Q&A: The Investment Firm Prudential Regime (W)
[accordion title=”Q&A: The Investment Firm Prudential Regime“]
[accordion-item title=”What is IFPR; is it relevant to my firm?”]
The revised UK Investment Firm Prudential Regime or “IFPR” is designed to be a streamlined and simplified regime for the prudential regulation of investment firms in the UK. The IFPR is being introduced by the Financial Conduct Authority (FCA) in accordance with the new Financial Services Bill and new Part 9C of the Financial Services and Markets Act 2000.
The IFPR is due to come into force on 1 January 2022 following a package of FCA consultation papers. The implementation of the IFPR is set out in https://www.fca.org.uk/publication/policy/ps21-17.pdf.
Broadly, the new prudential regime will be aligned with changes proposed by the European Union under the Investment Firm Directive (IFD) and the Investment Firm Regulation (IFR). This is legislation which came into force on 26 December 2020 and will take effect in the EU on 26 June 2021. Although Brexit means that the IFD and IFR do not strictly apply in the UK, the FCA was a key advocate of, and heavily involved in policy discussion before the UK’s exit from the EU. For this reason, the IFPR is heavily influenced by these EU changes.
The intention of the IFPR regime is to refocus prudential requirements away from the risks firms face, to take adequate account of the potential for harm to consumers and markets
The new rules will also make significant changes to the way UK investment firms will be regulated for prudential purposes and the remuneration rules to which those firms are subject and consequently. Significant resource and planning will need to be devoted by firms in order to be ready for the early 2022 implementation date.
[accordion-item title=”I think my firm is an investment firm and so will be impacted. How do I check?”]
The new regime will apply to the following types of firms:
(a) FCA authorised and regulated MiFID investment firms,
(b) Collective Portfolio Management Investment Firms (CPMIs), and
(c) Both regulated and unregulated holding companies of groups that contain either (a) or (b).
The final rules can be found in the following legal instruments FCA 2021/38 and FCA 2021/39.
Therefore, the following are caught by the rules;
- investment firms subject to BIPRU and GENPRU;
- full scope, limited activity and limited licence firms subject to IFPRU and the CRR;
- “local” investment firms;
- matched principal traders;
- exempt CAD firms;
- investment firms which previously were exempt under Article 3 of MIFID but opted in; and
- various specialist commodities derivatives investment firms.
You can check if you are performing investment services, and therefore amount to an investment firm, by comparing your permissions profile against the services which are MiFID services, described further in the following guidance in the FCA Handbook: PERG 13.3. There is a useful table tracking UK regulated activities to the following MiFID services using this link.
OK, we’re not an investment firm, so we don’t need to worry about these new rules, do we?”]
In most cases, the answer to this to be “no”. There are firms which will be impacted such as collective portfolio management investment firms (CPMI firms). These are firms with permissions to manage an alternative investment fund (AIF) and/or permission to manage a UK UCITS fund which also have what are known as “MiFID top up” permissions. Although these firms would appear not to be investment firms on the face of it, they do have permissions to conduct certain activities which are defined as “investment services”.
If you are a CPMI firm, you will have a restriction on your permissions profile (a CPMI restriction) on the FS register which makes this clear. If there are any queries, please ask us to review for you.
Therefore, technically, all CPMI firms, the new rules will mainly apply in respect of the MiFID business conducted by the CPMI firm. CPMI firms are already used to complying with dual prudential regimes in order to satisfy the higher of: (i) their AIFMD/UCITS prudential requirements as set out in IPRU INV; and (ii) their prudential requirements as a MIFID firm subject to either GENPRU/BIPRU or IFPRU. Under IFPR, CPMI firms will need to comply with new prudential requirements under the new FCA sourcebook MIFIDPRU (which replaces both BIPRU/GENPRU and IFPRU) (as well as continuing to satisfy the prudential requirements under IPRU INV).
There will however be a change from the existing approach in respect of remuneration code requirements, particularly for CPMI firms which are BIPRU firms. Under IFPR, CPMI firms must apply the new MIFIDPRU Remuneration Code to their firm’s MiFID business and the AIFMD/UCITS remuneration code to their AIFM/UCITS business.
For UCITS and AIF managers which do not have MiFID top ups, IFPR is not expected to apply. The could be a further change in IFD which impacts all UCITS managers and AIFMs regardless of MiFID top ups. This is the cross reference in IFD to the UCITS Directive and to AIFMD, such that own funds must be held by these firms which is no less than the FOR (fixed overheads requirement) calculated under Article 13 of the IFR.
[accordion-item title=”When will the new rules apply?”]
Firms will need to comply by 1 January 2022.
[accordion-item title=”So what’s the point?”]
The FCA has stated that the ongoing regulatory costs for firms should be lower as a result of the changes. However, this of course may not always be the case and firms should scrutinise the changes carefully to identify the impact upon them. It does seem clear that the simplification of the regime should free up management time and reduce time spent on complex capital calculations that do little to help firms manage risk.
The FCA has indicated its view that the changes should also reduce barriers to entry to the market and allow for better competition.
The key changes will involve:
- new liquidity rules across the board. UK investment firms are not currently subject to liquidity rules;
- changes to the level of initial capital to be held. Initial capital will increase for most firms;
- a brand new approach to calculating capital known as the “K factor” approach; and
- new rules on remuneration and disclosure which allow less scope for firms to determine their approach based upon proportionality principles.
[accordion-item title=”Will some investment firms remain subject to the UK onshored CRR requirements?”]
Yes. Dependant on size thresholds, Investment firms as well as firms that deal on own account and underwrite/place financial instruments on a firm commitment basis will remain on Capital Requirements Regulation (CRR) standards. Some firms within this range may be obliged to seek authorisation as a new type of non-deposit taking credit institution because they are considered “systemically important”.
We would not expect this to apply to many firms. Figure 3.1 of the DP20/2provides a useful flowchart and further details.
We run an investment with low risk activities, will we be excluded from the most onerous parts of the regime?
Specified firms under the IFPR are known as “small and non-interconnected investment firms” or SNIs will benefit from additional proportionality and have less demanding prudential obligations, as well as more simplified reporting, disclosure and remuneration requirements. Table 2 in paragraph 2.10 in the FCA’s CP20/24 sets out the threshold tests, based on financial criteria, to be considered an SNI firm and figure 1 in paragraph 2.12 provides a useful flowchart.
You can also find a quick summary guide of the difference between being an investment firm under IFD/IFR and an SNI firm in the table in 3.31 of the DP20/2.[/accordion-item]
[accordion-item title=”IFPR alleges to be a tailored regime but my firm’s initial capital that we are required to hold as an authorisation requirement is going up. Please can you explain?”]
The increase is significant for non-SNI investment firms, including current Exempt CAD firms which currently only require €50,000 initial capital. The FCA justifies the approach on the basis the levels under the previous regime have not been updated since 1993.
Paragraph 5.5 of the CP sets out a summary of the new levels of initial capital. These vary by regulated activities carried on but the categories are:
Put simply, a firm which does not have client money and custody permissions but which has “advising”, “arranging” (i.e. reception and transmission of orders), “dealing” (executing orders) and/or “managing investments” (portfolio management) permissions only will usually be required to hold initial capital of £75k.
[accordion-item title=”In practice, how much capital will I have to hold?”]
This depends on whether you are an SNI firm or non-SNI. The difference is explained in the answer to the “We run an investment with low risk activities ….” question above.
If you are non-SNI, your initial capital requirement will be the higher of the fixed overhead requirement (FOR), the permanent minimum requirement (PMR) and the K factor requirement (KFR). If you are SNI, then your capital requirements will be the higher of the FOR and the PMR.
The PMR is basically the initial capital as described above.
The FOR is expected to be one quarter of the fixed overheads for the previous financial year, although the details for calculation are not covered in the CP and the FCA will address this in its subsequent consultation papers.
The KFR is entirely new and is a new way of calculating the potential for harm in a firm (including its risk to clients and the market). Please refer to the “So, about the “K factors”. What are these?” question below.
The above explains the calculation for what is known as “Pillar 1” capital. Firms will also have to perform an additional Pillar 2 assessment and this may require them to hold additional capital. Please refer to the “My firm has to prepare an ICAAP (Internal Capital Adequacy Assessment Process). Is that being scrapped now?” question below.[/accordion-item]
[accordion-item title=”So, about the “K factors”. What are these?”]
The K factors are a completely new approach to determining the minimum own funds requirement. The K-factor capital requirements are essentially a mixture of activity and exposure-based requirements. It is intended to reflect harm and is very different from the historic calculations under the old regime. For many firms, some of the K factors will not be relevant and the calculation methods are designed to be straightforward.
The KFR is the sum of each of the K factors that apply to the business of the investment firm.
Figure 6.1 of the DP20/2 sets out the K factors and chapter 6 explains how to calculate them.
Briefly, the K factors are divided into three categories:
- risks to client (RtC);
- risks to market (RtM); and
- risks to firm (RtF).
Not all K factors will have to be considered by each firm, however. For instance, if a firm does not hold client money or assets then two RtC K factors for client money held (K-CMH) and assets safeguarded and administered (K-ASA) can be ignored.
[accordion-item title=”Will there be changes to the type of capital I will have to hold?”]
Yes, possibly, depending on your current status.
The IFPR still follows a similar approach to the CRR on assessing capital quality. Investment firms will have to hold Common Equity Tier 1, Additional Tier 1 and Tier 2 capital in the same proportions as set out in the CRR.
This will however be a huge change for firms that do not currently work on CRR concepts such as BIPRU firms and exempt CAD firms. These firms will not have some of the current categories available to them such as Tier 3 short term subordinated debt. Consequently, there may be changes to the type of capital held for this profile of firm. Further assistance may be required. Contact us to discuss your needs.[/accordion-item]
[accordion-item title=”The new IFD/IFR apparently impose new liquidity obligations?”]
All firms, even SNIs, under the regime must comply with minimum quantitative liquidity requirements. The overall intention is to create a resilience in each firm to a sudden liquidity shock. In short, the objective is to ensure that firms always have a minimum stock of liquid assets to fund the initial stages of a wind down process, should this be necessary, and to avoid crisis shutdowns.[/accordion-item]
[accordion-item title=”Our ICAAP, is that now being scrapped?”]
The ICAAP will be scrapped and replaced with a new ICARA process which is short for “internal capital and risk assessment”.
All firms including SNI firms will be required to conduct an ICARA. However, the FCA has indicated that there will be some proportionality in approach for SNI firms when conducting certain aspects of the ICARA. There will also still be a SREP process (short for Supervisory Review and Evaluation Process). This is the process by which the FCA determines if the firm has a sound understanding, management and coverage of its risks and may impose a capital add on where it has concerns.
Details can be found in Chapter 6 of the PS21/9.[/accordion-item]
[accordion-item title=”Is there a transition period to give me time to change?”]
Yes, there will be certain provisions in the IFPR intended to ease the change to the new regime. It is expected that these will vary depending on the current status and size of the relevant firm and may allow a more lenient calculation of the PMR and the own funds requirement (described above in “IFPR alleges to be a tailored regime ….?”) for a short term period.[/accordion-item]
[accordion-item title=”What will change so far as remuneration is concerned?”]
Remuneration is described across four chapters (numbered 7 to 10) in the PS21/9 and should be read depending on your categorisation.
These requirements are divided into basic, standard, and extended remuneration obligations (RemCodes) and will depend on the investment firm’s classification as either an SNI or non-SNI, and its on-and-off balance sheet. The new RemCode replaces the IFPRU Remuneration Code and BIPRU Remuneration Code.
With regards to remuneration reporting, MIFIDPRU Remuneration Report (MIF008) replaces the existing Remuneration Benchmarking Information Report (REP004) and High Earners Report (REP005).
The new reports should be submitted annually, within four months of a firm’s accounting reference date.