Shadow Banking

The Financial Conduct Authority’s (FCA) first consultation papers on the Investment Firms Prudential Regime (IFPR) was published on December 2020, focusing on the areas the regulator feels will need the most preparation. Given the quantity and complexity of the new requirements, firms are recommended to plan for the regime as soon as possible. By Rick Seehra and Jackie Domanska at Bovill

If you thought one of the benefits of leaving the EU would be that the FCA’s publications would be shorter than the European Banking Authority’s (EBA) tomes, you are going to be disappointed. The paper is more than 300 pages long and two further papers are planned in the coming months. The deadline for responses to this first consultation is February 5. 

SNI firms & thresholds 

The FCA expects IFPR to apply to some 3200 firms. Of the firms affected, it anticipates that circa 3000 will be either small interconnected firms (SNI) or small non-SNI firms. For these firms the fixed overhead requirement will be the firm’s capital driver, rather than K-factor capital. Only the remaining 200 or so firms are expected to use the new K-factors to calculate their capital. 

From our perspective, this estimate is very low. The FCA will have based the estimate on firms’ responses to its recent questionnaire but will have assumed that all respondents completed the questionnaire accurately.

In addition, the thresholds of what makes a firm SNI have all been moved to GBP Sterling from Euro. 

Consolidation & GCT

Consolidation – whereby the UK parent, along with all relevant entities within the group, are treated as if they were a single firm – is likely to apply to more firms under IFPR. Under the new regime, a consolidation group will include: 

  • an investment firm
  • a financial institution
  • an ancillary service undertaking (including service companies)
  • a tied agent

The FCA has confirmed that it is possible for a consolidation group to be an SNI group if the group remains under the thresholds for assets under management (AUM), balance sheet or revenue. 

Group capital test 

The FCA expects the majority of groups to be simple and therefore eligible for the group capital test (GCT). This is a more straightforward capital treatment where the parent simply needs to hold enough regulatory capital to support its capital investment in its subsidiaries. However, groups must obtain permission from the FCA for this treatment and the application process requires firms to submit a lot of detailed information in the application. 

The FCA says it expects a high volume of applications and therefore propose a transition period where firms can use GCT for up to two years. Firms who think they will have a consolidation group and want to apply for the GCT should start working on their application as soon as possible. 

Definition & capital composition 

For firms already subject to the capital requirements regulation (CRR), the own funds rules will look very familiar, although the FCA has converted risk weighted asset ratios to own funds ratios. For other firms, Tier 3 capital will no longer count as regulatory capital. 

Limited liability partnerships

The consultation includes specific conditions that limited liability partnerships (LLPs) must meet so that their capital can be treated as Tier 1 capital under IFPR. It needs to take the same form as share capital, and therefore: 

  • must be perpetual 
  • cannot be repaid/withdrawn by a partner unless an equal amount is replaced by a new or existing partner or the LLP is wound down or dissolved. 

Permanent minimum capital (PMC)

The key changes to permanent minimum capital (PMC) are: 

  • Under IFPR, matched principal firms will be treated the same as principal trading firms so need capital of £750,000 ($1.02m)
  • Firms which only operate an organised trading facility (OTF) or multilateral trading facility (MTF) see capital reduced to £150,000 
  • Firms holding client money or safeguarding client assets will need PMC of £150,000 
  • All other firms will need PMC of £75,000.  

Transitional provisions 

Under the proposed transitional period rules, the capital requirement for the current prudential sourcebook for investment firms (IFPRU) or banks, building societies and investment firms prudential sourcebook (BIPRU) firms will be capped at twice the current own funds requirement. 

Some exempt capital adequacy directive (CAD) firms could see a significant increase in their capital requirement if they have a large cost base and move to FOR. For such firms, the transitional provisions will be subject to the transitional PMC as a minimum starting point, increasing up to 100% for the sixth year.

Transitional relief 

For firms that deal on a matched principal basis PMC will be £750,000. Some currently operate as BIPRU €50,000 firms so could see a large increase in their capital requirement. For these firms, the FCA has set out specific transitional provisions. 

Concentration risk monitoring 

Under IFPR, all firms will need to monitor their concentration risk (K-CON), which can occur in various ways, including where firms hold bank accounts, client money or assets. Non-SNI firms will also be required to report on concentration risk, providing information on their exposures or positions with their five largest counterparties. 

Reporting requirements

The amount of information needed to complete the FCA’s reporting forms is limited but firms will need to calculate the detail behind the summarised numbers. Returns will need to be submitted quarterly on a calendar basis. 

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