FCA second consultation: implementation of the UK investment firms prudential regime

SUMMARY AND KEY HIGHLIGHTS

On 19 April 2021, the Financial Conduct Authority (“FCA”) published the second of three consultation papers on the implementation of the Investment Firms Prudential Regime (“IFPR”) (CP21/7).

Key highlights detailed from the consultation paper, but not limited to, are:

  • own funds requirements (such as the Fixed overheads Requirement (“FOR”) and the remaining rules and guidance on K-factors);
  • basic liquid assets requirements;
  • risk management and governance – the Internal Capital and Risk Assessment (“ICARA”) and the Supervisory Review and Evaluation Process (“SREP”);
  • remuneration rules and guidance; and
  • regulatory reporting and application to collective portfolio management investment firms (“CPMI”).

BACKGROUND

The IFPR introduced the new prudential regime for investment firms regulated by the FCA and authorised under the Markets in Financial Instruments Directive (EU/2014/65) (“MiFID”) and it will come into force from 1 January 2022. The new regime is largely derived from the Investment Firms Regulation ((EU) 2019/2033) (“IFR”) and the Investment Firms Directive ((EU) 2019/2033) (“IFD”) and will replace the 11 regimes currently applicable to these firms with a single proportionate regime that reflects a firm’s size and business.

The regime focuses prudential requirements on the potential harm to consumers, clients and the market. It includes the amount of liquid assets and capital levels a firm should hold to enable it to wind down in an orderly way if required. The regime is also expected to provide for better competition between firms and simplify requirements for new market entrants. The FCA’s latest update noted that the “new regime will streamline and simplify the prudential requirements for MiFID investment firms that are prudentially regulated by the FCA in the UK”.

OWN FUNDS REQUIREMENTS

Under the proposed rules, an FCA investment firm will first need to determine its total expenditure after it has made any distribution of profits and then deduct certain other expenses (to the extent that those items have been included in expenditure).

The first consultation looked at K-factors applicable only to firms with permission to deal on own account. This second consultation looks at the remaining K-factors not addressed in the first consultation, i.e.:

  • Assets safeguarded and administered (K-ASA)
  • Client money held (K-CMH)
  • Assets under management (K-AUM)
  • Client orders handled (K-COH)

Where relevant, these K-factors will also apply to an FCA investment firm group subject to prudential consolidation.

The first consultation questioned whether there should be an option of an adjustment to calculating the coefficients of the daily trading flow K-factor (K-DTF) in periods of extreme market stress. The second consultation sets out proposals as to how this should be done.

BASIC LIQUID ASSETS REQUIREMENTS

All firms will have to maintain a basic liquid asset requirement, based on holding an amount of core liquid assets equivalent to at least one third of the amount of their FOR (plus, if relevant, 1.6% of the total amount of any guarantees provided to clients).

RISK MANAGEMENT, ICARA AND SREP

In terms of risk management and governance, firms will determine through the ICARA process what level of own funds and liquid assets they need over and above the own funds and basic liquid assets requirements outlined above. The FCA will be introducing an ICARA Questionnaire reporting template in support of its move towards “proportionate” prudential supervision based on sectors and risk of potential harm to consumers and markets. A minimum SREP cycle will still apply to certain firms which present a higher risk of harm. This may also require a multi-firm review to be undertaken (e.g. sectoral reviews in line with the priorities specified by the FCA).

The rules will clarify the risk management responsibilities under the Senior Manager and Certification Regime (“SMCR”). In addition, the rules will also include high level requirements relating to internal governance and controls, clarification as to which firms are required to establish risk, remuneration and nomination committees and, where relevant, the composition and role of those committees.

REMUNERATION

All firms under the FCA’s proposals on remuneration will have to comply with a small number of basic remuneration requirements. Beyond that, non-smaller and non-interconnected firms (“SNI”) will be subject to more detailed requirements (such as identifying material risk takers, the ban on guaranteed variable pay, malus and clawback).

Only the largest non-SNI firms (i.e., for firms without a trading book, those with a rolling average of on and off-balance sheet assets above £300m over the preceding four-year period) would be required to meet the full remuneration requirements by complying with “extended remuneration requirements” (i.e., remuneration committee and payout process rules).

REGULATORY REPORTING

The amount of information that firms need to report to the FCA on their remuneration arrangements will be significantly reduced.  The FCA also proposes to simplify the additional reporting form for CPMI firms (such as Alternative Investment Fund Manager (“AIFM”) and Undertakings for the Collective Investment in Transferable Securities (“UCITS”) managers who also undertake “top up” MiFID activities).

NEXT STEPS

The second consultation paper should be read in conjunction with the first consultation paper, which introduced the IFPR and focused on the categorisation of investment firms, prudential consolidation, own funds and own funds requirements, and new reporting requirements. In particular, the FCA is interested in any suggestions for making the IFPR work better for different business models. The FCA aims to publish near-final rules on the first consultation in Q2 2021 and will conduct a third consultation in Q3 2021 with plans to publish policy statements and rules of the second and third consultations over the course of 2021.

The final rules will be published once the Financial Services Bill has passed through Parliament and all the consultations are complete.

FIRMS TO ACTION

The new regime represents a major change for investment firms. UK firms within the scope of IFPR should monitor developments in relation to the FCA’s approach to the new regime closely. It is critical that firms adequately prepare for the regime, since they will be required to comply with the new regulations when they start to apply from 1 January 2022.

To review the second Consultation Paper, please click here.

To review the FCA’s publication of CP21/7 outlining the new UK prudential regime for MiFID investment firms, please click here.

For more information, and any guidance or advice on IFPR and the respective FCA consultation papers, Cleveland & Co External in-house counsel™, your specialist outsourced legal team, are here to help.

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