Investment Firms Prudential Regime

Recent weeks have seen firms factoring in the introduction of new IFPR regulations to their 2021 planning. These will come into effect next January and will certainly have a big impact. They are aimed at protecting clients, consumers and the wider market of FCA investment firms specifically, and will seek to shield them from any potential harmful impact of the firms’ activities.

For asset managers these changes mark a significant transformation and it’s imperative that firms get their ducks in a row now.

What is it?

In full, IFPR is the UK Investment Firm Prudential Regime (IFPR) for FCA prudentially-regulated investment firms (FCA investment firms).

Quite a mouthful, which can perhaps best be described as a new, streamlined and simplified regime for the regulation of investment firms in the UK. In effect, this aims to replace the existing regulations with one, straightforward regime specifically for FCA investment firms with client and consumer protection at its heart. The UK regime will be broadly in line with the EU equivalent, which comes into force in June this year.

How will it impact firms?

As mentioned above, the new regime will have a big impact and firms need to be prepared to deal with a number of changes, which include:

• Changes to minimum initial capital requirements – in reality, this will mean an increase for most firms
• A new approach to calculating capital for larger firms (k-factor* approach)
• New liquidity rules totalling one third of fixed overhead requirement, compared to the current zero quantitative requirement for the majority of firms
• New rules on remuneration; a potentially increased threshold will mean fewer firms will have to comply with rules on retention and pay-outs

How will it affect capital requirements?

For smaller firms (primarily those with Assets Under Management of below €1.2bn and a balance sheet of less than €100m), the capital requirement will be the higher of the minimum requirement and the fixed overhead requirement. There will be no specific requirement for an internal capital calculation (Pillar 2) unless requested by the FCA.

For the larger firms, the capital requirement will be the higher of the minimum requirement, fixed overhead requirement and k-factor* requirement. These firms will also need to perform an internal capital assessment (Pillar 2).

* K-factors are a mixture of activity and exposure-based requirements and cover risks to client, risks to market and risks to firms

What about consolidation?

At the time of writing, we are waiting for further information from the FCA. However, we do know that consolidation excludes credit institutions (unlike the previous regulations which included them).

Further factors to consider at this stage:

• Under the new regime, a UK parent company and its subsidiaries will be treated as one entity; therefore, consolidation is required at the parent level whether the parent is regulated or not. Again, this is different from the previous regime and should not be overlooked
• There will be new rules on identifying consolidation groups
• Under IFPR, a UK parent company must comply with the composition of its own funds, own funds’ requirements, concentration risk, liquidity, disclosure and reporting

What about ESG requirements?

Whilst we expect new disclosure requirements, these will only be relevant for larger firms with assets in excess of €100m and will cover ESG related risks, physical risks and transition risks. If these requirements follow the EU model, we are likely to see ESG amendments to k-factors and risk criteria when the FCA review capital requirements for each firm.

However, it is important to note that the FCA has already highlighted that firms should integrate ESG related risks and opportunities into their businesses and actively consider these as part of their capital and liquidity requirements.

Internal capital assessment (Pillar 2)

As set out earlier, IFPR focuses on the business model and activities regarding the potential harm to clients, consumers and markets. This is of course a departure from the previous approach, which concentrated on defined risk categories.

Therefore, there will be a movement away from the detailed exposure of risks, to a greater emphasis on such considerations as changes in the book value of assets, trading book positions and losses from counterparty failures.

In addition, firms should note that wind down planning and calculations are specifically part of this process and that there is an implicit obligation for them to be forward-looking and firms should begin developing their own entity-specific stress testing models.

What have firms been doing so far to address the changes?

In our experience from speaking to clients and industry colleagues, firms’ preparations range widely from a very basic and limited analysis of the capital impact, to much more detailed work on all aspects of the regime change.

It’s also worth noting that, whereas some larger firms are expecting k-factors and fixed overhead requirements to drive capital, others are yet to perform any degree of k-factor analysis to reach their conclusions.

In general, most firms we speak to are comfortable with the new liquidity requirements, but to date there has been limited analysis of remuneration and disclosure requirements. This is clearly an important focus area to address going forward.

As set out at the beginning of this article, the clock is now ticking to January 2022, but there is still time to put plans in place, agree strategies and get those ducks in a row!

Cathy Husband

Devlin Mambo, January 2021

Devlin Mambo have extensive experience in assessing the impact of new regulations and in assisting in their effective implementation in a controlled, measured and robust way.  With a clear focus on long term partnerships, we will work hand in hand with you to help build the optimal IFPR framework for your business, with due consideration to your entity specific and consolidated requirements.

For further information contact cathy@devlinmambo.com or your usual relationship contact.