A new UK prudential regime for MiFID investment firms FCA Consultation Paper CP21/7

The weather is getting better, Firms are starting to plan how, when or even if staff will go back to the offices and everybody is starting to see some light at end of the tunnel, when BANG -FCA produce another Consultation Paper and want comments by 28th May 2021. But not just any Consultation Paper, A VERY SIGNIFICANT CONSULTATION PAPER.

So what are FCA consulting on?

FCA are consulting on their second phase of proposed rules to introduce the UK Investment Firm Prudential Regime (IFPR). IFPR is a new prudential regime for UK firms authorised under the Markets in Financial Instruments Directive (MiFID)

Why are they consulting?

It represents a major change for investment firms of which it is estimated there are 3600 firms. It is critical that firms adequately prepare for the regime. We know a number of firms responded to the first CP20/24 and were also contacted by the FCA directly for their comments.

A bone on contention was the definition and capture of SNI – small and non interconnected investment firms and whether or not the requirements for these firms was appropriate. Equally, there were concerns voiced that some small firms would not being captured as SNIs in CP20/24 because of their activities which meant they would be full scope Non SNIs.

This is the second in a programme of Consultation papers (CPs) and Policy Statements (PSs) that the FCA will issue to introduce the regime and FCA want your views on the proposed rules.

The new regime is designed to streamline and simplify the prudential requirements for MiFID investment firms with a single prudential regime.

What FCA want to change

The IFPR is specifically designed for FCA investment firms and represents a significant change to how they will be prudentially regulated. The new requirements seek to capture the potential harm posed by these firms to their clients and the markets in which they operate. It also considers the amount of capital and liquid assets the FCA investment firm should hold so that if it does have to wind-down or exit the market, it can do so in an orderly way.

Specific changes to the existing prudential regime for FCA investment firms that are included in CP21/7

Own Funds requirements

FCA are proposing to introduce a fixed overheads requirement (FOR) that will apply to all FCA investment firms. This will be another of the ‘floors’ below which the own funds of an FCA investment firm must not fall.

The Consultation Paper also provides more details on the FCA proposals for activity-based requirements known as K-factors.

Basic liquid assets requirement

FCA propose that all UK investment firms now have a basic liquid asset requirement. This would be based on holding an amount of core liquid assets equivalent to at least one third of the amount of their FOR. FCA explain the concept of core liquid assets and how this provides an appropriate set of assets that can be used to meet the basic liquid asset requirement.

K-Factor Requirements

More detail of how K-Factor calculations will work and be applied and this includes those firms dealing on their account, in this CP;

K Factor

Requirements based upon value

Coefficient

K- ASA

Client assets safeguarded and administered

0.04%

K-CMH

Client money held

0.4% (segregated accounts)

0.5% (non segregated accounts)

K-AUM

Assets under management

0.2%

K- COH

The client orders handled

0.1% cash trades

0.01% derivatives trades

 

K- Factor calculations are not applied to SNIs.  For those non SNIs there will be a 5 year transitional period to reduce the immediate impact of the IFPR requirements for (potentially smaller) firms that may find this difficult. The FCA estimate just over half of those firms required to incorporate K-Factors calculations can meet the requirement before the benefit of the 5 year transitional provisions.

Risk management & Governance (ICARA and SREP)

FCA propose to introduce an internal capital and risk assessment (ICARA) process for all FCA investment firms. Through this, firms will be expected to meet an Overall Financial Adequacy Rule (OFAR). This establishes the standard FCA will apply to determine if an FCA investment firm has adequate financial resources.

FCA propose how they expect FCA investment firms to determine through the ICARA process any necessary appropriate own funds and liquid assets requirements, in addition to the own funds and basic liquid assets requirements above. This includes that they consider harm to consumers and markets, including risks to their ability to engage in an orderly wind-down, as well as those from their ongoing activities.

With the ICARA, FCA are consolidating their requirements for business model analysis, stress-testing, recovery planning and actions, and wind-down planning. FCA propose new relevant expectations for senior managers and governance arrangements.

FCA also set out new guidance on intervention points, actions they expect of firms in certain situations and what firms can expect from FCA. As part of this, FCA intend to re-orientate their prudential supervisory approach for FCA investment firms towards being harm-led and in support of sector supervision. FCA will introduce an ICARA Questionnaire reporting template to support this.

Remuneration requirements

FCA propose that all UK investment firms must have a clearly documented remuneration policy and comply with at least a small number of basic remuneration rules in respect of all their staff. Non-SNI firms must comply with further requirements, which include identifying material risk takers and setting an appropriate ratio between variable and fixed remuneration. Under FCA proposals, only the largest non-SNI firms would need to meet the full requirements by also applying rules on deferral and pay-out of variable remuneration in instruments.

Regulatory reporting requirements

FCA propose to significantly reduce the amount of information that FCA investment firms need to report to the regulator about their remuneration arrangements.

What firms need to do?

If firms have not already analysed CP20/24, they need to read and analyse this Consultation Paper as soon as possible to understand the desired outcomes the FCA is seeking and the proposed new rules.

Once firms have an understanding of CP20/24 they need to read and understand in detail what FCA is proposing in CP21/7 and comment where they deem appropriate.

An analysis needs to be undertaken to access what the effect of the proposed new rules will have on the firm. For example:

  • Resource requirements
  • Training requirements
  • Changes to Management Information
  • System changes
  • Reporting lines

Start a dialogue with your system providers to ensure they are preparing for the changes.

Set up a project team and put together a project plan.

Identify any knowledge and experience gaps and decide how you are going to fill these gaps.

FSTP are here to help

Do not forget, FSTP are here to help. Pease do not hesitate to contact any of the Partners to discuss how we may assist.

Barry Howard

Partnership Adviser

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