The UK Investment Firms Prudential Regime

HM Treasury’s policy statement on prudential standards in the Financial Services Bill and an FCA discussion paper have set out more detail on the new UK prudential regime for investment firms. This blog considers the UK proposals and highlights some of the ways the UK regime for investment firms might differ from that proposed for the EU.

The Treasury proposes to legislate in the Financial Services Bill for a new UK prudential framework for investment firms, the Investment Firms Prudential Regime (IFPR), since the June 2021 implementation date for the EU’s Investment Firms Directive and Regulation (IFD/IFR) will fall after the end of the Brexit transition period. The Treasury states that given the UK’s role in the introduction of the IFD/IFR at EU level, it is “supportive of its intended outcomes” and targeted deviations from the EU prudential regime will only be implemented where they are necessary to reflect either the number, size and nature of UK investment firms or the structure of the UK market and how it operates. In the only derogation from the EU regime identified, the Treasury has stated that it will not require UK systemic investment firms to obtain re-authorisation as credit institutions, since such firms are already prudentially regulated and supervised under CRD 4 by the PRA, the UK banking regulator. The Treasury and the regulators consider that the existing PRA designation framework achieves the same outcomes sought by the IFR. 

With respect to level 2 EBA guidance and guidelines, the Treasury notes that whilst the UK is not bound by these, it will take them into account, where appropriate, in designing the UK regime. Therefore UK investment firms might wish to comment on the open EBA consultations on level 2 measures under the IFD/IFR.

The FCA discussion paper (deadline for comments is 25 September 2020) on the IFPR sets out the details of the EUIFD/IFR and seeks feedback on the appropriate rules for the UK to apply based upon the EU rules. The discussion paper raises questions on whether the FCA is interpreting the IFD/IFR appropriately and states how it will deal with specific issues under a UK domestic regime. 

Based upon the Treasury and FCA papers, the IFPR will follow the IFD/IFR closely but will be implemented by “UK-specific rules intended to achieve the same overall outcome”. The FCA’s discussion paper indicates that the UK is unlikely to deviate from the European rules to any significant extent. While not departing from the EU’s rules, the FCA does set out how it will approach some of the discretions in the EU rules in a way that it considers appropriate for the UK.

The FCA proposes not to replicate the discretion available at EU level to allow smaller investment firms that it prudentially regulates to opt-in to supervision on the basis of a regime mirroring the CRD 4 regime. It notes that were it to permit investment firms to opt-in it would need to develop a system to recover the additional costs involved in maintaining the resources within the FCA for supervision on a CRD 4basis from the individual firm(so) so as to avoid the investment firm population as a whole bearing this burden. The PRA is able to designate investment firms as subject to its supervision regardless of quantitative thresholds and the FCA states that it expects this route would be used for those investment firms that remain authorised under MiFID but that are still required to apply CRD 4 prudential requirements (essentially those with total value of consolidated assets equal to or above €15bn). In other words, investment firms that are subject to prudential supervision under CRD 4 will be regulated by the PRA rather than the FCA.

Under the proposed new EU regime small and non-interconnected (SNI) investment firms are subject to lesser requirements. However, the FCA has signalled that by (its equivalent) exercise of some of the national discretions available, it will not operate quite such a light touch regime for UK SNIs. The FCA states that it will exercise a discretion requiring SNI investment firms to put in place an internal capital adequacy and risk assessment (ICARA) process (as required by Article 24 of the IFD for non-SNI investment firms) since it is of the view that “all investment firms should review and manage their risks, regardless of their size”. The FCA is also minded to replicate the effect of the discretions permitting it to undertake a supervisory review and evaluation process (SREP) on SNI firms and require the holding of additional capital where appropriate. Significantly, the FCA has also stated that it does not want to utilise the discretion in the IFR which permits competent authorities to exempt SNI firms from all liquidity requirements, since it is of the view that the IFR liquidity requirements are a minimum that all investment firms, including SNI firms, should be able to meet. Although it proposes that a waiver could be granted from the liquidity requirements in “exceptional circumstances”. The FCA does, however, propose to use its discretion to permit use of the group capital test for those SNIs with simple group structures rather than the more onerous full prudential consolidation. 

All non-SNI firms will be subject to the remuneration rules in the IFPR. But smaller non-SNI firms will welcome the FCA’s stance on the use of a discretion with respect to the variable remuneration rules. Certain rules on variable remuneration (those on pay-out in shares etc, deferral and the holding and retention periods for discretionary benefits when an employee leaves) do not apply to firms with average on- and off-balance sheet assets of €100m or less over the last four years. The FCA has signalled that it may be appropriate for the UK to apply the IFD discretion to increase this amount to a maximum of €300 million where certain conditions are met, and may support a threshold above this (the FCA refers to a threshold of “at least €300 million”). Although the FCA also suggested that a threshold below €100m may be appropriate for some firms. The FCA also notes that it would not use a discretion to limit the types and design of instruments used to pay variable remuneration nor prohibit certain instruments, so as not to limit the options available to investment firms. It notes that it has not used a comparable discretion in the CRD.

The FCA states that it is minded to replicate the discretion allowing it to require the establishment of a UK intermediate holding company (IHC) where a non-UK parent company has two or more investment firm subsidiaries in the UK so as to apply prudential consolidation to the UK group. This point will be of particular relevance to any group which has two or more investment firms in the UK but no UK holding company.

One of the areas where the mechanics of how the FCA proposes to operate the new requirements will give a different result than currently is in the setting of pillar 2 capital. As part of the FCA’s SREP it is proposing to invite firms to apply a “pillar 2R” legally binding requirement by use of a voluntary requirement (VREQ) or imposed by the FCA at its own initiative (OIREQ).Although this will be similar to the current Individual Capital Guidance, breach of a VREQ or OIREQ could form the legal basis for enforcement action.

The timing of the FS Bill (and the introduction of the IFPR) is dependent on the passage of the Bill through the UK Parliament but the Treasury states that the UK will endeavour to introduce this by summer 2021, to be consistent with the EU. The Treasury intends to delegate the responsibility of firm requirements to the FCA, subject to an enhanced accountability framework, resulting in the majority of the IFPR being implemented by FCA rules. The IFPR will be subject to consultation by the FCA in due course.

Anyone who was hopeful that the UK might use the fact that it is not bound to implement IFD/IFR to fashion a bespoke UK prudential regime for investment firms will be disappointed. The FCA’s discussion paper indicates it will stick very closely to the EU framework, and that any tailoring to the UK will be done through replicating (or not replicating) discretions in the EU rules in the new UK regime. This may be the result of a desire to remain closely aligned for equivalence purposes, but it may also be the fact that the EU rules were generated and fashioned while the UK was a member of the EU and reflect the UK’s thinking on prudential matters. It is tempting therefore to think of IFD/IFR as one of the UK’s final contributions to the EU’s financial services framework before Brexit.