The New Prudential Investment Firm Regime – What it Means for Investment Firms

The Investment Firm Regulation, (IFR), is directly applicable in Ireland from 26 June 2021. The Investment Firms Directive, (IFD), must be implemented by Ireland by the same date.

The IFR and IFD will apply a new prudential regime for MIFID investment firms across the EU. They will also amend MiFID II and MiFIR.

The new framework will allow for differentiated regulation of investment firms depending on their classification. Higher impact investment firms will be held to more intensive regulation standards. The degree of regulation will depend on the firm’s particular business activity, risk profile, and structure. This will shape their new prudential class.

The IFR divides investment firms into three primary classes:

Class 1

Class 1 investment firms are divided into sub-categories. The first being systemically important large investment firms (SILIFs). These are often just referred to as Class 1 investment firms. The second being large investment firms not of systemic importance (non-SILIFs). These are often referred to as Class 1a or Class 1b investment firms.

SILIFs

In summary, SILIFs are investment firms:

• With total assets exceeding €30 billion in value

• That carry out the MiFID activities of dealing on its own account or underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis, or both

• That are not a commodity or emission allowance dealer, a collective investment undertaking, or an insurance undertaking

An undertaking with total assets below €30 billion that meets the two latter points above may also be deemed to be a SILIF. This depends on whether it is part of a group where the combined total value of the assets of all undertakings in the group exceeds €30 billion. Again, this depends on certain conditions.

Non-SILIFs

Non-SILIFs can themselves be broken into two sub-categories, being considered Class 1a investment firms and Class 1b investment firms.

An investment firm is a Class 1a investment firm if:

• Its business consists of carrying out the activities of dealing on own account or underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis, or both, and

• It is not a commodity and emission allowance dealer, a collective investment undertaking, or an insurance undertaking, and

where the following has been satisfied:

• The total value of its assets exceeds €15 billion

• It is part of a group where the combined total value of the assets of all undertakings in the group that carry out:

  • dealing on its own account, or

  • underwriting of financial instruments, and/or

  • placing of financial instruments on a firm commitment basis, or both,

  • exceeds €15 billion, or

• It is dependent on a decision taken by a competent authority under Article 5 of the IFD

An investment firm is a Class 1b investment firm if:

• Its business involves carrying out the activities of dealing on its own account. As well as the underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis, or both

• It is a subsidiary and is included in the supervision on a consolidated basis of a credit institution, a financial holding company or a mixed financial holding company, and

• Central Bank approval has been received

SILIFs will be reclassified as a credit institution under the CRD IV and the CRR. This is on the basis that these investment firms have business models and risk profiles like those of significant credit institutions. SILIFs will need to be re-authorised as a credit institution. Non-SILIFs will still have to answer to the CRD IV and the CRR but will not need to be re-authorised as a credit institution.

Class 2

Class 2 investment firms are investment firms that are neither considered SILIFS nor non-SILIFs but exceed the thresholds for ‘small and non-interconnected investment firms’. These will be discussed below. Class 2 investment firms will be subject to the IFR and IFD regime. This is the default categorisation for investment firms.

Class 3

Class 3 investment firms or ‘Small and Non-interconnected investment firms’ will also be subject to the IFR and IFD regime. However, they can benefit from various exemptions and modifications.

An investment firm is deemed to be a small and non-interconnected investment firm if it meets certain requirements, for example:

• AUM is less than €1.2 billion

• On and off-balance sheet total of the investment firm is less than €100 million, and

• The total annual gross revenue from investment services and activities of the investment firm is less than €30 million. Calculated as an average based on the annual figures from the two‐year period immediately preceding the given financial year

K-Factors

Investment firms will be required to use quantitative indicators, known as K-factors. These reflect the risk that the new regime intends to address. K-factors are divided in the IFR into three groups, and they aim to capture the:

• Risk to clients

• Risk to markets, and

• Risk to the investment firm

Class 2 firms will be required to calculate their capital requirement based on the K-factor formula. Class 3 firms are not required to calculate their capital based on the K-factor formula. However, Class 3 firms still need to calculate the K-factors for categorisation purposes.

Disclosures and reporting requirements

Investment firms will be required to disclose detailed information depending on their classification. This will include:

• ESG risks

• Information on internal governance arrangements, for example, details of the diversity policy relevant to selection for membership of the firm’s management body

• Details on the firm’s own funds and compliance with its own fund requirements

• Remuneration policies and practices, including aspects related to gender neutrality and the gender pay gap. As well as the level of variable remuneration and the ratios between fixed and variable remuneration, and

• Report to the Central Bank on the number of staff that receive remuneration of €1 million or more in any given financial year. This includes information on their job responsibilities, business area and details relating to salary, bonus, long-term award

Conclusion

Investment firms should take steps to consider the impact of the IFD and the IFR on their business models. The IFD and the IFR introduce significant changes for investment firms in terms of disclosure and reporting requirements, capital requirements, and rules around remuneration.

We assist investment firms by ensuring continued regulatory compliance. This can be done by clearly identifying the relevant classification that applies to a firm’s activities and by preparing a plan to address the impact this categorisation has on the investment firm’s activities going forward.

For more information, please contact a member of our Investment Funds team.

The content of this article is provided for information purposes only and does not constitute legal or other advice.