The FCA's first policy statement on the implementation of the Investment Firms Prudential Regime

This addresses in particular the FCA's proposed categorisation of "small and non-interconnected investment firms" (SNIs). The near-final rules contain the quantitative SNI thresholds originally proposed by the FCA (which are consistent with the EU IFR/IFD regime). It still expects that approximately 70% of firms to whom IFPR will apply will be SNIs and points to its draft transitional rules as to how firms should be determining their SNI status at the outset of the new regime. There is confirmation that, for the purposes of determining whether or not a firm is an SNI, some of the thresholds must be calculated on a combined, group basis – i.e.  AUM, COH, on- and off-balance sheet total and the total annual gross revenue.

This addresses the circumstances in which prudential consolidation will be triggered. There is some additional guidance on the members of the relevant group which must be included in the prudential consolidation, so, for instance, the near-final rules include amendments to the definitions of "investment firm group" and "consolidated basis" to clarify that an FCA investment firm group consists of a UK parent and its subsidiaries (and, if applicable, connected undertakings) – i.e. that it is a downstream consolidation. There is also further guidance on the "soft" consolidation tests for connected undertakings. There are detailed rules and guidance on how to perform consolidated capital and liquidity calculations (including consolidated FOR, consolidated PMR and consolidated K-factor requirements).  The policy statement also confirms the further practical guidance in relation to the eligibility for, and application of, the Group Capital Test or "GCT" which "sufficiently simple" groups which do not pose significant risks are able to apply instead of full prudential consolidation, subject to being able to provide a full explanation to the FCA in their applications. The concept of "sufficiently simple" remains undefined. The near-final GCT rules have been modified in the light of the FCA's new powers in relation to entities that are intermediate unregulated parent undertakings of financial undertakings, but are not parent undertakings of FCA investment firms: they will also be subject to GCT.

The near-final rules (in MIFIDPRU 3) address the definition and composition of own funds (i.e. regulatory capital) and contain some additional detail about the way in which firms must calculate the amount of capital they must hold.  The feedback in the policy statement and the near-final rules contain, amongst other things, detail on deductions from own funds. In terms of the own fund requirements, in addition to provisions on the ongoing permanent minimum capital requirement and initial capital requirement, there is a considerable amount of detail on the K-factors which the FCA determines to be applicable only to firms with permission to deal on own account – i.e. K-NPR (net position risk), K-CMG (clearing margin given), K-TCD (trading counterparty default) and K-DTF (daily trading flow). The other K-factors were consulted on in CP21/7.

The FCA continues to place significant emphasis on the ICARA process to address risks and harms not covered by the specific calculations.

These transitional provisions, relating to the calculation of the permanent minimum requirement (PMR), fixed overheads requirement (FOR) or K-factor requirement (KFR), will enable firms to increase their capital to the new levels gradually, over a period of five years.  In particular, the FCA has maintained the welcome new transitional regime for firms which are currently exempt CAD firms (also known as adviser-arrangers). Two respondents asked for this transitional to be extended to provide relief from having to provide additional own funds requirements resulting from the ICARA process (either by extending the transitional provision or by delaying implementation of the ICARA for exempt CAD firms). The FCA will respond on the ICARA process in its policy statement on CP21/7.  The transitional provisions will also apply to the calculation of capital on a consolidated basis, provided that the relevant transitional is available to the firm on an individual, solo basis.

Concentration risk monitoring will apply to all firms in relation to all of their activities: the concentration risk limits and the related K-factor (K-CON) are applicable only to firms with permission to deal on own account.

As consulted on, the FCA will be simplifying the process of prudential reporting so that there will be a single suite of forms for all firms which will need to be submitted on a quarterly basis. Groups may nominate a single firm to submit reports (although individual group members will remain responsible). This means that the FCA will stop collecting COREP forms and the numerous FSA0xx forms that are currently required.

The policy statement includes a significant amount of detail in near-final rules, which we will review as against the consultation versions and update clients as appropriate. Since it only addresses issues consulted on in CP20/24 (the "first" consultation paper), important issues addressed in the second consultation paper, such as those which relate to the K-factors for firms which do not deal on their own account, remuneration and the ICARA process are not covered.

If you would like further information or assistance in understanding the potential impact of the policy statement and the near-final rules, please speak to your usual Travers Smith contact or any of the individuals below.