UK investment firms facing wide-ranging changes in new prudential regime

In the consultation the FCA said its aim was to develop a single prudential regime for all FCA-regulated investment firms, reducing barriers to entry and allowing for better competition. The proposals will mean some firms will have meaningful capital and liquidity requirements for the first time, aligned with their potential harm.

The UK's proposals are similar to those introduced by the EU under the Investment Firms Directive (IFD) which must be implemented by June this year. Although the UK was instrumental in the introduction of the IFD, the timing of the UK's withdrawal from the EU meant that the UK is introducing its own version.

The consultation document (458 page / 4.71MB) published in April 2021 follows an earlier consultation in December 2020, but includes additional proposals not previously raised.

Financial services regulation expert Elizabeth Budd of Pinsent Masons, the law firm behind Out-Law, said: “Although the new prudential regime is intended to simplify matters, it is significantly different in its approach that firms should focus now on how it will apply to them.

“Implementation is expected to be from the beginning of January which does not leave much time to introduce new processes. Many firms will find that they need to hold more capital and this may result in the need to increase share capital either from existing shareholders or by seeking new investment,” Budd said.

Under the new regime there will be changes to the level of minimum capital that has to be held. For firms dealing on own account or underwriting or placing on a firm commitment basis the minimum will be €750,000; for firms with permission to hold client assets or money, receive and transmit orders, execute orders on behalf of clients, portfolio management, investment advice, and place financial instruments without a firm commitment basis, the minimum will be €150,000; and for firms not permitted to hold money or securities belonging to their clients the minimum will be €75,000.

There will also be additional capital to be held according to a “K factors” approach. K factors are divided into three categories: risks to client (RtC); risks to market (RtM); and risks to firm (RtF). The FCA is also introducing new rules on remuneration and disclosure which allow less scope for firms to determine their approach based upon proportionality principles.

The FCA said it was proposing to include a fixed overheads requirement (FOR) applying to all FCA-regulated investment firms, and the firm’s ‘own funds’ will not be allowed to fall below this requirement. All investment firms will be required to hold core liquid assets equivalent to at least one-third of their FOR. The purpose of requiring all firms to comply with liquidity rules is to ensure that all firms are able to withstand a sudden liquidity shock.

The prudential supervisory approach from the FCA for investment firms will be harm-led and in support of sector supervision and there will be revised expectations for senior managers and governance arrangements.

Firms will also be expected to put in place a clearly documented remuneration policy, and comply with basic remuneration rules for staff. However, the FCA said it would significantly reduce the amount of information investment firms would need to report about remuneration arrangements.

The regulator also intends to simplify the additional reporting form for collective portfolio management firms.

The ultimate aim is to align the IFPR better with the way that investment firms run their businesses, and ensure all FCA-regulated investment firms are subject to consistent prudential standards. The FCA said the regime should reduce the amount of time spent on complex capital requirement calculations and free up management to run their businesses and manage risk.

The consultation is open until 28 May 2021.