New Prudential Regime for MiFID Investment Firms

MiFID Investment Firms

January 11, 2022

MiFID investment firms across the EU became subject to the Investment Firms Regulation (IFR) and the Investment Firms Directive (IFD) from June 2021. UK MiFID investment firms will be subject to a distinct but substantially similar UK regime (the Investment Firms Prudential Regime (IFPR)) that comes into force in January 2022.

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 was designed for credit institutions like banks that take deposits and make loans but also captured investment firms.

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. The UK left the EU in January 2020 but has proposed a substantially similar regime.

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

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 regimes. 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
UK Update

In October 2021, the Financial Conduct Authority (FCA) published their final rules on IFPR ahead of it coming into force on 1 January 2022.

This follows Policy Statement (PS21/9) issued in July 2021 with near-final rules, and Policy Statement (PS21/6) issued in June 2021 which provided final rules and feedback to the first consultation paper. The FCA have also published their third and final policy statement (PS21/17) focused on disclosures at the end of November 2021.

The provisions of the IFPR will be contained in a new MiFID/PRU sourcebook in the FCA handbook with a separate sourcebook on remuneration requirements.

 

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 (December 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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