Puzzle pieces

The EBA has issued a raft of consultations on the prudential requirements, reporting, disclosures and remuneration elements of the IFR package (Investment Firms Regulation and Investment Firms Directive). The long-awaited publications provide much needed clarity on IFR and IFD – the new prudential regime which is likely to have a significant impact on UK investment firms, regardless of Brexit.

We are still waiting for the FCA to publish their consultation paper on IFR which was due end of December. That aside, we have not heard anything to suggest that IFR will not be implemented mid-2021 as planned.

The consultations cover a number of areas, providing further information on how the regulators expect firms to perform their calculations and providing templates for reporting.

The IFR / IFD consultations from the EBA should help you better understand how the new prudential regime will affect your firm and start to make plans. In particular it’s worth beginning to quantify the impact the changes would have on your projected capital requirements. The key points of the consultation are outlined below.

Prudential

The capital requirements for firms which are not small and non-connected will be the higher of permanent minimum, the fixed overhead requirement (FOR) and a K-factor requirement linked to activities. The latter is calculated using a number of methods. The impact on various categories of firms can be seen below.

Asset managers

  • Assets under Management (K-AUM) – additional clarification is provided on how to measure the value of assets so that where the fair value of an asset is negative, the absolute value must be used. In addition, further information is provided on how to treat assets whose management has been formally delegated to another firm or assets managed under non-discretionary arrangements.
  • Client Money Held (K-CMH) – provision has been made to exclude client money held from the calculation of K-AUM and K-ASA (assets safeguarded and administered). Also the values to be included should be based on a firm’s own records rather than those from a third party.
  • K-ASA – these will have to be measured at fair value

Brokers / MTFs / OTFs

  • Client Orders Handled (K-COH) – executing orders in a client’s name will be included once they are executed and the price known. However, reception and transmission of orders will be included at the point at which the order is transmitted by a firm – the price should be that per the order or if there isn’t such a price, the current market value. Double counting is avoided by providing that a firm cannot both transmit and execute the same order. MTF and OTF activities are excluded from the K-COH calculation.

Brokers (agency and principal)

  • Daily Trading Flows (K-DTF) – for the purposes of the calculation, it is clarified that ‘cash trades’ include transactions where a counterparty undertakes to deliver any instrument listed in Section C of Annex I of MiFID, at a market standard settlement or delivery price. In addition, a formula has been provided as to how the coefficient can be adjusted in times of extreme volatility.

Proprietary traders

  • Clearing Margin Given (K-CMG) – the method for calculating clearing margin has been specified: the highest amount per day in the collateral account. In addition, rules against regulatory arbitrage between the Net Position Risk (NPR) k-factor and CMG are set out – switches between the k-factors by a trading desk can only take place after a minimum of 2 years.

All firms

  • Fixed overhead requirement (FOR) – allowable deductions have been specified and what counts as ‘material change’ thus allowing the regulator to adjust your FOR
  • Consolidation – the situations in which different methods of consolidation are allowed have been clarified. In addition, how to calculate consolidated capital requirements has been detailed e.g. summing the individual permanent minimum capital requirements.

Reporting and disclosures

  • Reporting templates have been provided for ‘Class 2’ and ‘Class 3’ (small and non-connected) firms covering solo and consolidated capital requirements as well as threshold data. Class 2 will have quarterly reporting whilst Class 3 will be on an annual basis.
  • Templates have also been provided for public disclosures required for Class 2 firms.

Remuneration

Firms to which quantitative restrictions on variable remuneration apply

  • For certain larger firms, any member of staff who has a “material impact” on the risk profile of the firm (so called “identified staff”) will be subject to restrictions on how bonuses are paid out. Although there is no bonus cap in the IFD, at least 50% of variable remuneration needs to be paid in specific capital instruments. The qualifying conditions for such instruments have now been set out.

 

Next steps

The consultation period ends on 4 September 2020. We would recommend that firms take the opportunity to attend the public hearings scheduled for 30 June in order to provide feedback on areas of concern to them. In addition, it would be worthwhile quantifying the impact on projected capital requirements as a result of the proposed rules.