EU Commission s Proposed Prudential Regime for Investment Firms

Transcription

1 EU Commission s Proposed Prudential Regime for Investment Firms 18 April 2018 London Welcome

2 Agenda Welcome and Opening Remarks Andrew Lowin, Duff & Phelps New Prudential Regime for MiFID Investment Firms Richard Fox, The Financial Conduct Authority IF Directive and IF Regulation: Overview of The Regulatory Framework Tim Lewis, Travers Smith LLP Closing Remarks and Q&A Andrew Lowin, Duff & Phelps

3 New prudential regime for MiFID investment firms Where are we now? Richard Fox 18 April

4 Setting the scene Current rules based on those for banks as they also do investment business Focus is on risks of loss to the firm s own balance sheet and have become increasing more detailed and complex Investment firm business models are different so exclusions, derogations, alternative rules needed CRR mandate for the European Commission to report on an appropriate regime for investment firms Commission s proposals published in December

5 The new regime is different Focus is on militating against the potential for harm investment firms may cause to others Uses K-factors as simple proxies for the types of harm Easier for firms to identify which requirements apply to them Simpler calculation of capital requirements More straightforward for supervisors Introduces common minimum liquidity requirement 5

6 The K-factors 6 K-factor K-AUM K-CMH K-ASA K-COH K-DTF K-NPR K-TCD K-CON Description Assets under management under both discretionary portfolio management and non-discretionary (advisory) arrangements Client money held Assets safeguarded and administered Customer orders handled execution-only in name of the customer, and reception and transmission of orders Daily trading flow value of transactions Net position risk based on the market risk requirements of CRR II and made appropriate for investment firms Trading counterparty default based on the BCBS proposals for counterparty credit risk and simplified for investment firms Concentration taking inspiration from the CRR large exposures regime for the trading book and simplified for investment firms

7 Initial capital and fixed overheads Definition and composition of own funds remains the same Capital requirement made up of: > 56% Common Equity Tier 1 instruments < 44% Alternative Tier 1 instruments < 25% Tier 2 items Initial capital will be increasing Once authorised, this will become a firm s Permanent Minimum Capital (PMC) Fixed Overheads Requirement (FOR) remains the same, but now applies (as a floor ) to all investment firms. 7

8 Regulation Three categories of investment firm Systemic and bank-like the eight regulated by the PRA CRD/CRR applies in full Very small, non-interconnected higher of PMC and FOR, simplified reporting, mainly no public disclosure requirement All other investment firms K-factors apply, simplified reporting and public disclosure requirements. May need to have audit/remuneration committees etc 8

9 Next steps FCA providing technical support to HMT during the European Council negotiations Generally supportive of the proposals, whilst recognising that the text can be improved in places to make it more appropriate in practice Ask that firms engage now by providing any constructive comments on how to improve the text as soon as possible And that firms engage in future when we come to consult on what we might do in the UK as regards the final EU legislation 9

10 IF Directive and IF Regulation: Overview of the regulatory framework TIM LEWIS, TRAVERS SMITH LLP 18 APRIL 2018 Travers Smith LLP 10 Snow Hill, London EC1A 2AL T: +44 (0)

11 Legal framework and timeline Regulation and Directive following the structure of CRR/CRD IV In the EU, IF Regulation will be directly applicable across all Member States IF Directive will need to be transposed through national implementing measures (possible minor national variations) Timeline for adoption currently unclear, but even allowing for smooth EU legislative process, application unlikely before 2021 (at the earliest) Likely that UK will no longer be directly subject to EU law by that time due to Brexit However, policy objectives of IF Regulation and Directive broadly supported by FCA Broadly aligned regimes also simpler for international financial services groups In practice, seems likely that FCA would support adopting similar regime in UK FCA implementation would be subject to further consultation before final rules are made Equivalence assessments of third countries for purposes of MiFIR cross-border services regime (inc. UK post-brexit?) would require granular equivalence with these new prudential rules Query treatment of reu entities in UK post-brexit IF Regulation and IF Directive Overview April 2018

12 Classification of firms Firm category Classification criteria Class 1 firms Must deal on own account and/or engage in underwriting; and Either: o o The firm has total assets exceeding 30 billion; or Broadly, the firm is part of a group where the total assets of all entities dealing on own account and/or underwriting exceed 30 billion Policy aim to capture Global or Other Systemically Important Institutions In practice, these will be large investment banks or members of large investment banking groups Class 2 firms Firms that meet neither the criteria to be classified as Class 1 firms above nor the criteria to be classified as Class 3 firms below Class 3 firms The firm meets all of the following criteria: o o o o o o o Total balance sheet assets of 100 million or less at last FY end; Total annual gross revenue of 30 million or less at last FY end; Average assets under management (including assets under advice) of 1.2 billion or less; Average value of client orders executed or transmitted per day of 100 million or less (cash trades) and 1 billion or less (derivative trades); Doesn t hold client assets; Doesn t hold or control client money; Doesn t deal on own account IF Regulation and IF Directive Overview April 2018

13 Summary requirements by class of firm Requirement Class 1 firms Class 2 firms Class 3 firms Legislative regime CRD IV / CRR (and in due course, CRD V and CRR II) Must re-register as credit institutions Subject to new IF Regulation and Directive Subject to new IF Regulation and Directive Initial capital requirement Pillar 1 capital requirement Liquidity requirements Concentration (large exposures) rules Pillar 2 (ICAAP) requirement Pillar 3 disclosures 5 million As calculated under CRR Existing CRR Liquidity Coverage Ratio Existing CRR large exposures rules 75, ,000, depending on activities undertaken Highest of: Initial capital requirement Fixed overheads requirement K-factor requirement One third of fixed overheads requirement (i.e. equivalent to one month s overheads) If deal on own account, additional K- factor capital requirement Otherwise, general monitoring and regulatory reporting requirements 75,000 Higher of: Initial capital requirement Fixed overheads requirement One third of fixed overheads requirement May count some qualifying receivables Monitoring requirements only Existing CRD IV requirements Required; amendments to risks Required; amendments to risks Existing CRR requirements Revised disclosure regime, but includes data on governance, own funds, capital requirements, return on assets and remuneration Governance and remuneration disclosures Additional info required if firm issues AT1 instruments (rare in practice) IF Regulation and IF Directive Overview April 2018

14 K-factor approach for Class 2 firms Moves away from existing credit risk and market risk-centric approach Greater focus on individual activities undertaken by Class 2 firms K-factor Measure Basic calculation Reg. cap co-efficient / value Notes K-AUM Assets under management Monthly average across 12 months (End of last business day in month) 0.02% Includes AUA for ongoing non-discretionary mandates K-COH Client orders handled Daily average across 3 months (End of each business day) 0.1% (cash trades) 0.01% (derivatives) Includes orders executed and orders transmitted / placed K-ASA Assets safeguarded / administered Daily average across 3 months (End of each business day) 0.04% K-CMH Client money held Daily average across 3 months (End of each business day) 0.45% Includes client money controlled under a mandate K-DTF Daily trading flow Daily average across 3 months (End of each business day) K-NPR Net position risk According to current CRR (or future CRR II) position risk calculation 0.1% (cash trades) 0.01% (derivatives) As calculated (or 65% of CRR II standardised or internal model approaches) Only relevant if deal on own account Only relevant if deal on own account K-CMG Clearing member guarantee Highest total margin posted over previous 3 months TBD under new regulatory technical standards Only relevant if deal on own account K-TCD Trading counterparty default Based on exposure values in trading book Exposure value multiplied by counterparty risk factor Only relevant if deal on own account K-CON Concentration risk Based on trading book exposures to clients or connected entities Based on excess exposure over concentration limit Only relevant if deal on own account IF Regulation and IF Directive Overview April 2018

15 Liquidity requirements UK BIPRU and IFPRU firms currently subject to (at least) BIPRU 12 overall liquidity adequacy rule IF Regulation introduces new binding quantitative minimum liquidity requirements Both Class 2 and Class 3 firms will need to hold minimum level of eligible liquid assets equal to at least one third of fixed overheads requirement For these purposes, liquid assets include unencumbered cash and certain other assets listed in CRR Liquidity Coverage Ratio delegated regulation (e.g. certain high quality bonds) For Class 3 firms only, one third of the liquidity requirement can be made up of trade receivables, fees or commissions if: o due within 30 days; and o 50% haircut applied In practice, smaller firms unlikely to hold most other eligible asset types on balance sheet Therefore, likely that firms will ultimately need to hold more cash on balance sheet instead Firms can temporarily reduce level of liquid assets below minimum required amount if: o notification made to national regulator; and o full compliance restored within 30 days IF Regulation and IF Directive Overview April 2018

16 Remuneration Class 3 firms not subject to IF Directive remuneration rules (i.e. subject only to MiFID remuneration requirements) Class 2 firms subject to new IF Directive remuneration requirements (based in part on existing CRD IV rules) General requirement to establish and regularly review remuneration policies that are consistent with and promote sound and effective risk management Remuneration rules apply to material risk takers that population will be defined by EBA and ESMA, but seems likely to be similar to existing CRD IV concept No hard bonus cap (e.g. 2:1 variable to fixed remuneration ratio), unlike existing CRD IV rules Requirement to set a ratio of fixed to variable remuneration Other rules on variable remuneration similar to CRD IV e.g. prohibition on guaranteed variable remuneration (unless exceptional), pay-out process rules, prohibition on personal hedging, etc. IF Regulation and IF Directive Overview April 2018

17 Pay-out process rules The pay-out process rules relate to the manner in which individuals remuneration must be paid Broadly, pay out process rules require: o at least 50% of variable remuneration of in-scope staff to be paid in shares, equivalent ownership interests or linked instruments; o at least 40% (and for particularly high remuneration, at least 60%) of variable remuneration to be deferred over 3 5 year period appropriate to firm s business cycle; o deferred remuneration must vest no faster than on a pro rata basis; and o up to 100% of variable remuneration may be reduced where firm s financial performance is subdued or negative (including through use of malus or clawback arrangements) Proportionality applies in relation to shares/deferral requirements: on a firmwide basis, if firm has 4 year average asset value of 100 million or less; or for specific individuals, if annual variable remuneration of 50,000 or less, representing less than 25% of individual s total remuneration NB no proportionality override for malus or clawback (but malus irrelevant if deferral not required?) IF Regulation and IF Directive Overview April 2018

18 EU Commission Proposal a new Prudential Regime for Investment Firms Its Anticipated Impact on UK MiFID Investment Firms 18 April 2018

19 To which Investment Firms does this proposal apply? A new way of thinking, gone are the Full Scope, Limited Activity, Limited Licence and Exempt CAD way of thinking when applying Prudential Provisions. It s now Activity related. All MiFID Investment Firms (as defined by MiFIR.) Some MiFID Investment Firms will become reclassified as Credit Institutions in CRR, these will be those; With Balance Sheet Assets which exceed 30bn over a 12 month rolling average. Will UK, domestically, set circa. a 26bn threshold (as distinct from current 50bn threshold for Designated Investment Firms (dual regulated Firm).) and permitted to Dealing on Own Account and/or Underwrite/Place Financial Instruments on a Firm Commitment Basis. This will apply at Solo and Group Level (so, MiFID Investment Firms within a Group where the Groups Dealing on Own Account/Placing on Firm Commitment/Underwrting/Credit Institution Consolidated Balance Sheet exceed 30bn will also be reclassified as Credit Institutions.) Class 1 = Credit Institutions will remain subject to CRDIV/CRR. Firms remaining as MiFID Investment Firms will, then, be subject to the new Investment Firm Prudential Regime depending on whether they re considered to be; Class 3: Small, Non-Interconnected and not Systemic Investment Firms; or a Class 2: All Other.

20 Current MiFID Investment Firm Classifications In-Scope MiFID Investment Firms certainly in scope; BIPRU Firms; IFPRU Firms; and Exempt CAD Firms. Other Investment Firms which might fall within scope UK Implementation; Optional Exemption Firms (i.e. the Art.3 Optional Exemption Firms now subject to some elements of MiFID as a consequence of MiFID II), possible but unlikely? BIPRU CPMI (their Additional Requirement?), Likely?; IFPRU CPMI (their Additional Requirement?), Likely?; Exempt MiFID Firms (MiFID Art.2 Exempt Firms), Unlikely?.

21 Capital Permitted as Eligible Own Funds Own Funds = Basis in CRR. Common Equity Tier 1 (CET1); Additional Tier 1 (AT1); and Tier 2 (T2.) Minimum Eligible Composition of Own Funds which must be held at all times; CET1 must not be less than 56% of Own Funds Requirement; Tier 1 (i.e. sum of CET1 and AT1) must not be less than 75% of Own Funds Requirement (may be all CET1); and Tier 2 cannot be more than 25% of Own Fund Requirement. Total Own Funds may represent 100% CET1 or 56% CET1 plus 44% AT1.

22 So Called Class 3 Firms: Small, Non-Interconnected and non- Systemic Investment Firms - Definition All MiFID Investment Firms which don t breach one or more of the following thresholds; AUM (sum of Discretionary and Advisory Mandates) > 1.2bn; Client Order Average: > 100m/day Cash Trades or 1bn/day Derivatives; Balance Sheet > 100m; Total Gross Revenue > 30m; Exposure to Risks from Trading Financial Instruments > zero; Permitted to Administer and Safeguard Client Assets > zero; or Permitted to Hold or Control Client Money > zero. This does not distinguish between types of Investment Firm so it s conceivable a large Exempt CAD Firm could breach some of these thresholds. These Investment Firms are subject to a simplified regime, including Exempt CAD Firms; Higher of Initial Capital Requirement and Fixed Overhead Requirement; Liquid Asset Requirement of 1/12 th Fixed Expenditure (per CRDIV RTS); and MiFID II s Remuneration Code only.

23 Possible Application of K-Factors by Type of so called Class 2 Firm (we don t yet know UK policy.) K- Factor K-Factor Activity IFPRU Firms BIPRU Firms Exempt CAD Firms New Paradigm is that Requirements fit based on Regulated Activity not Status K-AUM Assets Under Management Y Y Y K-COH Client Orders Handled Y1 Y1 Y1 K-ASA Assets Safeguarded Administered Y2 Y2 X1 K-CMH Client Money Held (Controlled?) Y3 Y3 Y3 K-DTF Daily Trading Flow Y4 Y4 X2 K-NPR Net Position Risk Y4 Y4 X2 K-CMG Clearing Member Guarantee Y4 Y4 X2 K-TCD Trading Counterparty Default Y4 Y4 X2 K-CON Concentration Risk Y4 Y4 X2 For Key See Next Slide

24 Possible Application of K-Factors by Activity - Key Key Y1 Y2 Y3 Y4 X1 X2 Assumption/Consideration/Subject to Clarification To the extent the Firm Transmits Orders and Deals as Agent or as Principal (so can include Firms which don t Deal as Principal) Only if Permitted to Safeguard and Administer Client Assets or Manage AIF as a Small Authorised UK AIFM. When permitted to Hold Client Money or Control Client Money or do so while Managing AIF. When permitted to Deal in Investments as Principal even with a Matched Principal Limitation. Could apply to Exempt CAD Firms which are permitted Manage AIF. When permitted to Deal in Investments as Principal even with a Local Firm Limitation.

25 Other Points of Interest and Note Initial Capital Requirement; While basis of application will not change; 50k to 75k; 125k to 150k; and 730k to 750k. Transitional Provisions will apply smoothing the impact of new regime over 5 years. For example Exempt CAD Firms now only subject to 50k but will also then be subject to the FOR the impact will be gradually increased from the lower of 2x 75k and FOR to full provision over 5 years. UK Designated Investment Firm Threshold is set at 50bn for 730k Investment Firms; 7 Designated Investment Firms will be reclassified as Credit Institutions? Many more MiFID Investment Firms could be reclassified as Credit Institutions and will, thus, become PRA/FCA Dual Regulated Firms? Requirements are likely to be greater than current Pillar 1 for all Firms. This was not the published intention when this review commenced in It was meant to be; A simpler regime; and one which was; Reflective of the actual risks to which Investment Firms are subject. Evolving Policy likely to have been driven by desire of Competent Authorities not to set Individual Capital Guidance, Individual Liquidity Guidance or Total SREP Capital Requirements.

26 Q&A April 17, 2018