Directive (EU) 2019/2034 on the prudential supervision of investment firms (IFD) and Regulation (EU) 2019/2033 on the prudential requirements of investment firms (IFR) were published in the Official Journal of the European Union on 5 December 2019 and entered into force on 25 December 2019.
Member States have until 26 June 2021, to adopt and publish the measures necessary to comply with the Directive. However, Member States are required to apply the measures necessary to comply with Article 64(5) (an amendment to MiFID) from 26 March 2020.
The Regulation which is directly applicable throughout the EU applies from 26 June 2021 for the most part, subject to extensive transitional arrangements. A few provisions apply earlier (several amendments to MIFIR which applied from 26 March 2020 (Art. 63(2) and (3)) and an amendment to CRR which applied from 25 December 2019 (Art. 62(30))).
The EBA is tasked with developing 18 regulatory technical standards (RTS), three implementing technical standards (ITS), as well as several sets of guidelines and a list of eligible capital instruments. EBA published the first raft of consultations on 4 June 2020 (see key documents).
The UK and EU exit
As the new regime will only apply from 26 June 2021, this follows the end of the Transition Period and therefore will not automatically apply in the UK. The government intends to legislate through the Financial Services Bill to introduce a new prudential regime for investment firms – the Investment Firms Prudential Regime (IFPR). This new regime will achieve the same intended outcomes as the EU’s IFR/IFD but will be tailored to the UK where necessary to reflect the specificities of the UK market or UK firms.HM Treasury has also confirmed that it intends to delegate responsibility for the implementation of firm requirements to the Regulators, subject to an enhanced accountability framework meaning the vast majority of the IFPR will be implemented through FCA rules. (See also "Updating the UK’s Prudential Regime before the end of the Transition Period"). It seems likely the FCA will introduce the IFPR in June 2021 in line with the introduction of the IFD/IFR. (See FCA DP20/2 - A new UK prudential regime for MiFID investment firms).
On 5 December 2019, Directive (EU) 2019/2034 on the prudential supervision of investment firms (IFD) and Regulation (EU) 2019/2033 on the prudential requirements of investment firms (IFR) were published in the Official Journal of the European Union. Together these instruments will establish a new EU prudential regime for investment firms.
Until now, all investment firms have been subject to the same capital, liquidity and risk management rules as banks as set out in CRR/CRDIV. CRR and CRDIV are based on the Basel standards intended for internationally active banks and therefore do not fully take into account the specificities of investment firms.
The legislation sets out a significant revision to the existing prudential framework for investment firms set out in the Capital Requirements Directive and Regulation (CRD IV and CRR) and in the Markets in Financial Instruments Directive II and Regulation (MiFID II and MiFIR), introducing a more proportionate and fit-for-purpose regime for investment firms.
Classes* of firm
Investment firms will fall into one of four prudential classes depending on the type of activities they are licensed to perform, the scale of their activity and size of their assets. The largest firms (“class 1”) would be subject to the full banking prudential regime and would be supervised as credit institutions:
- Investment firms that provide "bank-like" services, such as dealing on own account or underwriting financial instruments, and whose consolidated assets exceed EUR 15 billion would automatically be subject to CRR/CRDIV;
- Investment firms engaged in "bank-like" activities with consolidated assets between EUR 5 and 15 billion could be requested to apply CRR/CRDIV by their supervisory authority, particularly if the firm's size or activities would involve risks to financial stability (“class 1 minus”)
- Of note, the IFR brings the largest class 1 firms (broadly those whose proprietary-risk-taking firms worldwide have consolidated assets exceeding EUR30bn) into the supervisory regime for banks, which for firms operating in the eurozone area means migration into the Single Supervisory Mechanism (SSM) and Single Resolution Mechanism (SRM).
Smaller firms that are not considered systemic would enjoy a new bespoke regime with dedicated prudential requirements. These would, in general, be different from those applicable to banks, but competent authorities could allow to continue applying banking requirements to certain firms, on a case by case basis, to avoid disrupting their business models.
Class 2 firms would be those investment firms not categorised as systemic. Such firms would be subject to a tailored prudential regime under the proposed new framework. The majority of MiFID investment firms will likely fall into this category as they will not be able to satisfy all of the criteria required to be a small and non-connected investment firm Class 3 firms would cover non-systemically relevant investment firms that do not fall into Class 2 and are defined as “small and non-interconnected investment firms”.
New risk metrics termed "K-factors" are used in the classification of investment firms and the new calculation methodology for capital requirements. K-factors are quantitative indicators that are intended to identify risks that an investment firm may pose to clients, market access or liquidity, and to the firm itself. There will be three K-factor groups:
- Risk to customers (RtC)
- Risk to market (RtM)
- Risk to firm (RtF)
The proposed framework provides for a 5-year transitional period to give companies enough time to adapt to the new regime. Nonetheless, this will mean higher regulatory capital requirements for firms and also new, more onerous remuneration rules based on those applicable to banks, in addition to a host of internal governance and disclosure and reporting requirements.
The smallest investment firms will be subject only to the MiFID II remuneration requirements but for all other investment firms which are not re-classified as “credit institutions” a new set of remuneration requirements under the IFD/IFR broadly based on those which currently apply to CRD4 full-scope investment firms, will now apply.
The new regime will have a three-pillar structure. Pillar 1 represents the minimum capital requirement, Pillar 2 an ICAAP and SREP process with the possibility of capital add-ons and Pillar 3 imposes a compulsory disclosure regime.
The new proposed framework also revises the equivalence regime, as set out in MIFID II and MIFIR, which would apply to third country investment firms. The Commission when carrying out any equivalence assessment in relation to a third country, will have to take into account whether firms in that jurisdiction are subject to prudential, organisational and business conduct requirements which are equivalent to those which apply in MiFIR, CRD IV and IFR/IFD; and whether they are subject to effective supervision and enforcement to ensure compliance with those requirements. Furthermore, the proposed requirements also seek to grant additional powers to the European Commission in order to monitor foreign financial firms which operate in the EEA. The revisions also pave the way for the possibility of partial equivalence, with national regimes continuing to apply for those services/activities where the European Commission has not granted equivalence.
*Note: The IFD and IFR do not specifically refer to "classes" of firms, however reference is made to such classes in the European Commission FAQ published at the time of the proposals and we have consequently used that classification for ease.