FCA Publishes Consultation Paper 21/7 – A New UK Prudential Regime for MiFID investment firms

Author

James Pont

Publish Date

Type

Compliance Alert

Topics

  • Compliance
  • Managed Services

The FCA has launched the second phase of its proposed rules to introduce the UK Investment Firm Prudential Regime (“IFPR”) by publishing Consultation Paper 21/7: A new UK prudential regime for MiFID investment firms ("CP21/7"), which should be read in conjunction with CP20/24, published in December 2020.

Highlights

The IFPR is specifically designed for FCA investment firms and represents a significant change to how they will be prudentially regulated. The new requirements seek to capture the potential harm posed by these firms to their clients and the markets in which they operate. It also considers the amount of capital and liquid assets the FCA investment firm should hold so that if it does have to wind-down or exit the market, it can do so in an orderly way. In CP21/7, the FCA sets out its proposals and asks for views on the areas noted below.

Chapter 4 and 5: Own funds requirements

In summary, the FCA’s latest proposals cover:

  • The introduction of a fixed overheads requirement (“FOR”) that will apply to all FCA investment firms. This will be another of the ‘floors’ below which the own funds of an FCA investment firm must not fall.
  • The remaining activity-based capital requirements (“K-factors”) that apply to any type of FCA investment firm. These are in addition to the K-factors proposed in CP20/24.
  • The method for adjusting the calculation of coefficients for the daily trading flow K-factor in periods of extreme market stress and volatility.
  • 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.

Chapter 6: Basic liquid asset requirement

The FCA proposes that all FCA investment firms should have a basic liquid asset requirement. This would be based on holding an amount of core liquid assets equivalent to at least one third of the amount of its FOR and 1.6% of the total amount of any guarantees provided to clients. The FCA explains the concept of core liquid assets and how this provides an appropriate set of assets that can be used to meet the basic liquid asset requirement.

Chapters 7 and 8: Risk management and Governance (Internal Capital and Risk Assessment and Supervisory Review and Evaluation Process)

The FCA covers its proposals regarding the introduction of an Internal Capital and Risk Assessment (“ICARA”) process for all FCA investment firms. Through this, firms will be expected to meet an Overall Financial Adequacy Rule (“OFAR”). This establishes the standard the FCA will apply to determine if an FCA investment firm has adequate financial resources. 

The FCA sets out how it proposes to expect FCA investment firms to determine through the ICARA process any necessary appropriate own funds and liquid assets requirements, in addition to the own funds and basic liquid assets requirements mentioned above. This includes that they consider harm to consumers and markets – including risks to their ability to engage in an orderly wind-down, as well as those from their ongoing activities. Firms would also be required to review their ICARA process at least once every 12 months.

With the ICARA, the FCA is consolidating its requirements for (i) business model analysis (ii) stress-testing (iii) recovery planning and actions and (iv) wind-down planning. The regulator also proposes new relevant expectations for senior managers and governance arrangements. New guidance is also set out on:

  • Intervention points;
  • Actions it expects of firms in certain situations; and
  • What they can expect from the regulator.

As part of this, the FCA intends to re-orientate its prudential supervisory approach for FCA investment firms towards being harm-led and in support of sector supervision. The FCA will introduce an ICARA questionnaire reporting template to support this.

Risk, remuneration and nomination committees

CP21/7 proposes to require the largest small and non-interconnected investment (“SNI”) firms to have risk, remuneration and nomination committees if:

  • The value of its on‑and off‑balance sheet assets over the preceding 4‑year period is a rolling average of more than £300m; or
  • The value of its on‑and off‑balance sheet assets over the preceding 4‑year period is a rolling average of more than £100m but less than £300m and it has trading book business of over £150m and/or derivatives business of over £100m.

Non-SNI firms meeting either of these requirements will need to establish the three committees at individual entity level.

However, individual firms can apply to the FCA for a modification of the requirement to establish 1 or more of the committees at individual entity level. For current significant IFPRU firms who have waivers or modifications of the existing requirements, the FCA may grant an extension of these if the firm applies for this. If a firm is not a significant IFPRU firm and expects to be in scope of the committees’ requirements under IFPR, it may make a waiver or modification application and firms are encouraged to submit their applications as early as possible after summer 2021.

Chapters 9 – 12: Remuneration and proposal to create a single remuneration code

The FCA proposes that all FCA investment firms must have a clearly documented remuneration policy. Firms that qualify as an SNI will only need to comply with the basic remuneration requirements such as creating a remuneration policy, setting an appropriate balance between the fixed and variable component of total remuneration, establishing certain governance and oversight requirements and certain light restrictions on variable remuneration.

Non-SNI firms that are above the (three committees) thresholds would be in scope of the extended remuneration requirements – such as rules on pay-out of variable remuneration, deferral and vesting, discretionary pension benefits and additional remuneration committee requirements.

A non-SNI below the thresholds would not be in scope of these more complex remuneration rules but would instead be subject to the standard remuneration requirements in addition to the basic remuneration requirements. These additional, standard requirements include performance-related variable remuneration of material risk-takers (“MRTs”), restrictions on non-performance-related variable remuneration of MRTs, ex ante and ex post risk adjustments and setting a ratio between variable and fixed remuneration.

Chapter 13: Regulatory reporting

The regulator proposes to significantly reduce the amount of information that FCA investment firms need to report to it about their remuneration arrangements. The FCA intends to simplify the additional reporting form for collective portfolio management investment firms. The FCA has also amended the MIF002 form for reporting liquid assets that accompanied CP20/24 to take account of its liquidity proposals in CP21/7 and is consulting on a new layout. The FCA proposes to introduce an ICARA reporting form for FCA investment firms which will replace the existing FSA019 return for these firms.

CPMs and CPMIs

CP21/7 sets out changes to how firms authorised under legislation other than MiFID will relate to the new sourcebook.

Collective portfolio management firms (“CPMs”) and Collective Portfolio Management Investment firms (“CPMIs”) (i.e. firms authorised either under UCITS/AIFMD, and who respectively operate without and with MiFID permissions) will have their sourcebook (IPRU(INV) 11 changed to have references altered to refer to the MIFIDPRU sourcebook and no longer to the UK Capital Requirements Regulation (“CRR”). The effect on CPMs should be limited but such firms are encouraged to review the basis for calculating the Fixed Overhead Requirement.

CPMIs will need to fully implement the IFPR, with regards to its MiFID business. Both the capital and liquid asset requirement calculated under both AIFMD and the IFPR can be met with the same funds. Therefore, the interaction of both sourcebooks does not incur “additive” or “top-up” requirements.

With regards to remuneration, the FCA is suggesting that it will apply the new MIFIDPRU remuneration code to the MiFID business of CPMIs, meaning that such firms will be subject to two remuneration codes for the first time.

Deadline for comments, proposed templates and forms is 28 May 2021

The FCA is particularly interested in any suggestions for making the IFPR work better for different business models. The regulator plans to:

  • Issue a further Consultation Paper in early Q3 2021; and
  • Will publish the final rules once the Financial Services Bill has passed through Parliament and all the consultations are complete.

Impact and action required

With the publication of the second of three consultations on the IFPR, ‘MIFIPRU Firms’ (in essence, Exempt CAD, BIPRU and IFPRU firms) have a good degree of clarity on the FCA’s proposals and so should commence planning for January 2022. This is a complex area with a wide scope of change for firms. Early preparation is key and will help avoid complications and pressure. 

Any firm that is not directly impacted by MIFIDPRU should assess whether it is brought into the scope of consolidation by another UK MIFIDPRU firm within their Group or have material connection to.

How we help

Contact us or call +44 (0)20 7042 0500 to learn more about how we can help you address these regulatory reporting requirements. 

Our prudential team are on hand to help you review, plan and prepare for the upcoming Investment Firm Prudential Regime.  In addition, we can provide regulatory oversight of your firm's capital monitoring and forecasting, and regulatory reporting processes. View our Prudential Reporting Services page to learn more.