Final rules on Investment Firms Prudential Regime

With the publication of the FCA’s final policy statement (PS21/17) on the new Investment Firms Prudential Regime (IFPR), we now have the final handbook text for the new regulations due to come into force on 1 January 2022.

Of course, we thought we had the final handbook text after the publication of instruments FCA 2021/38 and FCA 2021/39 in October, but PS21/17 came with three more in the form of FCA 2021/49, 50 and 51 – amending the ‘final’ handbook.

While PS21/17 addresses some of the less critical issues left over from the two major policy statements published earlier this year (PS21/6 and PS21/9), nevertheless the new handbook insertions and deletions are unwelcome at such a late stage – particularly where firms need to ensure that they are referencing the correct handbook sections to ensure that they are complying with the rules. Currently, it seems the only way to access a complete set of up-to-date rules is to use the ‘time-travel’ function of the online handbook, by setting the date to 1 January 2022. For those of you who have been following the FCA’s IFPR publications, this runs to a total of nearly 4,000 pages—well done to anyone has read every word!

Fortunately, the main focus of PS21/17 is on disclosure – what we would refer to as Pillar 3 in the old regime – so most sections will remain unchanged. However, it’s important that firms always use the most up-to-date version of the handbook. A summary of the key points from PS21/17 can be found below.

The FCA ran two webinars on the IFPR on 30 November to address questions raised by firms (recordings of these can be found on the FCA’s website). There was an emphasis on the change from viewing risk as the financial impact of events on a firm, to viewing risk as the harm that firms can cause to customers and markets. The old ICAAP (Internal Capital Adequacy Assessment Process) will be replaced by the new ICARA (Internal Capital and Risk Assessment), which is intended to assess whether firms have sufficient own funds/liquidity to either continue operating on an ongoing basis or to wind-down in an orderly fashion. The degree to which firms run unmitigated residual risk of causing harm to clients will dictate the level of additional funds and/or liquid assets they require to meet the OFAR (Overall Financial Adequacy Rule) that was introduced in FG20/1.

The FCA emphasised that firms must meet the OFAR from day 1 of the new regime—there is no transition provision for this requirement. This means that all firms must at least estimate the amounts required before the end of the year and ensure that they have sufficient additional own funds and liquid assets. Most firms should be able to recycle their ICAAP to estimate own funds, but liquid assets may prove more challenging. The FCA made it clear that it doesn’t expect firms to have undertaken a full ICARA review as at 1 January 2022, but nevertheless the requirement still stands, so firms must do something to estimate these amounts and to ensure ongoing compliance.

The webinars spent a lot of time addressing the question of how to identify which legal entities form an investment firm group, so this is clearly an area that firms are finding difficult. In this context, it is important for firms to distinguish between the formation of an investment firm group for prudential consolidation purposes, and the decision regarding whether to have separate or consolidated ICARA reviews. The rules for these are different and this can lead to some confusion. Regardless of which route firms choose for the scope of their ICARA, it is important to bear in mind the FCA’s emphasis on ensuring that each individual regulated entity complies with the OFAR and has its own wind-down triggers and wind-down plan.

The webinars also addressed some technical aspects of K-factor data, disclosure requirements, reporting and notification arrangements, plus the need to set dates for completing and submitting the first ICARA review.

There is clearly a lot of work to do in moving to the new regime, not least in terms of ensuring that the whole process of setting the business model and strategy, and managing risk, is undertaken in full recognition of the potential for harm to customers and markets. This means that everyone, from the Board down, must be fully aware of the new regime and work towards ensuring that such harms are both identified and mitigated.

Summary of key PS21/17 changes

Disclosure

The FCA requires firms to disclose certain information that is intended to give ‘stakeholders and market participants an insight into how the firm is run’. This includes the following:

• risk management
• own funds
• own funds requirements
• investment policy
• governance arrangements
• remuneration.

The FCA has clarified that disclosures are required to be made on an individual entity basis, although firms may voluntarily disclose this information on a consolidated basis as well if they so choose. This will disappoint a number of larger firms that will have been hoping to make disclosures for just the major operating unit, but it reflects the FCA’s desire to ensure that all individual, regulated entities comply with the regime.

The TP12 transition provision has been updated to allow disclosure of only own funds, own funds requirements and governance for firms with a financial year end in 2022 that falls on or before 30 December 2022. Details of risk management and investment policy will then be required starting from the year-end falling in 2023. There are also updates to TP12 in relation to remuneration disclosures.

The FCA has provided guidance on use of a firm’s website for disclosures – basically, if a firm has a website then it should use it! There is, however, provision for firms that don’t have a website or who are concerned about conflicts with laws in other jurisdictions to use other media.

Additional guidance has been provided on disclosure of investment policy and a new exemption has been introduced to allow firms to withhold information that they consider to be proprietary (a similar exemption existed under BIPRU 11). Updates have been made to the investment policy templates IP1 and IP2, so firms need to check that they are using the latest versions.

Changes have been made to the disclosure of the number and nature of directorships held by each member of the management body of a non-SNI firm to make these less onerous. The new requirements are set out in MIFIDPRU 8.3.2R.

The FCA added a guidance provision to clarify the treatment of categorising fixed and variable remuneration as MIFIDPRU 8.6.7G. In addition, MIFIDPRU 8.6.6R(2) has been changed to clarify the financial and non-financial criteria to be used to assess performance. Remuneration disclosure requirements have been amended so that firms are not required to show information that could identify individuals (examples are provided in MIFIDPRU 8.6.11G).

Own funds – excess drawings by partners and members

The FCA confirmed that it intended to replicate the existing provision for BIPRU firms in GENPRU 2.2.100R for all investment firms and that it would implement its proposed treatment of excess drawings by partners or members (of partnerships and LLPs) whereby these are to be deducted from CET1 capital, except where the amount is already required to be deducted or deemed repaid under other MIFIDPRU rules.

Technical Standards

There are a number of Binding Technical Standards (BTS) under the IFPR that are the onshored UK equivalents of EU-derived regulations. The FCA’s general approach is to keep the EU BTS intact, but to make amendments as necessary (e.g. to disapply provisions that are not relevant to IFPR). However, in the case of own funds requirements and prudent valuation, more extensive changes have been made.

Depositaries

The FCA confirmed that a MIFID investment firm that has been appointed to act as a depositary cannot be an SNI firm. The FCA has provided guidance for how depositaries should calculate their K-factor exposures and how these should be treated in the ICARA.

Our approach to the UK resolution regime

The FCA confirmed that FCA 730k investment firms will no longer be subject to the UK resolution regime (which implemented the Banking Act). However, it drew attention to the requirements under IFPR for recovery planning and for wind-down planning at an individual entity level.

Consequential changes to the Handbook

The FCA intends to make changes to other parts of its overall Handbook to reflect the IFPR, in line with its previous proposals. Firms should ensure that they meet any revised requirements in other Handbook modules, in particular SYSC, COCON, SUP and the WDPG.

FCA approach to enforcement

The FCA will apply its existing approach to investigations and imposition of sanctions to any breaches of the IFPR. Firms should note that the 2021 FS Act enables the FCA to investigate and impose disciplinary sanctions on non-authorised parent undertakings and persons knowingly concerned in a breach by the parent undertaking. Sanctions include requirements, prohibitions and financial penalties.

Applications and notifications

FCA investment firms and UK parent entities will be required to submit a formal investment firm group notification to the FCA when forming or changing an investment firm group. There will also be a ‘generic’ form for notification of matters that do not have a bespoke form. Investment firm group notification forms will be required after 1 January 2022, but firms that have responded to the FCA’s set-up questionnaire will not need to supply this information again unless changes have occurred.