BACKGROUND
The previous prudential regime of the Capital Requirements Regulation and the Capital Requirements Directive (CRR/CRD) was introduced after the financial crisis of 2008. This regime was designed for credit institutions like banks that take deposits and make loans but also captured investment firms.
The new regimes created 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-focused 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 remained subject to CRD/CRR, all investment firms that had been authorised under MiFID (including exempt Capital Adequacy Directive (CAD firms)) are 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 took effect from 1 January 2022
UK ICARA
The Internal Capital Adequacy and Risk Assessment (ICARA) was introduced as a replacement for the Internal Capital Adequacy Assessment Process (ICAAP). Some elements of the ICARA process are similar to the legacy ICAAP, but most firms have needed to adapt to the new framework in line with the FCA objectives of creating a risk-focused and commensurate capital framework.
The ICARA requires firms to have adequate financial resources to remain financially viable throughout the business cycle and enable them to conduct — with appropriate financial resources — an orderly wind-down. The process includes assessing and scoring risks to the business, stress testing, recovery planning and wind-down planning. These components are intended to demonstrate that firms are meeting the Overall Financial Adequacy Rule (OFAR), the minimum threshold for firms' financial resources.
Importantly, the ICARA is intended to provide information to enable senior managers to make decisions on the appropriate amount and quality of own funds and liquid assets that are proportionate to the nature, scale and complexity of their firms’ activities.
EU IFR vs. UK IFPR Divergence