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If you’re feeling overwhelmed and not sure where to start with the UK’s new Investment Firm Prudential Regime you are not alone. The regime is supposed to simplify the capital and liquidity requirements for investment firms but it presents the biggest challenge to less complex ‘Exempt CAD’ firms which typically only provide investment advice or arrange deals.
There are approximately 600 Exempt CAD firms regulated by the FCA. If you are one of these, it’s likely that this is the first time you’ll have to think about calculating variable capital such as the Fixed Overhead Requirement (FOR) or K-factor capital. You will also need to think about whether you have a consolidation group under the new regime and how you will monitor concentration risk. On top of this there is the requirement to produce a risk-based capital assessment, known as an ICARA. As firms who already have to produce an ICAAP document will confirm, is not a straightforward piece of work.
The FCA’s first consultation paper on IFPR (CP 20/24) was published in December and was over 300 pages long. The second CP (CP 21/7) was published on 19th April and is no shorter. There is a lot of content for firms to get through and the changes needed are wide ranging. It will come as no surprise then that in their CP, the FCA estimate that it will cost small firms approximately £23,000 and larger firms around £65,000 to implement the changes that come into effect with IFPR.
Of course, there are some areas where you will need more detail to progress, or would be wise to wait for final guidance, but there are some clear actions you can take now to understand the implications of the new prudential regime and make sure you’re prepared.
Where you can start preparing for IFPR now:
- Establish project management, resources and training needs
Whatever your size, we recommend that you have a point person in your firm to manage the IFPR project from the outset.
Think about what training your staff need – including board members. Documents that your board or that senior management currently review could look different. They will need to understand the changes to be able to provide effective challenges.
Bear in mind you may not have enough expertise in house to implement IFPR so factor this additional cost into budgets. You may need external help to work through the issues and help with staff training.
- Assess what sections of IFPR will impact your firm
A sensible place to start is thinking about whether your firm will be a “small and non-interconnected firm” or not. This is important as fewer parts of IFPR apply to SNI firms. You may exceed the SNI thresholds if balance sheet assets are greater than £100m, annual revenues are more than £30m or client orders handled are more than £100m a day for cash trades.
- Plan how to increase the capital you hold over the next five years
What is certain is your capital requirement will increase. Under current rules, some Exempt CAD firms can take advantage of the fact they hold appropriate levels of PII to reduce their capital requirement to £5k. For firms who don’t rely on PII, their capital requirement is still only €50,000. Under IFPR this will increase. Permanent minimum capital for all firms will be £75,000 or the fixed overhead requirement (25% of annual fixed costs) if higher. If you have a large cost base, using the fixed overhead requirement as the capital requirement will represent a significant increase in capital.
You will also need to calculate regulatory capital using rules set out in CRR. This may result in you having less regulatory capital than you have now as, for example, you cannot use Tier 3 capital in your own funds calculations and there could be more items you need to deduct from capital.
All this could represent a significant increase in the amount of capital you need to hold. There are transitional reliefs in place but you need to plan how you can increase the capital you hold over the next five years.
- Calculate what K-factors will apply to you
If you are not going to be an SNI firm, consider what K-factors will apply to you and whether you have the data available to calculate these. Most K-factors are calculated on a rolling annual average basis. Once you set out the parameters you will need data from the last 15 months to calculate K-factor capital.
For Exempt CAD firms, we would only expect the following K-factors to apply:
- K-AUM associated with assets under management where you have an ongoing advisory mandate; or
- K-COH (client orders handled) where you receive and transfer client orders for execution.
- Establish whether you will you be part of a consolidation group
As an Exempt CAD firm, under current rules you haven’t had to think about whether consolidation rules apply to your group. Under IFPR, you will have to go through this exercise. The rules on what gives firms a consolidation group are notoriously complicated. Think about whether you have the expertise to navigate these or need outside help.
Once you have established whether you have a consolidation group, you will need to calculate your consolidated capital resource and consolidated capital requirement under IFPR.
- If you have a consolidation group, consider applying for the Group Capital test as an alternative to preparing consolidated capital returns
The Group Capital Test – or GCT – should result in a more beneficial capital position for most groups but you will need to apply to the FCA to be able to take advantage of this treatment. The FCA has said firms can use the GCT while they are waiting for confirmation for up to two years. You should aim to submit the application by late 2021 so you can apply the GCT as soon as IFPR comes into effect. It may take you a while to pull data for the application together so you can start to look at this now.
- Establish what you need to do for the ICARA
The risk-based assessment of capital will be a new and involved piece of work for Exempt CAD firms. As a minimum, you will need to pull together a risk matrix and describe your risk management process. You will also need to assess what additional capital you may need to hold to mitigate risks not covered by K-factor capital and calculate the cost of winding down your firm.
The FCA’s second CP has provided more detail on the ICARA but the guidance is very high level so firms will still need to do a lot of the thinking themselves. An interesting point that comes out of the CP is that the ICARA will bring together recovery plans, wind down plans and many parts of the ICAAP. You may already have a wind down plan in place but Exempt CAD firms are unlikely to have thought about recovery planning before and have not had to prepare an ICAAP so the concept of allocating capital for wind down or operational risk will be new for most firms.
- Assess how remuneration requirements will affect you
Exempt CAD firms have not been subject to remuneration codes so this will be new for these firms. You will need to put in place remuneration policies and governance processes to comply with the new ‘basic remuneration requirements’.
- Consider potential increased reporting costs
We would expect most Exempt CAD firms to be small and non-interconnected (SNI) and capital will be driven by the fixed overhead requirement. Reporting looks reasonably straightforward but we are still waiting to hear whether the FCA will expect firms to use software such as XBRL to submit reports. If the FCA does require firms to submit reports in XBRL format, you should factor in the additional software cost.
- Changing prudential policies and compliance monitoring programme
If your compliance monitoring plan covers your prudential requirements (which it should do) you will need to update this for the new requirements under IFPR. This could be the first time that you will need to hold a specific amount of liquid assets, for example, so think about what policies and procedures will need to be amended.
- Changing permissions
You may want to think about whether you really need to be a MIFID investment firm or you can operate your business with a different set of permissions.
Firms need to respond to the FCA on the second CP by 28th May. The FCA has said it will issue final guidance from the first CP by “late Spring” so there is a lot to take on board and lots to do. If you haven’t started already, we recommend you kick off your project as soon as possible.
How we can help
Our specialist prudential team are working with a variety of investment firms to help them get ready for IFPR. We can help in a number of areas including:
- consolidation analysis
- capital modelling
- ICARA training
- board training
- review of permissions to see whether you need to be subject to IFPR.
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