New Prudential Regime for MiFID Investment Firms

MiFID Investment Firms

September 3, 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 became subject to the Investment Firms Regulation (IFR) and the Investment Firms Directive (IFD) from June 2021. Whilst the FCA will introduce a new UK prudential regime for UK MiFID investment firms to come into force in January 2022, the UK Investment Firms Prudential Regime (IFPR) is largely based on the 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) was introduced after the last financial crisis. This regime is more suitable for credit institutions like banks that take deposits and make loans.

In December 2019, the European Parliament approved a new prudential regime for investment firms. This represented a significant reform in the EU regulatory framework and will 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 EU regime re-focuses 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 papers 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 published three consultation papers and two policy statements 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

In April 2021, the FCA issued their second consultation paper (CP21/7) which covered the following areas:

  • 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

Third Consultation Paper

In August 2021, the FCA issued its third and final consultation paper (CP21/26).

The main themes are:

  • Disclosure requirements—including remuneration—but not ESG*
  • Recovery planning requirements
  • Application and notification forms
  • Enforcement

* The FCA changed its mind on ESG disclosures and there will now not be any ESG disclosure requirements under UK IFPR on day one. The FCA said that it wants to wait, given that there are so many other ESG developments, particularly at the international level and will see how this develops before imposing ESG disclosure requirements under UK IFPR.

Policy Statement to the First Consultation Paper

In June 2021, Policy Statement (PS21/6) provided final rules and feedback to the first consultation paper (CP20/24). The areas covered were:

  • Categorisation of investment firms
  • Prudential consolidation of the group and capital tests
  • Own funds requirements and transitional arrangements
  • Concentration risk and K-CON
  • Reporting requirements

Policy Statement to the Second Consultation Paper

In July 2021, policy statement (PS21/9) provided information and near final rules in the areas of:

  • Own funds requirement
  • Firms acting as clearing members and indirect clearing firms
  • Basic liquid asset requirement
  • Risk management, Internal Capital and Risk Assessment (ICARA) and Supervisory Review and Evaluation Process (SREP)
  • MIFIDPRU Remuneration Code
  • Governance
  • Regulatory Reporting
  • Summary of amendments to the Handbook text
  • Interaction with MIFIDPRU and other prudential sourcebooks
  • Applications and notifications
  • Summary of amendments to the Handbook text

Next steps: The FCA will issue a third and final policy statement and final rules in October-November 2021, ahead of IFPR coming into force on 1 January 2022.

The provisions of UK IFPR will be contained in a new MiFIDPRU sourcebook with a separate sourcebook on remuneration requirements.

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 took effect from June 2021
  • The UK IFPR will take effect from 1 January 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 policy statement (PS21/9) provided clarifications and near final rules on the FCA’s proposed remuneration requirements for investment firms. The FCA has published its single remuneration code to be known as 'the MIFIDPRU Remuneration Code'. This will become new SYSC 19G in the FCA Handbook and will replace the BIPRU and IFPRU Remuneration Codes. The new remuneration rules enter into force on 1 January 2022. Investment firms will therefore have to apply the new rules from the start of their next performance period beginning on or after that date.

The remuneration requirements include:

  • All investment firms will have to comply with a small number of basic remuneration requirements dependent on how the investment firm is classified under the new regime:
    • Smaller and non-interconnected (SNIs) - Basic Remuneration requirements apply
    • Non-SNIs not classified as Largest non-SNIs - Standard Remuneration requirements apply
    • Largest non-SNIs - Extended remuneration requirements apply
  • 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 i.e., MRTs.
  • MRTs will only be identified on the basis of qualitative criteria, and there is no requirement to identify MRTs based on remuneration alone.
  • 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 (September 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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