The Investment Firms Directive (IFD) and Investment Firms Regulation (IFR) came into force in December 2019 and apply to all investment firms as defined under the Markets in Financial Instruments Directive II (MiFID II). The IFR will apply across EU member states from June 2021 and they are required to implement the IFD in their respective jurisdictions by the same date. Transitional provisions will apply for a five-year period until 2026 to allow firms to prepare for, and adapt to the new regime, during which firms’ capital requirements will be more limited.

The aim of the IFD and IFR is to create a risk-sensitive, proportionate and harmonised prudential regulatory regime for investment firms, which is simpler than the existing regime under the Capital Requirements Directive (CRD) and Capital Requirements Regulation (CRR) and more closely aligned to the nature, scale and complexity of, and risks attaching to, the regulated activities they conduct.

Key aspects of the new regime

Classification and regime application:

Firms will be classified within one of three classes, with reference to their regulated activities and size of assets and, for all but the largest investment firms, the risks their regulated activities pose to their customers, the market and themselves:

• Class 1 firms: these will largely fall into two sub-sets: (i) ‘systemically important investment firms’ carrying out any of own account dealing, underwriting of financial instruments or placing of financial instruments on a firm commitment basis and with assets of €30 billion or more. They will remain subject to the CRD/CRR prudential regime and be required to obtain authorisation as credit institutions by December 2020; and (ii) firms which carry out the same regulated activities but with assets of €15 billion or more, which will be ‘treated’ as credit institutions. They will also remain largely subject to the CRD/CRR prudential regime, but will not be required to apply for authorisation as credit institutions.
• Class 2 and 3 firms: all other investment firms will be classified as Class 2 or 3 firms depending on the size of their assets and revenue, their regulated activities and the risks attaching to these activities (to be determined by a series of factors, known as ‘K-factors’). Class 2 firms will be subject to the full IFD/IFR prudential regime, which will contain different requirements to those under the CRD/CRR regime, and Class 3 firms will be subject to a limited form of it.

Transition between Classes:

Firms will move between the Class 1 sub-sets and from Class 2 to 1 depending on changes to the size of their assets, and between Classes 2 and 3 if they begin or cease to meet applicable thresholds, over specified periods. In summary:

• Within Class 1: where a firm’s total assets meet the Class 1 €30 billion threshold over a 12-month period, it will be required to apply for authorisation as a credit institution. Class 2 to Class 1: where a firm’s total assets meet the Class 1 €15 billion threshold over a 12-month period, it will be reclassified as a Class 1 firm.
• Class 3 to 2: a Class 3 firm will be reclassified as a Class 2 firm: with immediate effect, if it no longer meets all the Class 3 thresholds; after a three-month period, if it no longer meets any of four thresholds, including balance sheet total and total annual gross revenue.
• Class 2 to 3: where a Class 2 firm meets all of the Class 3 thresholds, it will be reclassified as a Class 3 firm six months after meeting those thresholds.

Brexit and UK implementation

The UK is intending to implement a bespoke prudential regime for UK investment firms through new primary legislation (the Financial Services Bill). HM Treasury announced in June 2020 that the new ‘Investment Firms Prudential Regime’ (IFPR) and updated prudential requirements for credit institutions will ‘achieve similar intended outcomes’ as the IFD and IFR, with ‘targeted deviations’ where necessary. The intention is that the IFPR and updated credit institution prudential requirements will be introduced by Summer 2021 to be consistent with the application date of the IFD and IFR.

 HM Treasury has indicated that two such deviations have already been identified, namely that: (i) UK ‘systemically important investment firms’, which will be the PRA-designated investment firms, will not be required to apply for authorisation as credit institutions (on the basis that these firms are already subject to the CRD/CRR through the PRA’s designation procedure); and (ii) FCA-regulated investment firms will not be required to comply with CRD V from its UK implementation in December 2020 to the application date of the IFPR.

A materially similar UK regime will be important to achieve the effective operation of a bespoke and harmonised regime for investment firms, given the majority of MiFID investment firms are based in the UK (an EBA Opinion in 2017 put the number at just under 60% of total firms as at end 2015). Furthermore, whether or not the UK introduces such a regime, UK banking, insurance and investment firm groups containing investment firms in the EU will, nonetheless, need to comply with the IFR, and the IFD as it is implemented in relevant EU member states, in respect of such EU subsidiaries.

Immediate considerations for firms

There are a number of immediate aspects that firms should consider now, if they have not already begun to do so:

• Classification: while the EBA’s level 3 guidance on a number of aspects, including the Class 1 authorisation process and Classes 2 and 3 K-factors, are not due until later in 2020 (and may, of course, be delayed given the current COVID-19 situation), firms should start to assess and determine which Class they will fall into under the new regime. This is particularly important for Class 1 ‘systemically important’ firms, which will need to obtain authorisation as credit institutions by December 2020.
• Capital and capital instrument changes: once firms have identified their classification, they should consider the changes to capital requirements and capital instruments that will be required and take action to achieve these. This is, again, particularly important for Class 1 ‘systemically important’ firms, whose initial capital requirement will increase to €5 million from €730,000.
• System and controls’ changes: firms should also consider the changes and enhancements to systems and controls, and governance, remuneration and reporting procedures that may be needed to comply with the CRD/CRR or IFD/IFR regimes as applicable and take steps to implement these;
• Group restructuring and intra-group business transfers: while Class 1 firms must not structure operations in such a way as to avoid authorisation, firms which would be categorised within Class 2 can consider whether any structural changes, transfer of activities to different entities or changes to activities should be undertaken in order to bring them within the Class 3 categorisation and the more limited prudential regime for such firms.

© Slaughter and May 2020