IFPR bringing a specific Prudential Regime to Investment Firms
Posted by Luuk Jacobs on 20 January 2022
As a reaction to the financial crisis of 2008-2009 Global regulators introduced a significant amount of regulation that aimed to reduce the risk that firms faced. This was very much aimed at the globally active systemically important banks and to protect depositors by ensuring that it is difficult for a bank to fail.
Ten plus years down the line, with a whirlwind of new regulations been implemented and arguably a much financially and operationally healthier banking and investment management industry, regulators have turned to change the regulatory focus and launch a separate prudential regime for investment firms.
As investment firms do not have depositors that need to be protected, it means that the current prudential requirements are not designed to address the potential harm posed by investment firms to their clients and the markets in which they operate. The EU and the UK have been at the forefront of this development of protecting the consumer and the market with for example regulation around ESG and Operational Resilience.
The FCA has over last Summer introduced Policy Statement 21/9 (PS21/9) “Implementation of Investment Firms Prudential Regime” (IFPR) which closely follows the aims of the EU’s IFD (Investment Firm Directive) and IFR (Investment Firm Regulation) to achieve the same overall outcomes for MiFID Investment Firms. Equally the IFPR introduces now a single prudential regime for all FCA investment firms.
We answer some key questions that any Investment Firm should be asking.
As of when is the IFPR applicable?
The IFPR is applicable as of January 1, 2022. This however does not mean that everything has to be fully implemented by then. Firms will however need to check which of the new rule requirements that are to be introduced will apply to them for capital requirements methodology, remuneration, risk management, liquidity, concentration, public disclosure, reporting and governance.
Ahead of the 1 January 2022 implementation date, investment firms were asked to fill in a FCA IFPR Questionnaire, which included questions relating to the firm’s status as a small and non-interconnected FCA investment firm (SNI), investment firms’ corporate structures and their expected ICARA reporting dates.
It is therefore important to know of the main changes that will apply to you as an investment firm so that you can start the implementation asap. For example, the 1st reporting on the Remuneration Code might only be due in 2023. You however will have to translate the implications of the Code in your remuneration policies and performance setting and assessment to ensure that each staff member is aware of the potential changes and that these are not changed in the middle of a performance year ie 2022.
Any firm that is not carrying on MIFID investment services or activities in the UK, including those that are article 3 exempt, is not affected by IFPR. Any Firms which would be MIFID article 3 exempt but have previously opted-in to MIFID will need to apply for a variation of permission if they would like to stop opting-in ie to avoid having to implement IFPR.
When do you classify as a Small and Non Inter-connected (SNI) Investment Firm?
Do be classified as a SNI an investment firm needs to fulfil certain criteria which are set out in detail in the FCA handbook under MIFIDPRU 1.2.1R (average AUM < £1.2 billion, average COH (Client Orders Handled) < £100 million (per day for cash trades) and <£1 billion (per day for derivatives trades), average ASA (Assets safeguarded and Administered) is zero, average CMH (Client Money Held) is zero, etc. Please note that the categorisation thresholds, with the exception of the “on-and off-balance sheet total”, only relate to the MiFID activities the firm undertakes.
If classified as an SNI certain provision of the IFPR do not apply, for example:
• Risk, remuneration and nomination committees;
• the provisions in SYSC 19G (MIFIDPRU Remuneration Code) which are not listed in SYSC 19G.1.6R(2);
• an SNI is not subject to the extended remuneration requirements, only to the basic/standard requirements instead of extended remuneration requirements (deferral, pay-out in instruments and pay-out of discretionary pension benefits).
How do I analyse the Investment Firms (group) structure (and what is the impact)?
Please note that the scope and composition of a consolidation group is similar to the scope under the UK CRR. A key difference is that under the IFPR the concept of an ‘investment firm group’ is used. Prudential consolidation than treats the whole investment firm group as if it was a single FCA investment firm.
Elements that need to be looked at are:
• Are you an UK parent entity;
• What are your subsidiaries (based on the company law test (Companies Act 2006);
• Are you a sub-group in a larger group;
• Are there any so called connected undertakings (CU, based on either majority common management, significant influence, single management or participation in);
• Does the CU have subsidiaries.
The impact of your analysis of your (Group) structure is that certain requirements of the IFPR will either apply to you or not and how for example K-Factors and Own Funds Requirement will be calculated. Equally, depending on your corporate structure different levels of remuneration requirements (basic, standard and extended remuneration requirements) for you as an FCA investment firm will apply.
How do I prepare for the significant changes regarding increased regulatory capital, disclosure and remuneration requirements?
As indicated in the above questions, how you need to prepare depends very much on what kind of organisational structure you have and what MiFID activities within that are carried out. A gap analysis between your current position (based on the UK CRR) and the new IFPR will be the basis of the changes that you will have to be making in your organisation. Be it organisational, how you carry out your periodic risk assessments, if you need to make changes to your remuneration policy, how you calculate your ICARA (former ICAAP), reporting requirements, etc.
What are the requirements of the Remuneration code?
All FCA investment firms should have remuneration policies and practices that meet certain minimum standards. These relate to:
• remuneration policy design;
• governance and oversight of remuneration policies and practices;
• fixed and variable remuneration;
• restrictions on variable remuneration.
This is essential for the objectives of the FCA’s overall approach to remuneration, which are to:
• promote effective risk management;
• ensure alignment between risk and individual reward;
• support positive behaviours and healthy firm cultures;
• discourage behaviours thaT can lead to misconduct and poor customer outcomes. The principles-based nature of these requirements provides firms with a high degree of discretion in how they comply with them.
• Both SNI and non-SNI firms must ensure that the fixed and variable components of an individual’s remuneration are appropriately balanced;
• This must be applied to all staff;
• There is an additional requirement that a firm sets out in its remuneration policies an appropriate ratio between variable and fixed remuneration. This is instead of setting a specific bonus cap. This requirement applies only to non-SNI firms and only in relation to those members of staff identified as material risk takers (MRTs).
The specific situation of your company (legal, organisational, etc.) will define the IFPR elements applicable to your company and which and how requirements need to be fulfilled.
Many details need to be considered as part of the new IFPR and AlgoMe Consulting can support you in summarising these and ensure that any necessary changes in for example your governance, operations, risk and reporting are implemented.