Important updates from the FCA relating to prudential rules

1. Goalposts changed for CPMI firms

Dual-regulated firms such as ‘Collective Portfolio Investment Management firms’ (CPMI firms) will now need to confirm that the ‘own fund threshold requirement’ reflects the amount which is the higher capital requirement between the two regimes (MiFID and AIFMD).

The specific Handbook reference is as follows: 

• MIFIDPRU 7.6 - Own Funds Threshold Requirement 

Where a MIFIDPRU investment firm is also subject to another prudential regime for its non-MiFID business, such as a collective portfolio management investment (CPMI) firm, its own funds threshold requirement (OFTR) cannot be lower than the total financial resources requirement under that prudential regime to ensure that the firm is adequately capitalised for all the activities that it carries out.  

The catch here is for those CPMI firms whose ‘Funds under management’ requirement under Chapter 11 of IPRU-INV exceeds their ‘Fixed Overheads Requirement’ (FOR). However, after considering any PII excess, exclusions or professional negligence capital requirement under the Chapter 11 rules, the firm may already be holding capital well in excess of the FOR. 

The interpretation of the new rules relating to OFTR means that the ‘early warning indicator’ will apply on the highest capital requirement figure between the two regimes and for some firms, it may mean that additional capital needs to be injected to cover the ‘early warning indicator’ requirement.  

2. FCA's Final Report on the IFPR and the ICARA

An insightful  ‘final report’ has been published by the FCA on its multi-firm review into how firms are implementing requirements on the Internal Capital Adequacy and Risk Assessment (ICARA) process and reporting under the Investment Firms Prudential Regime (IFPR). 

Key areas where the implementation has been analysed in detail are: 

1. ICARA process (investment firm group and solo basis)
2. Assessment of liquid asset requirements
3. Early warning indicators, triggers, and interventions
4. Operational risk capital assesments
5. Wind down planning process
6. Usability of the ICARA document process and, 
7. Data integrity

'Good practice’ and ‘poor practice’ within each of the above has been articulated in detail to help firms improve their processes where required. 

Some observations of concern which firms should address immediately if there are gaps: 

• Inadequate consideration of stressed conditions rendering firms unprepared to immediately address liquidity strain
• Lack of time-granular analysis of cash flows leading to inadequate understanding of cash needs, while impairing resilience
• Failure to distinguish the analysis of liquid assets from the analysis of own funds leading to inadequate assessment of resources required to mitigate harm
• The lack of adequately assessed internal early warning indicators and triggers for intervention due to which firms may not be able to take timely action to mitigate harm
• Little consideration of the role of group relationships potentially leading to inadequate assessment of resources to support an orderly wind-down
• Insufficient consideration of group-wide wind-down plan leading to incomplete assessment of harms to be mitigated
• Significant failings in the application of operational risk capital approaches leading to insufficient resources to mitigate harm.

Further, the FCA followed up with a detailed newsletter with specific points of clarification to the following in the light of the discrepancies: 

1. Investment firm groups
2. Compliance with requirements for issuing CET1 capital instruments
3. Deductions from own funds
4. Matched principal restrictions for firms with permission to deal on own account
5. IFPR reporting
   • Firms with permission to deal on own account - reporting of K-factors on Form MIF001
   • Items to be entered into cell 6A in RegData on Form MIF002
   • General reporting guidance for Form MIF006

3. FCA's latest quarterly consultation - Changes to the Prudential sourcebook for MiFID Investment Firms (MIFIDPRU) to provide clarification

Lastly, the FCA has published its quarterly consultation (CP23/25) proposing further clarifications on the IFPR. It is evident from the number of recent publications that investment firms are not interpreting MIFIDPRU as intended by the FCA and therefore further clarifications are deemed necessary.

The main points been addressed on the recent publication as follows: 

• MIFIDPRU 1.2.1R - Basic conditions for classification as an SNI MIFIDPRU investment firm 

MIFIDPRU 1.2.1R(5) will be amended to explicitly state that an SNI firm doesn't have permission to deal on its own account and can't undertake the underwriting of financial instruments or place them on a firm commitment basis. 

• MIFIDPRU 4.14.20R - Effective notional amount (K-TCD) 

The FCA will clarify the explanation provided in MIFIDPRU 4.14.20R(2)(b) with respect to the calculation of the notional amount for equity and commodity derivatives contracts and emissions allowances and derivatives. 

• MIFIDPRU 7.9.9G – Internal Capital Adequacy and Risk Assessment (ICARA) process for groups 

A second amendment to MIFIDPRU 7.9.9G(3) explains that the effect of any intra-group offsets should be reversed when allocating requirements to individual MIFIDPRU firms under a group ICARA process. Were such an offset to be allowed, the allocation of own funds and/or liquid assets from the Investment Firm Group (IFG) level to the firm level may not accurately reflect the risk profile of the individual firms and this isn't in line with the original policy intention. 

• MIFIDPRU 8 Annex 1R – Disclosure template for information required under MIFIDPRU 8.4.1R in respect of own funds  

A note will be added to the template explaining that MIFIDPRU investment firms that are partnerships or LLPs should adjust the template’s content as relevant to the type of legal entity and its corresponding accounts and consistent with the requirements as set out in MIFIDPRU 3.3.16R and MIFIDPRU 3.3.17R. 

The FCA is using the information at its disposal to improve the firms’ understanding, as well as to ensure they are implementing the prudential regime as proposed. The latest consultation will remain open until the 8 January 2024.