Written by Régis Deymié, Principal Consultant
CRR / CRD driven by the Basel committee recommendations mainly concern large credit institutions and Banks but do not impact all investment firms with the same magnitude, some are even exempted.
With IFR / IFD (Investment Firms Regulation EU 2019/2033 and Investment Firms Directive EU 2019/2034) the EU and the Council wishes to widen the scope of institutions impacted by European prudential rules, by including all MIFID investment firms. This means that, while Banks and Insurers will mainly remain under CCR / CRD framework, other investment firms like asset managers or advisors will fall under the newly adopted IFR / IFD framework. Some exemptions are of course provided by the regulator depending mainly on the size and on whether or not the firm is “interconnected”.
Investment Funds Managers regulated under AIFMD and UCITS are only marginally impacted by IFR / IFD. According to article 60 and 61 of the IFD, the own funds of a management company (regulated under AIFMD or UCITS) must at no time be less than one quarter of the fixed overheads of the preceding year. But AIFMD and UCITS remain the reference in all common topics like remuneration, reporting or disclosures. However, it is still not clear on what will be the obligations of the Firms falling under both frameworks (AIFMD / UCITS and MIFID).
The goal of this new piece of regulation is to consider specific risks incurred by MIFID Investment Firms like trading activity, large exposure, liquidity, leverage and provide a “level playing field” in terms of prudential framework to the industry. The main prudential requirements that will apply to them are of the same kind as for Credit Institutions under CRR and CRD and include capital requirements, remuneration rules, reporting and disclosure obligations. That said, the legislator has confirmed his objective to take into account the proportionality so that those requirements apply differently on the institutions depending on the category into which IFR is classifying them.
However, it is obvious that IFR / IFD will have a significant impact on several prudential aspects of most of the concerned Investment Firms. At least, it will certainly lead to an increase of capital requirement, new remuneration policies and new reporting and disclosure obligations.
Even if we are still missing some important details that will be provided by the EBA over the coming months, we would then advise all MIFID Investment Firms to proactively anticipate the possible impact on their institutions in order to be set at the time of the deadline that will come quickly.
The Legislative Framework (IFR and IFD) has been adopted on October 2019 and published in the official Journal of the EU on 5 December 2019. The Directive will still need to be adopted by each member state, but the Regulation (IFR) comes into effect immediately. Although most of the provision applies as of June 2021.
In order to move forward, the EBA, which has been mandated as well as ESMA by the European Commission, launched a consultation paper for the including draft Regulatory Technical Standards and Implementing Technical Standard (RTS and ITS known as level 2 regulation, meant to provide guidance on technical issues linked to IFR / IFD).
On 4 June EBA has delivered a roadmap for the implementation of the new regime and launched the consultation (with deadline as of 4 September), on the following 6 regulatory issues:
Supervisory convergence and the supervisory review process: IFR and IFD include the SREP (Supervisory Review and Evaluation Process) that is meant to build a “single rule book” for IFs.
ESG Factors and ESG risks: EBA objective is to deliver guidance on common definitions, risk management tools, prudential treatment, and disclosures. This will be done in conjunction with CRR / CRD work on the same issue, and the timeline will be aligned.
In terms of Timeline EBA plans to implement the different aspects of the regulation framework in 4 phases:
Phase 1 Dec 2020
Thresholds definition /
criteria for IFs subject to CRR / Capital requirements / Disclosures / remuneration 1
Phase 2 Jun 2021
Liquidity requirements / internal governance / remuneration 2 / SREP 1
Phase 3 Dec 2021
Remuneration completed / ESG Factors and risks 1
Phase 4 2022 to 2025
SREP final / ESG Factors and risk final
IFs considered as SNIFs (Small and Non-Interconnected Investment Firms) will be subject to only a partial application of IFR / IFD.
Considering that all the conditions described below should qualify an IF as a SNIF it is to be anticipated that a majority of IFs won’t be eligible to such a regime:
You will find a definition of each of these notions in Article 4 of the IFR that includes all definitions. Please also see below in K-factor section.
IFs considered as Credit institutions
IFR provides that certain IFs (systematic Investment Firms or Investment Firms being exposed to the same type of risks than Credit Institutions) should be treated as Credit Institutions and though subject to full CRD / CRR regulation.
IFs that do not belong to any of the 2 categories above
All other IFs will be subject to Full IFR / IFD regulation. This means to us that most of MIFID Investment firms will fall into this category due to the fact that they might not meet all SNIF criteria or because they belong to a group to which the need to consolidate their figures.
Among the other requirements that will apply to IFs (new Governance structure, new remuneration policy, new reporting, new disclosures) the one on capital requirements is certainly the most stressful for business players.
Subject to precisions brought from the consultation with the industry, the principle provided in the IFR is as follow:
Own funds will have to be at all times at least equal to the highest of:
The K-Factor shall represent at least the sum of 3 main risk components that are Risk to Client (RtC), Risk to Market (RtM) and risk to Firms (RtF). That is to say that each of these components is the addition of specific K-factors (please see below table and bullet point) that are then summed to provide the final K-factor requirement.
Here are the K-factors that entail a coefficient by which the underlying amount should be multiplied for their computation (Article 15 (2) IFR). The others have different calculation methodologies referred below:
Assets under management under both discretionary portfolio management and nondiscretionary advisory arrangements of an ongoing nature
Client monetary held
K-CMH (on segregated accounts)
K-CMH (on non-segregated accounts)
Assets safeguarded and administered
Client orders handled
K-COH cash trades
RtC = K-AUM + K-CMH + K-ASA + K-COH RtM is either equal to K-NPR (Net Position Risk) or K-CMG (Clearing Margin Given).
Where K-NPR calculation shall be computed according to 3 possible methods (Article 22 of IFR) retrieving the exposition of the IF,
and K-CMG is linked to margin paid by the IF in its collateral management activity.
RtF = K-TCD + K-DTF + K-CON
Where K-CON (Concentration risk) is linked to exposures which exceed certain IFR thresholds (please Article 39 of IFR),
And K-TCD (Trading Counterparty default) is calculated as follow (Article 26 of IFR):
For the purpose of calculating K-TCD, the own funds requirement shall be determined by the following formula:
Own funds requirement: α ⋅ EV ⋅RF ⋅CVA
α = 1,2
EV= the exposure value calculated in accordance with Article 27
RF = the risk factor defined per counterparty type as set out in Green Table.
CVA = the credit valuation adjustment calculated in accordance with Article 32.
Central governments, central banks and public sector entities
Credit institutions and investment firms
IFR and IFD have clearly been drafted in order to fil a gap in terms of prudential and governance regulation framework. The former situation presented some kinds of loophole between Credit Institutions that are subject to CRR / CRD IV, Investment funds that are subject to AIFM and UCITS (these regulations also provide a framework in terms of governance, risk management, remuneration, reporting and disclosure), and MIFID Investment Firms that were subject to none of them until now.
The fact that EBA and ESMA want to leverage on the existing regulations shows the objective to build a common “level playing field” for all actors of the financial industry in Europe, while considering the specificities of each category in terms of size and business model.
The gap is now filled completely! The question I am sure all actors have in mind is how far EBA and ESMA are ready to go to consider the “implementation burden” for institutions! We might have a beginning of answer on the 4 September 2020.