IFR/IFD applies to MiFID investment firms other than those larger firms which deal on own account and/or carry out the activities of underwriting or placing on a firm commitment basis and which by virtue of their size and/or interconnectedness in the financial system are considered to be of systemic importance. Those large firms will be subject to CRD IV and CRR instead (and, in due course, CRD V and CRR II).
The majority of MiFID investment firms, including portfolio managers, brokers, corporate finance houses, trading venue operators and adviser/arrangers, will therefore be subject to IFR/IFD.
Where a MiFID investment firm meets the requirements to be a "small and non-interconnected investment firm" (SNIF), IFR/IFD applies, but on a limited basis. In particular, the remuneration requirements will not apply to such firms and they will not be required to make use of the K-factors metric when calculating own funds.
The criteria that a firm needs to meet to qualify as a SNIF mean that all but the smallest firms will be subject to the full scope of IFR/IFD (e.g. firms with an annual income in excess of EUR 30 million will not qualify as a SNIF).
For the most part, IFR/IFD does not affect collective investment fund managers directly. However:
- depending on future UK government policy, AIFMs with MiFID top-up permissions will - consistent with the approach the UK has previously adopted in respect of prudential matters - be caught;
- as summarised below, despite generally not applying to AIFMs directly, the new legislation will nonetheless make a specific amendment to AIFMD in terms of own funds; and
- IFR/IFD will clearly be relevant to fund management groups which have MiFID firms within their structures.
As with the EU cross-border distribution of funds package, the IFR/IFD regime will likely apply some time after the UK has left the EU. To a considerable extent, IFR/IFD reflects policy developed in the UK and, for the time being at least, the assumption is that the UK authorities will wish to impose similar domestic legislation. Whether there may be divergences in the detail (for instance, with regards to the imposition of remuneration requirements) depends on the UK's policy on the interrelationship between UK and EU regulation, such as the degree of 'equivalence' that will be sought. Firms should therefore look out for details of how H.M. Treasury and the Financial Conduct Authority (FCA) intend to 'onshore' the regime in the UK.
Prudential groups and consolidation
All investment firms subject to IFR/IFD must comply with the regime's requirements relating to own funds (regulatory capital) composition, the calculation of capital requirements, concentration risk, liquidity requirements, disclosure and reporting on a solo (individual firm) basis.
In general, a parent investment firm, parent investment holding company or parent mixed financial holding company in the EU (whether or not regulated) shall also be required to apply all of the above requirements on a consolidated (or group) basis. For most firms, this does not represent a change to existing group requirements, but it will be new for some, e.g. adviser/arrangers.
By way of derogation to the full prudential consolidation requirement described above, supervisors will have the discretion to apply a simpler and lighter-touch group capital test in the case of group structures which they deem to be "sufficiently simple" and in respect of which no significant risks to clients or to the market will arise from not applying consolidated supervision.
If full prudential consolidation under the IFR applies, then the IFD's requirements relating to internal governance, transparency, treatment of risks and remuneration will also be applied to firms which are subject to the full application of the regime on a solo and consolidated basis (except in relation to certain third-country subsidiaries where it would be unlawful to do this).
The remuneration requirements apply in respect of staff, such as senior management and employees with comparable remuneration, whose professional activities have a material impact on the risk profile of the firm or the assets that it manages.
The requirements relating to remuneration include:
- A requirement to have a remuneration policy that is proportionate to the size, internal organisation and nature of the firm and the scope and complexity of its activities and which complies with a number of principles.
- A requirement to set - and publish - appropriate ratios of variable remuneration to fixed remuneration that may be paid to relevant staff, ensuring that the fixed component represents a "sufficiently high proportion" of the total remuneration to enable the operation of a fully flexible policy on variable remuneration components, which are likely to require firms to implement new processes and data capture arrangements so as to be able to calculate them correctly on an ongoing basis.
- A requirement for any variable remuneration to comply with a number of requirements, including as to payment in shares in the firm or other qualifying instruments and deferral as well as malus (i.e. restrictions on vesting) and clawback.
- A requirement to establish an independent and gender balanced remuneration committee.
- A requirement to make certain disclosures regarding the remuneration policy and practices as well as providing remuneration information to supervisors.
As stated above, none of the remuneration requirements apply to SNIFs. In addition, other firms which are below certain size criteria will not have to comply with the requirements governing the constitution of variable pay and the deferral of payment or the need to have a remuneration committee.
Quantitative capital requirements
Subject to transitional phasing-in, a firm will generally be required to have own funds at all times at least equal to the highest of its:
- fixed overheads requirement – at least one quarter of its fixed overheads for the preceding year;
- permanent minimum requirement – e.g. for a portfolio manager, corporate finance firm or adviser/arranger (which does not hold client money) it is likely to be EUR 75,000 and, for a firm with a principal dealing permission, EUR 750,000; and
- "K-factor" requirement – a new, activities-based capital requirement based on an aggregation of three risk factors applicable to the firm (each of which has a number of highly detailed components).
In addition to the own funds requirements, firms will be required to hold an amount of liquid assets equal to at least one third of their fixed overheads requirement, which, in practice, will equate to one month's fixed overheads.
Supervisors can also require firms to hold additional capital in certain circumstances such as where they consider that the firm is exposed to risks which are not adequately covered by the standard capital requirements.
Disclosures and public reporting
Firms will also be subject to a wide range of disclosure and reporting requirements under IFR/IFD. These include (but are not limited to) the requirement to make public disclosures about their capital, capital requirements, risk management objectives and policies, internal governance arrangements and remuneration policies and practices.
Public country-by-country reporting rules will also apply as well as a requirement to report certain regulatory capital information to supervisors and for larger firms to disclose certain voting information.
IFD/IFR firms (other than SNIFs) will be subject to high earners reporting and will be required to provide supervisors with information on the number of natural persons per firm that are remunerated EUR 1 million or more per financial year.
Third country firms and equivalence assessments
IFR/IFD amends the rules on assessing third countries for equivalence in relation to the provision of cross-border services by third country firms under MiFIR to state that when carrying out any equivalence assessment in relation to a third country for those purposes, the Commission must take into account (amongst other factors):
- whether firms in that jurisdiction are subject to prudential, organisational and business conduct requirements which are equivalent to those which apply in MiFIR, CRD IV and IFR/IFD; and
- whether firms in that third country are subject to effective supervision and enforcement to ensure compliance with those requirements.
Application to AIFM and UCITS
The new regime does not directly impact upon collective investment fund managers acting as such. However, consistent with the current approach adopted here, it is likely that it will apply to AIFMs and UCITS management companies with "MiFID top-ups" in the UK. Elsewhere it will depend on national EU member state implementation. In addition, IFD makes specific amendments to both AIFMD and the UCITS Directive to provide that own funds of an alternative investment fund manager or UCITS management company can never be less than the fixed overheads requirement as specified in IFR – i.e. at least one quarter of the fixed overheads of the preceding year.
The FCA is expected to publish a high-level discussion paper in the first quarter of 2020. This is likely to give the first clear steer as to how the UK will approach the implementation of a regime that will not become effective until after the end of the EU withdrawal transitional period (assuming that period is not extended).