This article has been updated as at 13 January 2021.
Last June, the FCA set out its proposals to implement a new Investment Firms Prudential Regime (IFPR) based upon the EU’s Investment Firms Regulation and Investment Firms Directive (IFR/IFD). These proposals were published in discussion paper (DP 20/2).
December 2020 saw the FCA publishing its first consultation paper on the IFPR proposals (CP 20/24). This paper contains the draft text for much of MIFIDPRU – the new prudential sourcebook for investment firms. The FCA plans to publish two more consultation papers covering aspects of the IFPR. It is currently working towards an implementation date of 1 January 2022 for all of the new rules.
In this briefing we aim to provide an overview of the key proposals as well as answers to some commonly asked questions.
Key changes at a glance
|Prudential categorisation||The prudential categories currently applicable to MiFID investment firms, such as IFPRU, BIPRU and Exempt CAD, will cease to exist. All subsidiary categorisations such as IFPRU limited activity firm, IFPRU limited licence firm etc will also cease to apply.|
|Existing prudential regimes to be disapplied for most investment firms||
Most firms currently categorised as IFPRU firms will no longer be subject to the requirements of the Capital Requirements Regulation (CRR). Firms categorised as BIPRU firms will not longer be subject to BIPRU. The new MIFIDPRU sourcebook will instead apply to all MIFID investment firms.However, a small number of larger interconnected investment firms permitted to deal on own account and/or underwrite on a firm commitment basis will remain subject to CRR and will therefore be out of scope of the new regime. These are already prudentially supervised by the PRA.
|Proportionality for smaller firms||Some investment firms which do not hold client money or assets and are not permitted to Deal on Own Account and meet other size tests will fall under a new category of “small and non-interconnected investment firm” (SNI). These firms will be able to benefit from additional proportionality under the new regime.|
|Own Funds Requirement||
There will be changes to the amount of Own Funds a firm will have to hold in order to meet the Initial Capital Requirement required to become authorised. This Initial Capital Requirement will become an investment firms’ permanent minimum requirement (PMR). In addition, firms subject to the regime will be required to calculate a fixed overhead requirement (FOR) and some firms will additionally be required to calculate a new activity based “K-factor” Own Funds Requirement (KFR).
All firms will be required to monitor and control their concentration risk.
Those which are not SNIs will need to report concentration risk to the FCA.Only firms with a Trading Book are subject to the K-CON Own Funds Requirement.
All investment firms will have a basic liquidity requirement based on holding liquid assets equivalent to at least one third of their fixed overhead requirement.
Investment firm only groups will still be required to apply group consolidation when calculating their regulatory capital requirements and undertaking their ICARA Process. This is similar to CRR’s Prudential Consolidation Regulations.For investment firms within non-investment firm groups these will remain subject to prudential consolidation from existing provisions such as those of CRR.
|Group Capital Test||
However, firms now have available to them the concept of the “group capital test” (GCT) which is expected to provide firm by firm relief from some prudential consolidation requirements. The GCT may be more appropriate to an investment firm group otherwise subject to the prudential consolidation provisions. These groups will have to make an application to the FCA for such an approach in preference to Prudential Consolidation.
|Existing waivers to cease||
Investment firm consolidation waivers and permissions granted under Article 15 CRR will fall away and not be available under this new regime. Such groups will have to consider the GCT rules closely and apply for these where possible.Importantly there will be no relief from deducting intangible assets when calculating consolidated Own Funds.
|Remuneration codes||The IFPRU and BIPRU remuneration codes will be replaced with a single remuneration code for investment firms. CPMI will remain subject to SYSC19B but will interact, as SYSC19C does now for BIPRU CPMI, with the new IFPR SYSC19 code.|
|Supervisory reporting requirements||Reporting requirements are expected be more appropriate and proportionate for investment firms (especially when compared to current requirements under the CRR). as the new forms are intended to be less complex than the COREP forms.|
|FCA powers to apply individual requirements||The FCA will have the power to require firms to hold more capital if they think that this is necessary following a supervisory review. Limits to variable remuneration, additional reporting requirements or specific liquidity requirements can also be imposed.|
|Transitional provisions||The new regime will include transitional provisions which will vary depending upon the prudential classification of a firm (ie IFPRU, BIPRU etc) immediately before the date the rules come into force.|
Commonly asked questions
Which types of firms will be affected by the new rules?
All investment firms which are authorised by the FCA in accordance with the provisions of MiFID should consider how the IFPR will affect them.
The new regime will not apply to banks, which will remain subject to the requirements of the on-shored CRR legislation (UK CRR), and insurers, which will remain subject to the on-shored Solvency II legislation.
Types of firm likely to be affected include FCA authorised (solo regulated) firms who manage investments, such as asset managers and some wealth managers, as well as those who provide investment advice, dealing or arranging services or who carry on other MiFID business. The FCA has also announced that IFPR will apply to collective portfolio management investment firms (CPMIs), in regard to their additional activities.
The current prudential categorisation of these types of firm depends upon their regulatory permissions. Some UK investment firms are currently be classed as IFPRU firms. Other firms (those who do not have permission to hold client money or client assets or deal in investment as principal) may be classed as BIPRU firms and those who are permitted only to advise and/or arrange may be in other “legacy” prudential categories, such as Exempt CAD. Under the proposed new regime, these prudential categories will cease to exist – most MiFID investment firms will simply be known as “investment firms” and will be subject to the IFPR.
Large investment firms (ie those with consolidated assets in excess of £15 billion and who have dealing on own account and/or underwriting permissions) will remain subject to the requirements of the UK CRR.
All other investment firms, regardless of their size or current prudential category, will move to the new regime and will need to consider how the new rules apply to them.
We are a small investment firm. Will the rules apply in a proportionate manner?
An investment firm which meets certain will be considered a “small and non-interconnected investment firm” (or SNI). The new prudential regime does apply to these firms but SNIs will benefit from additional proportionality and so less onerous prudential requirements. This includes less onerous Own Funds Requirements, reporting, disclosure and remuneration requirements.
In order to be an SNI, a firm must not hold client assets or client money. It must also satisfy other activity-related criteria and stay under certain AUM, balance sheet, earnings and other thresholds.
These thresholds are not insubstantial, for example, assets under management must be less than £1.2 billion, balance sheet size must be less than £100 million and total annual gross revenue from investment services must be less than £30 million, breach of any results in not being classified as an SNI. However, it is important to note that some of the thresholds are applied on a group basis, so when calculating whether your firm could be an SNI, you will have to take the effect of any group consolidation into account. The FCA has yet to clarify those entities which must form part of a "group" when determining these thresholds.
We are an AIFM with additional permissions to conduct investment activities. Do the new rules apply to us?
Yes. Some fund operators will need to take note of the new regime. UCITS ManCos or AIFMs who are permitted to undertake additional activities which allow them to undertake investment business (so called “collective portfolio management investment firms” or CPMIs) will also have to consider the new regime as they are authorised to undertake MiFID investment business.
How will our regulatory capital requirements change?
There will be changes to the Own Funds to meet the initial capital requirement that firms are required to hold in order to become authorised. This initial capital requirement will become an investment firms’ permanent minimum requirement (PMR).
In addition, all firms subject to the regime will be required to calculate a fixed overhead requirement (FOR) and some firms will be required to calculate a new activity based “K-factor” requirement (KFR).
An investment firm’s new Own Funds Requirement will be the higher of PMR, FOR and KFR.
Permanent minimum requirement
A firm’s PMR will depend upon the activities which it is permitted to undertake. This will be £75,000 or £150,000 for most smaller firms. Some activities (for example dealing on own account and underwriting) bring with them a significantly higher PMR of £750,000.
Fixed overhead requirement
Currently, a subset of investment firms are required to calculate their FOR. Under the IFPR, the requirement to calculate FOR will apply to all investment firms, including those previously classified in the UK as full scope investment firms. As currently, it is set at one quarter of the previous financial year’s audited fixed overheads. However, firms need to be careful to compare the current basis of calculating their fixed overheads with those proposed under IFPR.
KFR is a new Own Funds Requirement metric. It is intended to be a better way of reflecting the potential harm that an investment firm can do to its clients, the markets and to itself. KFR will be based on the type and scale of an investment firm’s activities. Broadly, an Own Funds Requirement is calculated for each activity and the sum of these requirements is the overall KFR Own Funds Requirement. KFR will not apply to firms who are deemed to be SNIs
Are the Own Funds Requirement for Investment Firms likely to increase or decrease?
As a result of these changes, current requirements will likely decrease for some investment firms and increase for others.
For some investment firms the increase in order to meet their new Own Funds Requirement will be significant, for example current Exempt CAD firms. The FCA has indicated that this reflects that some current requirements have not been updated since 1993, despite the significant changes in the size of firms and the nature of markets and business models.
To help investment firms accommodate the change, the IFPR introduces a transition period of up to five years for investment firms that are subject to lower capital requirements under the current regime than those of IFPR. This will include yearly stepped increases to the amount of Own Funds that an investment firm is required to hold in order to ease the change from any existing requirements, or other type of capital requirements, to the full application of Own Funds Requirements under the IFR.
We do not have a trading book. Will we still be expected to monitor concentration risk?
Yes. Under the IFPR all investment firms will be expected to monitor and control concentration risk. Although concentration risk includes exposure values for those firms with a trading book, it is not limited to this. All investment firms (whether they have a trading book or not) will be required to take account of any concentration in assets including debtors, off-sheet balance items. Firms will also be expected to monitor concentration risk arising from broader items such as location of client money or assets, a firm’s own cash deposits and the firm’s own earnings.
Non-SNI firms without a trading book will be required to report, not only monitor, these concentration risks, to the FCA.
We do have a trading book. How does this impact concentration risk?
In addition to monitoring and reporting concentration risk as set out above, if a firm has a trading book it is then subject to K-CON, the Concentration Risk Own Funds Requirement. Broadly where trading book exposures exceed the "soft" concentration risk limits (the amount depends on the type of entity to whom the firm is exposed) it will need to hold further Own Funds to cover the higher impact that this can have on them.
What are the new liquidity requirements?
Currently, not all UK investment firms must satisfy quantitative liquidity requirements (as set out in BIPRU 12.) However, the IFPR will introduce quantitative liquidity requirements to all investment firms, including SNIs.
The purpose of these requirements is to ensure that investment firms have some resilience to sudden liquidity shocks – and that they would be able to continue to function (or exit the market without disruption) by continuing to fund their overheads for a given period and without having to rely upon continued income.
The baseline requirement is that investment firms will be required to hold certain types of liquid assets to an amount of at least a third of their FOR, plus 1.6 per cent of any guarantees given to clients. A wide variety of instruments can be counted as liquid assets (eg trade debtors can be included to a point) but certain assets will be subject to a “hair-cut” as to their deemed value.
Our firm is part of a prudential consolidation group. Will we have to consider prudential consolidation under the IFPR?
If your firm is part of a wider group you will likely be familiar with prudential consolidation. Currently both IFPRU firms and BIPRU firms are required to determine whether they are part of a prudential consolidation group and, if they are, they must calculate their Own Funds and Own Funds Requirements, and report, on a consolidated basis.
Under the IFPR, investment firm groups will still be required to apply group consolidation when calculating their Own Funds Requirements.
The IFPR will use the concept of an “investment firm group” which does not include credit institutions. Although the way in which an investment firm group is triggered is very similar to consolidation groups under CRR and BIPRU, changed terminology and definitions may mean the entities within an IFPR consolidation group will be different (particularly if your current group includes asset management companies). Investment firms within a group containing banks will remain subject to CRR prudential consolidation. Firms should not assume that their consolidation group under the new regime will remain the same as under the CRR or BIPRU.
Currently, the obligation to undertake consolidated reporting for the group always falls upon a regulated entity (usually the uppermost regulated “trigger entity” in the consolidation group). However, under the IFPR, reporting obligations will fall upon the head entity of the consolidation group regardless of whether this entity is a regulated entity. This may mean non-regulated parents having to consider regulatory reporting obligations for the first time.
Our group currently benefits from a waiver under the CRR. Will we be able to continue to use this under the new regime?
No. All existing waivers (under BIPRU 8) and permissions (under Article 15 of the CRR) from prudential consolidation granted under the CRR and under BIPRU will cease to apply under the new regime.
However, the FCA’s proposals include the concept of the “group capital test” (GCT). This is expected to provide firm by firm relief from some prudential consolidation requirements.
Firms will need to apply to the FCA in order to apply the GCT (and depending on the group structure they may need more than one). In order to grant a GCT, the FCA will need to be satisfied that the group’s structure is sufficiently simple, and there are no significant risks to clients or to markets from the investment firm’s group as a whole.
On a positive note, the FCA has indicated that it expects many investment firm groups in the UK would be able to meet these requirements.
Will investment firms still be expected to complete an ICAAP under the IFPR?
The FCA has stated that the Internal Capital Adequacy Assessment Process (or ICAAP) will be replaced with the Internal Capital and Risk Assessment Process (ICARA Process). This a continuous internal review process in order to support the firm’s decision making as well as the exercise of management oversight. DP 20/2 has a detailed comparison of the current ICAAP and the proposed ICARA Process.
We are a BIPRU firm: will the BIRPU Remuneration Code continue to apply to us?
Under the current regime, most investment firms are subject to either the IFPRU Remuneration Code (SYSC 19A) or the BIPRU Remuneration Code (SYSC 19C). The exception is ‘Exempt-CAD firms’ which are only subject to a limited Remuneration Code (SYSC19F) required by MiFID.
The FCA has stated it intends to delete the IFPRU and BIPRU Remuneration Codes entirely and create one new remuneration code based on the IFD remuneration provisions. This new remuneration code will mirror the structure of the existing remuneration codes and will be supplemented with guidance.
CPMIs should take note that full-scope AIFMs will remain subject to the AIFM Remuneration Code (SYSC 19B) and UK UCITS management companies will remain subject to the UCITS Remuneration Code (SYSC 19E).
Will reporting requirements change under the IFPR?
It has long been felt that current reporting requirements are unduly burdensome and disproportionate, for many investment firms.
In its recent discussion paper, the FCA has indicated that the IFPR will replace this with a more appropriate and proportionate reporting regime for all investment firms. The intention is to, via one set of universally applicable templates for all IFPR firms, limit reporting requirements to those data points relevant to the business model of investment firms.
If you require further information about anything covered in this briefing, please contact Jessica Reed, or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, January 2021