By Martin Lovick, Director, ACA Group
Today marks 100 days until the implementation of the FCA’s Investment Firm Prudential Regime (IFPR) – setting in stone new requirements that dramatically impact investment managers, advisors and brokers who provide MiFID services.
So far, the timetable to absorb, interpret and implement the new requirements, ahead of the 1 January 2022 go-live date has been challenging. As late as last December, all firms had to go on was a Discussion Paper from the FCA on how they proposed to implement the equivalent EU Investment Firm Regime which had been grinding its way through the legislative system for several years.
However, with the publication of the FCA’s second Policy Statement, there is no longer a valid excuse to delay implementation. We recommend that firms address how this new prudential framework will impact them and begin to plan now for their capital and compliance resource needs.
Despite this, the amount of time needed to make these changes is still being underestimated. Making the changes to adhere to the FCA’s new regime is not a simple undertaking, and it’s crucial that firms understand that preparations for the IFPR cannot happen overnight.
Who IFPR applies to: IFPR establishes a new MIFIDPRU category of firms – those who provide MiFID services, including investment managers, advisors and brokers. Alternative managers categorised as Collective Portfolio Management Investment (CPMI) firms will also be subject to MIFIDPRU, although most of the IFPR activity-based metrics will apply solely to their MiFID activities.
A simpler regime for small firms: IFPR is intended to be both simpler and more proportionate to a firm’s operations than previous regimes. There is a less onerous set of requirements for small non-interconnected firms (SNI); and a fuller set of rules for “non-SNI” firms with more extensive operations or who undertake activities that place their clients, the market, or the firm itself, at a greater risk. The key threshold for SNI investment managers is Assets Under Management (AUM) of less than £1.2 billion.
Assets managed on an advisory basis – a key point of clarification
Private markets firms, especially those authorised as ‘CAD-Exempt’, are likely to be the ones most impacted by the new regime. One key issue is that assets under management, in the context of the AUM calculation for the SNI threshold, includes “non-discretionary arrangements constituting investment advice of an ongoing nature”. In its second Policy Statement, the FCA clarify that ongoing advice must relate to personal recommendations (i.e. not generic advice) and must relate to either recurring advice or advice given in the context of the continuous or periodic assessment and monitoring or review of a client portfolio. Genuine “one-off” advice should not be included in the AUM calculation. Global advisory firms will be pouring over these definitions and seek an interpretation which limits their scope to the purely UK segments of their portfolios.
Whether group consolidation is required: MIFIDPRU firms are required to consolidate the risk exposures of other firms within the group, including parent and subsidiary entities plus certain connected undertakings (note, this is a similar concept to accounting consolidation under IFRS or FRS). The identified group will be required to hold consolidated own funds equal to or greater than its consolidated capital requirements. ‘Sufficiently simple’ group structures (including, those without connected undertakings) are able to apply the Group Capital Test (“GCT”), hence avoiding full prudential consolidation.
Minimum capital resources: MIFIDPRU firms are required at all times to hold own funds (capital resources) in excess of the higher of:
- the Permanent Capital Requirement;
- the Fixed Overhead Requirement;
- the “K” factors (if relevant); or
- the ICARA requirement.
Permanent Capital Requirement (PCR): This replaces the Initial Capital Requirement. For most firms, this will be set at £150,000. Note that Matched Principal Brokers who were previously exempt from the full IFPRU regime will see their PCR rise from €50k to £750,000. However, transitional provisions permit firms to stagger these increases over a five-year period which will be a significant benefit to the most affected firms.
Fixed Overhead Requirement (FOR): The FOR will remain one of the primary drivers of firm’s capital requirements and will apply to advisory firms previously known as CAD-exempt for the first time. For firms operating in private markets, this is expected to result in very significant increases in capital requirements (again subject to transitional provisions). Some minor changes are expected to allowable deductions from total audited expenses, so it is worth firms running through the FOR calculations based on previous years to avoid any unwelcome surprises.
K Factors: These are an entirely new feature of IFPR, but they apply only to non-SNI firms. K Factors are intended to capture the underlying risk-drivers applicable to each business model. K-AUM will be the key measure for most investment managers. Firms dealing in an agency capacity or taking proprietary position will have a range of K-factors to take into account.
Liquidity: MiFID firms are required to maintain a minimum liquidity requirement for the first time, generally equal to one third of the FOR (in other words, one month’s fixed costs). Firms may have to implement a higher requirement dependent on its liquidity risk appetite. MIFIDPRU defines the main categories of available liquid assets plus any ‘haircuts’ that must be applied to these.
Remuneration rules: SNI firms will be subject to “basic remuneration requirements”, including a remuneration policy that is proportionate to the size, internal organisation, and nature of the firm. It must ensure that remuneration does not threaten the required capital base of the firm. Non-SNI firms will be subject to “standard remuneration requirements”, including setting a maximum ratio between variable and fixed remuneration, plus arrangements for in-year adjustments, malus and clawback. Large non-SNI firms (with balance sheets in excess of £300 million) have “extended remuneration requirements” including maintaining a remuneration committee, 50% of variable remuneration via approved instruments and deferral of 40% of variable remuneration for three years, or 60% if over £500,000.
From ICAAP to ICARA: the ICAAP is replaced by the Internal Capital Adequacy and Risk Assessment (ICARA). This documented risk assessment will be entirely new to firms previously categorised as CAD-Exempt. The ICARA places more emphasis on recovery action planning (where there is a risk of capital or liquidity requirements being breached) and wind-down planning. Firms will be required to hold sufficient capital and liquidity under new Overall Financial Adequacy Rules (“OFAR”) to ensure that they remain viable throughout the economic cycle and during wind-down.
Changes to Regulatory Reporting: IFPR de-commissions many of the reports currently required of IFPRU and BIPRU firms. Broadly speaking, regulatory reports for most firms will be simpler, albeit with new metrics and on a quarterly cycle.