New prudential regime for UK investment firms edges closer

On 19 April the Financial Conduct Authority (FCA) issued CP21/7, its consultation on the second tranche of proposed rules to introduce a new, UK-based prudential regime for Markets in Financial Instruments Directive (MiFID) investment firms.

What’s the context for this?

Prudential rules require investment firms to hold assets and put in place procedures so that financial markets stay stable even in tough economic times.

The current regime, based on EU Directives and Regulations, was based on rules for global banks and aims to mitigate risk for depositors should those banks fail. This risk profile is less suited to investment firms where the risk is to clients, counterparties and the wider market rather than to depositors. The EU therefore passed reforms in 2019 to create a new tailored prudential regime for investment firms, which apply from 2021.

Since the UK has left the European single market, an equivalent UK-specific regime is needed. The FCA’s proposal is a streamlined regime that it is simpler and more directly aligned with these risks.

A previous consultation, CP 20/24, covered initial aspects of the proposed regime and CP 21/7 supplements these. There is expected to be a third and final CP published in 2021 which will address any remaining issues, including consequential Handbook amendments.

Who's affected?

The new regime will apply to all firms currently subject to any part of the EU Capital Requirements Directive and Regulation, including Prudential sourcebook for Investment Firms (IFPRU), Prudential Sourcebook for Banks, Building Societies and Investment Firms (BIPRU), Exempt CAD and ‘opted-in’ MiFID-exempt firms. This represents around 3,600 firms.

What's changing?

Own funds

CP21/7 confirms that a fixed overhead requirement (FOR) will apply to all FCA investment firms. In addition it provides further details on the activity-based requirements (the so-called ‘K-factors’) that will apply as part of the own funds requirement.

Basic liquid asset requirement

All firms will be required to hold core liquid assets equivalent to at least one-third of the FOR.

Risk management and governance

The replacement for the internal capital adequacy assessment process (ICAAP) is the internal capital and risk assessment (ICARA). Firms will use their ICARA to meet an overall financial adequacy rule (OFAR). The ICARA will include business model analysis, stress testing, recovery planning and wind-down planning. The FCA will approach supervision and intervention on a harm-led basis.

Remuneration policy

All firms will need a remuneration policy which will vary depending on whether the firm poses systemic risk (an ‘SNI’ firm) or not.

Regulatory reporting

The good news for investment firms is that the FCA plans to significantly reduce the amount of information reporting. A new ICARA form will replace the current FSA019 (‘pillar 2’) form.

What is the impact on the FCA Handbook?

The combined rules will be included in a new prudential sourcebook called MIFIDPRU, which will replace GENPRU, BIPRU and IFPRU.

MIFIDPRU will also apply to Collective Portfolio Management Investment Firms (CPMIs) who currently apply either IFPRU or BIPRU – however, many of the requirements in MIFIDPRU will only apply to the MiFID business of CPMIs, not to their collective portfolio management business. There will be consequential changes to IPRU-INV Chapter 11.

When will the new regime apply?

The new regime is subject to Parliamentary approval of the Financial Services Bill, but is expected to apply from 1st January 2022.