FCA Consultation Paper 21/7 – A New UK Prudential Regime for investment firms

The FCA launched the second phase of its proposed rules for the UK Investment Firm Prudential Regime (“IFPR”) by publishing the Consultation Paper 21/7: A new UK prudential regime for MiFID investment firms (“CP21/7”). The CP21/7 should be read in conjunction with the FCA’s first consultation paper on the IFPR, published last December (CP20/24) which we summarised in our November newsletter last year.

The IFPR follows similar requirements that seek to capture the potential harm posed by investment firms to their clients and the markets they operate.

This month’s insight summarises the FCA’s proposals for FCA investments firms (“firms”).

Own funds requirements – (Chapters 4 and 5)

  • The introduction of a fixed overheads requirement (“FOR”) will apply to all FCA investment firms. This will be another of the ‘floors’ below which the own funds of an FCA investment firm must not fall.
  • The remaining K-factors apply to any firms. These are in addition to the K-factors that were proposed in CP20/24.
  • The method for adjusting the calculation of coefficients for the daily trading flow K-factor in periods of extreme market stress and volatility.
  • Specific proposals on own funds requirements and firm categorisation for FCA investment firms when they provide clearing services as clearing members and indirect clearing firms.

Basic liquid asset requirement – (Chapter 6)
FCA investment firms should have a basic liquid asset requirement. This would be based on holding an amount of core liquid assets equivalent to at least one-third of the amount of their FOR.  

Risk management & governance (ICARA and SREP) process – (Chapters 7 and 8)
The introduction of the Internal Capital and Risk Assessment (“ICARA”) process will require firms to meet the Overall Financial Adequacy Rule (OFAR). This establishes the standard the FCA will apply to determine if a firm has adequate financial resources.

The regulator expects that firms will determine through the ICARA process any necessary, appropriate own funds and liquid assets requirements, in addition to the own funds and basic liquid assets requirements mentioned above. This includes that firms consider harm to consumers and markets, including risks to their ability to engage in an orderly wind-down and ongoing activities. With the ICARA, the FCA is consolidating its requirements for business model analysis, stress-testing, recovery planning and actions, and wind-down planning. In addition, the FCA proposes new relevant expectations for senior managers and governance arrangements. The FCA also sets out new guidance on intervention points, actions it expects of firms in certain situations and what they can expect from the regulator. As part of this, the FCA intends to re-orientate its prudential supervisory approach for FCA investment firms towards being harm-led and supporting sector supervision. The FCA will introduce an ICARA questionnaire reporting template to assist this.

Remuneration – (Chapters 9 to 12)
In summary, the FCA proposes that all investment firms must have a documented remuneration policy and comply with at least a small number of basic remuneration rules of all their staff. Firms that are not small and non-interconnected (non-SNI firms) must comply with further requirements, which include identifying material risk takers and setting an appropriate ratio between variable and fixed remuneration. Under the FCA’s proposals, only the largest non-SNI firms would need to meet the full requirements by applying rules on deferral and pay-out of variable remuneration in instruments.

Regulatory reporting – (Chapter 13)
The FCA proposes that the amount of information that investment firms need to report to the FCA will significantly reduce and simplify. The FCA has amended the MIF002 form for reporting liquid assets that accompanied CP20/24 to account for its liquidity proposals in CP21/7 and is consulting on a new layout. In addition, the FCA proposes to introduce an ICARA reporting form for firms. This will replace the existing FSA019 (Pillar 2) return for these firms. Accompanying the CP21/7, the FCA has published further proposed templates for the new reporting to support the IFPR and the guidance for completing these templates. The FCA is also publishing proposed forms for applications and notifications.

Next steps
The deadline for comments on CP21/7 and the proposed templates and forms is 28 May 2021. A further CP will be published in Q3 2021, and two policy statements are expected, one in late spring and the second in the summer. The final rules on the IFPR will be published once the Financial Services Bill has passed through Parliament and all the consultations are complete.

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