European Commission proposes framework for new prudential regime for investment firms
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1 EU update European Commission proposes framework for new prudential regime for investment firms On 21 December 2017, the European Commission (the Commission ) published its proposed framework for a new prudential regime for investment firms by way of a new draft Directive and new draft Regulation. This proposed legislation follows on from a review into the appropriateness of the regulatory regime that currently applies to investment firms under CRD IV, which has been inputted into by both the European Banking Authority ( EBA ) and the European Securities and Markets Authority ( ESMA ). The proposals set out three categories of investment firms and the remuneration and governance requirements that would apply to them. In a nutshell What should I do next? What is it? Assess the potential categorisation of your firm based on the proposed framework and consider the implications that this could have for the application of remuneration and governance rules to your firm. European Commission proposal for a new prudential regime for investment firms. This includes rules on remuneration and governance. Who has published it? Who can I contact? European Commission. Tim Wright, Duncan Nicholls, Dominic Cowler, Thomas Gunning, Elliott Bewley. When was it published? Introduction Thursday 21 December On 21 December 2017, the Commission published its proposal for a new prudential framework for investment firms by way of a new draft Directive and a new draft Regulation. Who is this relevant to? All investment firms authorised and regulated under the Markets in Financial Instruments Directive ( MiFID ). Where can I find it? A link to the draft Directive can be found here. A link to the draft Regulation can be found here. What is the timing? Uncertain, however the process for finalising and implementing this new framework will likely take a considerable length of time. This proposal comes following the Commission s broader review of the appropriateness of the existing prudential rules applicable to investment firms. The current rules were designed predominantly for banks and so the Commission undertook a review to establish whether a new set of requirements more tailored to the nature of investment firms were required. As part of this review, the EBA and ESMA responded to Calls for Advice from the Commission. A joint response was provided in December 2015 discussing the categorisation of MiFID investment firms into three categories which would determine which rules would apply. A more detailed Opinion on the design of the framework was then provided by the EBA in September This Opinion provided additional advice on the criteria for classifying these firms and recommendations on how the remuneration and governance provisions would apply to firms in each of these classes. xxxx 2016
2 The Commission s proposed framework follows this same approach, with the three categories of investment firm proposed as follows: Class 1 - systemic and bank-like investment firms to which CRD/CRR rules will apply; Class 2 - other non-systemic investment firms to which a more limited set of prudential requirements will apply under this new Directive and new Regulation; and 3. Class 3 - very small firms conducting interconnected services to which MiFID II will apply. will now be included within the scope of a credit institution under the CRR and will remain within scope of the remuneration requirements of CRD IV. These tests refer to balance sheet assets and not funds under management. Class 2 criteria If a firm meets any one of the following criteria then they will be considered a Class 2 firm and will be within scope of this new Directive and new Regulation: Assets under management of over EUR 2bn1; Client orders handled are at least EUR 100m a day for cash trades and/or at least EUR 1bn a day for derivatives1; Assets safeguarded and administered are greater than zero; Client money held is greater than zero; As drafted, the Commission has proposed criteria for identifying if a firm is either Class 1 or Any firm that does not meet these criteria will be considered Class 3. Net position risk, clearing member guarantee, daily trading flow or trading counterparty default, greater than zero; Balance sheet total greater than EUR 100m1; Further detail on these criteria is set out below: Total gross revenues greater than EUR 30m A number of criteria have been set out by the Commission for determining the class of investment firms, as per the EBA s recommendation. Process for determining a firm s Class The Commission has set out a number of criteria for determining which class a firm is categorised as. Class 1 criteria Class 3 criteria Those firms that are: Any other investment firm that is not identified as either a Class 1 or Class 2 firm will be treated as a Class 3 firm. 1 Able to deal on their own account in financial instruments, or are able to underwrite/place financial instruments on a firm commitment basis; and Have total balance sheet assets that exceed EUR 30bn (or are part of a Group with other entities undertaking the above activities, the combined value of assets which exceed EUR 3obn); requirements for Class 1 firms All of the remuneration requirements of CRD IV will apply in full. This includes the bonus capping requirements. Should be calculated on a combined basis for all investment firms in the group. All other thresholds should be considered on a solo basis. 2
3 The European legislative bodies are currently in the process of drafting changes to CRD IV, which include clarifying within the legislation how proportionality should apply. Class 1 firms will need to apply any final proportionality framework set out in CRD IV. As these proposals currently stand, proportionality can apply only to the deferral and non-cash instrument requirements, on the following basis: Firm-wide basis: Total average balance sheet assets =<EUR5bn (over the previous four years); and Individual basis: Individual s total variable remuneration =<EUR50,000 and is no more than 25% of total remuneration. Crucially, as currently proposed, proportionality will not apply to the bonus capping requirements, which will be a significant concern to these firms. As the level of assets for determining a Class 1 firm is higher than the firm-wide proportionality tests being proposed under CRD IV (set out above), in practice, no Class 1 firms will be able to apply firm-wide proportionality to disapply any of the remuneration requirements, where these are finalised as drafted. requirements for Class 2 firms Remuneration requirements The new Directive proposes a new set of remuneration requirements that align to the existing remuneration and governance requirements established under CRD IV. However, these proposals do not include a prescribed maximum ratio of fixed:variable remuneration, which will be welcome news to the industry. While there are no formal bonus capping requirements included, firms will be expected to set their own maximum ratios, which is similar to existing requirements already in place under CRD IV. Identified Staff The EBA, in conjunction with ESMA, will be responsible for developing draft regulatory technical standards on the appropriate criteria to be used for identifying those staff members that have a material impact on the risk profile of the firm. It is likely that the EBA s approach here will be informed by its existing Material Risk Taker definition established by the EBA under CRD IV. Proportionality Firms will be able to disapply the deferral and non-cash instrument requirements, on the following basis: Firm-wide basis: Total average balance sheet assets <=EUR100m (over the previous four years); and Individual basis: Individual s total variable remuneration <=EUR50,000 and is no more than 25% of total remuneration. In practice, this proposed EUR1oom threshold is relatively low and will likely mean that a substantial number of firms will be impacted on a firm-wide basis by the deferral and non-cash instrument requirements. Disclosure The draft disclosure requirements are set out in the new Regulation and align to those requirements set out in CRR. As drafted, it is particularly unclear how (if at all) proportionality applies to these disclosure requirements. However, the end result is likely to be more detailed levels of disclosure for most firms. Governance Firms that are considered significant will be required to establish a Remuneration Committee. Significance, as proposed, will be determined by Member State regulators. As such, it is likely that firms already treated insignificant for these purposes by their local regulators will continue being able to disapply this rule. 3
4 Impact on firms The impact of these changes will likely vary significantly between firms, depending on the extent to which these firms are already subject to CRD IV, AIFMD or UCITS V and critically whether they have been able to apply proportionality to disapply the more onerous structural requirements to date. Timing - experience from the implementation of other European Directives is that the legislative process takes a significant length of time. As such, the timing of any final rules remains unclear - in particular, as the remuneration rules are part of a much broader set of proposals. 3. Interaction with other regulations - in particular, how firms are expected to comply with potentially conflicting regulations between different regimes (e.g. the non-cash instrument requirements under AIFMD and UCITS V). 4. Application to consolidated groups - The drafting suggests that any investment firm that is part of a CRD IV consolidated banking group will still be in scope of the CRD IV remuneration requirements on a consolidated basis. This will impact bank owned investment firms who will be required to comply with the full CRD remuneration requirements, including the bonus cap. 5. Application to UK-headquartered firms and the UK operations of non-uk headquartered firms The UK s exit from the EU creates further uncertainty as to whether/how these rules will apply to UK firms/operations. The pace and nature of the exit negotiations will be critical to understand in this context. In the UK, the biggest impact will likely be to those Class 2 firms that are currently operating under either the IFPRU or BIPRU regimes, who may be required to apply the deferral and non-cash instrument requirements for the first time and to a potentially much larger group of employees than these firms currently identify for regulatory purposes. Firms will however be relieved that the proposals have been published without the inclusion of CRD-type bonus capping requirements, which has been a significant concern for firms throughout the review of the prudential framework. requirements for Class 3 firms Only the MiFID II remuneration and governance requirements will apply to these firms. These requirements are much more focussed on the structure and governance of remuneration for client facing sales staff, which likely reflects the more conduct-based nature of risks for these smaller asset management firms rather than prudential-based nature of risks. Key uncertainties There are a number of uncertainties regarding the application of these proposals, as follows: Implementation of these proposals as final rules - there remains a number of stages in the legislative process where these requirements can be refined, amended, or removed. 4
5 Start a conversation Tim Wright Duncan Nicholls T: +44 (0) E: tim.wright@uk.pwc.com T: +44 (0) E: duncan.e.nicholls@pwc.com Dominic Cowler Thomas Gunning T: +44 (0) E: dominic.l.cowler@pwc.com T: +44 (0) E: thomas.gunning@pwc.com Elliott Bewley T: +44 (0) E: elliott.s.bewley@pwc.com Join the conversation #RemRegs #EuropeanCommission #EURemRegs This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers LLP. All rights reserved. In this document, refers to the UK member firm, and may sometimes refer to the network. Each member firm is a separate legal entity. Please see for further details TG-OS
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