FAQs: The Investment Firm Prudential Regime

The UK Investment Firm Prudential Regime or “IFPR” is a new streamlined and simplified regime for the prudential regulation of investment firms in the UK. The IFPR is being introduced by the Financial Conduct Authority (FCA) in accordance with the new Financial Services Bill and new Part 9C of the Financial Services and Markets Act 2000.

It is intended to come into force on 1 January 2022 following a package of FCA consultation papers. The first of these, CP20/24 (CP), was released by the FCA in December 2020 and followed an earlier FCA Discussion Paper, DP20/2 (DP). The second of these, CP 21/7 (CP), was released by the FCA in April 2021. It is intended that the final CP will be published in Q3 2021.

In broad terms, the new prudential regime will be aligned with changes proposed in the European Union under the Investment Firm Directive (IFD) and the Investment Firm Regulation (IFR). This is legislation which came into force on 26 December 2020 and will take effect in the EU on 26 June 2021. Although Brexit means that the IFD and IFR will not apply in the UK, the FCA was a key advocate of, and heavily involved in policy discussion on, the new EU regime before the UK’s exit from the EU. Unsurprisingly, therefore, the IFPR is heavily influenced by these EU changes.

In its first two CPs, the FCA makes clear that the intention of the new IFPR regime is to refocus prudential requirements away from the risks firms face, to take adequate account of the potential for harm to consumers and markets. The new proposals will also strip away much of the complexity in the existing prudential framework and this is to be welcomed.

However, the new rules will also make significant changes to the way UK investment firms will be regulated for prudential purposes and the remuneration rules to which those firms are subject and consequently, we expect that significant resource and planning will need to be devoted by firms in 2021 in order to be ready for the early 2022 implementation date.

The following firms will be caught by the new regime:

• investment firms subject to BIPRU and GENPRU;
• full scope, limited activity and limited licence firms subject to IFPRU and the CRR;
• “local” investment firms;
• matched principal traders;
• exempt CAD firms;
• investment firms which previously were exempt under Article 3 of MIFID but opted in; and
• various specialist commodities derivatives investment firms.

You can check if you are performing investment services, and therefore amount to an investment firm, by comparing your permissions profile against the services which are MiFID services, described further in the following guidance in the FCA Handbook: PERG 13.3. There is a useful table tracking UK regulated activities to the following MiFID services using the following link.

Generally speaking, we expect the answer to this to be “no”. However, for firms which are collective portfolio management investment firms (CPMI firms), they will be impacted by the new rules. These are firms with permissions to manage an alternative investment fund (AIF) and/or permission to manage a UK UCITS fund which also have what are known as “MiFID top up” permissions. These firms are not investment firms as such but they do have permissions to conduct certain activities which are "investment services".

If you are a CPMI firm, you will have a restriction on your permissions profile (a CPMI restriction) on the FS register which makes this clear. Please refer to the Restrictions heading in your entry on the FS register.

For CPMI firms, the new rules will mainly apply in respect of the MiFID business conducted by the CPMI firm. CPMI firms will already be used to complying with dual prudential regimes in order to satisfy the higher of: (i) their AIFMD/UCITS prudential requirements as set out in IPRU INV; and (ii) their prudential requirements as a MIFID firm subject to either GENPRU/BIPRU or IFPRU. Under IFPR, CPMI firms will need to comply with new prudential requirements under the new FCA sourcebook MIFIDPRU (which replaces both BIPRU/GENPRU and IFPRU) (as well as continuing to satisfy the prudential requirements under IPRU INV).

There will however be a change from the existing approach in respect of remuneration code requirements, particularly for CPMI firms which are BIPRU firms. Currently, CPMI firms subject to BIPRU, so long as they comply with SYSC 19B/19E (the AIFMD/UCITS remuneration codes) are also deemed to comply with the BIPRU remuneration code under SYSC 19C and therefore only need to consider one remuneration code. Under IFPR, CPMI firms must apply the new MIFIDPRU Remuneration Code to their firm’s MiFID business and the AIFMD/UCITS remuneration code to their AIFM/UCITS business.

This approach creates a tension where a member of AIFM/UCITS remuneration code staff will also be a material risk taker for the purposes of the MIFIDPRU remuneration code due to having responsibilities for both AIFMD/UCITS and MIFID business. The FCA in the second CP has proposed that in these circumstances the firm must apply the stricter of the requirements (for example, any longer deferral periods) to the individual.

For UCITS and AIF managers which do not have MiFID top ups, IFPR is not generally expected to apply. However, there is one further change in IFD which impacts all UCITS managers and AIFMs regardless of MiFID top ups. This is the cross reference in IFD to the UCITS Directive and to AIFMD, such that own funds must be held by these firms which is no less than the FOR (fixed overheads requirement) calculated under Article 13 of the IFR. It may be that a corresponding change will be made in IFPR in line with the above, in IFD. However, this will be addressed, it is expected, in a later FCA consultation paper.

It is expected that firms will need to comply by 1 January 2022. This is, however, subject to appropriate progress and amendments to the Financial Services Bill which was introduced by the UK Government on 20 October 2020. The passage of the Bill through Parliament may result in changes to the new Part 9C of the Financial Services and Markets Act 2000 and it is not impossible this may require subsequent changes to the new IFPR regime before it is introduced.

The FCA has said that it will be monitoring the relevant legislative developments and it will reflect those in subsequent consultations, where required.

The intention behind the new proposal is to create a new prudential regime which is tailored specifically for investment firms and better aligns the standards and rules which apply with the business model of this type of firm (as well as the possible sources of possible harm).

Presently investment firms have to comply with a prudential regime which has been designed primarily for credit institutions and the FCA indicates in its CPs that the current regime is not designed to address the potential harm posed by FCA investment firms.

The FCA has also stated that the ongoing regulatory costs for firms should be lower as a result of the changes. However, our view is that this may not always be the case and firms should scrutinise the changes carefully to identify the impact upon them. It does seem clear that the simplification of the regime should free up management time and reduce time spent on complex capital calculations that do little to help firms manage risk. The FCA has indicated its view that the changes should also reduce barriers to entry to the market and allow for better competition.

The key changes will involve:

• new liquidity rules across the board. UK investment firms are not currently subject to liquidity rules;
• changes to the level of initial capital to be held. Initial capital will increase for most firms;
• a brand new approach to calculating capital known as the “K factor” approach; and
• new rules on remuneration and disclosure which allow less scope for firms to determine their approach based upon proportionality principles.

The first CP covers in broad terms own fund requirements, prudential consolidation, concentration risk monitoring as well as reporting. The second CP covers remuneration, liquidity, risk management and governance and the ICARA and SREP (as discussed below). The final CP is expected to cover disclosures and ESG.

Please refer to the question above, "We’re not an investment firm, do we need to worry about whether these new rules will be applied to us?" which explains the position for CPMIs at the current time of writing.

Yes. Investment firms above certain size thresholds and which deal on own account and underwrite/place financial instruments on a firm commitment basis will remain on Capital Requirements Regulation (CRR) standards. Some firms within this cohort may be obliged to seek authorisation as a new type of non-deposit taking credit institution because they are considered “systemically important”.

We would not expect this to apply to many firms. Figure 3.1 of the DP provides a useful flowchart and further details.

Certain firms under the regime known as “small and non-interconnected investment firms” or SNIs benefit from additional proportionality and have less onerous prudential obligations, as well as reporting, disclosure and remuneration requirements. Table 2 in paragraph 2.10 in the FCA’s CP sets out the threshold tests, based on financial criteria, to be considered an SNI firm and figure 1 in paragraph 2.12 provides a useful flowchart. We suggest checking those charts to determine your likely status.

The SNI test is not a static or one-off test and is not based on activity type; a current exempt CAD firm, for example, will not necessarily be treated as an SNI. A firm which is not an SNI but subsequently becomes one will need to meet the conditions for a period of six months on a continuous basis in order to be treated as an SNI under the regime. This is explained in paragraph 2.13 of the CP.

You can also find a quick summary guide of the difference between being an investment firm under IFD/IFR and an SNI firm in the table in 3.31 of the DP.

The increase is significant for non-SNI investment firms, including current Exempt CAD firms which currently only require €50,000 initial capital. The FCA justifies the approach on the basis the levels under the previous regime have not been updated since 1993.

Paragraph 5.5 of the CP sets out a summary of the new levels of initial capital. These vary by regulated activities carried on but the categories are:

• £750k;
• £150k; and
• £75k.

A firm which does not have client money and custody permissions but which has “advising”, “arranging” (i.e. reception and transmission of orders), “dealing” (executing orders) and/or “managing investments” (portfolio management) permissions only will usually be required to hold initial capital of £75k.

This depends on whether you are an SNI firm or non-SNI. The difference is explained in the answer to the "I’m an investment firm but only a small one, and our activities are very low risk, will I be excluded from the most onerous parts of the regime?" question above.

If you are non-SNI, your initial capital requirement will be the higher of the fixed overhead requirement (FOR), the permanent minimum requirement (PMR) and the K factor requirement (KFR). If you are SNI, then your capital requirements will be the higher of the FOR and the PMR.

• The PMR is basically the initial capital as described above.
• The FOR is expected to be one quarter of the fixed overheads for the previous financial year, although the details for calculation are not covered in the CP and the FCA will address this in its subsequent consultation papers.
• The KFR is entirely new and is a new way of calculating the potential for harm in a firm (including its risk to clients and the market). Please refer to the "People are talking about the “K factors”. What are these?" question below.

Although theoretically the KFRs don’t apply to SNI firms. In reality, SNIs will need to assess their firm against these metrics to ensure that they remain an SNI. This is because the K factor tests are in practice relevant to the thresholds for remaining an SNI.

The above explains the calculation for what is known as “Pillar 1” capital. Firms will also have to perform an additional Pillar 2 assessment and this may require them to hold additional capital. Please refer to the "My firm has to prepare an ICAAP (Internal Capital Adequacy Assessment Process). Is that being scrapped now?" question below.  

This is a completely new approach to determining the minimum own funds requirement. The K-factor capital requirements are essentially a mixture of activity and exposure-based requirements. It is intended to reflect harm and is very different from the historic calculations under the old regime. For many firms, some of the K factors will not be relevant and the calculation methods are designed to be straightforward.

The KFR is the sum of each of the K factors that apply to the business of the investment firm.

Figure 6.1 of the DP sets out the K factors and chapter 6 explains how to calculate them.

In brief, the K factors are divided into three categories:

• risks to client (RtC);
• risks to market (RtM); and
• risks to firm (RtF).

Not all K factors will have to be considered by each firm, however. For instance, if a firm does not hold client money or assets then two RtC K factors for client money held (K-CMH) and assets safeguarded and administered (K-ASA) can be ignored.  

The FCA has also confirmed that CPMI firms do not need to include their collective portfolio management activities (i.e. their activities as AIFM or UCITS manager) when calculating their K factor requirement.

The first CP only addresses the K factors relevant to firms which deal on own account and the second CP addresses the remaining K factors as well as updated proposals for the daily trading flow (K-DTF) applicable to firms which deal on own account.

Yes, possibly, depending on your current status.

The IFPR follows a similar approach to the CRR on assessing capital quality. Investment firms will have to hold Common Equity Tier 1, Additional Tier 1 and Tier 2 capital in the same proportions as set out in the CRR.

This will however be a change for firms that do not currently work on CRR concepts such as BIPRU firms and exempt CAD firms. These firms will not have some of the current categories available to them such as Tier 3 short term subordinated debt. Consequently, there may be changes to the type of capital held for this profile of firm.  

There are also some changes against the CRR regime in order to simplify the calculation of certain deductions and to remove reference to concepts that do not exist in the IFPR. Further detail is set out in chapter 4 of the first CP.  

All firms, even SNIs, under the regime must comply with minimum quantitative liquidity requirements. The intention is to create a resilience in each firm to a sudden liquidity shock. In short, the objective is to ensure that firms always have a minimum stock of liquid assets to fund the initial stages of a wind down process.

In the second CP, the FCA has proposed a requirement to hold an amount of certain types of liquid assets equivalent to at least one third of the amount of the FOR (fixed overhead requirement). It is intended as a baseline requirement and firms are entitled to hold more. Chapter 6 of the second CP explains eligible liquid assets and the discounts (haircuts) which need to be applied to them.

The ICAAP will be scrapped and replaced with a new ICARA process which is short for “internal capital and risk assessment”.

All firms including SNI firms will be required to conduct an ICARA.  However, the FCA has indicated in the second CP that there will be some proportionality in approach for SNI firms when conducting certain aspects of the ICARA. There will also still be a SREP process (short for Supervisory Review and Evaluation Process). This is the process by which the FCA determines if the firm has a sound understanding, management and coverage of its risks and may impose a capital add on where it has concerns. 

The DP sets out a short table which explains the differences between the ICAAP and the ICARA process at figure 11.3. Additional detail on the ICARA process and how the FCA will assess it is set out in chapter 7 of the second CP.

Yes, there will be certain provisions in the IFPR intended to ease the change to the new regime. It is expected that these will vary depending on the current status and size of the relevant firm and may allow a more lenient calculation of the PMR and the own funds requirement (described above in "In practice, how much capital will I have to hold?") for a short term period.

Prudential consolidation is expected to be applied under the IFPR but it only captures investment firm groups (and in some circumstances sub-groups) which exclude credit institutions, unlike the CRR. The effect of consolidation is that the UK parent, along with all of the relevant entities in the consolidation group are treated as if they are a single entity. 

In order to identify the consolidation group, the key task is to identify where an investment firm is itself, or is a holding of, a parent undertaking where that parent undertaking is:

• an investment firm;
• an investment holding company; and
• a mixed financial holding company.

The concept of a mixed financial holding company is new and the definition of “financial institution” has changed (as against the CRR concept) to remove credit institutions from scope.   

The firms which will then be included in scope of the consolidation are the following:

• investment firms;
• financial institutions (including AIFMs and UCITS management companies as well as intermediate parent companies);
• ancillary service undertakings (including group service companies); and
• tied agents (appointed representatives).

The UK parent to which consolidation applies must comply with obligations relating to:

• composition of own funds;
• own funds requirements;
• concentration risk;
• liquidity;
• disclosure; and
• reporting.

Further details are set out in chapter 3 of the first CP. In addition, under IFPR, as an alternative to prudential consolidation and subject to FCA approval, a group capital test may be applied in order to mitigate the risk of investment firms being exposed to financial strain as a result of their membership of a group. This is discussed at paragraph 3.85 onwards of the first CP.

In the second CP, the FCA has proposed that the IFPRU and BIPRU remuneration codes will be consolidated into a single combined code. Under the new MIFIDPRU remuneration code, there will effectively be three tiers of requirements which will apply as follows:

Basic remuneration requirements. These will apply to all investment firms (including SNI firms). These requirements include higher level obligations such as to have a clearly documented gender-neutral remuneration policy and comply with certain governance and oversight requirements. Chapter 10 of the second CP sets out further detail of the basic remuneration requirements; 

Standard remuneration requirements. These will apply to non-SNI firms only. These requirements impose obligations (amongst others) regarding performance assessment; restrictions on non-performance related variable remuneration such as retention and buy out awards;  ex ante and ex post risk adjustment such as malus and clawback arrangements; and additional high level obligations for example, covering annual review. Chapter 11 of the second CP sets out further detail of the standard remuneration requirements; and

Extended remuneration requirements. These will apply to the largest SNI firms. A firm will fall within this category where:

• the value of its on‑and off‑balance sheet assets over the preceding four‑year period is a rolling average of more than £300m; or
• the value of its on‑and off‑balance sheet assets over the preceding four‑year period is a rolling average of more than £100m (but less than £300m), and it has trading book business of over £150m, and/or derivatives business of over £100m.

The extended remuneration requirements impose obligations (amongst others) regarding the pay-out of variable remuneration; deferral and vesting; discretionary pension benefits; and remuneration committees. Chapter 12 of the second CP sets out further detail of the extended remuneration requirements.

These proposals will have a significant impact on both Exempt CAD firms which will now become subject to a remuneration code even where they meet the criteria for an SNI firm and CPMI firms which will have to comply with at least two or three different remuneration codes (see "We’re not an investment firm, do we need to worry about whether these new rules will be applied to us?". 

In addition, perhaps the most fundamental change of all is that the broad brush approach of dis-applying the pay out process rules as a BIPRU firm, on grounds of proportionality, will no longer be possible as the application of these requirements will be determined strictly on the basis of which tier a firm falls in.

ESG is expected to be covered in the final consultation paper due to be issued at the start of Q3 2021, according to the FCA’s current timeline.

Based upon the DP, there will be new disclosure requirements under the regime, however, for now it appears that these requirements are only relevant for larger non-SNIs. Based upon IFD/IFR equivalent obligations, from 26 December 2022, those firms will have to disclose information on ESG-related risks, physical risks and transition risks every six months, although query if this deadline will be adjusted considering the later implementation date in the UK under IFPR.

Under IFD/IFR, the European Banking Authority (EBA) is also required to consider whether any ESG-specific amendments to the K factors should be made to ensure the appropriate prudential treatment of ESG-exposed assets. The EBA must also produce, if appropriate, guidelines which introduce ESG risk criteria for the SREP.

The FCA has acknowledged the importance of firms integrating consideration of ESG-related risks and opportunities into their business to enable the market to work well. It also encourages all investments firms to consider those risks when calculating their capital and liquidity requirements. Based on the EBA’s findings, the FCA may consider introducing its own guidelines for integrating ESG considerations into the supervisory review process. More is expected on this in the consultation paper in Q3 2021.