Start preparing for the new Prudential Regime (IFPR)
written by Mike Dalmiras
One of the many hot topics on the UK regulatory agenda is the implementation of the new Investment Firms Prudential Regime (IFPR). The new regime, which is authorised under the Markets in Financial Instruments Directive (EU/2014/65) (“MiFID”), is set to come into force on 1 January 2022. For EU authorised investment firms, the EU Investment Firm Regulation and Directive (IFR/IFD) will cease from June 2021.
The IFPR introduces a single prudential regime for all MiFID investment firms regulated by the FCA. IFPR will simplify firms’ prudential obligations and will establish a ‘risk-based approach’ that focuses on capturing any risks arising from the firms’ activities that could pose threats to their clients and the markets in which they operate.
With the introduction of the new regime fast approaching, firms need to begin to prepare to meet the IFPR’s requirements; ranging from holding additional liquid assets and increased regulatory capital. The new prudential regime will also bring significant changes for firms that were previously out of scope of being categorised in other prudential categories such as BIRPU, IFPRU and exempt CAD firms. Under the IFPR, those categories will cease to exist, and all firms will be either be categorised as either SNI (small non-interconnected) firms or non-SNI, depending on the regulatory activities they carry out and the financial thresholds they meet.
This April, the FCA published the long-awaited second Consultation Paper (CP21/7) of the IFPR which provided further details to the new prudential sourcebook, MIFIDPRU, as well as indicating how the rules will apply to Collective Portfolio Management Investment firms (CPMIs). It is anticipated that the FCA’s third consultation paper will be published in Q3 this year and will cover public disclosure requirements and consequential amendments.
Own funds requirements
The CP21/7 confirmed details of own funds requirements and set out how firms should calculate their Fixed Overheads Requirement (FOR), which will apply to all FCA investment firms. An investment firm’s FOR will be an amount equal to one-quarter of its relevant expenditure in the previous year. To calculate FOR, investment firms will first need to determine their total expenditure after they have made any distribution of profits and then deduct any other specific expenses stipulated in the Consultation Paper.
While the first CP20/24 addressed only K-factors applicable to firms dealing on own account, the CP 21/7 covers the calculations of the remaining K-factors and highlights the interaction between the assets under management (K-AUM) and client orders handled (K-COH) K-factor requirements as well as how investment firms should measure AUM if they have delegated the management of any assets to another entity.
Additionally, the FCA confirmed that firms are required to calculate an adjusted coefficient for the daily trading flow K-factor (K-DTF) that should be used in times of stressed market conditions to reduce the potential risk of lower market liquidity and potential harm to financial stability.
|K-Factor||Requirement based on the value of||Coefficient|
|K-ASA||Client Assets Safeguarded and Administered||0.04%|
|K-CMH||Client Money Held||0.04 (Segregated accounts)
0.05% (Non-segregated accounts)
|K-AUM||Assets Under Management||0.02%|
|K-COH||Client Orders Handled||0.1% (cash trades) & 0.01% (derivatives trades)|
Under IFPR, all investment firms are required to hold a number of liquid assets that are at least equal to the sum of one-third of the amount of its FOR and 1.6% of the total amount of any guarantees provided to clients (if relevant).
The basic liquid asset requirement aims to ensure that investment firms always have a minimum stock of liquid assets to fund the early stages of a wind-down process if wind-down becomes necessary.
The increased liquidity requirements will require firms to make provision either in cash or quickly retrievable assets. This is a significant change to the previous prudential regime.
ICARA, replaces ICAAP
Firms will be required to meet the Overall Financial Adequacy Rule (OFAR) which will establish the standard to determine whether investment firms have adequate financial resources to remain viable and allow an orderly wind-down process for their business.
This would be achieved through the implementation of Internal Capital and Risk Assessment (ICARA) which replaces ICAAP. The ICARA process will be a continuous process through which the firm will assess the adequacy of its own funds and liquid requirements. The firm’s risk management team will be required to be active to ensure they are on top of the firm’s capital requirements.
ICARA will introduce a number of changes for firms; such as the need to review their ICARA process on a regular basis. The ICARA should be updated immediately when a material change arises within the firms’ business model or operating model. The FCA recommends that large and complex investment firms should review their ICARA on a half-yearly basis. CP21/7 specifies that as part of ICARA, firms will have to conduct business model analysis, stress testing, recovery, and wind-down planning. The FCA have indicated wind-down planning is something that all firms must address as part of their regular business planning and make adequate provision.
The FCA emphasise that they will hold senior management or the firms’ governing body accountable if they fail to ensure they have appropriate governance and risk management systems and controls. The FCA also expects senior managers to have an active role in reviewing and approving the content of the ICARA document.
Governance, Remuneration, and Reporting Requirements
As part of the new regime, investment firms should maintain clear organisational structures with well-defined lines of responsibility, implement proper strategies and policies that identify, manage, monitor, and report risks. Firms will also need to establish committees (including risk, remuneration and nomination) depending on their categorisation to support management bodies in their supervisory functions. This responsibility lies with the firms’ Senior Management. If problems arise, the FCA will no doubt look at whether SMF holders were fulfilling their documented responsibilities.
In terms of remuneration, CP21/7 proposes the creation of a single remuneration code for FCA investment firms which will replace the IFPRU Remuneration Code (SYSC 19A) and the BIPRU Remuneration Code (SYSC 19C). Even though the FCA proposed to exclude SNI firms from having to comply with the IFPR’s remuneration rules in the previous DP, the CP21/7 proposes to go beyond the EU directive and apply the proportionality approach to the MIFPRU Remuneration Code.
In essence, the MIFIDPRU Remuneration Code provides a set of remuneration requirements (basic, standard, and extended) that investment firms will have to apply based on the risk of harm they pose to customers and the markets.
The reporting requirements of investment firms under the IFPR will be significantly reduced and firms will have to submit a single suite of reporting forms instead of different sets of regulatory returns that depend on which prudential sourcebook they fall under. All investment firms should complete and report the liquid asset reporting form (MIF002) which should be submitted quarterly, and the ICARA questionnaire (MIF007), which should be submitted annually and will replace the current FSA019.
With regards to remuneration reporting, the FCA proposes to introduce MIFIDPRU Remuneration Report (MIF008) that will replace the existing Remuneration Benchmarking Information Report (REP004) and High Earners Report (REP005). The new reports should be submitted annually within 4 months of a firm’s accounting reference date.
Lastly, CPMI firms will benefit from simpler reporting requirements as they will have to complete a revised FIN067 form that will replace FIN068 alongside the standard data on their capital in MIF001 and their liquid assets in MIF002.
Whilst COREP reports and XML data are going, there will be an onus on firms to retain historic data for reporting purposes. For K-AUM reporting the firm will be required to hold 15 months of data.
Exempt CAD firms
‘Exempt CAD firms’ are MIFID investment firms that are restricted to provide investment advisory services and/or receive and transmit orders. Currently, such firms benefit from simpler prudential requirements ranging from a minimum capital requirement of £50,000 to not having to comply with the FCA’s Remuneration Codes.
Following the introduction of the new regime, ‘Exempt CAD firms’ will have to be categorised as either SNI or non-SNI firms increasing their capital requirements to the highest of £75,000 (PMR), the FOR, and the ‘K-factors’ depending on the activities they undertake. In addition, those firms will have to comply with the liquidity, remuneration, and risk assessment requirements.
MIFIDPRU should not apply directly to overseas non-EEA investment firms that apply for authorisation in the UK, or firms that are using the Temporary Permissions Regime (TPR) to continue operating temporarily in the UK now that the passporting regime has ended.
Instead, the FCA needs proof that investment firms established overseas will be subject to largely equivalent prudential supervision to MIFIDPRU in their home jurisdiction before authorising them. Otherwise, the FCA would generally expect firms to establish a UK subsidiary, which would be subject to MIFIDPRU rules.
How Complyport can help?
If this article has raised any questions or you think your firm may require assistance meeting the new requirements under the new IFPR, please contact Jonathan Greenstein now, via email@example.com, and book in a free consultation.
Our teams are ready to support your firm in meeting the new requirements, putting together the ICARA, the calculation of K-Factors and more.
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