The new Investment Firm Prudential Regime (IFPR) that applies to MiFID investment firms regulated by the UK Financial Conduct Authority (FCA) came into force on 1 January 2022. These include current firms within scope of the regulator's prudential sourcebook for Banks, Building Societies and Investment Firms (BIPRU)) and less complex "Exempt CAD" firms (which typically only provide investment advice or arrange deals), as well as alternative investment fund managers that have MiFID top-up permissions (collective portfolio management investment (CPMI) firms).
Based on the EU IFR/IFD (see previous blog post), the aim is an overall streamlining of the prudential regime for investment firms by replacing the Capital Requirements Directive and Capital Requirements Regulation (which were designed for credit institutions) with a “fit for purpose” regime specifically tailored to the business models of investment firms. Nevertheless, the new rules do introduce more complex and, in many cases, more stringent capital, liquidity, reporting, governance and remuneration requirements for firms within scope.
The regulatory capital requirements are based on a quantitative assessment of the size the firm, and on the activities or services it undertakes or provides:
- Small and non-interconnected (SNI) firms must hold 'own funds' that is the higher of a permanent minimum capital requirement (PMR) (usually £75,000) and a fixed overheads requirement (FOR) (equal to one quarter of its relevant expenditure in the previous year).
- Non-SNI firms will be required to hold an 'own funds' amount that is the higher of its PMR, FOR, and total “K-factor” (which are newly introduced quantitative indicators, specific to each firm, to identify risks that a firm may pose to clients, markets or liquidity, and the firm itself) requirement.
Furthermore, all investment firms must establish an internal capital adequacy and risk assessment (ICARA) process, which is designed to supplement a firm’s own funds requirements and allow a firm to identify, monitor, and, if relevant, mitigate all material potential harms that could result from the ongoing operation or winding down of its business – this assessment may very well result in potentially higher capital requirements as firms will be required to satisfy an Overall Financial Adequacy Rule through this process.
Firm have to consider consolidation requirements if they belong to an 'investment firm group', (broadly where there is a UK parent entity of a group containing at least one FCA-regulated investment firm), and whether they can avail themselves of the group capital test (exempting the UK parent entity from applying the rules on a consolidated basis).
The remuneration requirements under this new regime will no doubt attract considerable interest. The new MIFIDPRU Remuneration Code (see our client briefing) will apply to all in-scope firms (including CPMI firms in respect of their MiFID business) and to remuneration paid to a firm’s 'staff' (broadly defined) although requirements will vary depending on the type of firm. All firms are required to establish and implement remuneration policies, on a proportionate basis. Additional requirements apply to 'material risk takers' within non-SNI firms, including the need to ensure that malus and/or clawback arrangements are in place for such persons. Non-SNIs (and SNIs on a more limited basis) are required to make remuneration disclosures, including a summary of their approach to remuneration, the objectives of their financial incentives and governance surrounding their remuneration policies and procedures.
A prudential regime specifically tailored for investment firms ought to be welcome - it should ultimately result in a more proportionate regime which better reflects and serves the business of investment firms. Nonetheless, as with any significant regulatory change, there will be challenges both in implementation and compliance: the classification process is complicated, groups have to assess the application of consolidation requirements, and there are new governance and risk-management processes as well as disclosure requirements to contend with.
The new rules do introduce more complex and, in many cases, more stringent capital, liquidity, reporting, governance and remuneration requirements for firms within scope.