requirements for investment firms (adopted and published in the Official Journal)

The FCA has so far published two of its three proposals to implement a new prudential regime specifically tailored for MiFID investment firms in the UK, based largely on the EU’s IFD/IFR.

In June 2020, the FCA issued its proposal for the implementation of equivalent requirements in the UK through Discussion Paper (DP20/2 Prudential requirements for MiFID investment firms).

Key points:

  • Pre-Brexit, the FCA had significant involvement in policy discussions about the EU's regime and has made it clear that it will look to achieve similar intended outcomes as the IFD/IFR whilst taking into consideration UK market specifics.
  • The FCA has confirmed that the targeted implementation date for the introduction of the IFPR will be 1 January 2022, six months after the IFR/IFD.

First Consultation Paper

In December 2020 the FCA issued their first consultation (CP20/24) on the new UK Investment Firm Prudential Regime (IFPR), the consultation paper covered the following areas:

  • Categorisation of small non-interconnected firms (SNI) and thresholds;
  • Prudential consolidation;
  • Own funds resources and aspects of the own funds requirement;
  • Concentration risk;
  • Reporting requirements.

Second Consultation Paper

Following the first consultation (CP20/24), on 19 April 2021, the FCA issued their second consultation paper (CP21/7) on the new prudential regime for investment firms. This second consultation paper seeks views on:

  • Remaining aspects on own funds requirements (such as the Fixed Overheads Requirement);
  • The basic liquid assets requirement;
  • Remuneration requirements;
  • Risk management – the Internal Capital and Risk Assessment (ICARA) process.

Next steps: The FCA will publish the Policy Statement to their first CP (CP20/24) and near-final rules in Q2 2021, and will also issue a third and final consultation in Q3 2021, ahead of the final rules coming into force on 1 January 2022.

Scope of the New Prudential Regimes

With the exclusion of a few large and systemically significant investment firms that will remain subject to CRD/CRR, all investment firms that are currently authorised under MiFID (including exempt Capital Adequacy Directive (CAD firms)) will be in scope of the new regime. The degree of regulation will depend on the firm's particular business activity, risk profile and structure, which in turn dictates their new prudential Class.

Timeline
  • The EU IFD and IFR will take effect from June 2021.
  • The UK IFPR will take effect from the beginning of 2022.

 

EU IFR vs UK IFPR Divergence

Remuneration Requirements for Investment Firms

IFR/IFD contains a new set of rules on remuneration. Many MiFID investment firms will already be subject to, and therefore familiar with, remuneration rules under the current Capital Requirements Directive, which align very closely with the IFD/IFR remuneration rules.

IFD’s renumeration rules apply depending on the investment firm’s classification:

  • Class 3 Firms are exempt from the remuneration requirements whilst Class 1 firms will be subject to the CRD IV’s remuneration requirements.
  • Class 2 Firms are in scope and must apply specific requirements to their material risk takers (“MRTs”) including variable pay in instruments, deferral of a proportion of variable pay, malus and clawback.
  • Class 2 Firms will also need to publicly disclose certain aspects of their remuneration policy and may need to establish a remuneration committee.

The second consultation paper (CP21/7) sets out the FCA’s proposed remuneration requirements for the investment firms, including draft proposals for all FCA investment firms to be subject to a new remuneration code (SYSC 19G).

The proposals further include:

  • All investment firms will have to comply with a small number of basic remuneration requirements with non-SNI firms subject to more detailed requirements.
  • The basic remuneration requirements apply to all staff in investment firms whereas the additional rules to be applied by non-SNIs are applicable only to individuals identified as MRTs.
  • Allowing MRTs who earn below a certain amount to be exempt from the rules on deferral of variable remuneration, payment in instruments, retention periods and certain rules relating to discretionary pension benefits.
Linda Gibson, Director of Regulatory Change (May 2021)

Although the proposed prudential regime for MiFID investment firms is better aligned to their business models, some firms will face significant changes under the new regime. Those firms who experience a significant increase in their capital requirement can avail of transitional phasing over a five-year period out to June 2026 (EU-based firms). The introduction of K-factors brings the most significant challenges for firms who will need to monitor relevant data to facilitate their reporting responsibilities.

Impacted firms should be project planning, identifying which classification they will fall into and identifying any changes that they need to make to their regulatory capital, liquidity arrangements and remuneration policies.

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