Are you an “exempt CAD”?

05 October 2020

In this article, Alexandra Green, Rachel Serene and Louise Bralsford explain why exempt CAD firms enjoying a relatively laissez-faire regime may soon become an extinct creature in the City…

Firms known as exempt CAD under the UK and EU’s current regulatory capital regime for investment firms have long enjoyed a relatively laissez-faire set of arrangements requiring them to hold just €50,000 of regulatory capital against the risks that they take as a firm. Not only this, the requirements of the Financial Conduct Authority (FCA) Remuneration Codes have been largely non-applicable to these firms, with lighter touch requirements under SYSC 4.3A.1A(3) R and SYSC 19F.1 (MIFID Remuneration Incentives).

This has, in many instances, left firms in relative peace to reward senior staff and material risk takers as they see fit, at least from an FCA Handbook perspective.

However, this old order looks set to change in 2021, under the FCA’s new prudential regime, proposed to mirror the EU’s IFD/IFR (which technically speaking will not apply in the UK as a result of Brexit). The FCA has openly said that it likes the policy intentions behind IFD/IFR and plans therefore to implement them.

So, if you are an exempt CAD thinking you can continue doing what you have always done unimpeded, 2021 may be a shock. Although the FCA has heralded the new regime as better aligned to business models, the risks that they pose and any sources of harm, in fact exempt CAD firms which have relatively low risk adviser-arranger permissions still look set to see a spike in regulatory capital to at least €75,000 or one quarter of fixed overheads (whichever is the higher) under IFD/IFR. Furthermore, an exempt CAD firm will have to complete a potentially complex k-factor calculation even if only to confirm they can take a lighter touch approach, due to meeting the requirements for a so called “SNI firm” because, for example, their advised business will fall under €1.2bn.

And the FCA has said that proportionality provisions under the remuneration code in IFD/IFR are already baked into the regime so the current flexibility present in many of the Remuneration Codes to dis-apply the stricter remuneration rules on performance adjustment, retention and deferral, on a wholesale basis, also has the potential to disappear. 

So, if the benefits of being an exempt CAD are being taken away, can anything be done to avoid the new regime and continue as before?

Perhaps ironically, some (but of course not all) exempt CAD firms will be firms which would alternatively have qualified as Article 3 MIFID exempt firms when they first sought permissions. Some of these firms will have obtained exempt CAD status, purely to benefit from EEA passporting rights (which are not available for Article 3 MIFID exempt firms). At that time, there weren’t many benefits of opting out of MIFID and there were disadvantages from an open border perspective, as exempt CADs with passporting rights can give investment advice across the EEA without worrying about breaching local perimeter regimes.

Of course with Brexit, passporting rights are also disappearing at the end of this year so for these firms, the case for being an exempt CAD will also be falling away. Moreover, at the time of writing it does not appear such Article 3 exempt firms will be brought into scope of the new FCA prudential regime – or at least, the FCA DP is silent on the topic.

If the FCA’s discussion paper proposals come to pass as proposed it may be that a permissions refresh to look at whether a different exemption as Article 3 exempt would be beneficial. Either way, the exempt CAD looks set to be an old dinosaur in a modern new era of increased scrutiny…