The FCA issues second consultation paper on the new UK Investment Firm Prudential Regime

21 April 2021

The Financial Conduct Authority (FCA) this week has issued its second consultation paper, CP 21/7, on rules and guidance for the UK Investment Firm Prudential Regime (IFPR).

The IFPR is due to come into effect on the 1 January 2022 and will apply to all firms authorised by the FCA under the Markets in Financial Instruments Directive (MiFID) as well as regulated and unregulated holding companies of groups that contain one or more of these firms. The purpose of the IFPR is to replace the 11 regimes currently applicable to these firms with a single harm focused (rather than risk focused) regime which, for many in-scope firms, will simplify their current prudential obligations.

The FCA issued its first consultation paper, CP 20/24 in December 2020; both consultation papers follow the discussion paper (DP20/2) which the FCA issued in June 2020. The third, and final, consultation is scheduled for early Q3 of this year and will cover disclosure and consequential amendments. 

As expected, CP 21/7 is more comprehensive than CP 20/24 introducing further draft text to the new prudential sourcebook, MIFIDPRU and changes to other parts of the FCA Handbook. CP 21/7’s main focus is:

  • the own funds requirement, particularly the determination of the Fixed Overhead Requirement (FOR) and the remaining rules and guidance on K-factors;
  • the liquidity requirements;
  • risk management, the Internal Capital and Risk Assessment (ICARA) and the Supervisory Review and Evaluation Process (SREP);
  • governance requirements;
  • remuneration rules and guidance; and
  • regulatory reporting.

The “small and non-interconnected” (SNI) and non-SNI firm distinction, discussed in our briefing, remains important. CP 21/7 introduces clarity on the proportionality principle which will result in fewer rules applying to SNI firms, than to non-SNI firms.

CP 21/7 also provides clarity on the extent which the IFPR rules will apply to Collective Portfolio Management Investment (CPMI) firms, discussed in our briefing. CP 21/7 indicates that, with the exception of the FOR requirement and other limited areas, the IFPR rules will not apply to the whole of a CPMI firm’s business; only that part which is a MiFID business.

We note the key areas in more detail below and will publish further briefings on CP 21/7.

Own Fund Requirements

CP21/7 covers the calculation of relevant expenditure for the purposes of the FOR which will be another of the “floors” below which the own funds of an FCA investment firm must not fall. Under the proposed rules, an FCA investment firm will first need to determine its total expenditure after it has made any distribution of profits and then deduct certain other expenses (to the extent that those items have been included in expenditure).

The FCA also set out its proposals for the calculation of the remaining activity-based capital requirements known as K-factors. The remaining K-factors, noting that the FCA consulted on the K-factors, such as net position risk, for firms operating a trading book, in CP20/24 are:

  • assets under management (K-AUM);
  • client assets safeguarded and administered (K-ASA);
  • client money held (K-CMH); and
  • client orders handled (K-COH).

CP 21/7 covers areas such as how firms should calculate an adjusted coefficient for the daily trading flow K-factor (K-DTF) in periods of extreme market stress and volatility and also sets out specific proposals on own funds requirements and firm categorisation for FCA investment firms when they provide clearing services as clearing members and indirect clearing firms.

It also contains guidance, which is likely to be helpful to asset managers, on the treatment of assets where there is a formal delegation of portfolio management and interaction between the K-AUM and K-COH requirements.

Basic liquid asset requirement

The FCA clarifies its views on how all FCA investment firms are to apply a basic liquid asset requirement. This would be based on holding an amount of core liquid assets equivalent to at least one third of the amount of their FOR.

Risk management & governance (ICARA and SREP)

In its first discussion paper on the IFPR (20/2), the FCA set out its initial views on how it expected  investment firms to carry out an ICARA process which supports firms in determining whether they adequately meet the IFPR’s own fund and liquid assets requirements. The ICARA is also intended to replace the current ICAAP. CP21/7 sets out draft rules on how FCA investment firms are to carry out this process. Through the ICARA, firms will be required to assess potential harm to consumers and markets, including risks to their ability to engage in an orderly wind-down, as well as those from their ongoing activities.

Firms are also expected to meet an Overall Financial Adequacy Rule (OFAR) which is the standard that the FCA will apply to determine if an FCA investment firm has adequate financial resources. CP21/7 also includes new and specific guidance on what the FCA expects from investment firms at certain intervention points when they run into difficulties, and what firms can expect from the FCA.

It is clear from CP 21/7 that the FCA views the IFPR as an opportunity to re-establish its expectations of FCA investment firms’ internal governance and risk management. In this regard, the FCA are proposing to re-orientate their prudential supervisory approach towards being harm-led rather than risk based. This approach will be supported by the introduction of an ICARA questionnaire reporting template and, in line with the Senior Manager and Certification Regime (SM&CR), by new expectations of senior managers responsible for ensuring the appropriateness of the firm’s governance and risk management.

The FCA also indicate that firms which are part of an investment firm group have the option to conduct the ICARA process on a group basis unless the FCA give a specific direction otherwise. The FCA will expect individual firms to comply with the OFAR on an individual basis and for each entity to have a wind down plan. Each individual firm will also be expected to consider any material risks from its membership of a group.    

Remuneration requirements

One change from the FCA’s proposals in DP20/2 (in which it seemed likely only non-SNI firms were expected to comply with the IFPR’s remuneration rules), is that the FCA is now proposing in CP21/7 that SNI firms must apply the IFPR’s basic remuneration requirements which will be set out in a new single remuneration code, the “MIFIDPRU Remuneration Code” in SYSC 19G of the FCA Handbook. For example, all FCA investment firms (including SNIs) must have a clearly documented gender-neutral remuneration policy and comply with certain governance and oversight requirements.

Non-SNI firms must comply with further rules, referred to as “standard remuneration requirements”, which include identifying material risk takers (MRTs), setting an appropriate ratio between variable and fixed remuneration as well applying appropriate risk adjustment (malus and clawback) terms to awards of variable remuneration. The FCA maintained its initial view as provided in DP20/2, that it “would not be appropriate” for the FCA to set a single maximum ratio between variable and fixed remuneration (often referred to as a "bonus cap"). 

For large non-SNI firms, extended remuneration rules will apply, including more stringent requirements in respect of deferral, payment in instruments, retention and treatment of discretionary pension benefits. Large non-SNI firms will also need to establish a remuneration committee.

In CP21/7, the FCA confirms its proposed approach for CPMI firms. Currently these firms comply with the Alternative Investment Fund Manager (AIFM) Remuneration Code (SYSC 19B) and/or the Undertakings for Collective Investment in Transferable Securities (UCITS) Remuneration Code (SYSC 19E). Based upon current rules, a CPMI which is a BIPRU firm will be deemed to comply with the BIPRU Code. Under IFPR, this will change as all CPMIs (including those which were previously BIPRU firms) must also apply the MIFIDPRU Remuneration Code to their MiFID “top-up” business. This means that CPMIs will now need to apply either two or three different remuneration codes, as their non-MiFID business will continue to be subject to the AIFM and/or UCITS Remuneration Codes.

Where a “material risk taker” (MRT) classified as “code staff” of a CPMI has responsibilities for just MiFID or just non-MiFID business, the firm should apply the relevant Remuneration Code. Where an MRT has responsibilities for both MiFID and non-MiFID business, the FCA expects the firm to apply the stricter of the requirements (for example any longer deferral periods) to the MRT.

Once the new MIFID Remuneration Code comes into force on 1 January 2022, the IFPRU Remuneration Code (SYSC 19A) and the BIPRU Remuneration Code (SYSC 19C) as well as all non-Handbook guidance on these codes will be deleted. Firms will need to apply the new remuneration rules from the start of their next performance year beginning on or after 1 January 2022. Firms currently in scope of the IFPRU or BIPRU Remuneration Codes should continue to apply those until 1 January 2022, or the beginning of their next performance year after that date, whichever is later. The FCA will consult on public disclosure of remuneration information in its third IFPR CP which is due to be issued in Q3 this year.

Regulatory reporting requirements

Under the IFPR, the amount of information that investment firms need to report to the FCA about their remuneration arrangements will be significantly reduced. Investment firms will only need to submit a new MIFIDPRU Remuneration Report (MIF008) instead of the existing Remuneration Benchmarking Information Report (REP004) and High Earners Report (REP005). Furthermore, the FCA intends to tailor the remuneration reporting requirements depending on whether a firm is subject to basic, standard or extended remuneration requirements and simplify the additional reporting form for CPMI firms.

Finally, the FCA has also amended the MIF002 form for reporting liquid assets that accompanied CP20/24 to take account of the FCA’s liquidity proposals set out in CP21/7 and, as noted above, an ICARA reporting form will replace the existing FSA019 (“pillar 2”) return for these firms.

International firms

Firms currently in scope of the FCA’s Temporary Permissions Regime along with non-EEA firms considering applying for FCA authorisation should also note the FCA’s remark in CP 21/7 that it is not proposed that MIFIDPRU will apply to an overseas investment firm. However, it appears that if the FCA on an application for authorisation is not satisfied that the firm is subject to equivalent home state supervision, it will be required to subsidiarise and that subsidiary would be subject to MIFIDPRU. This appears to be a departure from the FCA’s guidance on its approach to international firms published in February 2021 which stated that an international firm would be assessed on a case by case basis and has a “degree of choice” on its legal form if it meets the requirements to be authorised and has robust mitigation in place.

Next steps

The period for submitting feedback on this CP will run until Friday 28 May 2021. The FCA encourages firms and other relevant stakeholders to provide feedback on the proposals set out in CP 21/7. In particular, the FCA is interested in any suggestions for making the IFPR work better for different business models. As mentioned above, a further CP will be published in Q3 2021, and two policy statements are expected, one in late spring and the second in the course of the summer. The final rules on the IFPR will be published once the Financial Services Bill has passed through Parliament and all the consultations are complete.