First steps taken on new UK prudential regime for investment firms

On 23 June 2020, the FCA published its long-awaited Discussion Paper on a new prudential regime for MiFID investment firms, to be based on the EU Investment Firms Directive and Regulation (“IFD” and “IFR” respectively), which are due to be implemented in June 2021 (see our blog post).

On the same date, HM Treasury published a related Policy Statement on prudential standards in the Financial Services Bill, which complements and sets the parameters for the FCA's approach as outlined in the Discussion Paper.

Key timings and next steps

• HMT confirms that the UK will endeavour to introduce the new investment firms regime and updated prudential standards for credit institutions (those contained in so-called “CRR2” for the EU) by Summer 2021, broadly consistent with the June 2021 applicability date of the EU’s IFR/IFD and CRR2.
• Responses to the FCA's DP are required by 25 September 2020.
• The FCA then expects to publish a consultation paper in Q3/Q4 2020. 

HMT's Policy Statement

HMT's Policy Statement includes a summary of the pending EU-level reforms to be introduced under the CRD 5/CRR 2 legislation (which updates the prudential regulation regime for banks and certain MiFID investment firms) and the IFD/IFR (which sets out the prudential regime for MiFID investment firms not subject to the CRR).  HM Treasury is legislating new UK frameworks to update prudential rules for banks and to introduce a new Investment Firms Prudential Regime (IFPR).

HMT reiterates the statement made in the March budget statement on the upcoming Financial Services Bill (see our blog post) that it commits to four overarching principles in developing this legislation:

• financial stability and, where relevant, the implementation of international standards, in particular the Basel III and 3.1 standards. The UK is signed up to these standards as a member of the G20;
• supporting the Government’s wider objectives on growth, competition and competitiveness;
• a central role for the expert, independent UK regulators in designing and implementing the detailed and technical requirements that will apply to firms; and
• a flexible and proportionate approach, enabling the UK to both maintain a strong future partnership with the EU and other major economies, and to account for specificities in the UK financial services market.

A key component of this will be that HMT proposes to delegate responsibility for implementing the majority of the detailed prudential standards for banks and investment firms to the PRA and FCA respectively. These enhanced powers for the regulators will be balanced by increased Parliamentary accountability and public transparency within the rule making process. While the Policy Statement does not generally address substantive policy details of the new regimes, one point of divergence highlighted from the EU regime is that the UK (in contrast with the IFD/IFR regime) will not require systemic investment firms to be re-authorised as "credit institutions", although they will remain under PRA designation and supervision and subject to the CRR regime.

HMT also clarifies that CRD 5/CRR 2 and any subsequent updates to the banking regime should not apply to FCA-regulated (as opposed to PRA-regulated) investment firms, who should continue to comply with the relevant current regulation pending the introduction of the new IFPR.

FCA Discussion Paper

The FCA Discussion Paper takes the various requirements of the EU IFD/IFR regime as the basis for discussion, with a brief explanation of the key components (including capital and liquidity resources requirements, consolidation, remuneration  and supervisory review process), together with some initial views on UK implementation.

The FCA clarifies in its introduction that the UK has exited the EU and will therefore not implement the IFD/IFR "as is". However, the UK supported the overall goals of the IFD/IFR legislation and was heavily involved in its development. The FCA therefore anticipates that many of the EU regime's core policies will also be implemented in the UK, albeit with appropriate adjustments for UK firms and markets.

The Discussion Paper highlights some general impacts for UK firms, including:

• Anticipated positive outcomes of a similar UK regime for firms, including better alignment of prudential requirements to business models and potential for lower regulatory costs.
• Impact on the structure of the current prudential framework: the new IFD/IFR-derived regime would replace the current prudential categories and designations under the current prudential regimes (IFPRU, BIPRU, exempt CAD etc.) with the only key future distinction being between small and non-interconnected firms ("SNIs") and other MiFID investment firms.
• Anticipated removal of most MiFID investment firms from the scope of the CRR (or CRR-equivalent UK regime) save for systemic firms designated as such by the PRA (which would continue to be subject to the CRR and to PRA rules). The FCA defers to HMT on the boundary of the split between regulators.
• Continuing relevance of the FCA's existing guidance on financial resources (FG20/1) and wind-down planning guide (“WDPG Handbook module”) for firms in preparing for the new regime.

The Discussion Paper goes on to outline each of the main reforms required under the IFD/IFR. Most of the specific reforms are explicitly or implicitly endorsed by the FCA, although the FCA highlights some areas for particular further consideration, where UK adjustments may be appropriate.

There are many such points of detail (particularly on supervisory review, governance and individual capital and risk assessments), but some key examples include:

• Remuneration: The FCA proposes to base the new remuneration regime on the IFD/IFR (where possible and appropriate for the UK market). Of particular note is that the FCA indicates (albeit not definitively) that the current general discretion for UK BIPRU firms to dis-apply quantitative restrictions altogether on the basis of proportionality would not be carried forward in the future, except for firms that qualify as SNIs.
• Consolidation: The IFD/IFR provides for full consolidation for investment firm groups, or, on request (for "sufficiently simple" groups), the "group capital test". This "choice" is likely to be carried forward in the UK – the FCA indicates that most investment firm groups should be able to qualify in principle for the group capital test alternative.
• "Pillar 2" supervisory review and individual capital and risk assessments: The FCA proposes to include a legal minimum requirement for individual capital and liquidity resources, combined with an additional (guidance-based) buffer requirement where appropriate. The FCA also highlights differences between the new "ICARA" process and the current ICAAP structure, including increased focus on wind-down planning assessments.
• AIFMs: Extension of the IFD/IFR regime to AIFMs with MIFID services permissions ("CPMI firms") is anticipated – which is consistent in principle with the FCA's current prudential approach to these firms and furthers level playing field objectives.