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The FCA's third consultation paper on the implementation of the Investment Firms Prudential Regime

The FCA's third consultation paper on the implementation of the Investment Firms Prudential Regime

Overview

On 6 August 2021 the Financial Conduct Authority (FCA) published CP21/26: A new UK prudential regime for MiFID investment firms.

This marks the FCA's third and final consultation on the new prudential regime which will come into force in the UK on 1 January 2022. You can read our briefings on the FCA's first and second policy statements here (June) and here (July). The consultation paper should be read in conjunction with those policy statements, with their "near-final" rules. Consultation closes on 17 September 2021.

We will be digesting the proposals over the coming days and weeks. In the meantime, the topics covered in CP21/26 (see here) are set out at a high level below.

Disclosure

Disclosure generally

All required disclosures (see below) will need to be:

  • easy to understand, using clear language (and, where appropriate, diagrams);

  • published at least annually, at the same time as the firm's annual financial statements (although intra-year material changes may necessitate more frequent disclosures); and

  • available and easy-to-find on the firm's website (or, if it does not have a website, otherwise freely available).

In summary, the FCA's proposals regarding disclosure are that:

  • All firms will be required to make some disclosure regarding their remuneration policies and practices – these will be proportionate to the size of the firm and will contain qualitative and quantitative information. Firms will not, as the FCA had previously suggested, be required to publish the ratio they have set between variable and fixed remuneration.

  • All non-SNIs will be required to disclose information about their:

    • Risk management and governance arrangements;
    • Own funds (i.e., regulatory capital);
    • Own funds requirements (i.e., regulatory capital requirements);
    • Investment policy (larger non-SNIs only).
  • Any SNIs which have issued additional Tier 1 (AT1) instruments must disclose information about their risk management arrangements.

The disclosure requirements applicable to non-SNIs as summarised above will also apply to the UK parent entity of an FCA investment firm group which is subject to prudential consolidation under MIFIDPRU and is treated as a non-SNI.

All firms subject to a disclosure requirement will be permitted to comply with the qualitative requirements in a manner appropriate to their size, internal organisation and the nature, scope and complexity of their activities. This element of proportionality should allow firms some degree of flexibility with regards to such disclosures.

Aside from the disclosures relating to the firm's governance arrangements, there are no proposals at this stage in relation to environmental, social and governance (ESG) matters: the FCA will be consulting on these separately.

More detail on the proposed disclosures is set out below.

Remuneration disclosures

All firms (SNIs and non-SNIs) will be required to disclose a summary of:

  • Their approach to remuneration for all staff;

  • The objectives of their financial incentives;

  • The decision-making procedures and governance around the development of their remuneration policies and procedures.

Firms will be also be required to disclose prescribed, key characteristics of their remuneration policies and practices. For SNIs this will be restricted to the components of their remuneration, and their categorisation as fixed or variable, together with a summary of financial and non-financial criteria used to assess performance. Non-SNIs will be required to disclose more, for instance, how malus and clawback are applied and the policies and criteria applied for awards of guaranteed variable remuneration and severance pay. In line with the principle of proportionality, the largest non-SNIs will be subject to additional disclosure obligations regarding its deferral and vesting policy.

All non-SNIs will have to publish the types of staff they have identified as material risk takers (MRTs). But in a welcome reversal of the position that the FCA had previously adopted in PS21/9, they will not be required to disclose publicly the ratio they are required by the rules to set between the variable and fixed components of total remuneration.

Firms must publish quantitative remuneration disclosures. All firms will be required to reveal the total amount of remuneration they have awarded to all staff, split into fixed and variable remuneration. Non-SNIs will additionally have to show those amounts further broken down between senior management, other MRTs and other staff, together with information on awards made to MRTs. Again, the largest non-SNIs will be required to make to further, granular, quantitative disclosures.

Risk management disclosures

All non-SNIs (and those SNI firms that issue AT1 instruments) will be required to disclose their risk management objectives and policies for the categories of risk addressed by the rules governing own funds requirements, concentration risk and liquidity in MIFIDPRU. No template is provided, but the FCA proposes that disclosures should include a summary of the relevant potential for harm posed by the firm's business strategy (in respect of which the ICARA process may help) and how the firm intends to address the risks.

Disclosures relating to own funds

The FCA will be introducing a template which includes:

  • a table for the composition of own funds;

  • a table for reconciliation with capital in the balance sheet; and

  • a free text field in which, if relevant, the firm can describe the main features of the own funds instruments issued by the firm.

Disclosures relating to own funds requirements

No template is prescribed. Firms will be required to disclose:

  • the amount of their fixed overheads requirement (FOR);

  • their K-factor requirement (for non-SNIs), broken down into three groupings:
    • the sum of K-AUM, K-CMH and K-ASA – i.e., assets for which the firm is responsible;
    • the sum K-DTF and K-COH – i.e. execution activity undertaken by the firm (our July briefing on the FCA's second policy statement, PS21/9, referred to the fact firms that execute orders on behalf of clients in their own name, but without dealing on own account, will now be caught by K-DTF as regards that activity); and
    • the sum K-NPR, K-CMG, K-TCD and K-CON – i.e., exposure-based risks.

  • Summary of their approach to assessing the adequacy of their own funds required for their ongoing operations and during wind-down, as required by the ICARA process (no quantum is required).

Disclosures of the firm's governance arrangements

All non-SNI firms will be required to publish a summary of how they comply with the requirement in SYSC to ensure that their management body defines, oversees and is accountable for the implementation of governance arrangements that ensure effective and prudent management of the firm.

Disclosure as to whether the firm has a risk committee

All non-SNIs will be required to disclose:

  • Whether they have a risk committee (even if they are not required to have one);

  • Whether they are required to establish a risk committee (only the largest non-SNIs are required to do so); and

  • If they are so required, whether they have a waiver or modification from the FCA releasing them from that obligation.

Disclosure of other directorships

All non-SNIs will be required to disclose, in respect of each member of the management body, the number of separate directorships held by that person. This should be broken down into executive and non-executive directorships. The concept of "significant IFPRU firms" will be preserved in the rules, but under a new name of "significant SYSC firms". The firms will be subject to additional disclosures.

Disclosure of diversity policy

All non-SNI firms will be required to publish a summary of their approach to diversity on their management body, setting out the objectives of that policy and any targets set and the extent to which those objectives and targets have been met. Where they have not been met, this must be explained together with the firm's suggested remediation.

This disclosure reflects the importance that FCA clearly attaches to diversity within financial services firms - see our briefing on the discussion paper that the regulator recently co-authored with the PRA and the Bank of England on diversity and inclusion, and to which it refers in its consultation paper.

Larger non-SNIs only: disclosures relating to the firm's investment policy in relation to listed instruments

Where the firm is a larger non-SNI and holds more than 5% of the voting rights in a company whose shares are traded on a regulated market, it will be required to make certain disclosures as specified by a template. A firm will be a larger non-SNI if it exceeds the relevant thresholds for risk, remuneration and nomination committees set out in MIFIDPRU 7 (i.e., broadly, where the firm's on-balance sheet assets and off-balance sheet items, on a rolling average basis over the previous 4 years, is £100 million or less or £300 million or less, subject to conditions).

Own funds – excess drawings by members of LLPs and partners

The FCA proposes to introduce a rule which will, in certain circumstances, allow partners in a partnership and members in LLPs to make drawings in excess of profits without them being recorded as a loss. Instead, such drawings would be treated as a loan to the relevant partners or members.

A new element to the rule governing deductions from common equity tier 1 (CET 1) items will provide that the default position for a partnership or limited liability partnership is that it must deduct the amount by which the partners' or members' drawings exceed the profits, but that this will not apply to the extent that the amount has already been deducted from the firm's own funds as a loss or is offset by new capital contributions from other partners where permitted by the rules in MIFIDPRU 3.3 or is already reflected in a reduction of the firm's own funds as permitted by the rules.

Application of onshored technical standards

The consultation sets out the FCA's detailed proposals as to how it proposes to apply certain onshored binding technical standards for which it is a responsible regulator and which it regards as relevant for the IFPR regime. These are relevant technical standards under the UK CRR (to which certain MIFIDPRU rules cross-refer) and UK legislation representing the onshored version of the Financial Conglomerates Directive regime. In most cases, firms will be required to apply the onshored BTS, where relevant, with modifications.

Depositaries

The FCA is amending the capital rules that apply to depositaries that are investment firms, to make them subject to MIFIDPRU and not UK CRR. The proposed changes to the rules governing depositaries therefore include changes to the requirements so that:

  • permission to deal on own account will no longer be required (the current requirement which essentially means that an investment firm must be a full-scope IFPRU investment firm to be eligible to act as a depositary for certain types of AIF); and

  • firms that provide the MiFID ancillary service of safe-keeping and administration of assets will also be able to act as depositary.

There will also be changes to the minimum own funds requirements, depending on the type of fund.

Depositaries that are MIFIDPRU investment firms will not be required to comply with the operational risk requirement prescribed by UK CRR. However, they will be expected to consider the potential for harm arising from their activities as part of the ICARA process.

While depositaries will not be subject to K-CMH or K-ASA (since their depositary activities are not MiFID business) they may nevertheless have regard to the methodology set out in those K-factors when carrying out their ICARA assessment of whether they should hold additional own funds.

An amendment to the rules will make it clear that an investment firm acting as a depositary cannot be an SNI firm, except where it is a private equity-style depositary (subject to the other SNI conditions).

UK resolution regime

The FCA is proposing some consequential amendments to the Handbook to take account of the government's recent decision to remove FCA investment firms from the scope of the UK resolution regime. This is the regime which onshored the EU Bank Resolution and Recovery Directive in the UK. As a result, the FCA will delete IFPRU 11.

Consequential changes

There are numerous consequential changes designed to ensure that provisions in MIFIDPRU interact with relevant provisions in other prudential sourcebooks. These include amendments to:

  • remove references to the different categories of investment firm that are currently used for prudential purposes (e.g., "BIPRU firm", "IFPRU firm");

  • (as referred to above) replacing the term "significant IFPRU firm" with "significant SYSC firm";

  • delete the exemption that is currently in SYSC 4.3A (management body and nomination committee) for firms currently categorised as BIPRU CPMI firms which will mean that such firms will become subject to certain high-level requirements regarding the management body in accordance with those rules; and

  • GENPRU 3 (and associated definitions) in relation to cross-sector groups or financial conglomerates.

Enforcement against non-authorised parent undertakings

Under Part 9C Financial Services and Markets Act 2000 (FSMA) the FCA now has the power to impose obligations on unregulated parent undertakings of FCA investment firms. New rules set out how the FCA proposes to use these powers.

Forms: applications and notifications

In addition to the forms which the FCA has already consulted on, it proposes the following:

  • a form for firms (and UK parent entities) to make a notification that the firm has become, or ceased to be, part of an investment firm group or financial conglomerate (in the latter case, the FCA says that the Classification of groups form should be submitted at the same time); and

  • a generic MIFIPRU application and notification form to enable firms to apply for permission under MIFIDPRU but only where there is no dedicated application form – this is designed as a temporary measure to address the additional application and notification requirements that will arise from the incorporation of binding technical standards into MIFIDPRU (see "Application of onshored technical standards" above).

In advance of the new regime: MIFIDPRU applications and notifications – IFPR set-up questionnaires

The FCA's gateway for MIFIDPRU applications is now open and application forms for certain MIFIDPRU permissions have been made available on the FCA's dedicated IFPR webpage. These relate to the types of MIFIDPRU permissions that firms will have to apply for in advance of MIFIDPRU coming into force and will have to be submitted via Connect. Other application and notification forms will be made available in the autumn.

Note that the FCA will also be sending out IFPR set-up questionnaires to firms in the autumn which will solicit certain information such as whether the firm will be an SNI or non-SNI, the membership and composition of the investment firm group (if relevant) and the firm's expected ICARA reporting date.

Next steps

Consultation closes on 17 September 2021. The policy statement, together with the final rules for the entire regime, will be published in the autumn. Shortly after the final rules have been made by the FCA Board it should be possible to "time travel" on the FCA's online handbook to view them. The new regime will come into force on 1 January 2022.

 

 

If you would like further information or assistance in understanding the potential impact of the issues discussed in the consultation paper and how they relate to the now-settled policy issues addressed in near-final rules attached to the FCA's first and second policy statements, please speak to your usual Travers Smith contact or any of the individuals below.

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