The Investment Firm Directive and Regulation
IFD/IFR in summary
The EU's Investment Firms Directive (IFD) and Investment Firms Regulation (IFR) will put in place a new prudential framework for MiFID-authorised investment firms (Investment Firms). The new framework will aim to ensure the safe functioning of Investment Firms and to ensure that they properly manage customer and market risk. The new framework will allow for differentiated regulation of Investment Firms depending on their classification, with higher impact Investment Firms being subjected to more intensive regulation. The degree of regulation will depend on the firm's particular business activity, risk profile and structure which in turn dictates their new prudential class. Once implemented a relatively small number of Investment Firms will be subject to the same prudential requirements that are applied to banks. The remaining Investment Firms will be subject to a harmonised, and for some an enhanced, set of prudential requirements.
Central Bank Regulated Investment Firms
Investment Firms authorised by the Central Bank of Ireland (Central Bank) now have 12 months to prepare for IFD and IFR implementation. IFD is required to be transposed into local law and applied by EU Member States from 26 June 2021 at which time the IFR will also directly apply. IFD/IFR will have significant impacts for a number of Investment Firms. Implementation will require Investment Firms to project plan, identify which classification they will fall into, engage (where applicable) with the Central Bank for re-authorisation or treatment as a credit institution and identify any changes that they need to make to their regulatory capital, liquidity arrangements and remuneration policies. As part of Ireland's IFD implementation, the Department of Finance issued a consultation in May 2020 on discretions available to Ireland in applying IFD which closes on 6 July 2020.
FCA Regulated Investment Firms
Investment Firms headquartered in Northern Ireland should note that the FCA has published a discussion paper (DP) on its approach to implementing a prudential regime for UK Investment Firms. As the requirements of IFD/IFR will take effect after the scheduled end of the UK’s transition period to exit the EU, the UK will introduce its own prudential regime for Investment Firms. However, the FCA had significant involvement in policy discussions about the EU's regime and has made it clear that it will look to achieve similar intended outcomes as the IFD/IFR whilst taking into consideration UK market specifics. The scale of some of the changes are also significant and the FCA is seeking feedback from stakeholders on the appropriate rules for the UK to apply in this area. Northern Irish Investment Firms and other interested stakeholders will have until 25 September to respond to the 35 questions raised in the DP.
Classifications of Investment Firms
Investment Firms will be categorised into one of the following four classes:
"Class 1" Investment Firms
Systemically important Investment Firms dealing on own account and/or who underwrite or place financial instruments on a firm commitment basis and who have average of monthly total assets, calculated over a period of twelve consecutive months exceeds €30bn; or (if below €30bn) where the undertaking is part of a group in which the total value of the consolidated assets of all undertakings in the group exceeds €30bn
Key impacts
- Must re-authorise as Credit Institutions
- Supervised under the SSM if located in the Eurozone
- Regulated under the CRR and CRD IV
- Initial capital requirement €5m, but could be subject to higher ongoing capital requirements depending on nature of activities carried out
"Class 1 minus" Investment Firms
Systemic Investment Firms dealing on own account and/or who underwrite or place financial instruments on a firm commitment basis and where the average of monthly total assets, calculated over a period of twelve consecutive months, exceeds €15bn; or (if below €15bn) where part of group in which the total value of the consolidated assets exceeds €15bn.
Investment Firms may be designated as Class 1 minus at the option of competent authorities where they have consolidated assets of €5bn or more and meet other criteria relating to their significance and the risks posed in the event of their failure.
Investment Firms may also elect to be subject to CRR if they are part of a group which includes a credit institution which is supervised under CRR and obtain competent authority approval.
Key impacts
- Do not require re-authorisation as Credit Institutions
- Will be regulated under the CRR and CRD IV
- Initial capital requirement equal to the initial capital requirement for authorisation to conduct the relevant investment services set by IFD
"Class 2" Investment Firms
Large Investment Firms that are not systemically important which hold own funds at certain thresholds based on the higher of their permanent minimum requirement, fixed overhead requirement, or k-factor calculation.
This is the default categorisation for Investment Firms, although national competent authorities can assess some Investment Firms as being systemically important and therefore falling into class 1 minus and it is also likely that a number of Investment Firms will be able to benefit from a lighter regime if falling within the parameters for class 3 Investment Firms. The ultimate assessment will be determined by the firm's daily trading flow, assets under management, client money, and net position risk.
Key impacts
- Subject to IFD supervisory requirements
- Subject to IFD/IFR remuneration requirements
- Publish reports on environmental, social or governance risks, physical risks and transition risks related to the transition into a more sustainable economy, subject to a three year phase in period
- Establish internal capital assessment process
- Establish liquidity adequacy assessment process
- Subject to new "K-factor" requirements which are a means to calculating a directly proportional capital requirement for each firm's risk profile
- Hold liquid assets equal to at least one third of the firm's fixed overhead requirement
- Initial capital requirement of €750,000, €150,000 or €75,000 depending on nature of activities
"Class 3" Investment Firms
Small Investment Firms that are not interconnected with other Investment Firms and do not undertake any higher risk activities and fall below a range of size-related thresholds and criteria. Class 3 Investment Firms will be subject to a relatively lighter prudential framework under the new regime, but will still need to assess the changes they need to make to prepare for the new regime.
Key impacts
- Must not hold client money or client securities
- Subject to the current MiFID II remuneration framework and not the remuneration framework in IFD/IFR
- Subject to new "K-factor" requirements which are a means to calculating a directly proportional capital requirement for each firm's risk profile
- Hold own funds equal to permanent minimum capital requirement or a quarter of their fixed overheads (whichever is higher) measured on the basis of their activity in the preceding year.
- Initial capital requirement of €750,000, €150,000 or €75,000 depending on nature of activities carried out
EBA workplan and consultations
The EBA has published a Roadmap on Investment Firms which sets out its workplan for implementing the new framework. The EBA mandates cover 6 main thematic areas:
- Thresholds and criteria
- Capital requirements and composition
- Reporting and disclosure
- Remuneration and governance
- Supervisory convergence and SREP
- Environmental, Sustainable and Governance factors and risks (ESG)
The EBA has launched a number of public consultations on its first set of regulatory deliverables under the roadmap. The first consultation on prudential requirements includes three draft Regulatory Technical Standards (RTS) on reclassifying certain Investment Firms as credit institutions and further draft RTS on capital requirements for Investment Firms at solo level and prudential consolidation for Investment Firms at group level.
A second consultation paper relates to reporting requirements and disclosures and includes draft Implementing Technical Standards (ITS) on capital levels, concentration risk, liquidity, the level of activities as well as disclosure of own funds. In addition there are draft RTS on the disclosures required in order to enable monitoring of the thresholds that determine whether an Investment Firm requires authorisation as a credit institution.
An additional consultation paper issued in relation to remuneration requirements for "risk takers", including draft RTS on identification of categories of staff whose activities have a material impact on the firm's risk profile or assets it manages.
The EBA also launched a voluntary data collection exercise. The deadline for responses to the consultation papers is 4 September 2020.
A table of key dates for the implementation of the IFD/IFR and associated regulatory measures is available here.
Conclusion
Investment Firms operating in multiple jurisdictions across the EU should note that the IFD provides for discretion in relation to certain rules on remuneration. For Investment Firms with operations in the UK the FCA indicates the possibility of divergence, particularly in relation to remuneration requirements. Given the volume of proposed regulatory change Investment Firms will have to structure and resource their compliance plans accordingly. The various consultation process on individual proposals provide an opportunity for Investment Firms to shape the development of the regulatory standards that will be implemented in future.
If you have any queries relating to the information in this article please contact Dario Dagostino, Kevin Allen and Patrick Brandt, Partners, Financial Regulation, Dublin or Sinéad Prunty, Financial Regulation Knowledge Lawyer or Christopher Jessup, Finance Associate, in our Belfast office.
Date published: 24 June 2020