The European Banking Association (EBA) has responded to investment firms’ requests for a new prudential regime that better represents the risks they face, rather than the one-size-fits-all banking package established by the Capital Requirements Directive (CRD) and Capital Requirements Regulation (CRR). The Investment Firms Regulation (IFR) and Investment Firms Directive (IFD), collectively known as the “IFS package,” which will come into effect 26th June 2021, would replace the patchwork of existing prudential regimes with a modern, bespoke prudential regime for most MiFID Investment Firms. The rule changes will affect all types of Investment Firms. This includes investment banks, brokers, and fund managers, among others. The new rules represent a complete revamp of prudential regulation with new and re-shaped requirements relating to own funds, liquidity, group supervision, governance, and regulatory reporting.
The aim of the IFS package is to enact more proportionate and risk-sensitive laws for investment companies, such as lowering reporting and disclosure standards. The IFS package would replace the CRR package’s current prudential structure for investment firms. However, a limited number of businesses will be still required to use the CRR package. It is worth noting that MIFIR and MIFID will continue to apply in full to all investment companies, regardless of their classification.
What are the main changes?
The reclassification of investment companies, as well as its implications, is the most significant change in this framework. According to the IFS Package, firms would be divided into three classes and 1 sub class: Class 1 and the sub-class, Class 1 Minus, Class 2, and Class 3 firms.
In contrast to the CRR package, the IFS package includes the K-Factors quantitative metrics to accurately represent the threats that investment firms face. K-Factors are divided into three categories: risk to client, risk to market, and risk to the firm itself.
In terms of liquidity, all investment companies must have internal processes in place to track and control their liquidity needs, as well as maintain a minimum of 1/3 of their fixed overheads in liquid assets.
Firms will be required to perform an internal capital adequacy risk assessment procedure (ICARA), which can result in a firm having to maintain a higher amount of capital than that recommended by the mechanical, own funds criteria alone, according to the IFD/IFR.
The IFS package also outlines changes to Governance and Remuneration arrangements.
What does this mean for firms?
The new prudential regime applies to all MiFID 2 firms and therefore captures all investment firms that carry out activities which include transmission of orders in relation to financial instruments, execution of client orders, dealing on own account, portfolio management, providing investment advice, underwriting financial instruments, and operating trading facilities.
The regulator would require companies to be diligent in conducting an impact review to determine if the change in regulations has a substantial impact on their firm’s capital adequacy. This impact review should be included in the company’s capital planning documents, such as the ICAAP and all other forward-looking capital adequacy evaluations.
Firms should also create strategies to correct any gaps identified by this analysis to ensure that they are completely compliant prior to implementation. Raising capital or re-engineering company processes to increase capital efficiency will take time, so companies should be aware of any gaps as soon as possible.
Firms must ensure that they have solid systems in place to collect the data needed to calculate the K-Factors and disclose their firm classification thresholds. These would necessitate companies putting in place these procedures well in advance of implementation.
How can RMC Wise assist
Contact us today to learn more about how RMC Wise will help you determine how the latest IFS package will impact your company through a customized assessment tailored to your unique needs. We will be able to evaluate the required on-going reporting criteria as well as any new assessments (including ICARA) that need to be planned in accordance with the IFS package through this exercise.
Stephanie Borg Caruana, Senior Risk Associate, RMC Wise Limited