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Last updated: 27 May 2021
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Investment Firms Prudential Regime (IFPR) – initial assessment and risk management expectations

With the consultation progressing and the implementation date approaching, IFPR has become a very hot topic . So what do you need to do as part of the initial assessment, and how can you meet the risk management expectations?

The FCA have opened the consultation to seek views on the second tranche of their proposed rules to introduce the Investment Firm Prudential Regime (IFPR) for UK firms, authorised under the Markets in Financial Instruments Directive (MiFID). 

CP21-7 in conjunction with the first CP, CP20-24, sets out the FCA’s proposals for changing prudential standards, which aim to streamline and simplify rules for FCA investment firms. 

IFPR represents a major change for investment firms, and it’s critical that firms adequately prepare for the regime.

While it’s recommended to implement a step-by-step approach to be fully ready by the 1 January 2022, there’re matters which need immediate attention. 

In this article, we explore two important steps in preparing for the IFPR: what should firms do as part of the initial assessment? And what can you do to lay the foundation for meeting the risk management expectations. 

About the author

Priya Mehta

+44 (0)20 7556 1372
mehtap@buzzacott.co.uk
LinkedIn

The FCA have opened the consultation to seek views on the second tranche of their proposed rules to introduce the Investment Firm Prudential Regime (IFPR) for UK firms, authorised under the Markets in Financial Instruments Directive (MiFID). 

CP21-7 in conjunction with the first CP, CP20-24, sets out the FCA’s proposals for changing prudential standards, which aim to streamline and simplify rules for FCA investment firms. 

IFPR represents a major change for investment firms, and it’s critical that firms adequately prepare for the regime.

While it’s recommended to implement a step-by-step approach to be fully ready by the 1 January 2022, there’re matters which need immediate attention. 

In this article, we explore two important steps in preparing for the IFPR: what should firms do as part of the initial assessment? And what can you do to lay the foundation for meeting the risk management expectations. 

Initial assessment of the impact of IFPR

Initial assessment of the impact of IFPR

If you haven’t already done so, the first step is establishing the classification of your firm between ‘Small and non-interconnected firm’ and ‘Non-small and non-interconnected firm’, depending on the quantitative assessment of the activities carried out by you. 

Then, you must determine if your existing capital instruments qualify as ‘common equity tier 1 capital’, ‘additional tier 1 capital’ or ‘tier 2 capital’, as the FCA intends to tighten the definition of regulatory capital

Depending on whether you’re currently an exempt-CAD firm, BIPRU or an IFPRU firm, you may have to deal with some significant changes to your capital requirement, with the introduction of ‘fixed overheads requirement’ as the base floor, plus further complications through the K-factor requirement. 

So what’re K-factors and which do you need to consider? K-factors are the capital requirement metric that take into account a firm’s risk profile, size of the balance sheet, client assets and volume of trading and investment activities; representing the range of risks the firm can present. There are nine K-factors in total, broadly split into:

  • Those which apply to firms that don’t have the permission to deal on their own account (K-AUM, K-CMH, K-ASA, K-COH).
  • And those that have a trading book (K-DTF, K-NPR, K-CMG, K-TCD, K-CON).

Not to forget the increase in the base capital requirement itself, which under IFPR is £75,000, £150,000 or £750,000. As opposed to the corresponding current levels of €50,000, €125,000 or €730,000 for different types of firms. 

Something positive for you to note is that the transitional rules are quite generous, allowing firms to build the required capital over a time horizon of five years. However, this does require careful tracking of the rules at each of the base capital, fixed overheads requirement, and K-factor requirement levels. 

Lastly, surrounding all of the above is the consideration of your group structure itself, to determine whether you need to comply with all of the above rules at a solo as well as consolidated level. A simple structure may make you eligible for ‘Group Capital Test’ which is subject to the FCA’s granting permission, but worth avoiding the ‘prudential consolidation rules’ if you can. 

Putting in place an on-going risk management framework

Putting in place an on-going risk management framework

The FCA stress that they see IFPR as an opportunity to re-establish their expectations for investment firms’ internal governance and risk management. They expect firms to have a robust framework in place to identify harm and put in place appropriate financial and non financial mitigants to minimise the likelihood of crystallisation and/or impact of the material harm. 

To facilitate this, firms need to introduce the following two processes into their regulatory compliance procedures:

1. ‘Internal Capital Adequacy and Risk Assessment’ (ICARA)

2. Wind-down planning

Internal Capital Adequacy and Risk Assessment’ (ICARA)

The ICARA process should be the centrepiece of your firm’s risk management, and should undertake business model assessment, forecasting capital and liquidity needs, including expected and stress-scenario testing, along with a qualitative and quantitative assessment of risks that a firm would pose. This should feed into the ‘additional capital requirements’ to be observed above the fixed overheads requirement. 

Wind-down planning

Through the ICARA process, the IFPR also introduces the ‘Overall Financial Adequacy Rule’ (OFAR) which establishes the standard the FCA will apply to determine if your firm has adequate financial resources. OFAR will require all firms to hold adequate own funds and liquid assets at all times in order to:

  • ensure it can remain viable throughout the economic cycle, with the ability to address any potential harm from its ongoing activities; and,
  • to allow its business to wind‑down in an orderly way.

Wind-down planning means setting out, at an entity-level, a credible and reliable wind-down plan, including timelines for when and how to execute these plans. 

The FCA Handbook includes detailed guidance under Regulatory guides – Wind-down Planning Guidance, which sets out its expectations of firms to document the process they intend to follow for an orderly wind-down. Guidance states that, besides having a clear-headed and prompt decision-making ability, it’s important to articulate a wind-down plan at an operational level. The starting point of the wind-down timeline is the decision, and the end point is the successful cancellation of the regulatory permissions. But the ‘planning’ is all about the numerous tasks and challenges in between. 

Key questions your wind-down plan should address are as follows:

  • What’s the estimated length of your wind-down period?
  • What resources (both financial and non-financial) would be needed to implement it?
  • Who needs to be available to assist the firm in winding down?
  • How would the firm deal with redundancies and, conversely, which employees need to be retained with special financial arrangements?
  • Which systems (e.g. IT systems) need to be available to the firm during the winding down?
  • Will the firm need to engage professional advisors to wind-down?
  • Has the firm considered the implications for any overseas offices and branches?

Overall, it’s essential to have a robust wind-down plan which gives a clear picture of your firm’s governance process, operational analysis, estimated revenue/costs schedule and resource assessment.

Stay tuned in

Stay tuned in 

We urge firms like yours to start spending the much needed time to address the matters above to create a solid foundation for a smooth transition to IFPR. It’s critical to familiarise yourself with the various monthly monitoring requirements being introduced, as well as the series of new regulatory returns that will have to be completed on a quarterly basis. 

Another important topic is the MIFIDPRU Remuneration code which applies to all firms. The code needs to be implemented for remuneration arrangements from the start of performance year, beginning on or after 1 January 2022. There are ‘standard’ or ‘basic’ proportionality rules depending on your classification and the remuneration policy that will need to be designed accordingly. 

Lastly, we’ll see a third consultation paper from the FCA in Q3-2021 covering some residual topics which will be followed by the final rules. 

As we continue to dissect this significant regulation and assess the impact of it, stay tuned for more updates.

View our previous articles on the topic here:

The FCA releases its second IFPR consultation paper (CP21/7)

Investment Firms’ Prudential Regime (IFPR) – Act now

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