The IFR and IFD were finalised in December 2019.  We commented on the IFR and IFD ahead of its finalisation in the quarterly Private Funds Regulatory update.

With a year to go before the expected implementation date for the new investment firms prudential regime on 1 January 2022, the DP is a timely reminder for investment managers to begin focusing on the new regime and its impact on their business.

The DP will be of interest to all investment managers authorised under the rules implementing MiFID and governed by the FCA’s BIPRU and IFPRU rules. It will also be relevant to those managers classified as Collective Portfolio Management Investment Firms (CPMIs) and those classified as exempt-CAD firms.

Those with investments or looking to invest in other managers or broker-dealers, including private equity and credit fund managers, will also be in scope. The provisions in the DP on groups will potentially impact holding companies of those firms directly, with discussion between HM Treasury, the Bank of England, the Prudential Regulatory Authority (PRA) and the FCA ongoing as to the imposition of requirements directly upon holding companies.

Purpose and relevance

In the DP, the FCA makes clear that the aim of the new prudential regime is to achieve similar intended outcomes as the IFR and IFD, such as simplified yet effective prudential requirements that ensure a level playing field across all investment firms whilst also taking into consideration the specifics of the UK market.

The DP is focused on ensuring the prudential regulation is fit for purpose with Chris Woolard, the interim Chief Executive of the FCA, noting that the new regime is designed with investment firms in mind, replacing many rules that were largely designed for deposit-taking credit institutions. The FCA notes that new prudential rules in the UK would help it better deliver against its objectives and introduce significant improvement whilst lowering “ongoing regulatory costs”.

There is, however, no mention of the FCA’s objective to mitigate the ever escalating costs of the Financial Services Compensation Scheme (FSCS) borne by well-run asset and investment management firms. The growing market concern that the prudential regime and the mutualisation system of the FSCS should be reformed to ensure the “polluter pays” was discussed in Charles Randall’s recent speech. It is unclear how much of this has fed into the FCA’s thinking on the IFR and IFD.

The final word on the application of the IFR and IFD in the UK?

Although the FCA formally states in the DP that the UK will not be implementing the IFD/IFR as it has now left the EU, it is clear from the DP that the FCA is in broad agreement with its policy objectives and intended outcomes, and of course, the FCA was heavily involved in the discussions on the new EU regime.

The FCA, however, takes care in the DP to reserve its position noting that the DP does “not necessarily reflect our final settled position on the correct interpretation of certain elements of the legislation.” Readers of the DP hoping to glean the extent to which the new UK regime might potentially deviate from the detail of IFD/IFR (or gain broader insight into the Brexit negotiations between UK/EU and the extent of our future alignment with EU rules) are likely to be disappointed.

However, the FCA is also clear that a considerable amount of detail remains outstanding in the new EU framework. The FCA has stated that it will issue several consultation papers and stagger topics consulting earlier on the topics it considers firms need the most time to prepare.

Main prudential impacts

Important changes introduced under the IFR and IFD, which the FCA notes in the DP, include:

• increase in the initial capital required for authorisation for most firms set at €75,000, €150,000 and €750,000 depending on the investment activities the firm carries out;
• changes in capital calculations, with some deductions from capital now applying in full, and bigger firms that issue AT1 instruments able to specify trigger events;
• changes in own funds requirements, with a firm’s permanent minimum requirement (PMR) having to be the same as the capital required for authorisation, a requirement for all investment firms to calculate a fixed overhead requirement (FOR) and to calculate a new activity based, or K-factor capital requirement (KFR). The minimum ongoing capital requirement to be the higher of PMR, FOR and KFR. (K-factors are discussed further below in the context of CMPIs.);
• re-examination of the rules on prudential consolidation for groups, adapting the current processes under the Capital Requirements Regulation (CRR) to the requirements of the IFR to make it more fit for investment firms. Where the FCA deems a group structure is sufficiently simple (and provided there are no significant risks to clients or to market), it will have the power to allow an investment firm group to instead apply a group capital test;
• changes in rules dealing with concentration risk, liquidity requirements, the powers of the FCA to impose additional capital requirements on individual firms, regulatory reporting requirements and public disclosure requirements; and
• new environmental, social and governance requirements limited at this stage to disclosure requirements but also potentially having an impact on governance and other rules on governance.

Remuneration changes

The new regime also introduces significant changes to the current remuneration requirements for investment firms. The FCA confirms in the DP that the IFRPU (SYSC 19A) and BIPRU (SYSC 19C) remuneration codes will be deleted entirely and a new remuneration code for all investment firms in scope of the IFR/IFD will be introduced. Full scope AIFMs and UK UCITS management companies will however remain subject to their sectoral remuneration codes i.e.  AIFM remuneration code (SYS19B) and UCITS remuneration code (SYSC 19E), respectively. The MiFID remuneration requirements in SYSC 19F would also continue to apply to all MiFID investment firms and to their staff.

The new remuneration rules will require many investment firms to apply more onerous remuneration structure rules such as deferral, payment in non-cash instruments and performance adjustment which such firms have previously been able to avoid through proportionality or regulatory status. The current remuneration regime allows firms to apply certain rules “to the extent” that is appropriate, with the result that many UK asset management and wealth management firms currently disapply the more onerous remuneration structure rules mentioned above on grounds of proportionality. Since the IFD removes this wording, the FCA appears to interpret this to mean that EU firms will not be entitled to disapply such rules altogether, solely on the grounds of proportionality, because “instead proportionality is built into the IFD”. This may in due course prove unwelcome news for many firms and their material risk-takers. 

In addition to getting to grips with the remuneration rules, some EU firms will be required to establish a remuneration committee to oversee the review and execution of their remuneration policy, where they are not currently obliged to do so. Again, based upon the current regime, many firms disapply the remuneration committee requirement. The IFD also requires that remuneration committees must be “gender balanced” without defining this concept further. The FCA indicates that it interprets it as requiring “a culture of inclusion” and “appropriate representation” rather than prescribing an equal gender split.  

CPMI firms and other discussion points

The DP addresses the position of CPMIs specifically, which will be important to the many investment managers that fall under this category. The FCA notes that the requirements in IFD and IFR will replace those in Capital Requirements Directive (CRD) and CRR for investment firms.

The FCA takes the view that a CPMI should be subject to the same prudential requirements for its additional “MiFID business” as a MiFID investment firm would be for its MiFID business. Therefore, if the K-factor for assets under (discretionary and non-discretionary) management (K-AUM) applies there would be no limit on the ultimate amount of the requirement. This would mean that there is no prudential benefit to a firm carrying out MIFID activities as a MIFID investment firm or a CPMI firm.

The FCA also notes its intention to use the same definition of own funds as it would for investment firms to specify the composition and quality of capital that a CPMI holds for its “MiFID business”.

The DP also deals with waivers and CRR permissions and transitional provisions which are important, in practice, for firms. 

It also contains a useful discussion of the national discretions which the UK will exercise, most notably with respect to: the ongoing application of the CRD/CRR to investment firms; the approach for small and non-interconnected investment firms; technical discretions relating to K-factor requirements and to concentration risk; group consolidation and the group capital test; governance and remuneration; and assessment of third-country supervision.

Other relevant developments

The DP follows the first set of IFR and IFD related draft technical standards issued by the European Banking Authority on 4 June 2020 although the DP does not deal with these.  The standards deal with matters such as fixed overhead calculations and K-Factor calculations, determining application thresholds, prudential consolidation, reporting and disclosure requirements, and the identification of classes of staff for remuneration purposes.

The DP’s publication also coincided with the statement by the Chancellor on the proposed new prudential regime for the UK, including changes for banks and other PRA authorised firms under the new Fifth Capital Requirements Directive (CRD V).  Helpfully, the statement clarified that the Government does not intend to require FCA authorised investment firms to comply with the requirements of CRD V in the interim period before the IFR and IFD apply. This is especially good news for PRA-designated investment firms as they will not have to re-authorise as credit institutions.