EU Prudential Supervision of Investment Firms

The European Parliament has approved legislation which will see new rules in relation to the prudential regulation of the majority of EU investment firms, namely the Investment Firms Directive (IFD) 2019/2034 and Investment Firms Regulation (IFR) 2019/2033.

The aim of the rules, which will come into force at the end of December, is to facilitate the regulatory process whilst levelling the playing field between small and larger firms by adapting the old rules i.e. Directive 2013/36/EU, Regulation (EU) No 575/2013 and Directive 2014/65/EU.

Some entities will be governed by the old rules and others will come under the new rules. For example, credit institutions and certain large investment firms may represent a threat to the stability of the financial markets, therefore they will still be regulated under the old rules[1]. To determine which rules apply, the Regulation will use a system to measure the risk to firm and risk to market factors of each firm. These will be referred to as “K-factors” and are set out in Articles 15 to 32 of the Regulation.

Business for small and non-interconnected firms will be made much simpler. They will be subject to limited prudential requirements and when it comes to initial capital requirements, the Directive will provide a one stop shop for all investment firms which come under it. It aims to remove the differences in initial capital requirements across the market which were allowed by the old rules.

The initial capital requirements are set out by Article 9 of the Directive and is broken down into groups of EUR 750,000, EUR 75,000, and EUR 150,000 depending on the activities carried out by the investment firm. The capital requirement will be the same for each firm which falls into one of those categories. It will also no longer be possible to replace the initial capital requirement with a given amount of professional indemnity insurance[2]

The Regulation includes various protective measures. Firstly, it requires investment firms to have procedures in place to monitor concentration risk and ensure that they meet minimum liquidity requirements. It includes provisions which require larger firms to disclose their levels of capital, risk management objectives and policies, governance arrangements, capital requirements, and their remuneration policies and practices[3]. These firms will also be required to give quarterly reports to the competent authority[4], small and non-interconnected firms will need to submit these reports annually.

The Directive will meet the demand for tax transparency by requiring investment firms to disclose certain information such as profits made. This will not apply to firms which are deemed to be small and non-interconnected.

Article 51 of the Directive ensures that there is effective supervision where the parent undertaking of an investment firm has its head office in a third country. It does so by requiring the competent authorities to assess whether the investment firm is subject to supervision by the third country supervisory equivalent to that set out in the Directive.

Although some changes may inadvertently place new burdens on some investment firms, Article 57 of the Regulation sets out transitional arrangements for the application of the new rules over a period of five years. This period is intended to allow firms to adapt to the new regime and comply with the monetary and other regulatory provisions in due course without stifling their business.

For guidance in relation to the new rules, please contact Jeremy Requena or Aaron Payas from the Hassans’ Funds Team.

[1] Article 60 of the Regulation.

[2] Art 31 of CRD IV Directive.

[3] As set out in Articles 45 to 51b

[4] Articles 54 and 55 of the Regulation.