14 June 2022
In November last year, the FCA issued its latest Policy Statement (PS21/17) with regards to the Investment Firm Prudential Regime (IFPR). The statement sets out the final rules for MiFID investment firms which became effective on 1 January this year.
In this article we examine, at a high level, what the regime means for investment firms and how RSM can help firms ensure they are aligned with the new rules.
Who does IFPR apply to?In general, IFPR applies to any investment firm undertaking MiFID business. Subject to specific criteria, this includes any MiFID investment firm authorised and regulated by the FCA that is currently subject to any part of the Capital Requirements Directive (CRD) / Capital Requirements Regulation (CRR).Most notably, and where the most substantial changes will likely occur, is the inclusion of exempt-CAD firms, which were previously exempt from large parts of previous prudential Regimes.Outside of the above, IFPR also applies to Collective Portfolio Management Investment Firms (CPMIs) and holding companies of groups that contain an investment firm in the scope of IFPR.
How IFPR is applied
IFPR introduces two new categories of investment firm – small and non-interconnected (SNI) firms and non-SNI firms – which drive how each element of the Regime is applied.
To determine which is applicable to firms, the FCA has outlined a series of qualitative and quantitative criteria.
Specifically, a firm will be classified as an SNI if it does not breach any of the below indicators:
- average assets under management (AUM) < £1.2bn;
- average client orders handled (COH) is less than:
- £100m per day for cash trades; and
- £1bn per day for derivatives trades;
- zero assets safeguarded and administered (ASA);
- zero client monies held (CMH) is zero;
- the firm does not have permission to deal on own account;
- on and off-balance sheet total < £100m;
- total annual gross revenue from investment services and/or activities (averaged over the last two years) < £30m.
New own funds requirements
A new calculation for own funds requirements has also been introduced as part of the IFPR. For non-SNI firms, this is set as the highest of the Permanent Minimum Requirement (PMR); Fixed Overhead Requirement (FOR); or K-Factor Requirement (KFR).
SNI firms are not required to calculate a KFR, and therefore the own funds requirement is set as the highest of the PMR and FOR.
The most detailed and complex calculation introduced as part of the IFPR is the KFR. The KFR is built up through the sum of a series of individual K-Factors, which are formulated to quantify the level of harm firms have the potential to cause to clients, the market or the firm. Given most firms do not deal as principal, the only K-Factors usually required are those categorised under harm to clients.
The level of own funds firms need to hold to meet the requirements is largely based on the UK CRR definitions, with some amendments which the FCA has communicated in PS21/6.
Liquidity and IFPR
Under IFPR, all investment firms will be required to calculate and hold a minimum level of qualifying liquid assets – the basic liquid assets requirement. For most firms (for example, those that do not provide guarantees to clients), this will be equal to a third of the FOR.
The FCA also provides a detailed list of qualifying liquid assets , which must be highly liquid in their nature.
Internal capital and risk assessment (ICARA)
Under IFPR, firms will be required to produce an annual ICARA, which replaces the ICAAP for those firms who were previously required to produce one. As described by the FCA, the ICARA is the ‘centrepiece of firms’ risk management processes’, and covers, among other things, the identification, monitoring and mitigation of harms.
In the ICARA, firms are expected to calculate an own funds threshold requirement and liquidity threshold requirement to meet an ‘Overall Financial Adequacy’ rule. These should be in excess of basic requirements and based on stress testing outputs.
IFPR recognises that harm can arise from different types of concentrated exposures or relationships, and therefore sets out requirements for firms to monitor and control concentration risk exposures.
This includes assessing concentration risk from the following sources, including exposures in a trading book and assets (for example, trade debts) not recorded in a trading book
The FCA’s requirements apply to all investment firms, including both SNI and non-SNI firms. Concentration risk reporting is only required for non-SNI firms.
The new Regime brings a series of remuneration requirements for firms, which are targeted on a proportionate approach. SNI firms are subject to ‘basic remuneration requirements’, whilst non-SNI firms are subject to an increasingly detailed set of requirements.
These are dependent on the value of its on and off-balance sheet assets. The largest non-SNI firms are subject to ‘extended remuneration requirements’, while those within the thresholds are required to comply with ‘standard remuneration requirements’.
Non-SNI firms are required to assess which staff should be categorised as ‘Material Risk Takers (MRTs)’. The additional rules under standard and extended remuneration requirements apply only to MRTs, whereas basic requirements apply to all staff.
Basic remuneration requirements are based on four key components:
- Remuneration policy.
- Governance and oversight.
- Fixed and variable remuneration.
- Restrictions on variable remuneration.
- Standard remuneration requirements add the following components:
Restrictions on non-performance related variable remuneration of Material Risk Takers.
Ex ante and post risk adjustment.
Other requirements (including setting ratios between variable and fixed remuneration).
Extended remuneration requirements add the following components:
- Pay-out of variable remuneration.
- Deferral and vesting.
- Discretionary pension benefits.
- Remuneration committees.
A key aim of the IFPR is to introduce consistency into the prudential framework for investment firms. This is evident in the regulatory reporting framework, where the FCA has introduced a single suite of reports for all firms. Certain firms will be exempt from particular returns due to their category and activities. The FCA has also confirmed which reporting frameworks will be retired, including the requirement to submit COREP returns for applicable firms.
PS21/17 provided confirmation of the FCA’s intention with regards to disclosure requirements. In summary, annual disclosures will be required for all firms, though a simplified approach is in place for SNI firms which do not issue Additional Tier 1 capital.
Firms are only required to publish disclosures on an individual basis, though can produce group consolidated disclosures if a firm decides to.
A significant aspect of the new Regime is the treatment of prudential requirements for investment firm groups.
IFPR applies at a consolidated level to ‘investment firm groups’ which have been explicitly defined within the MIFIDPRU rules. An investment firm group comprises a UK parent undertaking and all subsidiaries (as defined in the Companies Act 2006), provided at least one subsidiary is a MiFID investment firm. The basis of prudential consolidation follows accounting principles and it is important to bear in mind the parent entity may be an unregulated holding company. The application of the rules around prudential consolidation is complex and requires detailed analysis.
For firms required to undertake prudential consolidation for the first time on transition to IFPR, early analysis and planning is essential. Accounting adjustments arising at consolidated level may be required to be deducted from the group’s eligible regulatory capital resources.
For example, the recognition of goodwill and intangibles connected with past acquisitions can have a significant impact on eligible capital resources of the group.
IFPR permits an alternative approach to ‘full consolidation’ which is known as the Group Capital Test or ‘GCT’. Use of the GCT requires prior consent from the FCA and requires each parent entity in the group to hold regulatory capital equal to the cost of its investment(s) in subsidiaries. This method does not appear to reduce the amount of own funds required but does offer an operational simplification where an accounting consolidation is not otherwise required.
As outlined at MIFIDPRU 2.5, a number of elements of the Regime are applied at both an individual and consolidated level, including:
- Own Funds.
- Own Funds Requirements.
- Concentration Risk.
Crucially, the FCA has confirmed that investment firm groups will be unlikely to be required to produce a group-level ICARA, unless the risks relating to the Group as a whole differ significantly from those affecting the firm on an individual basis. However, if the ICARA is only produced on an individual basis, it is important that group risk is considered.
How we can help
RSM has assisted a number of investment firms with IFPR implementation over the course of the last 12 months. It is clear that firms are currently at a wide range of stages of implementation.
We can help firms with implementation through:
- advisory support for scoping / identifying / interpreting rules;
- support for development of key documents (e.g. ICARA);
- internal audit and support for second-line Risk teams;
- regulatory reporting assurance / advice; and
- assistance to audit teams reviewing regulatory capital calculations for going concern purposes.
For more information, please contact James Roberts.