Coming into force on 1 January 2022, the new prudential regime for investment firms represents a major change for firms, so it’s critical businesses prepare properly. Among the changes are new rules requiring some firms to hold much more capital and introducing new obligations such as the Internal Capital Adequacy and Risk Assessment (ICARA) process.
The FCA released their first policy statement on IFPR on 29 June 2021. Having made some changes and clarified a few points following the consultation period, the rules the FCA set out for capital, consolidation, K-factors for firms with a trading book, concentration risk and reporting largely remain the same.
With more than 3,000 FCA investment firms in the UK, the introduction of IFPR means there will be single prudential regime for all FCA investment firms, with the regulator aiming to reduce barriers to entry and allow for better competition. It will affect all FCA prudentially regulated MiFID investment firms, including principal brokers and matched principal brokers; investment managers; and adviser/arranger firms categorised as ‘exempt-CAD’.
Key changes at a glance:
Categorisation – current prudential categories such as IFPRU, BIPRU and Exempt CAD will cease to exist.
Existing regimes disapplied – most IFPRU firms will no longer be subject to the requirements of the Capital Requirements Regulation (CRR), and BIPRU firms no longer subject to BIPRU. Instead, the new MIFIDPRU category will apply to MiFID firms.
Proportionality for smaller firms – investment firms which don’t hold client money or assets and are not permitted to deal on their own account and meet other size tests will fall into a new category; small and non-interconnected investment firm (SNI). SNIs will be able to benefit from additional proportionality under IFPR.
Own Funds Requirement – there are changes to the amount of Own Funds a firm must hold to become authorised. This initial capital becomes an investment firm’s Permanent Minimum Requirement (PMR). Additional ongoing capital will be calculated by reference to a Fixed Overhead Requirement (FOR) and for some, a new activity based “K-factor” Own Funds Requirement (KFR), will be required.
Concentration risk – all firms will have to monitor and control their concentration risk (i.e. the reliance they have on any single provider) and, other than SNIs, report to the FCA. Firms with a trading book are also subject to the K-CON Own Funds Requirement. Given this, firms will monitor and control the extent to which assets are concentrated at particular banks and investment firms. Concentration risk limits will generally be 25% of the firm’s own funds, and can increase to the lower of £150 million or 100% of the firm’s own funds if the exposure is to an institution.
Liquidity requirement – all investment firms will have a basic liquidity requirement based on holding liquid assets equivalent to at least one third of their FOR plus 1.6% of guarantees to clients. These core liquid assets must be easily monetised, e.g. UK gilts, but can include receivables due within 30 days subject to a 50% haircut. If an investment firm in a group relies on a centralised treasury function for liquidity the firm will need to make sure it holds adequate liquid assets on its own balance sheet.
Prudential consolidation – investment firm only groups will still be required to apply group consolidation when calculating their regulatory capital requirements and undertaking their ICARA process. Firms within non-investment firm groups will remain subject to prudential consolidation from existing provisions such as those of CRR. While prudential consolidation and accounting consolidation are similar, they are deliberately different concepts.
Group capital test – an investment firm group can request for a Group Capital Test (GCT) to apply rather than prudential consolidation, allowing relief from some of its requirements. This is a more straightforward capital treatment where the parent simply needs to hold enough regulatory capital to support its capital investment in its subsidiaries.
Because of the volume of GCT applications expected, the FCA has proposed a transition period where firms can use GCT for up to two years while applications are being determined.
Waivers – existing consolidation waivers and permissions granted under Article 15 CRR will fall away and impacted groups will have to consider GCT rules.
Remuneration code – the IFPRU and BIPRU remuneration codes will be replaced by a single remuneration code, with SNI firms only having to comply with “basic remuneration requirements”.
Supervisory reporting requirements – reporting requirements are expected to be more appropriate and proportionate, with the new forms intended to be less complex than the COREP forms. Returns will be submitted quarterly, and all firms will do a balance sheet and profit and loss account using the current FSA029 and FSA030 forms used by Exempt CAD firms.
FCA powers – the regulator will have the power to require firms to hold more capital if they think it’s necessary following a supervisory review. Additionally, the FCA will be able to place limits on variable remuneration, introduce further reporting requirements or specific liquidity requirements.
Transitional provisions – IFPR will include transitional provisions which vary depending on the prudential classification of a firm immediately before the date the rules come into force.
In terms of next steps, investment firms must start planning for IFPR now and make sure their financial models use the information in the capital forecast section. With the line of applications for GCT likely to be long, we recommend firms pull together the detailed information required as soon as possible, and joining the queue early. For some, a great deal of time might need to be spent on recapitalising balance sheets and considering wider groups.
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