How the revised prudential rules for investment firms impacts regulatory reporting

In April 2019, the European Parliament endorsed the revised prudential rules for investment firms, the Investment Firm Regulation (IFR) and the Investment Firm Directive (IFD). The need for stronger capital markets within EU resulted in new tailored and risk-sensitive rules for investment firms. Consequently, the great majority of investment firms will no longer be subject to the requirements set out in the existing Directive 2013/36/EU (CRD IV) and Regulation (EU) No 575/2013 (CRR).

The time to prepare for the regulatory reporting impact of IFR and IFD is now.

The Key implications

The key features of the new regulation are presented below:

  • Revised categorization of investment firms (class 1, 2 and 3)
  • Capital requirements
    • Initial Capital (Permanent Minimum Capital)
    • Risk metric based on K-factors
    • Rules introduced regarding concentration risk
  • Requirements on liquidity
  • Revised reporting and disclosure requirements

Categorization of investment firms

The prudential rules set out in IFR/IFD introduces three classes for investment firms. Class 1 refers to investment firms of systemic importance and these will continue to fall under the CRR/CRD IV regime, and upcoming CRR II and CRD V. Class 2 applies to larger, ‘non-systemic’, investment firms that exceed certain threshold criteria based on their size and level of specific business activities. Finally, Class 3 is made up of small and non-interconnected firms that fall below these thresholds.

Capital and liquidity requirements

Class 2 firms will be required to hold own funds which amount to the highest of their permanent minimum capital requirement (PMC), fixed overheads requirement or the so-called K-factor requirement. The small and non-interconnected firms, Class 3, are met by lighter prudential rules and are required to hold own funds based on the highest of their PMC requirement or their fixed overheads requirement.  The calculation of fixed overheads remains unchanged, but the IFD have changed the levels of the initial capital. Investment firms dealing on own account or underwrite and/or place financial instruments on a firm commitment basis will receive a higher PMC requirement and other investment firms will benefit from a lower PMC.

A key implication of the new prudential framework is the K-factor methodology. The K-factors aim to capture the risks inherent in the investment firm’s business activities and cover different dimensions of risk such as; client risk, market risk, and risk associated with the firm itself. Concentration risk is a firm-specific risk that has been highlighted in the new regulation and which the investment firm will be obligated to evaluate. The sum of all calculated risks will make up the K-factor capital requirement.

The regulation also requires investment firms to monitor and manage their liquidity situation. It stipulates that investment firms must hold high-quality liquid assets (HQLA) to a minimum of 1/3 of their fixed overheads at all times.

Reporting  and disclosure

All investment firms will be required to report to their competent authority the composition of own funds, capital requirement and level of activity. Class 2 firms also need to report their concentration risk and liquidity risk. Further, under IFR investment firms will be required to disclose information on regulatory capital, capital requirement, return on assets, risk management objectives and policies, governance arrangements and information regarding remuneration policy and practices.

Implementation and final remarks

The final prudential rules are yet to be published and implemented. Once the final versions of IFR and IFD have been published in Official Journal, implementation is expected to begin 18 months thereafter. The views expressed above may, therefore, continue to evolve as implementation continues and further guidance is made available.

The new proportionate regime is a positive direction for the European investment firm market. It will make life simpler for small and non-interconnected investment firms, while at the same time better correspond to the specific risks that the investment firms are exposed to. However, to which extent these new features will apply to investment firms depends on their size and complexity. The first step for investment firms would, therefore, be to asses which class their firm is subject to.

How can we help you?

To support our clients in handling regulatory reporting challenges, FCG has developed an automated and individually customized Managed Services solution, adapted for investment firms. We will take care of the whole process, map your data, create the reports and submit them to the local Financial Supervisory Authority (FSA) after a sign-off from you. It will help your company free up time, resources and make sure that you focus on your core business. The process will be performed in close cooperation between FCG and your company and enables you to address the numerous regulatory changes with full peace of mind.

FCG also provides customized solutions that guide and support your company through the complex maze of global regulatory requirements you face, whether it’s reviewing your current regulatory reports, analyzing the impact of new regulations such as IFR and IFD or providing with interim expertise.

This autumn, we will be holding a seminar on the new investment firm regulation and its direct impact on regulatory reporting. Stay tuned for updates!

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