New Prudential Framework for Investment Firms (IFR/IFD)
On 26th of June 2021 the Investment Firm Regulation ("IFR") and the Investment Firm Directive ("IFD") came into force. The new framework is focused on Investment Firms, contrary to the European Directive 2013/36/EU (the "CRD IV"), which IFR/IFD replaced, that was initially designed for credit institutions.
The new framework introduces a classification for the Investment Firms (Class 1A, Class 1B, Class 2 and Class 3) and sets new initial capital requirements as these are shown in Section D of CySEC’s practical guide and are summarised in the table. The Composition of the Initial Capital and Own funds is set according to percentages of Article 9 of the IFR with regards to CET 1, Additional Tier 1 and Tier 2 Capital.
IFR further lays down, depending on their classification, uniform prudential requirements which apply to investment firms in relation to the following:
(a) Own funds requirements relating to quantifiable, uniform and standardised elements of risk‐to‐firm, risk‐to‐client and risk‐to‐market;
According to the new framework Class 1 Investment Firms are still subject to CRR/CRD IV. Class 2 and Class 3 Investment Firms on the other hand, are subject to the IFR/IFD and should maintain own funds of at least the higher between:
i. Their fixed overheads requirement
ii. Their initial capital requirement
iii. Their K-Factor requirement
K-factors are quantitative indicators that reflect the risk that the new prudential regime intends to address. They are divided into three groups and they aim to capture the risk the investment firm can pose to customers (‘RtC’), to market access (‘RtM’) or the investment firm itself (‘RtF’). The K-factor requirement is the sum of (‘RtC’), (‘RtM’) and (‘RtF’).
For Class 3 Firms, only (i) and (ii) of the above are considered excluding K-Factors.
(b) Requirements limiting concentration risk;
Class 2 and Class 3 Investment Firms (subject to exemptions) are required to monitor and control their concentration risk in order to not exceed certain limits according to Article 37 of IFR.
(c) Liquidity requirements relating to quantifiable, uniform and standardised elements of liquidity risk;
Class 2 and Class 3 Investment Firms (subject to exemptions) are required to hold liquid assets amounting to at least one third (1/3) of their Fixed overhead requirement.
(d) Reporting requirements related to points (a), (b) and (c);
Both Class 2 and Class 3 Investment Firms are subject to the same reporting requirements as listed below, however the requirement for Class 2 Firms is on a quarterly basis whilst Class 3 Firms are required to report annually.
i. Level and composition of own funds
ii. Own funds requirements
iii. Own funds requirement calculations
iv. The level of activity, in respect of the conditions of Article 12(1) of the IFR, including the balance sheet and revenue breakdown by investment service and applicable K-Factor
v. Concentration risk
vi. Liquidity requirements
(e) Public disclosure requirements
A number of disclosure requirements derive from IFR/IFD, all of them applicable for Class 2 Investment Firms and to an extent to Class 3 Firms. Specifically, public disclosures are required in respect of:
i. Risk management objectives and policies
ii. Internal governance arrangements
iii. Own funds requirements
iv. Remuneration policy and practices
v. Investment policy
vi. Environmental, social and governance risk
Other supervisory requirements
Class 2 Investment Firms are required to have in place an internal capital adequacy assessment process (ICAAP) whilst the competent authorities may also request Class 3 Investment Firms to comply with the ICAAP requirement to the extent they deem it to be appropriate.
Class 2 Investment Firms will also have to establish internal governance processes on treatment of risks, country-by-country reporting and specific remuneration rules which are largely based on the framework set out in CRR/CRD IV.
Class 3 Investment Firms will also have to establish internal governance processes on treatment of risks.
Investment Firm groups should examine the criteria set in Article 46 of IFD to determine whether they fall under consolidated supervision. The prudential consolidation requirements are stated in Article 7 of IFR.
If you have any questions, do not hesitate to contact us.
Written by Constantinos Constantinides, Director of FAI Comply