By Murray Campbell, CASS Business Consultant, AutoRek.
The Investment Firm Prudential Regime (IFPR) comes into effect in the UK on January 1, 2022, and will overhaul the prudential regulations that are currently applicable to MiFID investment firms. This will bring significant changes to the way investment firms assess their capital adequacy and monitor associated risks.
The IFPR will serve as the UK’s version of the EU’s prudential regime, the Investment Firm Regulation and Directive (IFR/IFD), signalling the UK’s new regulatory regime post-Brexit. It will greatly simplify the UK’s current prudential regulation for FCA-regulated firms and will be applicable to all prudential categories for MiFID investment firms such as Exempt CAD, BIPRU, and various IFPRU categories. For such firms, it will replace the Capital Requirements Directive (CRD) and the Capital Requirements Regulation (CRR).
New minimum capital calculations
As represented by the Own Funds Requirement, investment firms will now face several changes to the minimum amount of capital they need to hold. There are three key elements, including the Fixed Overheads requirement (FOR), the Permanent Minimum Requirement (PMR) and the new K-factor Requirement (KFR). The Own Funds Requirement will be equal to the highest of the three. In order to meet these new regulations, firms will have to ensure sufficient capital resources are available as firms could potentially see significant increases in their capital requirement – ranging from 300% to 2,300%.
An investment firm’s Fixed Overheads Requirement must be calculated as a quarter of their fixed overheads for the preceding year’s audited accounts.
Specifically geared towards the risks faced by investment firms, the clients they serve and the wider market, the K-factor Requirement is a new requirement for firms to calculate and is based on the activities of the firm. Relevant business activities include client assets safeguarded and administered, client money held, assets under management and client orders handled. The FCA has tailored the IFPR to meet the specific nature of a firm’s business – the larger and more complex a firm is, the more K-factors will be applied. If a firm is smaller in size, they are likely to have fewer K-factors to calculate and report on.
Once calculated, the FOR and KFR must be compared against a firm’s PMR to understand where their Own Funds Requirement is set. These three requirements ensure investment firms maintain a minimum amount of capital to facilitate the early stages of a wind-down process, if it becomes necessary.
In addition to the Own Funds Requirement, the IFPR introduces a requirement for investment firms to hold liquid assets that are at least equal to a third of its Fixed Overheads Requirement, plus 1.6% of the total amount any guarantees provided to clients. This ensures that a firm has immediate access to resources in the event of wind-down.
As the core element of the IFPR is to ensure firms are always holding sufficient capital and reporting it accurately, a large portion of the work required for the IFPR will be spent on determining the correct capital firms need to hold, as well as calculating and monitoring this capital on a monthly basis.
Firms that qualify under the IFPR will need to perform several calculations on all elements of it. These calculations are likely to involve extensive amounts of data, which will take significant human resource to analyse and calculate. Excel has traditionally been a common way to perform such calculations, but it faces inherent challenges when tasked with handling large data volumes and complex calculation steps.
Firms should look to automate these calculations with a bespoke solutions to reduce the time and reliance on internal resources. An automated solution will work in conjunction with a firm’s source data, perform the necessary calculations and then present the output in the format required by the FCA. Automation further removes the burden of manual processing, ensuring the numbers reported are both accurate and in the correct format. Firms can also benefit from additional control around workflow and approval by automating IFPR calculations, which will demonstrate an ongoing oversight of the underlying data and regulatory returns.
Avoiding FCA sanctions
Calculating these figures is not only a complex and time-consuming, but presents a challenge to these firms as the calculations need to be performed on a monthly basis and submitted to the FCA each quarter. Firms that fail to report or report inaccurately will risk sanctions from the FCA, which can in turn lead to fines and the removal of permissions to operate as a firm.
The FCA is also introducing threshold reporting requirements where a firm must provide notice should their own funds fall to prescribed levels in addition to quarterly reporting. For example, if a firm’s own resources fall to 110% of their Own Funds Threshold Requirement, a notification must be sent to FCA. This is to ensure the FCA is fully aware of any firm who may be likely to face prudential harm. Hence, reporting accurately and on time is of crucial importance under the new regime.
While a single streamlined Prudential Regime will identify key risks to clients and markets when firms are assessing their prudential requirements, it will also place a large burden on firms to ensure they are calculating and reporting accurately on their capital and liquidity. With three weeks to go to IFPR, investment firms need to not only know their capital and liquidity requirements, but also to have their reporting frameworks in place.