Investment firms authorised under the Markets in Financial Instruments Directive (MiFID) provide a range of services and activities to investors in financial markets. These services are essential for the functioning of the financial markets and include, among others, the reception and transmission of orders, the provision of investment advice, discretionary portfolio management and trading on own account.
The population of investment firms across the EU is diverse and firms vary greatly in terms of size, business model, risk profile, complexity and interconnectedness, ranging from one-person companies to large internationally active groups.
Having considered their diversity, as well as their specific risk profiles, that were not always properly captured by the banking prudential framework, the European Commission developed a new prudential framework, consisting of the Directive (EU) 2019/2034 (IFD) and the Regulation (EU) 2019/2033 (IFR).
The Investment Firm Directive (IFD) and Investment Firm Regulation (IFR) were published in the Official Journal on 5 December 2019 and entered into force 20 days later. The IFD and IFR will be applicable 18 months after their entry into force (i.e. 26 June 2021). In the IFR/IFD, a significant number of mandates have been given to the European Banking Authority (EBA), often in consultation with the European Securities and Markets Authority (ESMA), which has direct implications for the implementation of the framework.
The new prudential framework introduces a new approach to classify investment firms and a different prudential regime will be applied to each class. The investment firms will be split into three classes according to their size and complexity and each will be subject to a specific prudential framework.
- Class 1: Systematic investment firms or investment firms exposed to the same types of risks as credit institutions, to which the full CRD/CRR requirements will continue to be applied.
- Class 2: Investment firms that are not included in Class 1 or Class 3 will be subject to the full prudential IFR/IFD regime.
- Class 3: Small and non-interconnected investment firms will be subject to the limited scope prudential IFR/IFD regime.
Under the current CRR prudential regime, the capital requirements for an investment firm depends on the activities and services that the investment firm offers. The IFR/IFD framework introduces a risk-weighted quantitative system, K-Factors, which is an approach that takes into consideration the size and operations of the investment firm to ensure that all firms will be fairly capitalized.
K-Factors analysis consist of three proxies (Risk to Client, Risk to Market and Risk to Firm) and it is only applicable for Class 2 Investment Firms which are requested to maintain capital of at least the highest of their Initial Capital, Fixed Overheads requirement and K-Factors requirement. Class 3 Investment Firms are only requested to calculate their capital requirement as the highest between Initial Capital and Fixed Overheads requirement.
The IFR / IFD prudential framework includes the following elements:
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- Pillar 1 requirements include minimum regulatory capital, liquidity buffer and concentration risk limits (Class 3 firms will be partially exempted from some of the elements).
- Pillar 2 capital add-ons based on ICAAP / ILAAP and SREP (very limited application to Class 3 firms).
- Pillar 3 disclosure and reporting requirements (scope and frequency of the reporting differs for Class 2 and Class 3 firms, the latter are also subject to limited disclosure obligations).
- New remuneration framework and internal governance principles (not applicable to Class 3 firms).
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On 4 June 2020, the EBA published its roadmap on the implementation of the IFD & IFR and defined six thematic areas within its mandates as follows:
- Thresholds and criteria for investment firms to be subject to the CRR
- Capital requirements and composition
- Reporting and disclosure
- Remuneration and governance
- Supervisory convergence and the supervisory review process (SREP)
- Environmental, social and governance aspects (ESG factors and risks)
Depending on the deadline set up by the prudential framework, the EBA has established the following timeline:
The EBA mandates cover a broad range of areas related to the prudential treatment of investment firms. These include 18 regulatory technical standards (RTS), 3 implementing technical standards (ITS), 6 sets of guidelines, 2 reports, the requirement for the EBA to maintain a list of capital instruments and a database of administrative sanctions, and a number of notifications in various areas. Overall, the mandates are divided into four phases, mostly in accordance with the legal deadlines. All the regulatory products will be accompanied by a cost-benefit analysis supported, when necessary, by dedicated data collections.
Panayiotis Antoniou, Chartered FCSI, CFE, CAMS
CEO, MAP Risk Management Services Ltd (MAP RMS)
Related Training Programmes
New Course | Regulatory Requirements Under the New Prudential Framework for Investment Firms (IFR/IFD)
New Course | Regulatory Requirements Under the New Prudential Framework for Investment Firms (IFR/IFD)
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