Overview and recap
On 19 April 2021, the FCA published CP 21/7: ‘A new UK prudential regime for MiFID investment firms’. This Consultation Paper (CP) introduces the FCA’s second tranche of proposed rules to introduce the Investment Firm Prudential Regime (IFPR) in the UK. Firms following the progress of the reforms will recall that this latest consultation follows CP20/24: ‘A new UK prudential regime for MiFID investment firms’ (December 2020), covering the first tranche of proposed new rules, including overall scope of application of the regime, and certain components of the own funds and reporting requirements. For more information, see our December blog post on CP20/24, and our blog post on the FCA’s initial June 2020 Discussion Paper on the IFPR.
In this second CP, the detailed consultation discussion and proposed rules cover extensive ground on the new regime’s K-factor (risk-based) and fixed overheads capital requirements, liquidity rules, remuneration rules, supervision and governance and reporting. The FCA has also published draft templates for reporting, applications and notifications under the new regime, as set out on the landing page announcing the CP.
The IFPR will be similar in many respects to the EU Investment Firms Directive and Regulation (IFD/IFR) (expected to enter into force in June 2021), a regime which the UK was instrumental in developing before leaving the EU. However, the UK’s exit from the EU and its pivot towards a more regulator-led prudential regime enables the UK to calibrate the IFPR to take account of UK market characteristics. In a speech on 13 April, the FCA’s Nausicaa Delfas highlighted the IFPR as a key priority for the FCA in its future intentions for the UK as a global financial centre – citing UK support for the overall goals of the EU regime, but welcoming the opportunity to tailor the IFPR appropriately for the UK market.
Firms in scope
The proposed rules will be relevant to all MiFID investment firms (including those subject to the CRR and those subject to GENPRU and BIPRU) as well as to Collective Portfolio Management Investment Firms (CPMIs – i.e. AIFMs with MiFID investment management related permissions), and UK holding companies of groups containing such firms. It is not expected to apply to AIFMs other than CPMIs, nor to non-MiFID investment firms (including Article 3 exempt firms, unless they have opted in to MiFID).
Some aspects of the proposals will also be relevant by extension to appointed representatives meeting the “tied agent” definition (i.e. providing MiFID-scope services). This is because certain own funds and group risk requirements will apply to firms that supervise and host tied agents in connection with business carried on by these firms’ tied agents.
Key policy proposals
Chapters 4 and 5 cover the FCA’s proposed approach to fixed overheads and K-factor capital requirements (except to the extent already covered in the December CP, which focused only on K-factors relevant to principal trading). These various requirements are in addition to the fixed minimum permanent capital requirements for firms and the K-factors specifically applicable to principal trading firms, which were discussed by the FCA in its December CP.
Fixed overheads based requirement: A capital requirement based on one quarter of annual fixed overheads (FOR) is proposed for all firms. Many existing investment firms will already be subject to similar rules under the CRR or BIPRU regimes. Chapter 4 sets out the basis for calculating the FOR and the expense items that can be deducted. The FOR is designed to be a loss-absorbing measure intended to reflect the costs of exiting the market in a wind-down scenario, and the FCA expects that firms will consider in more detail the amount needed to wind-down as part of their internal capital adequacy and risk assessment (ICARA) process (the proposed successor to the current ICAAP process, discussed briefly below). This may mean that some firms are expected in practice to hold more capital than is strictly required by the FOR, to capture firm-specific risks.
K-factors: The K-factors covered in this CP will be more broadly relevant to all investment firms, although the specific K-factors that apply to an individual FCA investment firm will depend on the MiFID investment services and activities it undertakes. Relevant K-factors covered in this CP include those risks arising to firms and their customers in connection with assets under management, client order handling and holding of client assets and money. One point to highlight is that consistent with the EU IFD/IFR, a firm’s “AUM” calculation must include assets “managed” under ongoing advisory (i.e. non-discretionary) mandates and assets managed by third party delegates under delegation arrangements with the firm. The FCA’s proposed rules also potentially go beyond the IFD/IFR in requiring that firms also count assets managed by the firm as delegate for third parties, in scenarios where this would not result in double counting.
Clearing services – own funds requirements and firm categorisation: Chapter 5 also sets out specific proposals on own funds requirements and firm categorisation for FCA investment firms when they provide clearing services as clearing members and indirect clearing firms. In particular, the FCA proposes that all FCA investment firms that are clearing members or indirect clearing firms (i.e. firms that are clients of clearing members and also provide indirect clearing services to third parties) will be unable to qualify as small and non-interconnected (SNI) investment firms (which benefit from a lighter-touch regime, as further discussed in the earlier CP). This will be the case even if they meet all the other requirements for being an SNI firm – and would also preclude such firms’ groups from qualifying as SNI groups.
The IFPR will introduce, for the first time, a requirement for all FCA investment firms to have a quantified liquid assets requirement. Chapter 6 sets out the basic liquid assets requirement that must be met by all FCA investment firms and the asset types that can be used to meet this requirement, including coins and banknotes, short-term deposits at a UK bank, UK gilts and Treasury bonds or similar assets, and units or shares in a short-term regulated money market fund or comparable third country fund. SNI firms and non-SNI firms that do not deal on own account or underwrite/place financial instruments on a firm commitment basis will also be permitted to include trade receivables, subject to limitations. The basic quantitative liquid assets requirement will be based on a proportion of an FCA investment firm’s FOR (at least one third) and any guarantees provided to clients (at least 1.6% of the total amount). The FCA outlines the proposed application of these liquidity requirements at individual and consolidated level and potential exemptions.
Supervision, risk management and governance
The FCA explains in Chapter 7 that it regards the IFPR as an “opportunity to re-establish our expectations for FCA investment firms’ internal governance and risk management.” The IFPR will establish new baseline requirements for investment firms in relation to risk management, governance and supervisory oversight. The proposed new rules will introduce an Overall Financial Adequacy Rule (OFAR), establishing the standard applied by the FCA to determine if an FCA investment firm has adequate financial resources.
This will be underpinned by the “ICARA” process, which will be similar in principle (but not identical) to the current ICAAP or “Pillar 2” requirements followed by CRR and BIPRU firms. The ICARA process may mean firms need to hold increased capital and/or liquid assets to reflect individual firm risks.
The ICARA process will need to be overseen by a firm’s senior management. It covers:
– identification, monitoring and mitigation of harms;
– business model planning and forecasting;
– recovery and wind-down planning; and
– assessing the adequacy of financial resources.
The ICARA process is outlined in detail in Chapter 7 and will potentially be a very involved risk management exercise for firms and may also involve review by the FCA. However, the FCA confirms that proportionality considerations will apply, meaning that it will expect SNI firms to do a lower level of analysis than that expected from non-SNI firms. A firm’s ICARA must be reviewed and updated at least annually.
The IFPR proposals reflect and build upon the framework established in its previous guidance ‘FG20/1 Assessing Adequate Financial Resources’ (June 2020) and the FCA recommends that firms should use that guidance as a starting point for the new requirements.
The FCA recognises the diversity of FCA investment firms and proposes to reflect this by limiting the core governance framework under the IFPR to high-level minimum standards, including:
- a clear organisational structure with well defined, transparent and consistent lines of responsibility
- effective processes to identify, manage, monitor and report the risks they are (or might be) exposed to, or pose (or might pose) to others
- adequate internal control mechanisms, including sound administration and accounting procedures
More specific requirements will be introduced for larger non-SNI firms. They may be required to establish risk, remuneration and nomination committees – similar to, but superseding, the current thresholds and requirements for “significant IFPRU firms”. The FCA’s third IFPR consultation will discuss changes to the SYSC governance requirements which result from the proposals in this CP and CP20/24.
Chapter 9 sets out the proposed scope and application of a new remuneration regime for FCA investment firms, including application of specific requirements to firms and to individuals within firms. The extent of the specific requirements in this area will be distinguished based on firm type, with fewer requirements for SNI firms and smaller non-SNI firms. Additional requirements for non-SNI firms (some of which apply only to larger firms) are discussed further in Chapters 11 and 12.
We will be publishing a separate briefing on the remuneration requirements in due course.
Chapter 13 sets out further proposals for regulatory reporting under the IFPR (beyond those consulted upon in CP20/24). This includes proposals for reporting on liquid assets, the ICARA process, remuneration, updating FIN067; and additional reporting for CPMIs.
Next steps and key timings
- 28 May 2021: deadline for responses to the consultation.
- Late spring 2021: the FCA to publish its first Policy Statement (PS) on the IFPR setting out the feedback received to CP20/24, together with related near-final rules.
- Summer: a further PS is anticipated, setting out feedback and responses to areas covered in this CP.
- Q3 2021: FCA to publish a third CP, covering public disclosure and ESG requirements, as well as consequential amendments to and interaction with existing regimes (such as the BRRD regime).
- When all consultations have closed, the FCA will then consider stakeholder feedback before publishing a further PS and remaining near-final rules.
- The FCA will publish the final rules once the Financial Services Bill has passed through Parliament and all consultations are complete.
- 1 January 2022: subject to the progress of the Financial Services Bill through Parliament, the FCA plans to introduce the IFPR.
- Transitional arrangements or phase-in periods, in some areas lasting up to five years, will be available to certain firms.
Implementing the new IFPR will require other transitional and consequential changes to be made to primary and secondary legislation, as well as retained EU law. HM Treasury published a consultation in February 2021 addressing this (together with its proposals for implementing the Basel III standards and amending current UK law implementing CRD IV and the UK CRR).