The European Commission and Council have developed a new prudential regime more tailored to the nature of risks that investment firms face instead of being subject to requirements stated in the CRR/CRD. Investment firms (IFs) that are authorized under MIFID II, will need to comply with the new prudential requirements defined in the Investments Firm Regulation EU 2019/2033 (IFR) and Investment Firms Directive EU 2019/2034 (IFD). From July 2021 onwards, IFR/IFD will impact the way liquidity and capital requirements are calculated and the new regulation will also have consequences on the reporting and disclosures obligations, the internal governance and the remuneration framework within investment firms. The proportionality regime built-in within IFR/IFD will ensure that those new regulatory requirements are applied differently depending on the category into which IFR is classifying these investment firms .
Being officially in 2021, the deadline for investment firms to prepare for the new IFD/IFR framework is only a few months away. As of the 26th of June 2021, those new requirements will be applicable to all Class 2 and Class 3 investment firms in the EU. Class 1 investment firms will remain subject to CRR/CRD(2).
This article will give you an overview of the important elements:
- Classification scheme of investment firms
- Capital & liquidity requirements
- Reporting and disclosures
Is your IF a Class 1, Class 2 or Class 3 investment firm? There are differences
There are different types of investment firms operating on the financial market. Before even looking into the details of the regulation, investment firms need to determine to which class they belong. The classification of the IFs will determine how large the impact of the new framework will be for the firm. Internal evaluations and assessments are a must before proceeding, as the class determines the capital requirements too. There are three classes defined by EBA:
- Class 1: bank-like & systemic investment firms. These are firms that are exposed to risks similar to credit institutions. Those firms usually have a consolidated balance sheet total of € 15 billion or more and are considered as systematically important. The CRD/CRR framework remains appliable to them. Investment Firms with a consolidated balance sheet total of € 30 billion or more are even classified as systemically important and are henceforth subject to direct ECB supervision.
Class 2 and Class 3 investment firms will be subject to the new framework, but the impact on each class will be different.
- Class 2: Type of IF that will be most impacted by the new framework
- Class 3: small and non-interconnected investment firms (SNIF): the new regulation will have a limited impact on these type of firms.
The thresholds for being classified under Class 3 are defined within Article 12 of the IFR:
- Assets Under Management (AUM) is less than EUR 1,2 billion;
- Clients Order Handled (COH) is less than either:
- EUR 100 million/day for cash trades; or
- EUR 1 billion/day for derivatives;
- Assets Safeguarded & Administered (ASA Art. 19) is zero;
- Client Money Held (CMH measured in accordance with Art. 18) is zero;
- Daily Trading Flow (DTF measured in accordance with Art. 33) is zero;
- NPR or CMG measured (in accordance with Art.s 22 and 23) is zero;
- Trading Counterparty Default (TCD measured in accordance with Art. 26) is zero;
- the on‐ and off‐balance‐sheet total of the investment firm is less than EUR 100 million;
- the total annual gross revenue from investment services and activities of the IF is less than EUR 30 million.
If an IF meets the threshold metrics mentioned above, it will be classified as a Class 3 investment firm. If the values of the above mentioned elements exceed the threshold, the IF is then considered Class 2 and will need to comply with the complete IFR/ IFD regulation.
Investment Firms Classification Test
Find out whether your firm is a class 1, class 2 or class 3 investment firm.
Capital & liquidity requirements
There are other requirements that will apply to investment firms, such as the governance structure, the new remuneration policy etc. However, the capital and liquidity requirements are by far the most stressful for the firms.
Investment firms are required to hold capital to cover the risks incurred in their operation, such as market risk, credit risk and operational risk. The classification to which the investment firm belongs, will also drive the way the own funds capital requirements are calculated:
Class 2 firms will be required to conduct a new “K-factor” risk assessment to determine their capital requirements, based on the extent to which they participate in certain risk-related activities. These K-factors are new risk metrics set to help determine to what extent an investment firm is exposed to risks. To determine the K-factor requirement, firms will need to calculate the amount for each K-factor, multiply it by the relevant coefficient (if applicable for the relevant K-factor) and add all resulting individual K-factor amounts together to obtain the overall K-factor requirement. The K-factors are divided into three groups of risk factors:
Based on the above table, the total K-factor capital requirement results into RtC + RtM + RtF.
Besides the own funds requirements, an investment firm will also need to comply with the liquidity requirements as defined within IFR.
Investment firms are required to hold at least one third of their fixed overhead requirement in liquid assets. This applies to both class 2 and class 3 firms, but the competent authority may exempt class 3 firms that meet certain requirements from this obligation.
Brace yourself for adapted reporting & disclosures
The proportionality principle is also applied on the reporting and disclosure requirements and thus Class 3 firms can benefit from a simplified supervisory reporting scheme. The reporting frequency is also reduced from quarterly (for Class 2) towards annually for Class 3 investment firms. Furthermore, an exemption can be applied for Class 3 investment firms related to the disclosure requirements in case they haven’t issued Additional Tier 1 capital instruments.
On a quarterly basis, Class 2 IFs need to report the following information to the competent authorities:
- Level and composition of own funds
- Own fund requirements & calculations
- Additional details regarding the K-factor requirements
- Concentration risk
- Liquidity requirements
- More information related to the group capital test & the verification of the total assets
Download the brochure on reporting requirements overview via the button below.
It is important to know that COREP will no longer be applicable to Class 2 and 3 IFs, since they are no longer subject to the CRD IV/CRR regulation.
Don’t forget your reporting software
A new set of reporting templates will need to be integrated. Since the new K-factor and its calculations will have implications on the data and reporting requirements, it is important to know that adaptations to your reporting solution will be necessary as well. Feeling overwhelmed? A partner with a solid in-depth knowledge in regulatory reporting and expertise in technology can support you in this process. As a partner in regulatory reporting, b.fine supports different investment firms and banks with their new regulatory reporting processes with our SaaS reporting platform b.rx. It is the first user centric platform which supports the full regulatory reporting process in the most optimized & efficient way. b.fine helps you apply the new regulation requirements and takes care of your reporting supply chain so that you don’t have to worry about not being compliant in time for the IFD/IFR.