Key Takeaways From The FCA Consultation Document for Investment Firms This document is designed to act as a summary of the key points covered in the FCA consultation paper CRD IV for Investment Firms, released July 2013. All comments on this paper have to be submitted to the FCA by 30 th September and a full copy of the consultation paper is available here.
Introduction Who is this summary for? Investment firms that are currently subject to the CRD (Capital Requirements Directive) including: firms that benefit from the current exemptions on capital requirements and large exposures for specialist commodities derivatives firms; and firms that only execute orders and/or manage portfolios, without holding client money or assets. Other firms in the investment sector (exempt-cad (Capital Adequacy Directive)firms, management companies as defined under the UCITS Directive, Alternative Investment Fund Managers (AIFMs) as defined under the Alternative Investment Fund Managers Directive (AIFMD)), subject to certain CRD IV provisions (e.g. on initial capital in the Directive, etc.). What will it do for you? Discover which types of investment firms will be affected by the changes surrounding CRD IV Find out which FCA category your business fits into and therefore which reporting and compliance exceptions apply to your business Decode some of the most significant proposals and understand the key takeaways for your business Common sense disclaimer: This guide is supposed to provide support in navigating the content of the 400+ page consultation paper; whilst it is a helpful entry point to a potentially daunting body of information, it is not a substitute for reading the paper or taking regulatory and legal advice. We re also not in a position to guarantee that any information provided or parts of the paper referenced will impact on the Policy Statement & final rules released by the FCA later this year, as this document is based on a consultation paper which is subject to change. Some common acronyms We try not to use complex jargon but some terms are unavoidable and come up so often that we ve used their accepted acronym to save our typing fingers. Name Capital Requirements Directive IV Capital Requirements Directive Acronym What is it? CRD IV The latest version of the CRD consisting of two parts, the CRR and the Directive. Europe says a "directive is a legislative act that sets out a goal that all EU countries must achieve. However, it is up to the individual countries to decide how. In terms of regulation, Europe says that a regulation is a binding legislative act. It must be applied in its entirety across the EU. CRD The EU goals that the FCA must decide how to achieve; this is where most of the consultation paper focus is.
Capital Requirements Regulation Prudential sourcebook for Banks, Building Societies and Investment Firms Prudential sourcebook for Banks, Building Societies and Investment Firms Markets in Financial Instruments Directive Capital Adequacy Directive General Prudential sourcebook GAthering Better Regulatory Information ELectronically CRR BIPRU IFPRU MIFID CAD GENPRU These are rules relating to capital requirements that are being applied wholesale across the EU, so the only things the FCA addresses in the consultation paper are national exceptions to those rules. The current Prudential standards and sourcebook for Banks, Building Societies and Investment Firms. The new Prudential standards and sourcebook for Investment Firms replacing BIPRU. The 2004 European Union law that provides harmonised regulation for investment services across the 31 member states of the European Economic Area A European directive to establish uniform capital requirements for both banking firms and non-bank securities firms first issued in 1993 and revised in 1998. A CAD firm is an investment firm that is subject to the requirements imposed by MiFID (above). General Prudential Standards & Sourcebook for Banks, Building Societies, Insurers and Investment Firms GABRIEL The FCA s online regulatory reporting system for the collection, validation and storage of regulatory data. What s in the consultation paper? Proposals on Handbook Rules and Guidance for: National discretions and derogations in the CRR (Capital Requirements Regulation) and the Directive New requirements and changes to existing requirements in the Directive Existing requirements in the Directive that are carried across However, it does not include: New, changed and existing requirements now in the CRR (which are directly applicable unless there is a national derogation, choice or action) Any other policy changes not essential to meet our legal obligations to transpose CRD IV
Who is affected by the changes and what exceptions are made for investment firms? Who exactly is affected by the changes? CRD IV was designed for banks but it is also applied to investment firms in the EU to some extent; the FCA paper for investment firms provides detail on the proposals for how this would work. This means that the overall outcome of CRD IV places more requirements on investment firms. However, this is mitigated through a combination of provisions referred to as derogations or national discretions that effectively dis-apply certain requirements in the CRR and/or in the Directive for different types of investment firms. The definition of investment firms in the CRR has been amended, so that there will be specific prudential requirements for different types of investment firms that carry out MIFID (Directive 2004/39/EC or Markets in Financial Instruments Directive) investment activities. Key takeaway: There are different rules for different types of company, knowing where you fit is the vital first step in understanding what you need to do. BIPRU vs. IFPRU Under CRD IV the FCA are creating a new Prudential Sourcebook for Investment Firms (IFPRU), but they have minimised as much as possible changes to the prudential categories (e.g. they have kept the structure replacing BIPRU with IFPRU ) in line with our overall approach. See the diagram below: Full scope BIPRU investment firm Full scope IFPRU investment firm BIPRU limited activity firm IFPRU limited activity firm BIPRU limited licence firm IFPRU limited licence firm
They have also created a new prudential category called BIPRU firms for certain firms that only execute orders and/or manage portfolios, without holding client money or assets. Where do I fit? The below table is reproduced from table 3 at 2.10 in the consultation paper: Category name Full scope IFPRU firm IFPRU limited activity firm Category definition A CAD full scope firm with its head office is in the United Kingdom and it is not otherwise excluded from the definition of BIPRU firm - exclusions are: (1) an incoming EEA firm; (2) an incoming Treaty firm; (3) any other overseas firm; (4) an ELMI; (5) an insurer; and (6) an ICVC. A limited activity firm means a CAD investment firm that satisfies all the following conditions: (1) it meets the criteria in (a) or the criteria in (b): (a) it deals on own account only: (i) for the purpose of fulfilling or executing a client order; or (ii) for the purpose of gaining entrance to a clearing and settlement system or a recognised investment exchange or designated investment exchange when acting in an agency capacity or executing a client order; or (b) it satisfies the following conditions: (i) it does not hold client money or securities in relation to investment services that it provides and is not authorised to do so; (ii) the only 3 investment service 3 it undertakes is dealing on own account; (iii) it has no external customers in relation to investment services it provides; and (iv) the execution and settlement of its transactions in relation to investment services it provides takes place under the responsibility of a clearing institution and are guaranteed by that clearing institution; (2) (in the case of a CAD investment firm that is a BIPRU investment firm) its base capital resources requirement is 730,000; (3) (in the case of a CAD investment firm that is an EEA firm) it is subject to the CRD implementation measures of its Home State for Article 9 of the Capital Adequacy
IFPRU limited licence firm Exempt IFPRU commodities firm Exempt CAD firm BIPRU Firms (new category) Directive (Initial capital requirement of 730,000); and (4) (in the case of any other CAD investment firm) its base capital resources requirement would be 730,000 if it had been a BIPRU investment firm on the basis of the assumptions in BIPRU 1.1.14 R (3)(a) and BIPRU 1.1.14 R (3)(b). A limited licence firm means (as specified by Article 20(2) of the Capital Adequacy Directive (Exemptions from operational risk)) a CAD investment firm that is not authorised to: (1) deal on own account; or (2) provide the investment services of underwriting or placing financial instruments (as referred to in point 3 63 of Section A of Annex I of 3 MiFID3) on a firm commitment basis. A firm to which the exemption in BIPRU TP 15.6R (Exemption for a BIPRU firm whose main business relates to commodities) applies. (1) it would have been a CAD investment firm if exempt CAD firms were not excluded from the definition; and (2) it is only authorised to provide the service of investment advice and/or receive and transmit orders from investors (as referred to in Section A of Annex I of MiFID) without in both cases, holding money or securities belonging to its clients and which for that reason may not at any time place itself in debit with its clients. Only executes orders and/or manages portfolios, without holding client money or assets. Important note - Firms that are authorised to carry out: MIFID investment services and activities (1) (reception and transmission of orders) and/or (5) (investment advice); and MIFID ancillary service (1) safekeeping and administration of financial instruments for the account of clients, including custodianship and related services such as cash/collateral management; Will no longer be exempt from the definition of investment firm and will instead become subject to the CRD IV. Key Takeaway: If you were previously exempt from the definition of investment firm you must check as certain companies are now included that weren t previously.
What exemption rules apply to my category? The consultation paper provides a detailed list of exemptions and conditions per category. If you are interested in what allowances are being made for your category or wish to comment on the proposals before they are finalised you can explore them in the paper; however for those who are not everyone will need to read these once the proposals are finalised into rules. Exemption highlights: Full scope IFPRU investment firm The firm must comply with liquidity regime, but the FCA may exempt it pending the outcome of the Commission s review by the end of 2015. Pending the Commission s review and if the group comprises only investment firms, the FCA may exempt them from compliance with the obligations on liquidity on a consolidated basis, taking into account the nature, scale and complexity of the investment firm s activities. The FCA may exempt small and medium sized (SME) investment firms from the Capital Conservation buffer (CCoB) and the Countercyclical capital buffer (CCyB). IFPRU limited activity firm As per the full scope IFPRU investment firm and in addition: This type of firm is excluded from the leverage requirements on an individual basis. FCA may waive application of own funds requirements on a consolidated basis. If all entities in a group of investment firms are exempt from leverage ratio on an individual basis, the parent investment firm may choose not to apply leverage provisions on a consolidated basis. Large exposures do not apply to limited activity firms. IFPRU limited licence firm As IFPRU limited activity firm and in addition: Excluded from the liquidity provisions. Exempt from the capital buffers. Excluded from the regime for designation of significant branches. IFPRU Exempt IFPRU commodities firm Excluded from the provisions on own funds requirements until 31 December 2017 or the date of entry into force of any modifications, as a result of the Commission s review by the end of 2015. Exempt from large exposure provisions until 31 December 2017 or the date of entry into force of any modifications as a result of the Commission s review. BIPRU firm CRD IV requires them to apply the higher of requirements in the CRR article 92(3) except for operational risk or the Fixed Overhead Requirement (FOR) and to meet the requirements in the CRR articles 92(1) on own funds and (2) on calculation of capital ratios. The FCA may keep such firms on the current CRD, as it stood under national law (i.e. BIPRU and GENPRU) on 31 December 2013. This would include the current (less
onerous) definition of own funds, the FCA simplified approach to calculating credit risk and reporting under GABRIEL (not COREP). Exempt CAD firm Exempt-CAD firms that find they still conform to the new definition of the category i.e. they are not additionally authorised to provide the ancillary service which is safekeeping and administration of financial instruments for the account of clients, including custodianship and related services such as cash/collateral management will not be affected by the current reporting changes resulting from CRD IV. Key takeaway: In many cases these exceptions lighten the compliance burden and so should come as welcome news to most businesses. Significant Firms Some of the reporting requirements apply only to firms that are deemed significant i.e. their failure would have significant impact. The definition of significant firms is detailed in chapter 5 of the consultation paper and will be calculated from: Total balance sheet assets Total balance sheet liabilities Annual fees and commission income Client money Client assets The indicator threshold that defines significant in each case is: Total assets - 530 million Total liabilities - 380 million Annual fees and commission income - 120 million Client money - 425 million Client assets - 7.8 billion Section 7 of the consultation paper sets out the FCA s proposals in relation to the treatment under the CRR of rule waivers and modifications granted to firms in accordance with section 138A of FSMA. Rule waivers and modifications are jointly referred to in this Chapter as waivers.
What does the FCA actually want? Another Common Sense Disclaimer: As with the rest of the paper, this summary has been produced as the author s interpretation of the highlights from the proposals in the consultation paper, this is not intended as a substitute for legal advice or reading the consultation in full; it should also be noted that these are still proposals and up for discussion and change before the rules are finalised. That said, they should provide an insight into where the FCA is going. The CRD (Capital Requirements Directive) Pillar 2 The consultation paper provides a good overview, The Directive requires a firm to assess and to maintain on an on-going basis the amounts, types and distribution of internal capital that it considers adequate to cover the nature and level of the risks to which it is or might be exposed. The FCA is then required to review and evaluate this assessment by the firm. If necessary, additional own funds may be needed on top of the minimum level of own funds set by the CRR. Together, these are known as Pillar 2. Pillar 2 remains very much the same as the current CRD (see mapping table below) Any Individual Capital Guidance (ICG) given to firms will therefore continue to be the sum of the minimum own funds requirements ( Pillar 1 ) and the additional own funds requirement under Pillar 2 (previously named Pillar 2A ). Implementation of current CRD in the FCA Handbook Adequacy of financial resources requirement (GENPRU 1.2) Internal capital adequacy standards (BIPRU 2.2) Internal capital adequacy standards (BIPRU 2.2) The Directive Internal capital (Articles 73, 79-87) Level of application of internal capital adequacy assessment process (Article 108) Supervisory review and evaluation (Article 97) Key takeaway: Pillar 2 remains very much the same as the current CRD The 5 Capital Buffers There are 5 different possible capital buffers that will be accumulated and reported on by firms during positive economic conditions to provide a greater cushion to absorb losses during less favourable times and to help address the pro-cyclical mechanisms that contributed to the origins of the financial crisis and aggravated its effect. The Capital Conservation Buffer (CCoB), which is a fixed amount to provide a cushion, and (ii) the Countercyclical Buffer (CCyB), which is variable (and can be zero where no specific amount is set). These two buffers apply on an institution, sub-consolidated and consolidated level to all investment
firms that have permission to deal on their own account, and/or underwrite financial instruments and/or placing of financial instruments on a firm commitment basis. There is an exemption from both the CCoB and CCyB for limited licence firms caught by the CRD IV.5 The CCoB rate is fixed. It will eventually be 2.5% multiplied by total risk exposures, subject to a five year transition period: 2014 2015 2016 2017 2018 2019 0% 0% 0.625% 1.25% 1.875% 2.5% The CCyB captures excess credit growth and is calibrated using measures such as the deviation from long term trends in the ratio of credit to GDP and other relevant factors for addressing cyclical systemic risk. It will be set by an authority yet to be appointed by the Treasury (likely Bank of England) and will be subject to the same 5 year roll out capped rates as detailed above for CCoB. NB: Even though they are worked out in the same way and subject to the same capped roll out percentage figures, these are two separate buffers and will need to be differentiated in reporting. The other three buffers that make up the Combined Buffer (CB) are designed to address systemic risks. These are the: Globally Systemically Important Institutions Buffer (G-SIIB) Other Systemically Important Institutions Buffer (O-SIIB) Systemic Risk Buffer (SRB) As before these three buffers also only apply to investment firms that have permission to deal on their own account, and/or underwrite financial instruments and/or placing of financial instruments on a firm commitment basis. With the first two, they will be decided on a per firm basis and the FCA expect only PRA regulated firms or groups to be deemed systemic on a global basis and hence subject to the G-SIIB, and probably the same on a domestic level as regards the O-SIIB. The SRB is not decided on an individual firm basis, but rather is to be applied either to the whole financial sector, or one or more sub-sets of it. Key takeaway: Where a firm fails to meet the required amount for the Combined Buffer, there are restrictions on the amount of distributions (i.e. dividends, repayment of capital etc.) it will be able to make. Recovery and resolution plans Under the directive firms must prepare, maintain and update recovery plans for the restoration of their financial situation following a significant deterioration; and must cooperate closely with the resolution authorities providing them with all the necessary information, so the resolution authorities can prepare and draft the resolution plans setting out options for the orderly resolution of the firms in the case of failure.
In real terms the application of this will be reduced by the FCA if it considers that the failure of a specific institution due to its size, to its business model, to its interconnectedness to other institutions, or to the financial system in general, will not have a negative effect on financial markets, on other institutions or on funding conditions. Further guidance on how this will work will be supplied after the FCA has decided its proposed approach with the Bank of England but it is highly likely to be based on proportionality. Stress testing Firms will be expected to carry out stress tests at least annually to facilitate the review and evaluation process under Article 97. It is expected that the EBA will issue guidelines in this area setting up common methodologies to be used when conducting annual supervisory stress tests. The FCA are advising that tests be made using methods appropriate to the nature, size and complexity of the firm s business and of the risks it bears. They also say that only firms described as significant need report on this. Key takeaway: Both stress testing and recovery and restitution plan requirements will be adjusted to a level considered appropriate to the size and complexity of the business. Remuneration The principle of proportionality continues to be an important part of the remuneration framework in the Directive which means the application of certain remuneration requirements may vary in relation to certain types of investment firms based on their size, internal organisation and the nature, the scope and the complexity of their activities. There are new restrictions on bonuses as part of the regulation but how these will be reported has yet to be decided.
The CRR (Capital Requirements Regulation) The FCA will not be making rules to implement the Regulation as most of it passes directly into EU law without any need for National Authorities to intervene; the exception to this is where permitted as a national discretion, or required as a national implementing measure. Here are the highlights from those exceptions: A quick reference guide to proposed liquidity requirements: IFPRU Chapter 7 FSA0xx liquidity templates COREP liquidity reporting (2014) Binding minimum requirements (2015) A full scope IFPRU investment firm that is identified as significant and is an ILAS firm A full scope IFPRU investment firm that is not covered in the first column An IFPRU limited activity firm An IFPRU limited licence firm x x x x x x Key takeaway: All businesses must report FSA0xx liquidity templates, COREP only applies to full scope IFPRU investment firms that are identified as significant and are an ILAS (Individual Liquidity Adequacy Standards) firm. Changes to the definition of capital and transitional provisions on capital There have been huge changes to the definition of capital under CRD IV and as such transitional provisions on capital have had to come into place. It is not practical to try and summarise these and readers would be advised to read sections 4.19-4.29 of the consultation paper for detail on how this will work. National Discretions There are a number of items that are subject to small national discretions (i.e. changes the FCA can make that are not part of the CRR) that may be of limited application to the majority of investment
firms that are covered in this section of the paper (chapter 4.30 onwards). Firms to whom these are of interest are encouraged to read the relevant section: Internal models Large exposures Recognised exchanges, regulated markets and third-country stock exchanges Exposures secured by mortgages on commercial real estate property Financial reporting: FINREP The CRR allows the FCA to consider extending the definition of which IFPRU investment firms are subject to FINREP (beyond those firms mandated to submit FINREP templates under Article 99(2)) if the FCA believes that this is necessary to obtain a comprehensive view of the risk profile of the activities of, and a view of the systemic risks to the financial sector or the real economy posed by these firms. This does not imply that the FCA intends to automatically implement this discretion. The nature of this discretion is such that by adopting it we are retaining an option to determine if we need to extend the scope of FINREP in the future. In practice, for the FCA to introduce this discretion, we would first have to consult with the EBA on extending the scope of IFPRU investment firms subject to FINREP. Key takeaway: Watch this space; there s no guarantee that your firm might not end up being subject to FINREP even if it s not currently mandatory for you under the CRR. This won t happen immediately but is worth bearing in mind. Simplified credit risk calculation The CRR does not permit the simplified method of calculating credit risk weights in relation to credit risk which is currently permitted in BIPRU. Accordingly, IFPRU firms should note that they will no longer be able to use this method. The New Sourcebook for IFPRU The FCA will make a new sourcebook IFPRU that transposes the relevant directive provisions and implements the discretions afforded to competent authorities in the CRR. It will apply to the investment firms subject to CRD IV that are presently subject to GENPRU and BIPRU with the effect that GENPRU and BIPRU will no longer apply to these firms. COREP and FINREP must be reported in XBRL format to the EBA, the FCA have also announced they will require firms to submit in this format. If you are subject to COREP and/or FINREP then you should give us a call as we can make the reporting so much easier for you, Arkk Solutions has produced the industry s simplest XBRL reporting tool for COREP and FINREP that enables you to work as normal in the EBA s Excel reporting templates with no need for any XBRL tagging, complicated or expensive new software! To find out more please email or call UK +44 (0)207 036 2758 or Eire:+353 (0)1 525 5409.