In June 2021 a new prudential regime for investment firms will come into effect. The prudential regime will now be more tailored for investment ...
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In June 2021 a new prudential regime for investment
firms will come into effect. The prudential regime
will now be more tailored for investment firms, and
is a significant revision of the current prudential
requirements for investment firms.
Overview and Classification The aim of the new framework is to firms that carry out the following
Overview introduce more proportionate and risk- activities:
The new IFR/IFD prudential regime sensitive rules for investment firms. • Reception and transmission of orders in
revises capital requirements, capital Under the new framework, the vast relation to financial instruments;
composition, liquidity requirements, majority of investment firms in the EU • Providing investment advice;
reporting, disclosure, governance, will no longer be subject to rules that • execution of client orders;
remuneration and supervision of were originally designed for banks. The • dealing on own account;
investment firms as set out in CRR/CRD largest and most systemic investment • portfolio management;
and MiFID. firms, however, will remain subject to the • underwriting financial instruments,
same prudential regime as European and/or placing financial instruments on
banks (i.e. CRR and CRD). a firm commitment basis;
• placing of financial instruments without
The IFR/IFD prudential regime applies a firm commitment basis;
to all MiFID authorised investment firms • Operating trading facilities - MTF/OTF
and therefore captures all investment
Classification
Under the IFR/IFD framework, investment
firms fall under one of the following four
classifications:
‘Class’ Authorisation Prudential
Regime
‘Class 1’ Credit CRR and
Institution – CRD
CRD
‘Class 1 Investment firm CRR and
Minus’ - MiFID CRD
‘Class 2’ Investment firm IFR and IFD
- MiFID
‘Class 3’ Investment firm Reduced IFR
- MiFID and IFD
This is a significant reduction when
compared with the CRR/CRD prudential
framework that has 11 different categories
of investment firm.
Class 1 and Class 1 minus investment firms
remain subject to the CRR/CRD prudential
framework. Class 1 investment firms, who
are the largest and most systemic, are
required to apply for authorisation as credit
institutions. Capital and Own funds
Own funds composition
Class 2 and Class 3 investment firms are
subject to the new IFR/IFD prudential Requirement Class 2 Class 3
regime, albeit Class 3 investment firms
Definition of Broadly the same as
benefit from a proportionate lighter touch
Capital the CRR with some
regime under the IFR/IFD than Class 2
derogations relating to
investment firms.
deductions
If the Central Bank considers that a Class 2
The own funds composition requirements of
investment firm poses a systemic risk, then
the IFR/IFD are broadly the same as the own
they can on a case-by-case categorise that
funds requirements of the CRR/CRD.
investment firm as Class 1 minus.
The IFR/IFD utilises the CRR/CRD capital
There will only be a handful of Class 1 and
framework but includes some specific
Class 1 minus firms in Ireland, therefore,
derogations which are tailored towards
this new prudential regime will have an
investment firms in relation to deductions
impact on the majority of investment firms
from capital.
operating in Ireland. As such, this article in
the main will explore the impact of the new
regime to Class 2 and Class 3 investment Requirement Class 2 Class 3
firms. Capital Higher of: Higher of:
Requirements Fixed overhead Fixed overhead
requirement (FOR); requirement (FOR);
Permanent Minimum Permanent Minimum
Requirement (PMR); Requirement (PMR).
K-Factor requirement.
Fixed Overhead Requirement (FOR) For some firms there is a significant Own Funds Requirements based on the
The FOR of the CRR was only applicable to increase or decrease in their initial capital extent to which they are exposed to certain
a subset of investment firms. Under the amount. Investment firms that were risk-related activities. Some elements of
IFR all investment firms must now calculate previously categorized as ‘local firms’ this requirement are completely new for
their FOR. would have been subject to an initial investment firms, while others are either
capital requirement of €50,000 but under direct applications of, or comparable to,
The FOR is set as one quarter of the the IFR/IFD would be subject to an initial existing CRR provisions.
previous year’s fixed overheads. The way in capital requirement and a capital floor of
which the FOR is calculated under the IFR €750,000. Class 3 investment firms will have to
is largely similar to that of the CRR method, monitor their K-factor metrics to ensure
however, some additional clarity has been The PMR thresholds are included in they have not breached their categorisation
provided in relation to deductions from Appendix I. threshold.
expenses.
K-Factor requirement The K-Factor requirement is the sum of:
Permanent Minimum Requirement The K-Factor requirement is a new • the Risk to Client (RtC)
(PMR) requirement under the IFR which is only • the Risk to Market (RtM)
Under the IFR an investment firm’s PMR is applicable to Class 2 investment firms. • the Risk to Firm (RtF)
the same as the initial capital required (ICR) These firms are required to calculate their
for authorisation.
The categories of risk and their constituent components are outlined in the table below:
Category K-Factor K-Factor description
RtC K-AUM K-AUM reflects the potential harm associated with the management of assets for clients such
(Assets under as incorrect discretionary management or issues relating to best execution.
management
K-CMH (Client K-CMH covers potential risks associated with the holding of client money by an investment
money held) firm. CMH should be the amount of money that the investment firm holds, which is held in
accordance with the Client Asset Regulations.
K-ASA (Assets K-ASA captures the risk of safeguarding and administering client assets, and ensures that
safeguarded investment firms hold capital in proportion to such balances, regardless of whether they are
and on its own balance sheet or in third-party accounts. ASA have a clear link to CMH, as being the
administered) total financial instruments that must be treated as such under CAR, as CMH is the total client
money in accordance with CAR.
K-COH K-COH captures the potential risk to clients of an investment firm which executes orders (in the
(Client orders name of the client, and not in the name of the investment firm itself), for example as part of
handled) execution only services to clients or when an investment firm is part of a chain for client orders.
RtM K-NPR (Net K-NPR is designed to cover potential risks of an investment firm dealing on its own account, or
position risk) executing for clients in the name of the investment firm.
K-CMG As an alternative to K-NPR, investment firms trading financial instruments with positions that
(Clearing are subject to clearing may, with the approval of the Central Bank, use K-CMG. In order to use
margin given) K-CMG all or most of the investment firm’s trading activity should be mostly encapsulated by
this approach.
RtF K-TCD (Trading K-TCD reflects the risk of trading counterparties failing to meet their obligations to the
counterparty investment firm. K-TCD only applies to investment firms dealing on their own account, including
default) executing for clients in the name of the investment firm.
K-CON K-CON is the K-Factor own funds requirement for concentration risk in the trading book, which
(Concentration captures large exposures to specific counterparties, where exposure exceeds the limits set out
risk) in IFR.
K-DTF (Daily K-DTF reflects the operational risks to an investment firm of trading large volumes on its own
trading flow) account or for clients in the investment firm’s name, in one business day.Internal Capital and Liquid Assets Liquidity requirements
Under IFR, the Central Bank can
Under the IFD Class 2 investment firms The IFR brings a new approach to managing
exempt ‘Class 3’ firms from the
are required to have “sound, effective and liquidity in comparison to the CRR. While
liquidity requirements, however
comprehensive arrangements, strategies both the IFR approach and the CRR
the Central bank do not consider
and processes to assess and maintain on approach, which is the liquidity coverage
these requirements to be overly
an ongoing basis the amounts, types and ratio (LCR), result in investment firms
burdensome, and are therefore
distribution of internal capital and liquid holding enough High Quality Liquid Assets
not proposing to apply a blanket
assets that they consider adequate to (HQLA) to survive for a month, they differ
exemption for ‘Class 3’ firms, and
cover the nature and level of risks which in how they are calculated. Under the IFR,
instead exercise this discretion on a
they may pose to others and to which expenses in the form of the fixed overhead
case-by-case basis as outlined in its
the investment firms themselves are or requirement are used as the relevant
CP135.
might be exposed.”. This requirement metric for the calculation whereas the LCR
is conceptually the same as the internal uses the expected net outflows over a 30
capital adequacy assessment process day stress scenario. As a result of these Internal Governance and
(ICAAP) and internal liquidity adequacy new requirements, firms must address Remuneration
assessment process (ILAAP) required by technological, governance and reporting Internal Governance
the CRD. The arrangements, strategies considerations and implications, which In general, the internal governance
and processes should be proportional to must be acknowledged through processes requirements of the IFR/IFD are similar
the nature, scale and complexity of the and control environment changes. The to those of the CRR/CRD. The internal
activities of the investment firm concerned. Central Bank had previously exempted governance requirements of the IFR/IFD
investment firms, bar systemic investment are applicable to Class 2 investment firms
By default Class 3 investment firms are firms, from the CRR liquidity requirements, in full with some requirements applicable
exempt from this requirement, however, therefore, under the IFR it will be the first to Class 3 investment firms such as the
the Central Bank has the discretion to time many Irish based investment firms will provisions relating to the treatment of risks.
request Class 3 to meet this requirement to be subject to a liquidity requirement.
the extent deemed appropriate. The IFD requires Class 2 investment firms
The IFR introduces a minimum quantitative to have robust governance arrangements
liquidity requirement for all investment that are appropriate and proportionate
The Central Bank of Ireland “considers
firms that requires investment firms to to the nature, scale and complexity of the
it good practice to require all
hold eligible liquid assets equivalent to risks inherent in the investment firm. The
investment firms to review their own
at least one third of their fixed overhead EBA has published Draft Guidelines that
risks and ensure they have adequate
requirements. The intention is that, by provide clarity in how both the Central
capital and liquidity regardless of their
basing the minimum liquidity requirement Bank and investment firms should apply
size.” Therefore, in CP135 the Central
on a proportion of the fixed overhead the principle of proportionality.
Bank has stated that it proposes to
requirement, an investment firm should
exercise its discretion and require all
be able to meet its relevant overheads for The Guidelines:
Class 3 investment firms to perform
at least a month by using such liquidity, in • Specify the tasks, responsibilities and
an assessment of internal capital and
the event that other sources of cash-flow organisation of the management body;
liquid assets.
are unavailable. There is an additional • Specify the organisational requirements
requirement where firms provide of investment firms including the need for
guarantees to clients. transparent structures;
Liquidity • Specify the requirements to ensure
Requirement Class 2 Class 3 This minimum requirement is designed sound risk management across the three
to act as an appropriate baseline for all lines of defense; and
Liquidity Minimum liquidity
investment firms. Firms should consider, • Specify requirements for the independent
requirement set at 1/3
as part of the internal risk assessment risk management and compliance
of FOR.
process whether additional liquidity should function and the internal audit function.
Liquid asset eligibility
be maintained above the fixed overhead
largely based on the
requirement. Class 2 investment firms should review
LCR DA with fewer
these Guidelines and ensure that they
restrictions on their
will be able to comply with their internal
composition.
governance requirements under the IFD.Remuneration The “bonus cap” will no longer apply to
Requirement Class 2 Class 3 investment firms; however, they will be
required to set appropriate ratios between
Remuneration No bonus No additional
the variable and the fixed component of
cap but requirements
the total remuneration of their MRTs.
similar core to those in
remuneration MiFID II.
The IFD will require the total amount
principles
of performance-related variable
and approach
remuneration to be based on a
to variable
combination of the assessment of the
remuneration
performance of the individual, of the
as CRD.
relevant business unit and the firm’s overall
results. This ensures that the individual’s
interests are aligned with those of their
The IFD sets out remuneration
business unit and the firm as a whole.
requirements that aims to ensure all
investment firms in its scope have
To better align the interests of individuals
remuneration policies that are consistent
with the interests of the investment firm
with, and promote, effective risk
and its clients, the IFD requires that at
management.
least 50% of an individual’s remuneration
be paid in shares or other non-cash
The IFD requirements are based on the
instruments. To reflect the diverse legal
same core remuneration requirements
structures of investment firms, the IFD
as CRD IV but differs in some areas. Major
simplifies the types of instruments which
deviations (compared to the CRD IV) mainly
can be used when compared to CRD IV.
relate to variable remuneration and gender
requirements.
Additionally, at least 40% of variable
remuneration, and 60% in case of
Policies
particularly high amounts, should be
The remuneration requirements have
deferred over a 3- to 5-year period.
not changed materially from the existing
CRD IV provisions. As is the case under
The Department of Finance have
CRD IV these requirements will apply to
issued a Consultation Paper, on the
identified Material Risk Takers (MRT’s). The
exercise of national discretions in IFD,
types of staff considered as Identified Staff
in which they discuss the proposed
is somewhat broader than was the case
exemption of some staff from certain
with CRD IV. Firms must ensure that their
thresholds in regard to variable
remuneration policies are:
remuneration. This is still under review
• Consistent with, and promote, sound and
and we await the final outcome.
effective risk management;
• Take into account the long-term effects
A Gender-neutral Remuneration Policy
of investment decisions, and encourage
and Practice
responsible conduct and prudent risk-
The IFD requires the remuneration policy
taking; and
and practice to be gender-neutral. This
• Gender neutral.
entails the principle of equal pay for male
and female workers for equal work or work
Variable Remuneration
of equal value.
Under the IFD there will be changes
to the way variable remuneration is
Remuneration Committee
calculated to include more consideration
Under IFD investment firms with average
of risks and other instruments apart from
on-and off-balance sheet assets of over
purely a percentage relative to the fixed
€100 million over the 4 years immediately
component. Furthermore, there is more
preceding the given financial year must
governance surrounding the calculation
establish a remuneration committee. The
and criteria that must be met to reach
remuneration committee should be able
certain benchmarks.
to exercise competent and independentjudgment on the remuneration policies clients or market arising from the group additional capital required as per IFR
and practices and the incentives created as a whole (that would otherwise require (Pillar 1) and the SREP (P2R), in line with the
for managing risk, capital and liquidity. supervision on a consolidated basis). investment firm’s ICAAP.
Unlike under CRD IV, the Central Bank
cannot waive this requirement, however CRR/CRD IV Provisions which no longer As mentioned previously, there are no
the committee may be established at group apply specific buffers under the IFR/IFD regime.
level. Capital Stack In the absence of guidance from the
Under CRD, where an investment firm Central Bank there is the potential for
A new feature in the IFD is the requirement is authorised under MiFID to provide equivalent buffers to be prescribed, either
to have a gender-balanced remuneration investment services and activities as part of the Pillar 1 capital requirement or
committee. of ‘dealing on own account’ and/or as a discrete capital add-on as part of Pillar
‘underwriting of financial instruments and/ 2 requirements.
The EBA has published a consultation or placing of financial instruments on a firm
paper on sound remuneration policies. commitment basis’, then the investment Leverage
firm must maintain a Capital Conservation CRR outlines how institutions are to
Consolidation Buffer (CCB) and a Countercyclical Capital calculate their leverage ratio and the
Prudential consolidation means Buffer (CCyB). There is no equivalent associated reporting requirements.
supervisors not only look at one single provision included in IFD. This requirement was only applicable to
investment firm for the compliance with commodity derivatives investment firms
IFD/IFR prudential requirements, but also The diagram below highlights the that are not exempt under the MiFID, and
at other entities in a group. This may apply differences and similarities between the any investment firm that did not fall into
to parent undertakings, but also to other capital stack under the CRR/CRD and the any other investment firm category under
subsidiaries in the group, or subsidiaries IFR/IFD. the CRD framework.
of the investment firm. IFR mainly sets
out terms on the application level of the The IFD does however include provisions From 1 January 2022 CRR2 makes a
new prudential requirements, while IFD which allow the Central Bank to require 3% leverage ratio a binding minimum
covers more general terms on consolidated Class 2 investment firms to hold ‘additional requirement for banks. There are no
supervision. own funds’ (P2G). This ‘additional own leverage requirements included in the IFR.
funds’ requirement complements the
When does consolidation apply?
Investment firms are typically subject
to individual regulatory requirements,
however under prudential consolidation
CRR/CRD Capital IFR/IFD Capital
those requirements are also applied to an
Requirements Stack Requirements Stack
investment firm on the basis of the position
of its wider ‘consolidation group’.
Pillar 2 guidance (P2G)
By definition, an ‘investment firm group’
Systemic Risk Buffer (SyRB)
excludes credit institutions, and therefore Guidance on Additional
Own Funds (P2G)
IFR prudential consolidation rules do not Countercyclical Buffer (CCyB)
apply to an investment firm who is part of a
group which includes a credit institution. Capital Conservation Buffer (CCB)
What does this mean for firms?
The parent firm may have a higher own
funds requirement at a consolidated level Additional Own
Pillar 2 Requirement (P2R)
than the subsidiary firms need to hold Funds Requirement (P2R)
individually. One potential implication
is that union parents may have to hold
capital for subsidiaries based outside the
union (e.g. UK), leading to a competitive
disadvantage.
Minimum Own Funds Minimum Own Funds
Group Capital Test (GCT) Requirement (P1) Requirement (P1)
The Central Bank may allow a Group Capital
Test for groups that are sufficiently simple,
provided there are no significant risks toWhat next?
General Disclosures and Reporting - Pillar 3 Challenges and Getting ready
Investment firms must determine which Investment firms should establish/update IFR/IFD Impact assessments:
classification they fall under and should the necessary policies and procedures in • Carry out a Gap analysis against IFR/IFD;
carry out an impact assessment and gap order to be able to meet their reporting • Impact assessment on IT systems,
analysis against the IFR/IFD and all level and disclosure requirements of the IFR. reporting operating model, data
two texts published to date by the EBA to Investment firms should carry out an governance.
understand what their requirements are assessment of the new reporting templates
and where they have any gaps. and address any data gaps. Project Plan:
• Following the impact assessment
A number of MiFID investment firms may Investment firms that do not have an in firms should develop a project and
apply different definitions of capital than house reporting solution should be looking implementation plan to ensure
those prescribed under the CRR or IFR. The to procure a solution from a vendor. compliance with the regulations in a
IFR will apply to all MiFID investment firms See Appendix II for reporting and timely manner.
and this will mean that definitions of capital, disclosure requirements.
such as the concept of ‘Tier 3’ capital (for Develop a K-factor calculator:
example, short term subordinated debt), Capital Requirements – Pillar 1 • Carry out data mapping, and source data
that firms previously may have been able to Class 2 investment firms should be for any gaps;
utilise would no longer apply. developing the necessary calculators in • Develop an internal calculation solution
order to be able to calculate their K-Factor or implement a solution from a vendor.
The finance function, the risk function and requirement and identify any data gaps
the Board will be significantly impacted by that need to be sourced. ICAAP:
the new prudential regime. In particular, • Include forecasted capital requirements
risk and finance functions should consider Investment firms already subject to the due to IFR/IFD in your firms ICAAP.
how their current operating model will FOR should update their policies and
be impacted by the liquidity, reporting, procedures to capture the changes made Quality Assurance (QA):
disclosure and capital requirements. by the IFR. Investment firms who have • Review project teams impact assessment;
not previously calculated the FOR should • Perform a User Acceptance Testing (UAT)
Liquidity – Pillar 1 develop the appropriate policies and on K-factor calculator.
Investment firms should calculate their procedures.
expected liquidity requirement and make EBA Roadmap:
sure that the assets they intend to hold to Responsibilities of the Board The level 2 text on Pillar 1 and Pillar 3
meet this requirement are eligible under Board members of investment firms need requirements are further developed
the IFR and LCR DA. In Ireland, most firms to be familiar with the impending IFR/IFD than the same on Pillar 2. This has
will not have been subject to a liquidity legislation and the potential impact it will caused some uncertainty in regard to the
requirement previously. Therefore, it is have on the investment firm’s business. internal additional capital and liquidity
important that investment firms develop Boards should arrange for training to requirements.
and implement processes and procedures upskill on the new prudential regime.
to monitor and manage their liquidity SREP Guidelines will not be finalised
requirement as well as a process to report until the end of 2022. The RTS on Pillar
on their requirement. 2 add-ons and the RTS on liquidity risk
measurement will not be finalised until June
2021.Appendix I: Initial Capital Requirement under the IFD
Investment Activities ICR/PMR
• Dealing on own account €750,000
• Underwriting/placing of financial instruments on a firm commitment basis
• Operation of an OTF (where that investment firm engages in dealing on own
account or is permitted to do so)
Any other MiFID activity €150,000
Undertaking the following MIFID activities without permission to hold client money € 75,000
or securities:
• Reception and transmission of orders;
• Execution of orders on behalf of clients;
• Portfolio management;
• Investment advice; and
• Placing of financial instruments without a firm commitment basis.
Appendix II: Reporting and Disclosures
Requirement Class 2 Class 3
Reporting Required to report information quarterly Required to report information annually on:
on: • The level and composition of their own funds;
• The level and composition of their own • Their own funds requirements their own
funds; funds requirement calculation;
• Their own funds requirements their own • Their activity profile and size; and
funds requirement calculation; • Their liquidity requirements*.
• Their activity profile and size;
• Concentration risk; and *There is a possible exemption from the
• Their liquidity requirements. liquidity reporting requirement if the
investment firm is exempted from their
liquidity requirement.
Disclosures Class 2 investment firms are required to Class 3 investment firms that issue AT1 capital
disclose information on the following: are required to disclose information on the
• Risk management objectives and policies following:
• Governance • Risk management objectives and policies
• Own funds • Own funds
• Own funds requirements • Own funds requirements
• Remuneration policy and practices
• Investment policy*
• Environmental, social and governance
risks*
*Subject to additional criteria being met.
ESG disclosures are not applicable until
2022.To find out more please contact: Dublin
29 Earlsfort Terrace
Dublin 2
T: +353 1 417 2200
F: +353 1 417 2300
Sean Smith
Partner Cork
seansmith1@deloitte.ie No.6 Lapp’s Quay
Cork
T: +353 21 490 7000
F: +353 21 490 7001
Lochlann O’Connor
Director Limerick
loconnor@deloitte.ie Deloitte and Touche House
Charlotte Quay
Limerick
T: +353 61 435500
F: +353 61 418310
Galway
Galway Financial Services Centre
Moneenageisha Road
Galway
T: +353 91 706000
F: +353 91 706099
Belfast
19 Bedford Street
Belfast BT2 7EJ
Northern Ireland
T: +44 (0)28 9032 2861
F: +44 (0)28 9023 4786
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