FCA's new consultation on the definition of capital for FCA investment firms

On 24 April 2025, the FCA released a consultation paper CP 25/10 on the definition of capital for FCA investment firms.

The FCA says it wants to simplify the rules around what counts as regulatory capital (or "own funds") for investment firms.

Right now, firms have to juggle between different sets of rules, including some that were originally designed for banks. This can be pretty confusing and cumbersome. 

The FCA's goal is to streamline these rules, making them easier to understand and apply, without lowering the standards of financial resilience.

However, the FCA’s proposals appear to be not just about simplification. They’ve made some important clarifications and changes that should be welcomed by investment firms, especially private equity investors in investment firms. 

We discuss below clarifications concerning the loss-absorption criteria for capital to qualify as Common Equity Tier (CET) 1 instruments, and changes concerning the inclusion of minority interests in a prudential consolidation.

CET1 loss absorption criteria

In the past there has been uncertainty about whether non-CET1 shares that rank equally with CET1 shares in terms of claims on residual assets could affect the eligibility of CET1 instruments. Additionally, there has also been uncertainty about whether non-CET1 shares that carry a claim on a specific proportion of residual assets might undermine the quality of CET1 instruments.

The worry was that non-CET1 shares might dilute the loss-absorbing capacity of CET1 shares. Under the proposed new rules, the FCA clarifies that CET1 instruments can still be eligible even if there are equally ranked non-CET1 instruments or if non-CET1 shares have a claim on a specific proportion of residual assets. This is because CET1 shareholders’ potential return remains unlimited, and they would absorb losses first.

These clarifications provide greater flexibility for investment firms in structuring their capital. They ensure that firms can issue different types of shares without worrying about compromising the eligibility of their CET1 instruments. This can be particularly useful for firms with complex capital structures, allowing them to use various classes of financing and employee incentivisation strategies without affecting their regulatory requirements. 

Minority interests

A minority interest refers, broadly, to the amount of CET1 capital of a subsidiary of a UK parent entity that is attributable to external investors. It can arise in various situations, such as when shares in a subsidiary are issued to a seller as part of an earnout arrangement, or when target management are issued equity as part of a management incentive plan.

For a minority interest to be recognised in the consolidated regulatory capital of the UK parent, specific conditions need to be met, one of which is that the minority interest must be issued by an FCA investment firm, UK credit institution or designated investment firm (a PRA investment firm). Under the proposed new rules, this condition will be removed, so that capital issued by any subsidiary could in principle be eligible for inclusion in the UK parent entity’s consolidated own funds, provided the other conditions are satisfied.  

This proposed change could increase the consolidated own funds of a group, allowing it to recognise a minority interest as CET1 regulatory capital in the prudential consolidation of the parent company, when it had been unable to do so before.  This could permit greater flexibility when structuring minority holdings in an investment firm group.

Even where minority interests are eligible, they are eligible only to the extent (i) they are being used to meet the subsidiary’s own funds requirement or (ii) of the contribution that the subsidiary makes to the consolidated own funds requirement of the group, whichever is the lower.  Under the FCA proposals, only the latter measure would be used.   

The FCA is inviting feedback on these proposals to ensure the new framework is effective and proportionate. The final rules are expected to be published later in 2025, with the new framework coming into force on January 1, 2026.